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no central bank in Hong Kong; and currency notes which, in Hong Kong, are circulated by the commercial banking
system, are required by legislation to be fully backed. In
practice, they are fully-backed by sterling which has
been surrendered to an Exchange Fund by the banks against the issue of their own currency notes and the Fund has
accumulated a substantial surplus from interest earnings
over the years. This sterling is derived in large measure
from Hong Kong's export earnings: as exports increase,
banks' foreign exchange assets will also tend to increase
and so will deposits with the banks and currency in
circulation. The converse applies equally. It follows
that, under these institutional arrangements, the money supply (comprising both bank deposits and notes in
circulation) is largely determined by the balance of trade (visibles and invisibles taken together) as influenced from
time to time by capital movements. Any increase in the
rate of growth of aggregate demand arising from an
increased rate of growth of exports will tend to be
accompanied by an increase in the rate of growth of the money
supply and bank credit which will facilitate an increased
rate of growth of imports and consumption and push up
the internal cost/price structure. But, as the rate
of growth of imports increases, the rate of growth of banks'
foreign exchange assets and, with it, the rate of growth
of bank deposits, currency in circulation and bank credit
will decline, and this helps ensure that the economy deflates
so as to eliminate any excess demand all the more
quickly.
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