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10. THE CUSTOMER WITHDRAWS HS HKD DEPOSIT FROM HIS BANK IN CASH,
BECAUSE HE KNOWS THAT THE NEXT BANK DOWN THE STREET WILL TAKE
THE NOTES OFF HUM AT DOLLARS 7.10 IN ORDER TO REDEEM THEM AT THE
EXCHANGE FUND AT DOLLARS 7, MAKING A NICE TURN. MEANWHILE THE
FIRST BANK HAS HAD TO BUY CASH FROM THE EF AT DOLLARS 7 IN ORDER TO
MEET THE CUSTOMER'S WITHDRAWAL. CLEARLY THE FIRST BANK WOULD HAVE
BEEN BETTER ADVISED TO QUOTE THE CUSTOMER A RATE OF DOLLARS 7.10 IN
THE FIRST PLACE.
11. THUS THE MARKET RATE TENDS TOWARDS THE CN RATE. IN PRACTICE
HT WILL NOT BE NECESSARY FOR CUSTOMERS TO CART LOADS OF BANKNOTES
AROUND TOWN IN ORDER FOR THE ARBITRAGE PROCESS TO WORK. THE
SIMPLE FACTS (1) THAT BANKS GUARNATEE THE CONVERTIBILITY OF
DEPOSITS INTO CASH, AND (2) THAT THE EXCHANGE FUND GUARANTEES CONVERT-BILITY (LIMITED IN DIRECT ACCESS TO NOTE-HSSUMING BANKS,
BUT PRESUMED TO BE EASHLY ACCESSIBLE FOR THE WHOLE BANKING SYSTEM)
OF CASH TO FOREIGN CURRENCY, SHOULD BE SUFFICIENT TO MAKE THE
PROCESS WORK.
12. INITIALLY WHEN THE SCHEME S NAUGURATED, ARBITRAGE MAY NOT
BE PERFECT, SHANCE THERE WILL BE A LEARNING PROCESS AND HENCE CAUTION, AND POSSIBLY SOME RUGDTHES ON ACCOUNT OF LARGE DEALS COMING TO MARKET. EVEN SO, THE MARKET RATE WOULD TEND
TOWARDS RATHER THAN AWAY FROM THE Chu RATE.
WHERE'S THE CATCH?
13. SO FAR, IT ALL SOUNDS TOO GOOD TO BE TRUE. WHERE'S THE CATCH?
WHERE DO THE COSTS OF ACHIEVING STABILITY FALL?
14. UNDER THIUS SCHEME, UNLIKE UNDER PRESENT ARRANGEMENTS, AN
INCREASE IN THE DEMAND FOR FOREIGN CURRENCY WOULD TEND AUTO-
MATICALLY TO PUT A CONTRACTIONARY PRESSURE ON THE MONEY SUPPLY.
THIS WOULD IN TURN, IN THE SHORT-TERM, TEND TO MEAN HIGHER
INTEREST RATES AND SOME DEPRESSANT EFFECT ON ECONOMIC ACTIVITY
UNTHIL LOWER COST/PRICE LEVELS WERE ESTABLISHED. IF THE SCHEME
SUCCEEDED IN RESTORING CONFIDENCE 4N THE EXCHANGE RATE, THE
PRESSURE OF DEMAND FOR FOREIGN CURRENCY WOULD SUBSIDE AND
ANY MONETARY CONTRACTION WOULD BE ALLEVIATED. HT IS, OF COURSE, IMPOSSIBLE TO PREDICT THE IMPACT, BUT VIRTUALLY ANYTHING WOULD BE TOLERABLE FOR A SHORT WHILE IN THE INTERESTS OF STABILIS»ING
THE EXCHANGE RATE.
DECINSHIONS AND ACTION.
15. IF THE SCHEME IS TO BE IMPLEMENTED, THE CHIEF DECISION TO BE TAKEN CONCERNS THE CH RATE. DEALLY ONE MIGHT WISH TO RE-ESTABLISH
IMMEDIATELY A RATE CALCULATED TO BE APPROPRIATE, SOLELY BY
REFERENCE TO ECONOMIC FUNDAMENTALS. THIS WOULD PERHAPS BE IN THE
RANGE 6.50 TO 7.00. HOWEVER, IF ONE FAILED TO WIN 100 PERCENT CONFIDENCE IN THE DURABILITY OF THAT RATE, THE PRESSURES OF
MONETARY CONTRACTION MIGHT BE UNDULY SEVERE. A RATE OF 7.50 MIGHT
BE MORE CREDIBLE, OR PERHAPS 7.25 ON THE GROUNDS THAT THIS WAS
THE LAST RESTING POINT ON THE RECENT DOWN TREND.
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