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fficulty is the absence of any Government debt or borrowing requirement, to provide
a lever on the banking system. In addition, in a very open and financially sophisticate
economy like Hong Kong's the authorities could be expected to face problems in inter-
preting the meaning of amovements in different monetary aggregates of the kind that we
ourselves have had to cope with in recent years.
9. Control of the money supply and control of the exchange rate could in principle
be linked, as they often are for relatively simple economies, by using the official foreign exchange reserves as the backing for the note issue. This was indeed roughly the system in force in Hong Kong up to 1972, at a time when its financial system was a good deal less developed than now, and when exchange controls were in force. For a highly developed economy, like Hong Kong today, there seems no necessary reason to
establish a mechanical link of this kind between monetary and exchange rate policy,
any more than we do in the UK. But the Hong Kong authorities are now considering an early move back in this direction under which Certificates of Indebtedness (issued by the Hong Kong Government Exchange Fund to back the balance of the notes issue by the Hong Kong and Shanghai and Chartered Banks) would be "demoninated" in US $. So far as we can see, this will in essence mean that issues of new HK bank notes
will in future only be made against US deposits made by note-issuing banks with the official reserves. This may provide a way of boosting the official reserves (in effect a redistribution of Hong Kong's external reserves), so long as the banks do not themselves/or can be prevented from selling) HK $s in the market to acquire
US $s to deposit with the reserves. It could therefore have some value.
sell
General Implications
10. Politics apart the Hong Kong economy is basically healthy. It is feeling the effects of recovery in the USA. Exports grew by 9% in real terms for the first half of 1983 compared with the same period in 1982, and re-exports by 4%. The Government's miu term statement on the economy on 16 September anticipated real GDP growth of 6% in 1983, compared with 4% forecast in February and a 2.4% outcome in 1982. Neither
these nor other encouraging signs that the local real economy is emerging from
recession have, however, been sufficient to dispel the effects on the exchange rate
of the political uncertainty about Hong Kong's future. As indicated above, this has
been accelerated in the past two weeks by intensified Chinese propaganda indicating
their intention to recover both sovereignty and administration over the territory
and attacking the attitude of the British Government.
11. The broad effects of the decline in the exchange rate have been:
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