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Speculations About the Speculation Against the Hong Kong Dollar
David T. Beers. Thomas J. Sargent, and Neil Wallace*
In this paper, we attempt to explain the Hong Kong dollar's recent substantial depreciation, or its loss in value in terms of foreign exchange. This task is a challenge. mainly because of the unusual monetary policy recently espoused by the government of Hong Kong. From 1974 until October 1983, the officially professed policy al- lowed both the quantity and the exchange value of Hong Kong currency to be determined by market forces (or to float). The subject is also interesting because current events in Hong Kong are so much affected by expecta- tions, expectations about what will happen after 1997, the year that Britain's lease on most of the colony's territory expires.
The recent depreciation was indeed substantial. Be- tween mid-1980 and October 1983, when the govern- ment announced a new policy, the U.S. dollar value of the Hong Kong dollar fell about 33 percent. During that period, there also occurred substantial declines (even in terms of local currency) in the value of assets located in Hong Kong Hong Kong real estate and common stock in Hong Kong companies. All of these declines coincided with a generally unfavorable reassessment of the pros- pects for maintaining the political status quo beyond 1997.
The unfavorable reassessment easily accounts for a decline in real estate and stock market values. Prospec- tive events after 1997 can reasonably be expected to reduce the stream of returns flowing to the owners of real estate and shares in Hong Kong so that their value now would fall. The fall in the Hong Kong dollar has also been widely attributed to unfavorable speculation about 1997. apparently on the basis of a vague notion that the Hong Kong dollar is somenow a claim against the wealth of the current residents of Hong Kong Closer scrutiny show: that movements in the value of the Hong Kong goliar are
not directly linked with speculation about 1997. This is because the events of 1997 do not adversely affect interest-bearing foreign assets held as backing for the currency by the Hong Kong government. Thus, distinct lines of reasoning seem to be needed to account for the fall! of Hong Kong real estate and stock prices, on the one hand, and the fall of the foreign exchange value of the Hong Kong dollar, on the other.
We explain the depreciation of the Hong Kong dollar as the result of a chain of influences involving the Hong Kong government and speculation about the events of 1997. The existence of this chain of influences is supported by indirect evidence that the Hong Kong government actually departed from its pre-October 1983 official float policy. In particular. we interpret the depre- ciation of the Hong Kong doliar as having been welcomed and supported by the government in order to help private financial intermediaries in Hong Kong face the substan- tial declines in the real value of Hong Kong real estate and other real assets.
Our case for this interpretation rests heavily on how we think the Hong Kong monetary system would have functioned if the government had actually adhered to its float policy. We argue that under that policy market fundamentals alone could not have determined an equi- librium exchange rate for the Hong Kong dollar and, in particular. did not propel that rate downward. Our circumstantial evidence supporting the case that the government departed from its official policy in order to promote the depreciation of the Hong Kong dollar is
*Sergent ant Wallace are advisen to th. Rescarer Deparment of the Federal Reserve Bank of Minneapons and professors o' economie a UK Liniversity of Minnesota Beers is ar assistant vice president of Banken Trus Company who maependent collaborates with Sargen, and Wallaut oF LE-
pax
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