(c) Banks are allowed to trade between the two foreign
•
exchange markets, which means that the free market rates cannot depart significantly from $HK7.80 For example a rise in the free market rate above HK$7.80 per US dollar would induce banks to surrender US
dollars to the Exchange Fund for HK dollars which could be resold to
the non-bank
public for a profit. The actions of the banks would
be reversed if there is a fall in the free market rate below HK$7.80
per US dollar.
3.
The linked exchange rate to the US dollar also disciplines the level of local interest rates which, in general, will remain close to
US interest rates. If however there were a loss of confidence in the
linked rate, Hong Kong interest rates would rise above US interest rates until the interest rate gap is sufficiently high to compensate for the perceived extra risk attached to holding Hong Kong dollars
rather than US dollars. Similarily local interest rates cannot fall
far below US interest rates unless there is an expectation of appreciation against the US dollar ie the prospect of a future capital gain is sufficient to encourage people to hold Hong Kong dollars even though interest rates payable are lower than on US
dollars.
4.
The linked exchange rate system in effect does not allow the Hong Kong Government discretion to carry out an independent monetary policy; money issue and local interest rates are determined by market forces in combination with the linked exchange rate. However the Exchange Fund has sought to develop new methods of monetary management to intervene in foreign exchange and money markets with the objective of sustaining stable and orderly markets. Accounting arrangements were entered into in mid-July 1988 between the Exchange Fund and the Hong Kong and Shanghai Banking Corporation (HSBC) as the Management Bank of the Clearing House of the Hong Kong Association of Banks.