TNAG-0379-FCO40-425-Sterling-assets-and-balance-of-payments-of-Hong-Kong-1973 — Page 258

system which could subsume sterling's role as a reserve currency.

3. Any guarantee arrangements (present and future) between the Hong Kong Government and the banks are essentially devices to eliminate or reduce the risks attaching to bank holdings of foreign exchange assets against liabilities in Hong Kong dollars. The only alternative method of eliminating such risks would be to provide banks with the opportunity to reduce their foreign exchange holdings to levels sufficient only for their normal requirements: the exchange risk on such reduced holdings could be covered in the normal way. And the only way in which banks could substantially reduce their foreign exchange holdings would be by selling the amounts in excess of their day to day requirements for obligations expressed in local currency. The banks' Hong Kong dollar liabilities would then be matched by assets in the same currency and their foreign exchange 'books' would be similarly balanced. The banks would then be in the same position as their counterparts in other sophisticated economies. The Government as in all advanced countries would take into the colony's official reserves the foreign exchange holdings and later accruals surplus to the banks' legitimate requirements. This is the essence of the case for the issue of Government paper to the banks in exchange for sterling. In view of the way in which the situation is likely to develop it would be wise to initiate the process without too much delay in order that there may be an orderly and gradual transition to what would be a more normal and rational arrangement in the interests of the banks and of the Government. The latter would then find itself in a more satisfactory position vis-a-vis the private sector, having resolved what is fundamentally an institutional problem which would be bound to give rise to difficulties whenever a change in currency relationships occur.

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4. It follows from what is said above that the object of issuing Government paper would be to give the banks an opportunity to dispose of their excess external assets if they wanted to, and in the probable future set of circumstances outlined it is likely that any prudent banker would take advantage of the facility. There need be no question of compulsion. It is recognised, of course, that exchange risks are not eliminated by a transfer of foreign exchange holdings

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