TNAG-1270-FCO40-1620-Financial-policy-in-Hong-Kong-1983 — Page 125

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to the proposals made by Greenwood, who has been quite active in helping officials to work it up.

5. The essential elements are:-

Ell

(a)

The official Exchange Fund (EF) guarantees the US 8 (or other foreign currency) value of K notes - through

the mechanism of issuing so called certificates of indebtedness to note-issuing banks. The foreign currency in the EF DOW around US $5 billion comfortably exceeds the present

HK $14 billion note issue. If extra notes are issued this

will only be against the deposit of equivalent foreign currency with the EF. This means, in effect, that HK % notes will be convertible into foreign currency at an exchange rate stated by the authorities; and the HK Government's liability is confined to the size of the existing note issue.

(0) Opportunities for arbitrage mean the market exchange rate will never move far from this "official" exchange rate.

(c) If there are pressures therefore they will fall not on the exchange rate or on the Exchange Fund, but on banks. We assumed, and this assumption was shared by all who we spoke to, that banks at all costs would want to maintain converti- bility between HK S bank deposits held with them and bank notes. In a society like Hong Kong's, where queues to withdraw cash are not uncommon et times of uncertainty, no bank could risk the blow to public confidence in it that a refusal to permit cash withdrawals could bring about.

(a) Banks would then have a choice. HK banks (or rather the banking system as a whole) could either switch foreign currency into Hong Kong dollars, so as to acquire extra HKS notes to meet any extra demand (or banks could permit customers to switch from HK & deposits to US $ deposits without themselves seeking to make a corresponding switch in the currency of their assets). Or they could bid K $ interest rates up to the point where customers no longer wished to move into notes or foreign currency.