TNAG-1270-FCO40-1620-Financial-policy-in-Hong-Kong-1983 — Page 161

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10. THE CUSTOMER WITHDRAWS HIS HKD DEPOS:NT FROM HIS BANK IN CASH,

BECAUSE HE KNOWS THAT THE NEXT BANK DOWN THE STREET WILL TAKE

THE NOTES OFF HIM AT DOLLARS 7.10 4 ORDER TO REDEEM THEM AT THE

EXCHANGE FUND AT DOLLARS 7, MAKING A NICE TURN. MEANWHILE THE

FIRST BANK HAS HAD TO BUY CASH FROM THE EF AT DOLLARS 7 IN ORDER TO

MEET THE CUSTOMER'S WHTHDRAWAL. CLEARLY THE FIRST BANK WOULD HAVE

DEEN BETTER ADVISED TO QUOTE THE CUSTOMER A RATE OF DOLLARS 7.10 IN

THE FIRST PLACE.

11. THUS THE MARKET RATE TENDS TOWARDS THE CIN RATE. IN PRACTICE

HT WILL NOT BE NECESSARY FOR CUSTOMERS TO CART LOADS OF BANKNOTES

AROUND TOWN KAY ORDER FOR THE ARBUTRAGE PROCESS TO WORK. THE

SHMPLE FACTS (1) THAT BANKS GUARNATEE THE CONVERTIBILHTY OF

DEPOSITS INTO CASH, AND (2) THAT THE EXCHANGE FUND GUARANTEES

CONVERTIBILITY (LIMITED *N DIRECT ACCESS TO NOTE-ISSUING BANKS,

BUT PRESUMED TO BE EASHLY ACCESSIBLE FOR THE WHOLE BANKING SYSTEM)

OF CASH TO FOREIGN CURRENCY, SHOULD BE SUFFICIENT TO MAKE THE

PROCESS WORK.

12. FINATIPALLY WHEN THE SCHEME AS UNAUGURATED, ARBITRAGE MAY NOT

BE PERFECT, SINCE THERE WILL BE A LEARNING PROCESS AND HENCE

CAUTION, AND POSSIBLY SOME RINGEDERTIES ON ACCOUNT OF LARGE

DEALS COMING TO MARKET. EVEN SO, THE MARKET RATE WOULD TEND

TOWARDS RATHER THAN AWAY FROM THE CH RATE.

WHERE'S THE CATCH?

13. SO FAR, MT ALL SOUNDS TOO GOOD TO BE TRUE. WHERE'S THE CATCH?

WHERE DO THE COSTS OF ACHIEWANG STABILITY FALL?

14. UNDER THIUS SCHEME, UNLIKE UNDER PRESENT ARRANGEMENTS, AN

INCREASE IN THE DEMAND FOR FOREIGN CURRENCY WOULD TEND AUTO-

MATICALLY TO PUT A CONTRACTIONARY PRESSURE ON THE MONEY SUPPLY.

THIE WOULD ON TURN, IN THE SHORT-TERM, TEND TO MEAN HIGHER

INTEREST RATES AND SOME DEPRESSANT EFFECT ON ECONOMIC ACT-INNITY

UNTHE LOWER COST/PRICE LEVELS WERE ESTABLISHED. IF THE SCHEME

SUCCEEDED RESTORING CONFIDENCE IN THE EXCHANGE RATE, THE

PRESSURE OF DEMAND FOR FOREIGN CURRENCY WOULD SUBSIDE AND ANY MONETARY CONTRACTION WOULD BE ALLEWIATED. HT IS, OF COURSE, MPOSSIBLE TO PREDICT THE IMPACT, BUT WIRTUALLY ANYTHING WOULD BE TOLERABLE FOR A SHORT WHILE IN THE INTERESTS OF STABILISING

THE EXCHANGE RATE.

DECISIONS AND ACTHON.

15. IF THE SCHEME S TO BE IMPLEMENTED, THE CHIEF DECISION TO BE TAKEN CONCERNS THE CN RATE. DEALLY ONE MIGHT WISH TO RE-ESTABLIKSH HMMEDIATELY A RATE CALCULATED TO BE APPROPRIATE, SOLELY BY REFERENCE TO ECONOMIC FUNDAMENTALS. THIS WOULD PERHAPS SE IN THE RANGE 6,50 TO 7.00. HOWEVER, IS ONE FAILED TO WIN 100 PERCENT CONFIDENCE IN THE DURABILITY OF THAT RATE, THE PRESSURES OF MONETARY CONTRACTION MIGHT BE UNDULY SEVERE. A RATE OF 7.50 MIGHT

BE MORE CREDIBLE, OP PERHAPS 7.25 ON THE GROUNDS THAT THIS WAS

THE LAST RESTING POINT ON THE PECENT DOWN TREND.

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