TNAG-1270-FCO40-1620-Financial-policy-in-Hong-Kong-1983 — Page 183

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10. THE CUSTOMER WITHDRAWS HS HKD DEPOSIT FROM HIS BANK IN CASH,

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

THE NOTES OFF HUM AT DOLLARS 7.10 IN 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 WITHDRAWAL. CLEARLY THE FIRST BANK WOULD HAVE

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

THE FIRST PLACE.

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

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

AROUND TOWN IN ORDER FOR THE ARBITRAGE PROCESS TO WORK. THE

SIMPLE FACTS (1) THAT BANKS GUARNATEE THE CONVERTIBILITY OF

DEPOSITS INTO CASH, AND (2) THAT THE EXCHANGE FUND GUARANTEES CONVERT-BILITY (LIMITED IN DIRECT ACCESS TO NOTE-HSSUMING 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. INITIALLY WHEN THE SCHEME S NAUGURATED, ARBITRAGE MAY NOT

BE PERFECT, SHANCE THERE WILL BE A LEARNING PROCESS AND HENCE CAUTION, AND POSSIBLY SOME RUGDTHES ON ACCOUNT OF LARGE DEALS COMING TO MARKET. EVEN SO, THE MARKET RATE WOULD TEND

TOWARDS RATHER THAN AWAY FROM THE Chu RATE.

WHERE'S THE CATCH?

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

WHERE DO THE COSTS OF ACHIEVING 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.

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

INTEREST RATES AND SOME DEPRESSANT EFFECT ON ECONOMIC ACTIVITY

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

SUCCEEDED IN RESTORING CONFIDENCE 4N THE EXCHANGE RATE, THE

PRESSURE OF DEMAND FOR FOREIGN CURRENCY WOULD SUBSIDE AND

ANY MONETARY CONTRACTION WOULD BE ALLEVIATED. HT IS, OF COURSE, IMPOSSIBLE TO PREDICT THE IMPACT, BUT VIRTUALLY ANYTHING WOULD BE TOLERABLE FOR A SHORT WHILE IN THE INTERESTS OF STABILIS»ING

THE EXCHANGE RATE.

DECINSHIONS AND ACTION.

15. IF THE SCHEME IS TO BE IMPLEMENTED, THE CHIEF DECISION TO BE TAKEN CONCERNS THE CH RATE. DEALLY ONE MIGHT WISH TO RE-ESTABLISH

IMMEDIATELY A RATE CALCULATED TO BE APPROPRIATE, SOLELY BY

REFERENCE TO ECONOMIC FUNDAMENTALS. THIS WOULD PERHAPS BE IN THE

RANGE 6.50 TO 7.00. HOWEVER, IF 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, OR PERHAPS 7.25 ON THE GROUNDS THAT THIS WAS

THE LAST RESTING POINT ON THE RECENT DOWN TREND.

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