TNAG-1270-FCO40-1620-Financial-policy-in-Hong-Kong-1983 — Page 72

PROPOSAL

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5. THE CENTRAL ELEMENT IN THE SCHERE WHICH IS NOW PROPOSED IS

THAT THE CERTIFICATES OF INDEBTEDNESS, WHICH ARE ISSUED BY THE EXCHANGE FUND TO THE NOTE-ISSUING BANKS TO BE HELD AS COVER

FOR THEIR NOTE ISSUES, SHOULD HERCEFORTH BE ISSUED AND REDEEMED

AGAINST FOREIGN CURRENCY (U.S. DOLLARS) AT A FIXED RATE. AT PRESENT

THEY ARE ISSUED AGAINST HONG KONG DOLLARS, WHICH NORMALLY SUBJECT

TO TIMING WERE USED TO PURCHASE FOREIGN EXCHANGE.

6. THUS PROPOSAL 4S NEITHER NOVEL NOR UNTRED. THERE ARE

PRECEDENTS HERE AND FURTHER AFIELD. FOR INSTANCE, AN ANALOGOUS ARRANGEMENT EXISTED IN HONG KONG FROM 1935 TO 1972, WHEREBY

CERTIFICATES OF INDEBTEDNESS WERE SUED AND REDEEMED AGAINST

STERLING, BUT OF COURSE THE ENVIRONMENT IN WHICH THE SYSTEM

THEN OPERATED - STERLING AREA AND ASSOCIATED EXCHANGE CONTROLS,

A PREDOMINANCE OF FIXED EXCHANGE RATES AROUND THE WORLD, AND NO POLITICAL OVERHANG HN HONG KONG WAS VERY DIFFERENT.

HOW THE SCHEME WOULD WORK

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7. ALTHOUGH THE PRICE OF CERTIFICATES OF INDEBTEDNESS AGAINST

U.S. DOLLARS WOULD BE. THE ONLY FORMAL, ANNOUNCED, FIXED RATE,

THE PROCESSES OF COMPET:UTHON AND ARBITRAGE WITHIN THE MONETARY

SYSTEM SHOULD BRING THE MARKET EXCHANGE RATE TO WITHIN A SMALL

RANGE OF THE ANNOUNCED RATE. THE SCHEME MAINTAINS BY ARBITRAGE THE

EXCHANGE RATE FIXED IN THE FIRST #STANCE. SINCE A BANK, OR THROUGH

A BANK A BANK CUSTOMER, CAN ALWAYS OBTAIN FOREIGN CURRENCY (SAY

AT U.S. DOLLARS 1 PER HONG KONG DOLLARS 8), THEN ANY EXCESS

SALES OF HONG KONG DOLLARS ON THE FOREIGN EXCHANGE MARKET DRIVING

IT BELOW DOLLARS 8 SAY TO DOLLARS 8.25, WILL, SUBJECT TO TRANSACTIONS COSTS, INDUCE THE BANK, OR ITS CUSTOMER, TO BUY

HONG KONG DOLLARS AT 8.25 AND PAY FOR THEM IN U.S. DOLLARS

OBTAINED BY REDEEMING NOTES WITH THE EXCHANGE FUND AT DOLLARS 8.

PURE ARBITRAGE WILL ENSURE THAT THE RATE MUST REMAIN LINKED SO

LONG AS THE PUBLIC HAS THE WHEREWITHAL (IN NOTES OR FOREIGN CURRENCY) TO TRADE WITH THE EXCHANGE FUND. THE PUBLIC, OF COURSE,

CAN RENEW WTS NOTE HOLDING BY SHIFTING FROM BANK DEPOSITS TO NOTES, SO LONG AS CONVERTIBILITY REMA-INS. IF, THEN, THE PUBLIC WANTS TO MOVE INTO, SAY, U.S. DOLLARS AT THE FIXED RATE, WHAT

PREVENTS WT CONTINUALLY CHANGING MORE HONG KONG DOLLAR DEPOSITS

HINTO HONG KONG DOLLAR NOTES AND THENCE INTO U.S. DOLLARS? THE

ANSWER TO THAT IS THAT THE SHIFT OUT OF HONG KONG DOLLAR DEPOSITS

NTO NOTES (WHETHER HONG KONG OR V.S.) PUTS PRESSURE ON THE

AVAILABLE LIQUID RESERVE BASE OF THE BANKS. INITIALLY THEY MAY

BE ABLE TO DRAW ON SURPLUS AVAILABLE LIQUID FOREIGN CURRENCY

ASSETS. BUT IF THE DRAIN CONTINUES THEY HAVE TO REACT MORE

FORCEFULLY. THEIR REACTION WILL TAKE THE FORM ENTHER OF BRINGING

IN TO HONG KONG ADDITIONAL FOREIGN CURRENCY, IF THE RETURN AND

RISK PROSPECTS MER-IT IT, AND/OR PAISING INTEREST RATES ON HONG

KONG DOLLAR DEPOSITS AND LOANS TO STEM THE DRAIN.

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