ENG-1968 — Page 70

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FINANCIAL STRUCTURE

at no time a statutory one; it was established and maintained by the operations of the Exchange Fund in conjunction with the note- issuing banks. It came, however, to be generally regarded, in com- merce and banking, as a fixed relationship; while Hong Kong, as both a dependent territory and a member of the sterling area, was required in practice to keep its official reserves and the greater part of the reserves of the banking system (there being no central bank) in the form of sterling. Towards the end of 1967 Hong Kong's total sterling assets were of the order of £350 million.

In consequence of this situation, when sterling was devalued by 14.3 per cent in November 1967, the immediate effect was a loss. to the Colony which may be estimated at $700 million; and Hong Kong was faced with the dilemma of following the pound down and so letting the loss fall directly and fully on the standard of living of the people (by reason of their almost total reliance on imported food and other goods) along with a costly and completely unnecessary deterioration of terms of trade; or of not devaluing the Hong Kong dollar and taking the loss for the most part, directly on the reserves of Government and the commercial banks. After an initial devaluation which maintained temporarily the previous relationship with sterling, the Hong Kong dollar was revalued four days later by 10 per cent against sterling to a new rate of 1s 44d, equivalent to a 5.7 per cent devaluation of the Hong Kong dollar from its previous international parity. This decision cost Hong Kong public funds $450 million or nearly $120 per head of popula- tion. This sum included nearly full compensation paid from the Exchange Fund to commercial banks against their consequential losses.

These events finally made it clear that the old relationship with the pound was no longer appropriate to Hong Kong's present economic situation. On the other hand, it was not possible for Britain to allow any significant deversification of Hong Kong's sterling assets of £350 million into other currencies, in view of her own depleted reserves; while at this stage she was not prepared to offer guarantees of the international value of sterling reserves. Negotiations in London in April and May resulted in a novel arrangement whereby Hong Kong was given the right to use its sterling assets to purchase British Government bonds, of seven