ENG-1974 — Page 59

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FINANCIAL STRUCTURE

currency in nominal circulation at the end of 1974, and details of its constitution, are shown in Appendix 10.

The value of currency issued by the note-issuing banks is regulated by an Ex- change Fund, which was set up in 1935 when the Hong Kong dollar ceased to be based on silver. The fund receives payment from these banks in exchange for certi- ficates of indebtedness denominated in Hong Kong dollars. These certificates are non-interest bearing and are issued and redeemed at the discretion of the Financial Secretary. They provide the legal backing for the notes issued by the banks (apart from their small ‘fiduciary' issues—these are limited to a total of $95 million and are issued against securities, of a kind approved by the Secretary of State, which are held by the banks and deposited with the Crown Agents in London). The fund's resources are employed in a variety of investments, both long and short-term, denominated in sterling and other currencies. Out of the income derived, the fund bears the cost of the note issue except for a small proportion, equivalent to the proportion borne by the 'fiduciary' issues to the total note issue, which is met by the note-issuing banks. In practice, from 1937 to 1968, the Exchange Fund operated in a similar manner to traditional Colonial Currency Boards.

The exchange value of the Hong Kong dollar was established in 1935 at about 1s 3d sterling ($16 to £1). On the setting up of the International Monetary Fund after World War II, the Hong Kong dollar was given its own gold parity at a rate reflecting this relationship. The relationship with sterling was, however, not a statutory one, and was established and maintained by the operations of the Exchange Fund in conjunc- tion with the note-issuing banks. Nevertheless, it came to be generally regarded as a fixed relationship. 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, in the form of sterling.

The link with sterling weakened after the devaluation of the pound by 14.3 per cent in November 1967, when the value of the Hong Kong dollar was adjusted to leave it with a devaluation of only 5.7 per cent to a rate of $14.55 to £1. And the link weakened further after the pound was allowed to float downwards in June 1972 -early in the following month the Hong Kong Government decided to fix the ex- change value of the Hong Kong dollar in terms of US dollars instead of sterling. The new exchange rate, of HK$5.65 to US$1, made good nearly all of the sharp depreciation suffered, along with the pound, immediately after the floating. When the US dollar itself was devalued by 10 per cent in February 1973, the Hong Kong dollar's gold parity was not changed and a new rate of HK$5.085 to US$1 became operative. The Hong Kong dollar was allowed to float upwards on November 26, 1974. Heavy selling of US dollars had brought the exchange rate under pressure at the Hong Kong dollar's upper margin of HK$4.9706, despite intervention by the government in the market. The government decided that further resources should not be committed to maintaining this margin. The Hong Kong dollar quickly ap- preciated further, to a middle market rate of about HK$4.60 to US$1, but by the end of the year the rate had returned to about HK$4.92 to US$1.

Various arrangements between 1968 and the end of 1974 provided a guarantee by Britain of the external value of other countries' sterling holdings, as an inducement