Should the Hong Kong dollar continue its peg to the United States dollar? This has become a frequently discussed topic in recent years. Yet because numerous officials in the Hong Kong Special Administrative Region government have repeatedly emphasised that the Hong Kong dollar will not unpeg from the US dollar, the question has become decidedly sensitive. But does avoiding this discussion mean there are no issues with the peg? While the government insists on maintaining the link, does it guarantee the Hong Kong dollar can remain stable against the US dollar at its current level? It may be worthwhile to consider, from several perspectives, whether the current exchange rate is appropriate and whether the Linked Exchange Rate System should continue.
First, can the linked exchange rate system be maintained solely through unilateral efforts by the Hong Kong Special Administrative Region government? Looking back at the 1998 attack on the Hong Kong dollar by international speculators like George Soros, the Hong Kong Monetary Authority (HKMA) was able to repel speculators using its sizable foreign exchange reserves. More significantly, Hong Kong's foreign exchange reserves stood at $418.9 billion as of the end of September. Although this falls short of the $499.4 billion peak in 2021, it remains substantially higher than the $89.6 billion level in early 1998. In theory, if speculators launch another attack, the HKMA's reserves should still be sufficient to defend the currency.
However, relying solely on the size of foreign exchange reserves is not a scientific approach, as several critical factors appear to have been overlooked. For example, the growth in Hong Kong's M3 money supply since 1998 directly impacts whether the reserves are truly adequate to support the Hong Kong dollar. Another consideration is Hong Kong’s fiscal reserves. While fiscal reserves are not meant to, nor should be, used to support currency stability, a sustained decline in fiscal reserves could force the HKMA to choose between using reserves to support government operations or to defend the currency, creating a dilemma. Thus, it is important to monitor when the government’s fiscal situation may improve; if deficits persist, fiscal reserves may continue to decline and could potentially turn negative within the next five years.
