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Black Saturday Crisis 1983

Essay by   •  March 14, 2013  •  Case Study  •  2,711 Words (11 Pages)  •  2,013 Views

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Introduction

In 1983, Black Saturday crisis occurred and there was an uncertain fluctuation in domestic currency. Thus, linked exchange rate system was introduced. Hong Kong dollar (HKD) is linked with United States dollar (USD) at HKD7.8=USD1. Today, property prices in Hong Kong are at a high record and some say that this is due to the linked exchange rate system. In the following, we will analyze the relationship between the Hong Kong Linked Exchange Rate System and record high property prices today. Besides, we will discuss the advantages for keeping Linked Exchange Rate System and possible solutions for solving the problem of high property prices in Hong Kong.

Relationship between the Hong Kong Linked Exchange Rate System

and high property prices today

The Hong Kong Linked Exchange Rate System was established in 1983. This exchange rate system aims to stabilize the exchange rate between the Hong Kong dollar and the United States dollar. The internal fixed rate is HKD 7.80=USD 1. (7.75 as a lower limit and 7.85 as an upper limit since May 18, 2005).The Hong Kong Monetary Authority authorizes note-issuing banks to issue new banknotes provided that they deposit an equivalent value of US dollars with the HKMA.

Hong Kong is known for having one of the most expensive real estate sectors in the world. The property price is determined by the supply and demand of property in the Hong Kong property market.

Due to the linked exchange rate system between Hong Kong and United States, the interest rate of Hong Kong and United States approximately synchronized. Hong Kong would accompany with United States when the interest rate decreased, and vice versa.

As the Fed aims to help boost the US economy, the Federal Reserve is likely to keep the US interest rates at the current near-zero rates until 2015. The policy of pumping fresh money into the economy---A third round of quantitative easing (QE3) was announced at the Fed's September meeting. The policymakers of Fed assume that an environment of low interest rates stimulates business investment and consumption expenditure.

Low interest rate in Hong Kong is resulted, which makes it less attractive for people to hold on to cash. Investors would seek out higher yields in property, stock market, and commodities. Besides, with lower interest rate, the cost of borrowing decreases. Thus, there is an increase in quantity demanded of loanable funds. A certain percentage of these loanable funds go to the property market. The above cause an increase in the demand in Hong Kong property market. As a result, demand curve shifts rightward, causing the property price raise.

As it is normal for home purchases to be funded by a mortgage loan, lower interest rate decrease the interest they pay on their mortgage loan and this lead to an increase in demand in the property market. Lower interest rates thus boost the property prices.

Apart from the lower interest rate, the exchange rates also affect the property prices. With linked exchange rate system, the depreciation of US dollar causing HK dollar depreciates at the same time. However, China undergoes rapid economic growth in the recent years. As Hong Kong is a close trading partner with China, Hong Kong becomes a market which is worth to invest. As a result, the demand for HK dollar increases. Facing the deprecation of HK dollar but rapid economic growth, people tend to buy property, rather than holding cash. Therefore, increase in property demand causes property prices increase.

In addition, there is negative correlation between US exchange rate and Hong Kong property prices. In 1985, US exchange rate started to decrease and it reached its bottom in 1995. After that, it bounced back and rose continuously until 2002. On the other hand, Hong Kong property prices increased from 1984 to a peak in 1997 and then decreased to 2003. With the above historical data, we can see the negative correlation between US exchange rate and Hong Kong property prices and we can expect today weak US dollar lead to a record high property prices in Hong Kong.

In conclusion, Hong Kong Linked Exchange Rate System created a low interest rate, low exchange rate and high capital inflow economic environment in Hong Kong. All of these contribute to the record high property prices in Hong Kong today.

Advantages for keeping Linked Exchange Rate System

Due to the Black Saturday crisis, in which the Hong Kong dollar exchange rate was very low with USD 1= HKD 9.6. This uncertain fluctuation in domestic currency caused Hong Kong to change from adopting floating exchange rate system to linked exchange rate system. Why did Hong Kong choose to adopt linked exchange rate system? The first advantage is that the linked exchange rate system stabilizes the currency.

Linked Exchange Rate System is a currency exchange rate regulating system where exchange rate of one currency is linked to exchange rate of another currency and are kept constant or at a range. HKD is linked with USD at USD 1=HKD 7.8. There is no interference from the government and the central bank in the foreign exchange market or the demand and supply control of a particular currency. The Hong Kong Monetary Authority (HKMA) sets a range for Hong Kong currency to float between from USD 1=HKD7.75 - HKD 7.85. When the exchange rate rises above HKD 7.8 and HKD is going to depreciate, the HKMA will use the US reserves to buy HKD to stabilize the linked exchange rate. As this process goes on, money supply which means money held by the public decreases. The interest rate increases and thus attracts people to invest. So, the linked change rate remains stable. On the contrary, when the exchange rate drops below HKD 7.8, the HKMA will buy USD from the licensed bank to bring the exchange rate back into balance. This is how the system works. So, people can estimate the exchange rate and it will not have great fluctuations and people will be confident in holding HKD. The three note-issuing banks in Hong Kong are required to submit US dollars at the linked exchange rate to the HKMA for the account of the Exchange Fund in return for Certificates of Indebtedness. The Certificates of Indebtedness serves as backing for the banknotes issued. Therefore, the Hong Kong dollar banknotes are fully backed by US dollars held by the Exchange Fund.

The exchange rate of HKD being linked with USD can stabilize the currency because USD has the function of medium of exchange in many countries. It has the power of influencing the world's economy. Also, in the past years, US had a mature and well-developed financial structure. As Hong Kong is an

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