The Hong Kong dollar has become one of the best-performing currencies in the world today.
Hong Kong is a key financing conduit and provides large stock markets for investors with a currency that has generated much strength.
This "strength" is generated from the low exchange rate as it takes only a few Hong Kong dollars to purchase one US dollar.
As a result of the rapid depreciation of the Hong Kong dollar in the year 1983.
This ultimately led to a 36 year-long fixed exchange rate where the Hong Kong dollar has been pegged against a tight band of between HKD $7.75 and HKD $7.85 per 1 US dollar.
This article explores the relationship between the Hong Kong and US dollar, discusses the reasons behind the pegging of the currency, and highlights its impact and importance.
A little background
It is important to look back at some of the events that have greatly impacted the currency and have contributed to its position today.
Previously, Hong Kong was under a floating exchange rate regime.
During that period, the exchange rate between the Hong Kong dollar and the US dollar was at its lowest point.
This depreciation of the Hong Kong dollar encouraged local business owners to quote their goods and services at US dollar prices.
Moreover, the Hong Kong dollar fluctuation increased uncertainty, followed by the transfer of sovereignty over Hong Kong, which reestablished the country's state as an administrative region of China.
This further raised concerns amongst consumers and investors who were anxious about the rapid currency depreciation.
During this time, the public had lost faith in the country's financial system and feared price rises and product scarcity.
People had to wait in long lines to get a hold of basic essentials, which also became historically known as the 'Black Saturday' crisis.
The events of the crisis resulted in the introduction of the peg.
The motive of this was to restore faith amongst individuals, consumers, investors, big corporations, and the population itself.
The pegging of the Hong Kong dollar meant that a very specific fixed exchange rate would be set for the currency in terms of foreign exchange and therefore pegged between either HKD $7.75 and HKD $7.85 per 1 US dollar.
This approach comes as no surprise to maintain the value of the country's currency as it lessens the risks of foreign exchange that investors, importers, and exporters are concerned about.
A fixed exchange rate would maintain the value of the Hong Kong Dollar, exporters, importers, and international investors become more certain about their transactions; hence the government can keep up a low inflation rate.
Why this is a good thing is the economic benefits that come with pegging.
Breaking It Down: The Hong Kong Dollar Peg
A fixed exchange rate system is when the government or the central bank of a country pegs the country's currency exchange rate to another country's currency or the price of gold.
The purpose of doing so is to ensure that the currency is stable and only fluctuates between a narrow upper and lower limit.
A fixed exchange rate provides many benefits in maintaining inflation, reducing uncertainty, and increasing the overall business confidence of the country compared to other exchange rate regimes.
How does it work?
The Hong Kong dollar peg works as the fixed exchange rate system automatically self-corrects to maintain the currency's stability.
For example, if money is leaving the country, the currency will depreciate to 7.85 HKD per US dollar, hitting the rate's upper limit.
In that case, the Hong Kong Monetary Authority (HKMA) will buy Hong Kong dollars held in reserve by banks.
As a result, interest rates are pushed back to the level at which they initially attracted money into the country.
On the other hand, if the currency appreciates, the Hong Kong Monetary Authority will sell Hong Kong dollars held in reserve by banks, resulting in the currency being pushed back into its original rate.
Increase in export & trade
By maintaining a fixed exchange rate, the goods, and services that are being sold abroad gain more competitiveness.
For instance, synthetic reconstructed jewelry stones are one of the major exporters from Hong Kong.
This would mean that manufacturing these stones would be much cheaper in Hong Kong than in a European Union country.
We also see great advantages in trade between countries with a low cost of production and first world countries with stronger economies.
For example, the cost of human hair production in Hong Kong is very cheap compared to Germany or the United Kingdom.
When manufactured in Hong Kong and sold abroad, this generates greater profit through the low fixed exchange rate.
This makes it more profitable for the home country by initiating money into the economy that shields the state from any likelihood of a currency crisis.
Increase in foreign direct investment
A country with a fixed exchange rate such as Hong Kong is confirmed to attract foreign investors.
The currency's stability assures the investors that the value of their investment, be it monetary or business, will not obliterate because of the fixed exchange rate.
Large enterprises and companies become more intrigued by building and depositing money into commercial ventures, shares, properties, etc.
Through foreign investment, Hong Kong benefits from economic development to stimulate the local community, increase productivity through more advanced facilities and equipment, tax incentives, and more job opportunities bracing an increased income, hence a better standard of living.
Large foreign corporations investing provide a much higher paying wage, increasing national income, which can aid in economic growth. More of the population becomes capable of accessing basic needs and more luxurious goods.
Reduced economic volatility
A reduction in volatility boosts confidence that the currency will hold and maintain its value, and this is music to every investor's ears.
The currency, in this case, does not fluctuate, and Hong Kong remains in a good position economically.
You hold currency to exchange and savings. Therefore a person who decides to save money can be comfortable that the monetary value of the currency will still be maintained in the future.
What if there was no fixed exchange rate system?
Without pegging and fixed exchange rates, businesses become uncertain about their investments which resultantly reduces the rate of investment and places a strain on the economy.
Moreover, any decline in the gross domestic product (GDP) growth puts the country at risk of being in a recession.
Hong Kong today is a highly developed free-market economy with a very rigorous trade market.
The currency's strength, the banking system, being free from debt, and a fixed foreign exchange rate have boosted the state's economic value.
The pegging of the HKD has made it easier and more predictable for investments and easier for businesses between the two countries.
The country has become one of the highest-rated states to start a business.
The economy needs to grow.
The stability of currency gives people hope that the value of the currency will protect their future interests.
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