After the SNB dropped its minimum exchange rate, an interesting comparison between the Swiss franc and Hong Kong dollar is discussed. Paul Krugman introduced this comparison in his recent blog post, mainly to depict how similar Swiss minimum exchange rate policy and Hong Kong’s currency board are, except for institutional setups and history of the system. If this is the case, it might be a good reason to worry about stability of Hong Kong dollar since these two countries used very similar mechanism. Krugman, however, further argues that “no chorus demanding the peg that the peg be abandoned” in Honk Kong because of “hard-money ideologues” which Hong Kong has and Switzerland did not.
On the other hand, the recent article by the WSJ focuses on difference between two countries, as the title of the article “Hong Kong Dollar Peg Doesn’t Fit in Swiss Hole” suggests. While the article also pointed out institutional difference just as Krugman does, it further says that Switzerland and Hong Kong are facing opposite pressure in terms of capital flow, which should lead the opposite implications for the currency management. Specifically, while the SNB probably worried about huge capital inflow comes in the country given widely expected the ECB’s QE and Greek election, Hong Kong would face pressure of capital outflow (thus devaluation pressure on the currency), since the Fed is widely expected to raise its interest rate later this year. And in terms of whether Hong Kong could drop its currency peg, the article insists it’s unlikely since Hong Kong has a long history of defending its currency board system even when other Asian currencies collapsed during the Asian financial crisis in 1998.
On similarity vs. difference discussion, I would rather agree with the WSJ’s argument especially because “the direction of capital flow” matters under their policy mechanism. In theory, while central bank can depreciate its own currency indefinitely by printing money to buy foreign currency, the opposite is not true if central bank used up all foreign reserves. In this sense, we could say Hong Kong dollar is a mirror image of what the Swiss franc was used to be, with severer restriction in maintaining currency peg.
So what about potential instability of the Hong Kong dollar? I’m not confident enough to say it won’t happen. In terms of institutional setup and history of currency peg in Hong Kong, we have to remind how the Gold Standard was abandoned after the Great Depression happened. Although the Gold Standard had been believed as the best policy to maintain currency stability, all major countries eventually gave up their currency peg to restore domestic economy. Thus, we cannot exclude possibility that Hong Kong will follow this case. What’s more, although the WSJ article argues that Hong Kong is unlikely to abandon the policy that has anchored the financial system for decades given the recent political instability, I would say the political instability might be an incentive for policymakers to give up its currency board, since people might not accept sharp economic slump driven by currency defending policy which was implemented during the Asian financial crisis.