The Case Against the RMB-HKD Currency Swap Line
It is at best unnecessary but potentially catastrophic
Hong Kong was still under British colonial rule in 1992. The Legislative Council passed an amendment to the Exchange Fund Ordinance and subsequently, in April 1993, established the Hong Kong Monetary Authority ("HKMA").
The HKMA has one and only one function, which is to defend the linked exchange rate of the Hong Kong dollar, i.e., the peg. Other tasks such as monitoring the risks of the banking system and managing exchange funds are merely the necessary means to defend the Hong Kong dollar peg.
But it took almost a decade since the introduction of the peg in 1983 for the HKMA to be established. Have you ever wondered why?
Since WWII ended, the US dollar has been the dominant currency for international trade and finance. Even when Hong Kone was a member of the Sterling Bloc, the private sector adopted the use of the US dollar out of necessity.
The adoption of a dollarized economy made Hong Kong a global trade hub. The choice of the institution was not out of the foresight of any individual.
After the fall of the Sterling Bloc, Hong Kong's economy was fully dollarized in the 1970s. From 1973 to 1983, the exchange rate of the Hong Kong dollar was benchmarked and managed to the greenback.
Most accounts for the introduction of the peg in 1983 cite the uncertainty surrounding the Sino-British negotiation on the sovereignty of Hong Kong. However, one must not overlook that since the 2nd quarter of 1983, the dollar has appreciated enormously. It was difficult for the Hong Kong government to maintain the city's dollarized economy unless its currency was pegged and guaranteed.
I cannot reiterate more that the peg is essential to Hong Kong. Nevertheless, the operation of a currency board regime is uncannily simple. The simplicity and resilience of the peg are arguably the most under-appreciated aspects of the institution.
Since the introduction of the peg in 1983, Hong Kong has experienced many external shocks. Although the city couldn't avoid the cyclical impacts, the dollar peg remained.
Economists think differently. We do not ask asking what the best institutional arrangement should be. Instead, we question how the world operates and how it might fare under other alternatives.
Besides the US dollar, the gold standard was the only institutional arrangement that has ever existed as an international financial order. The demonetization of gold began in the 1930s.
The end of WWII brought about the Bretton Woods System, which replaced the gold standard of the past with a fixed exchange rate pegged to the US dollar. Alongside the globalization of the dollar, the post-WWII global economic regime also promotes multilateralism in trade and other areas.
It turns out the fixed exchange rate regime was transitional. When a government can print money, it will. When all governments compete to print money, there is always pressure on the exchange rate regime. So in the 1970s, the Bretton Woods System collapsed.
Nevertheless, the world did not end with the end of the fixed exchange rate regime. On the contrary, humankind experienced an unprecedented improvement in living standards thanks to the expansion of the market economy.
The gold standard certainly has its merits. Some individuals insist the gold standard is the better alternative. I must confess I do not have a definitive answer to this debate. Only future history can tell.
Anyone who believes that reverting to the gold standard will solve all the problems in the modern world underestimates the complexity of society. Social institutions are never designed and chosen. Out of necessity, people experiment with new solutions to social problems and eventually come up with customs and practices for other people to follow. Whenever new institutions and innovations are in place, unique challenges emerge. Hence, there can never be a panacea to all the ills in the world.
The global economic order dominated by the US dollar likewise poses new challenges. The fluctuation of the US dollar exchange rate always foreshadows a financial crisis somewhere in the world. The massive appreciation of the US dollar in the early 1980s brought about the Latin American debt crisis. From 1985 to 1988, after the Plaza Accord, the US dollar fell from its historical high, triggering the Japanese asset bubble burst. Subsequently, the US dollar's rise and the Japanese yen's devaluation from 1995 to 2002 culminated in the Asian financial crisis. Even the sharp rise in the dollar after the US financial tsunami in 2008-2009 indirectly resulted in the European debt crisis.
In the past two decades, the US Federal Reserve instituted currency swap agreements with central banks to reduce exchange rate fluctuations. When countries have a sudden short-term demand for the US dollar, central banks can use their foreign exchange reserves as guarantees to borrow US dollars from the Federal Reserve. Hence, the currency swap line ameliorated the fluctuation of exchange rates through the direct provision of credits from the world's most influential central bank.
Since the emergence of dollar currency swap agreements, there have been similar arrangements between other central banks. Some people even perceive the network of multilateral currency swap agreements as a return to the Bretton Woods System.
However, any market operations carried out by the central banks entail risks, especially moral hazards. For instance, some people see the US dollar currency swap line provided by the Federal Reserve as bailouts of foreign banks by the people of the United States.
On the contrary, according to the same reasoning, it can also be said that under the international financial order led by the United States, every time the Federal Reserve rescues Wall Street, people worldwide are paying the price.
The last wave of dollar gains began in 2014 - 2017. During this period, mainland China's macroeconomic environment was also greatly affected by the strengthening of the US dollar. The 2015 A-share stock market crash was just a prelude to the Great Recession. The cyclical fluctuation in the Chinese economy as a result of the external shocks poses a massive challenge for the Chinese Communist Party. The so-called dual-cycle economic model theory proposed two years ago by Xi Jinping was a call for further decoupling of China from the US dollar. But I would argue that the call for decoupling has more to do with the need to strengthen China's economic firewall and less with the fear of being sanctioned.
In the CCP's perspective of the world, everything runs in a duality, one system for the rest of the world outside China's firewall against another tightly controlled one inside the Great Wall of China. Although the CCP has been promoting the idea of RenMinBi internationalization, its end game scenario is not free circulation and currency exchange.
The demand and supply of RMB will always be "managed" by the state apparatus. Under the existing system, China's State-owned banks act as offshore renminbi liquidity providers. Therefore, in theory, the renminbi does not need any currency swap agreement to maintain exchange rate stability. The recent expansion of the RMB-HKD swap agreement does not seem to serve any meaningful function. It appears somewhat like a move only for fulfilling specific requirements imposed top-down by the People's Bank of China simply for achieving the milestones of RMB Internationalization.
Under normal circumstances, it is not a big deal for the government to do something just for the sake of doing it. However, the RMB-HKD currency swap agreement leaves some questions unanswered. Firstly, the HKMA is not a central bank. Hong Kong's foreign exchange reserve has only one use. When someone sells the Hong Kong dollar, the HKMA must have enough funds to maintain the Hong Kong dollar exchange rate. Any use other than the above will only weaken Hong Kong's capability in defending the peg.
Secondly, we cannot ignore the possibility of the worst-case scenario. In case both HKD and RMB encounter at the same time enormous market pressure, will the currency swap arrangement function as intended? Or will it create undue stress on Hong Kong, given the city is entirely open to the international financial market?
In computer jargon, the RMB-HKD Swap Line is similar to bloatware. When we have sufficient memory and CPU power, such unnecessary addition might not be noticeable. When resources are scarce, however, these extra burdens may slow down or even shut down the system.
Though I disagree with the conspiracy theorists' take that the RMB-HKD Swap was a heist in broad daylight, I am disturbed that no one in Hong Kong can be openly skeptical against any command directed from Beijing. Big Brother cannot always be correct. Under authoritarianism, minor issues eventually culminate into major catastrophes because no one feels safe to speak out.
One Country Two Systems was intended not only to protect Hong Kong's capitalist system but also as the firewall that allows mainland China to access the capital and information of the outside world without opening up its socialist institutions. No one wins if this firewall collapse.
Since the 1950s, China relied on Hong Kong to access the outside world. In the 2020s, China hasn't, can't, and won't decouple itself entirely from the dollarized global economy. Leaving Hong Kong alone is the only way for the Chinese Communist Party can be left alone by the rest of the world.
Further Reading: Are China’s RMB Swap Lines an Empty Vessel? | Council on Foreign Relations (cfr.org)
我深信, 佢只會關心自己的權力, 其他, 都可被犧牲的, 他不在乎