The Interplay of the “China Factor” and US Dollar Peg in the Hong Kong Economy*

This article examines the significance of the “China factor” in maintaining economics stability and growth in Hong Kong, relative to the role played by the “US dollar peg” exchange rate regime that has been in place since 1983. It shows how, by virtue of the peg, Hong Hong was made subservient to US monetary policy, and how unsynchronized business cycle with the US resulted in spiralling wage and land costs to trigger a mass exodus of Hong Kong’s manufacturers across the border to China. The article analyses in detail to what extent the economic base of Hong Kong’s export industries has been expanded as a result of the relocation; and measures, in particular, by how much the cost-savings has helped to lower Hong Kong’s overall export costs and thus enhance the viability of the peg that is so crucial to such a small and entirely open economy. The analysis extends through the Asian financial crisis and beyond, examining how the peg has fuelled deflation but the “China factor” may have helped mitigate it. Important questions are raised about the peg in light of the disastrous consequences of the Asian financial crisis for some Asian economies, and the concomitant search for a more viable exchange rate regime. It concludes that despite the increased integration of the Hong Kong and mainland China economies, the likelihood of the Hong Kong dollar being de-pegged from the US dollar and re-pegged to the Chinese currency is yet remote. The Hong Kong dollar was pegged to the US dollar at the rate of HK$7.8 in October 1983. Not long afterwards, commencing in April 1984, China made a decisive move to court more foreign investment by opening 14 cities along the eastern seaboard. Launched with entirely different objectives, these two important policy measures have nevertheless jointly and profoundly affected the performance of the Hong Kong economy over the past two decades. The dollar peg, aimed at stabilizing the Hong Kong currency following the severe loss of investor confidence resulting from the deadlock in the Sino-British negotiations over the future of Hong Kong, immediately deprived the Hong Kong government of monetary policy flexibility in countering cyclical economic movement, and actually contributed to * We are indebted to Dr Elspeth Thomson for making the article more readable. 1. The move was preceded by the establishment in 1979/80 of the four Special Economic Zones (SEZs) in Guangdong and Fujian provinces. However, while SEZs were little different from the small export-processing zones established in many other countries, the April 1984 opening of 14 major coastal cities represented the most significant initial step in the opening of the entire country for foreign investment and trade. It was followed, only four years later in early 1988, by the even more spectacular opening of eleven coastal provinces, comprising a total of 288 “opened” municipalities and counties (xian); and subsequently by the even more strategic decision, made by Deng Xiaoping himself after his celebrated “South China tour” in early 1992, to open up China further not only in geographic terms but institutionally as well. For a detailed study of this opening process, see Y.Y. Kueh, “Foreign investment and economic change in China,” in Robert Ash and Y.Y. Kueh (eds.), The Chinese Economy under Deng Xiaoping (Oxford: Clarendon Press, 1997), pp. 159–216. 2. On 23 and 24 September 1983 the value of the Hong Kong dollar plummeted by some 15% to as low as HK$9.5 per US dollar amidst massive selling. It had been around HK$5.6 to the US dollar.  The China Quarterly, 2002 388 The China Quarterly increased economic instability. However, export-manufacturers were permitted to relocate to the Chinese hinterland to take advantage of the “open-door” policy, and thereby avoid the pressures of spiralling wage and land costs. Crucial to a small, entirely open economy as Hong Kong’s, they were able to remain competitive and the integrity of the peg