The Hong Kong Dollar Peg: Black Saturday and the 1983 Currency Board

On Saturday 24 September 1983 the rice shelves in Hong Kong's supermarkets emptied before noon. Shoppers cleared out cooking oil and toilet paper as well, on the reasoning that goods keep their value and paper does not. Outside the money changers in Central the queues ran along the pavement. By the close of the half-day session the Hong Kong dollar had traded at 9.60 to the US dollar, against roughly 8.30 two days earlier and about 7.60 at the start of the month. Nothing had happened to the colony's factories, its container port or its export orders. What had happened was that a fourth round of Sino-British talks in Beijing had adjourned the previous day without a communiqué.

Three weeks later the currency stopped moving. It has scarcely moved since. Between 17 October 1983 and today the Hong Kong dollar has been held within a few cents of 7.80 to the US dollar through the handover of sovereignty, the Asian crisis, the collapse of Lehman Brothers and a decade of near-zero American interest rates — one of the longest-surviving fixed exchange-rate arrangements in the world, operated by a jurisdiction that is not a sovereign state and has never had a conventional central bank.

Nine Years Without an Anchor

Hong Kong had spent most of the twentieth century tied to something. It abandoned the silver standard in November 1935, when China's own silver outflows made the position untenable, and the Currency Ordinance of that December created the Exchange Fund to hold the sterling assets backing the note issue. The link ran at HK$16 to the pound. After sterling's 14.3 per cent devaluation in November 1967 Hong Kong first followed the pound down and then revalued partway back, settling at HK$14.55, a fortnight of improvisation that cost the Exchange Fund a good deal of money and taught the government that an anchor to a weak currency is not much of an anchor.

When the Bretton Woods arrangement came apart after Nixon closed the gold window in August 1971, Hong Kong moved. The sterling link ended in July 1972 and the Hong Kong dollar was pegged to the US dollar at 5.65, revalued to 5.085 after the American devaluation of February 1973. That did not last either. On 25 November 1974 the government let the currency float, making Hong Kong one of the first small open economies to do so.

The float was not really a monetary policy. It was the absence of one. Hong Kong had no central bank, no reserve requirements worth the name, no open-market operations and no instrument for controlling the money supply other than the interest-rate cartel run by the Hong Kong Association of Banks. Deposits could be created without limit by a banking system that was expanding at speed after exchange controls were lifted, and the arithmetic showed up where it always does. Broad money grew above 20 per cent a year through the late 1970s, consumer price inflation climbed into the mid-teens by 1980, and property prices in Hong Kong roughly tripled between 1975 and the peak in 1981.

Tony Latter, later a deputy chief executive of the monetary authority, described the decade of floating as a period in which the authorities discovered they had no lever at all — the exchange rate moved, but nothing the government did moved it in any reliable direction (Latter, 2007). John Greenwood, then chief economist at G.T. Management and editor of the quarterly Asian Monetary Monitor, had been making the same argument since 1981 in a series of articles that almost nobody in government wanted to read.

The Politics of a Number

What turned a monetary weakness into a run was the question of who would govern Hong Kong after 1997. The New Territories lease, signed in 1898, expired on 30 June 1997, and by the early 1980s banks could no longer write fifteen-year mortgages without confronting the date.

Margaret Thatcher went to Beijing in September 1982, arriving from Tokyo with the Falklands victory behind her and a conviction that the three nineteenth-century treaties were valid in international law. Deng Xiaoping did not accept the premise. In their meeting on 24 September 1982, according to Thatcher's own account, Deng told her that China could "walk in and take the whole lot this afternoon" if it chose. Her reply conceded the military point and no other:

"There is nothing I could do to stop you, but the eyes of the world would now know what China is like."

She then slipped and fell on the steps of the Great Hall of the People, in front of the cameras, and the photograph travelled faster than the communiqué. The Hang Seng Index, which had been above 1,300 in July 1981, fell to 676 by early December 1982. The Hong Kong dollar, around 5.59 on average through 1981, weakened through 1982 and kept weakening as the talks dragged on in secrecy across 1983.

Confidence was being drained from several directions at once. Property was in free fall, down roughly 60 per cent from the 1981 peak by 1984. The Carrian group, a property conglomerate that had grown from nothing to a listed empire in four years, collapsed in 1983 amid a fraud investigation that reached into Bumiputra Malaysia Finance and included the murder of a bank auditor in Hong Kong that July. Smaller deposit-taking companies were failing. In the same week as Black Saturday, the government moved to take over Hang Lung Bank, the first of several bank rescues that ran into the middle of the decade.

Seven Point Eight

The mechanism that stopped the run was published, in outline, in the September–October 1983 issue of Asian Monetary Monitor while the currency was still falling. Greenwood's proposal was not the ordinary one of announcing a target and defending it with reserves, which invites a market to find out how deep the reserves are. He proposed reviving the note-issue mechanism that had been dormant since 1974 and making it the whole of monetary policy (Greenwood, 2008).

Hong Kong's banknotes are not issued by the government. They are issued by commercial banks — in 1983 by the Hongkong and Shanghai Banking Corporation and the Chartered Bank, joined by the Bank of China in 1994. Under the arrangement announced by the Financial Secretary, Sir John Bremridge, on Saturday 15 October 1983 and effective on Monday 17 October, a note-issuing bank that wants to put HK$780 of new notes into circulation must first deliver US$100 to the Exchange Fund and receive in exchange a non-interest-bearing Certificate of Indebtedness. Withdrawing notes reverses the trade at the same rate. The monetary base is therefore backed, at the margin and by construction, by US dollars at 7.80. The withholding tax on Hong Kong dollar deposit interest was scrapped in the same package, removing a standing disincentive to hold the local currency.

The market rate was never fixed by decree. It was left to float, on the expectation that arbitrage between the 7.80 issue rate and the open market would pull the two together, and that any residual gap would be closed by interest rates rather than by intervention. Money leaving Hong Kong would shrink the base and drive local rates up until it stopped leaving. This is the classic currency-board bargain: the exchange rate is guaranteed and the price of money is surrendered to whoever sets policy in the anchor country.

Read the line and the design is visible in it. Between 1980 and 1984 the currency loses more than a third of its value against the dollar. From 1984 onward the series is a flat rule with a wobble of a few cents, and the wobble is itself informative: the market rate spent much of the 1990s a little stronger than 7.80, because capital was arriving rather than leaving.

The Machinery Behind the Rate

A note-issue link is a narrow instrument. Banknotes are a small and shrinking part of the money in a modern economy, and the cash arbitrage that was supposed to hold the market rate near 7.80 worked slowly and imperfectly. For its first five years the link rested less on mechanism than on the willingness of one institution to cooperate: HSBC ran the clearing system for the whole banking sector, so interbank liquidity was effectively that bank's balance sheet, and the Exchange Fund influenced it by asking.

That was fixed in stages, each one prompted by a scare.

The 1988 Accounting Arrangements mattered more than their dull name suggests. By taking HSBC's net clearing balance onto its own books, the Exchange Fund could for the first time drain or add liquidity to the banking system directly, which is to say it could make overnight money expensive on a morning's notice. When the real-time settlement system arrived in December 1996 and every bank got its own account with the authority, the plumbing finally matched the doctrine.

Sovereignty was settled in the meantime, and the currency board was written into the constitutional text. Annex I of the Sino-British Joint Declaration of 19 December 1984 provided that the Hong Kong dollar would continue to circulate and remain freely convertible. Article 111 of the Basic Law, promulgated in 1990 and in force from 1 July 1997, went further:

"The Hong Kong dollar, as the legal tender in the Hong Kong Special Administrative Region, shall continue to circulate. The authority to issue Hong Kong currency shall be vested in the Government of the Hong Kong Special Administrative Region. The issue of Hong Kong currency must be backed by a 100 per cent reserve fund."

A backing rule that began as a technical fix for a run had become a term of the handover.

The Double Play

The Asian financial crisis of 1997 and 1998 tested the design in a way its authors had not anticipated. The Thai baht went in July 1997, the rupiah and the won followed, and attention turned to the largest remaining fixed rate in the region. The currency board worked as advertised: selling Hong Kong dollars drained the clearing balances and drove interest rates up. On 23 October 1997 the overnight interbank rate reached roughly 280 per cent and the Hang Seng Index fell 10.4 per cent in a day.

That was the vulnerability. A speculator who shorted the currency and simultaneously sold Hang Seng Index futures did not need the peg to break. Joseph Yam called it the double market play: the defence of the currency was itself the mechanism that moved the equity leg into profit, so the attacker was paid whether or not the link held. Charles Goodhart and Lu Dai's study of the episode concluded that the position had become close to a one-way bet by the summer of 1998 (Goodhart and Dai, 2003).

Between 14 and 28 August 1998 the Hong Kong government spent about HK$118 billion, roughly US$15 billion, buying Hang Seng constituent shares in the open market. For an administration whose official philosophy was positive non-interventionism, it was close to heresy, and the Financial Secretary, Donald Tsang, knew how it would read. The operation closed on 28 August, the August futures settlement day, on turnover of some HK$79 billion. The government finished as a substantial shareholder in HSBC, Hongkong Telecom and Cheung Kong, and was criticised from Washington to Zurich for it.

On 5 September 1998 Yam announced the Seven Technical Measures, of which one changed the system permanently. The HKMA gave a Convertibility Undertaking to buy Hong Kong dollars from licensed banks' clearing accounts at 7.75, converting a note-issue link into a full currency board covering the whole monetary base. The rate was then walked from 7.75 to 7.80 by one pip per calendar day from 1 April 1999, arriving on 12 August 2000. The shares bought in August 1998 were sold back to the public through the Tracker Fund of Hong Kong, listed in November 1999, which raised about HK$33 billion and at the time was the largest share offering in Asia outside Japan.

The Convertibility Zone

On 18 May 2005 the HKMA completed the architecture. It added a strong-side undertaking to sell Hong Kong dollars at 7.75, moved the weak-side undertaking from 7.80 to 7.85 over five weeks, and declared the band between them a Convertibility Zone within which it would not normally act. The system that began as a defence against capital flight now had a symmetrical defence against capital flooding in, which by 2005 was the more pressing problem.

Both edges have been hit. Inflows after 2008 pushed the rate to the strong side repeatedly and swelled the Aggregate Balance — the sum of banks' clearing accounts at the HKMA — from a few billion Hong Kong dollars to hundreds of billions. When the Federal Reserve raised rates from 2022 and Hong Kong's own rates lagged, the carry trade ran the other way, and the HKMA bought Hong Kong dollars at 7.85 dozens of times, and the Aggregate Balance fell from well above HK$300 billion in early 2022 to under HK$50 billion by the end of 2023. The mechanism did exactly what it is built to do, which is to convert an exchange-rate problem into an interest-rate problem and hand the bill to domestic borrowers.

Why Hong Kong's board survived when Argentina's convertibility regime collapsed in 2001 and 2002 is the comparison that matters. Both fixed to the US dollar and both promised full backing. Argentina ran persistent fiscal deficits, borrowed in dollars, allowed provincial governments to issue quasi-currencies and held reserves that were a fraction of its obligations. Hong Kong ran fiscal surpluses for most of the period, carried no net public debt, and held foreign reserves that have generally been several multiples of the monetary base they are required to cover. Y.C. Jao's account of the 1997 and 1998 defence puts the fiscal position first among the reasons the commitment was believed (Jao, 2001). A currency board is a promise about a balance sheet, and the promise is worth what the balance sheet is worth — a point the Swiss National Bank illustrated from the other direction when it abandoned its euro floor in January 2015 rather than keep buying.

The cost is visible in Hong Kong's property market, which has imported American interest rates for four decades regardless of local conditions, and in the fact that the territory has no counter-cyclical monetary tool whatever. Every adjustment falls on wages, rents and asset prices. Greenwood's defence was always that this is a feature: a small open economy with a vast financial sector and no political capacity to run a credible discretionary policy is better off outsourcing the decision entirely (Greenwood, 2008).

There was nothing sacred about 7.80. It sat near enough to where the market had traded before the panic to be plausible, and far enough from a round number to be awkward to attack. That figure has now outlasted the colony that adopted it, the Financial Secretary who announced it, the Chartered Bank's old name and the two negotiating positions whose collision caused the run. In September 1983 it was a number found over a weekend to stop people queueing for rice.