A linked exchange rate system is a type of

exchange rate regime An exchange rate regime is a way a monetary authority of a country or currency union manages the currency about other currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent on many ...

that pegs the exchange rate of one

currency A currency is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general definition is that a currency is a ''system of money'' in common use within a specific envi ...

to another. It is the exchange rate system implemented in

Hong Kong Hong Kong)., Legally Hong Kong, China in international treaties and organizations. is a special administrative region of China. With 7.5 million residents in a territory, Hong Kong is the fourth most densely populated region in the wor ...

to stabilise the exchange rate between the

Hong Kong dollar The Hong Kong dollar (, sign: HK$; code: HKD) is the official currency of Hong Kong. It is divided into 100 cents. Historically, it was also divided into 1000 mils. The Hong Kong Monetary Authority is the monetary authority of Hong Kong an ...

(HKD) and the

United States dollar The United States dollar (Currency symbol, symbol: Dollar sign, $; ISO 4217, currency code: USD) is the official currency of the United States and International use of the U.S. dollar, several other countries. The Coinage Act of 1792 introdu ...

(USD). The Macao pataca (MOP) is similarly linked to the

. Unlike a

fixed exchange rate A fixed exchange rate, often called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a currency basket, basket of other currenc ...

system, the government or

central bank A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the mo ...

does not actively interfere in the foreign exchange market by controlling supply and demand of the currency in order to influence the exchange rate. The exchange rate is instead stabilized by an exchange mechanism, whereby the

Hong Kong Monetary Authority The Hong Kong Monetary Authority (HKMA) is the central bank, central banking institution of Hong Kong. It is a government authority founded on 1 April 1993 when the Office of the Exchange Fund and the Office of the Commissioner of Banking merge ...

(HKMA) authorises note-issuing banks to issue new banknotes provided that they deposit an equivalent value of US dollars with the HKMA. The Government, through the HKMA, authorises three commercial banks to issue banknotes: * The Hongkong and Shanghai Banking Corporation Limited; *the Standard Chartered Bank (Hong Kong) Limited; and *the Bank of China (Hong Kong) Limited. Notes ( HK$10 only) are also issued by the HKMA itself because of the continuing demand for small value notes among the public.

History

As a response to the Black Saturday crisis in 1983, the linked exchange rate system was adopted in

on October 17, 1983 through the currency board system. The redemption of certificates of indebtedness (for backing the

banknotes A banknote or bank notealso called a bill (North American English) or simply a noteis a type of paper money that is made and distributed ("issued") by a bank of issue, payable to the bearer on demand. Banknotes were originally issued by commer ...

) were sent out by note-issuing banks to peg the domestic currency against the US dollar at an internal fixed rate of HK$7.80 = US$1. The

(HKMA), Hong Kong's de facto central bank, authorised note-issuing banks to issue

banknote A banknote or bank notealso called a bill (North American English) or simply a noteis a type of paper money that is made and distributed ("issued") by a bank of issue, payable to the bearer on demand. Banknotes were originally issued by commerc ...

s. These banks are required to have the same amount of US dollars to issue banknotes. The HKMA guarantees to exchange US dollars into Hong Kong dollars, or vice versa, at the rate of 7.80. When the market rate is below 7.80, the banks will convert US dollars for Hong Kong dollars from the HKMA; Hong Kong dollar supply will increase, and the market rate will climb back to 7.80. The same mechanism also works when the market rate is above 7.80, and the banks will convert Hong Kong dollars for US dollars. The Hong Kong dollar is backed by one of the world's largest

foreign exchange reserves Foreign exchange reserves (also called forex reserves or FX reserves) are cash and other reserve assets such as gold and silver held by a central bank or other monetary authority that are primarily available to balance payments of the country, ...

, which is over 7 times the amount of money supplied in circulation or about 48% of Hong Kong dollars M3 at the end of April 2016.

Strengthening of Currency Board Arrangements

Since 5 September 1998, the HKMA has provided an explicit convertibility undertaking to all licensed banks in Hong Kong to convert Hong Kong dollars in their clearing accounts into US dollars at the fixed exchange rate of to . Starting from 1 April 1999, the convertibility rate in respect of the Aggregate Balance moved from 7.75 by 1 pip (i.e. $0.0001) per calendar day. It converged with the convertibility rate applicable to the issuance and redemption of Certificates of Indebtedness at 7.80 on 12 August 2000. The HKMA announced three refinements on 18 May 2005 to remove uncertainty about the extent to which the exchange rate may strengthen under the Linked Exchange Rate System: # the introduction of a strong-side Convertibility Undertaking by the HKMA to buy US dollars from licensed banks at 7.75; # the shifting of the existing weak-side Convertibility Undertaking by the HKMA to sell US dollars to licensed banks from 7.80 to 7.85, so as to achieve symmetry around the Linked Rate of 7.80. This shift was achieved in a gradual manner over five weeks by moving the exchange rate of the weak-side Convertibility Undertaking by 100 pips on every Monday starting with 7.81 on 23 May 2005 until it reached 7.85 on 20 June 2005; # within the zone defined by the levels of the Convertibility Undertakings (the "Convertibility Zone"), the HKMA may choose to conduct market operations consistent with Currency Board principles. These market operations shall be aimed at promoting the smooth functioning of the Linked Exchange Rate System, for example, by removing any market anomalies that may arise from time to time.

Notes and references

External links

Linked Exchange Rate System
at Hong Kong Monetary Authority (HKMA)

p. 22 {{DEFAULTSORT:Linked Exchange Rate Hong Kong-centric Foreign exchange market Monetary policy Finance in Hong Kong

History

Strengthening of Currency Board Arrangements

See also

Notes and references

External links