Whatever uses other economies might have for them, exchange controls are out of the question for Hong Kong: the Basic Law, which sets out our basic principles of government, expressly prohibits them, and, even if it did not, we know that, at least for Hong Kong, any attempt to introduce them, and to turn inwards on ourselves, would spell the end of our prosperity. But free market principles cannot mean markets that are left defenceless against manipulation. One troubling aspect of the Asian crisis, and a sign of larger problems in the world financial system, has been the extreme volatility in markets created by the rapid flows of highly leveraged funds around the world. As markets in the region became more vulnerable, these flows increasingly took on a predatory character and became more and more subtle in their planning and sophistication. This August, as you know, the Hong Kong financial markets became the target of a well planned attack by international hedge funds. We took unconventional actions to fend off that attack and to fortify our financial system against future attacks. Not unexpectedly, these actions have been the cause of extensive controversy, and of a great deal of misunderstanding. Let me attempt to present the issue from Hong Kong’s perspective by outlining what happened in August and explaining why we took action. Oddly enough, Hong Kong became a target because of the transparency of its financial system: we were singled out for our efficiency and predictability rather than for any fundamental flaws.
Nor is devaluation necessary to help make us more competitive, even given the fact that many of our neighbours have seen currency devaluations of between 20 and 80 per cent. Currency devaluation is not the only means to achieve economic adjustment, and the argument that Hong Kong is losing out by maintaining the link makes little sense for such an externally oriented economy. Hong Kong is achieving its adjustment through other variables. Asset prices and the cost of production, particularly in the form of land and rentals, BIS Review 98/1998  -5-  have come down very sharply. Wages are easing. Manufacturers and service providers are increasingly able to lower their costs while at the same time seeking improvements in productivity. It is therefore quite misleading to claim, as many sceptics do, that without currency devaluation Hong Kong cannot be competitive. We have chosen an alternative route towards adjustment, and we consider ourselves fortunate that we have the capacity to make that choice. This capacity comes from the fundamental strengths that make it possible for us to run an effective currency board. These fundamentals can be reduced to four basic, and some what obvious, points. They are so obvious, in fact, that they are too often overlooked in the narrow discussions about the prospects for the link, and it is worth setting them out. First, our ample foreign currency reserves. These are the fruits of strict fiscal discipline, which has produced surpluses year after year, and of prudent investment.