Since the Asian crisis erupted in mid-1997 we experienced a number of speculative attacks aimed at toppling the Hong Kong dollar and breaking its fifteen-year-old link to the US dollar. This link is successfully maintained by a strict and automatic currency board system, backed by more than adequate foreign currency reserves. During the attacks speculators took out large short positions against the Hong Kong dollar with the aim of destabilizing the linked exchange rate. On all these occasions the attacks activated the autopilot mechanisms under the currency board and drove up interbank interest rates to such high levels that the speculators (who had to borrow locally to fund their short positions) were forced to unwind their positions and incur heavy losses. The speculators failed, the currency board worked, and the link survived. But the interest rate volatility, and the consequent additional pain imposed on the community, was extreme: during one attack, on 23 October 1997, the overnight interest rate shot up to nearly 300%. In August we faced a much more complicated situation, in which speculators launched coordinated and well planned attacks across our financial markets. Speculators had discovered that by intensively selling Hong Kong dollars over a short period they could temporarily drive up interest rates under the currency board system, which would exert a downward pressure on stock prices. By pressuring the currency and selling stocks short, they could realize a profit on stock index futures contracts, even if they could not break the exchange rate link.
BIS Review 95/1998  -2-  Clearly, what happens in the EU matters to Hong Kong. What therefore will be the impact of the euro on the participating countries? There should certainly be a number of economic benefits, including in particular: • a huge increase in transparency from the single currency which will make it easier to compare prices across national frontiers. This will boost competition, bring down costs and prices, and improve efficiency; • a reduction in transaction costs, in particular from the elimination of foreign exchange commissions. This will encourage trade and cross-border investment flows; • lower interest rates in individual countries from the elimination from the foreign exchange risk premium. This will reduce financing costs and stimulate investment and output; • the development of larger and more liquid debt and stock markets across the euro zone. This will create a vast new pool of capital for companies, thus giving a further stimulus to investment; • tighter fiscal discipline on the member countries under the Stability and Growth Pact and monetary discipline exercised by the new European Central Bank. Both these should ease inflationary expectations and produce a more stable financial environment for the euro zone. In summary, the single currency should be able to deliver higher economic growth and therefore increased demand for imports by the euro countries. As one of the EU’s major trading partners, this should benefit Hong Kong.