Fifth, the complexity of many of these structured products and the risks involved were simply beyond the comprehension of the ordinary investors and perhaps even the professional investors who did not have the time to look into the fine details of the financial arrangements. And so the rating agencies were relied upon, for a fee, to provide an objective view, or rather a rating that was as objective as it could be under the circumstances. But we all noticed the instability of these ratings, some falling from AAA to junk within a short time span, which threw doubt not so much on the integrity of the rating agencies – they are respectable organisations essential to the functioning of the financial system and they do a good job generally – but, in my view, on the appropriateness of the models that they used. Relative ratings comparing the risks of different financial structures do not throw light on the absolute level of risk when different structures are taken together. This I think requires a wider market or general equilibrium view, taking account of the behaviour of the entire economy and the financial markets in particular. Sixth, then, the structured products containing sub-prime mortgages were given the necessary qualifications to get into the hands of different investors, high net-worth individuals who probably can assume the risk and take the hit, leveraged hedge funds that may be a lot more vulnerable, financial institutions with surplus liquidity, and so on.
I should of course start by re-iterating the firm HKSARG policy of keeping our exchange rate to the US dollar within the range of 7.75 to 7.85 through the linked exchange rate system, characterised by currency board arrangements that require our monetary base, and any changes in it, to be 100% backed by US dollars. With the weakening US dollar and the strengthening renminbi; with the local inflation rate, excluding the temporary effects of tax relief, edging higher; with an “asset bubble” on the lips of many commentators; with the exchange rate hitting the strong side Convertibility Undertaking late last month, requiring our passive and un-sterilised foreign exchange intervention, injecting quite a lot of Hong Kong dollar liquidity into the inter-bank market; and with current US monetary policy possibly becoming inappropriate for Hong Kong; questions have understandably been raised on the appropriateness of the system. Let me provide answers to these questions. First, the appropriateness of the linked exchange rate system should be judged by its ability to deliver monetary and financial stability in Hong Kong through economic cycles, and should not be judged by the short-term cyclical conditions of the economy relative to that of the US economy. The linked exchange rate system has served Hong Kong extremely well since its establishment.