The Interplay of the “China Factor” and US Dollar Peg in the Hong Kong Economy

Abstract

This article examines the significance of the “China factor” in maintaining economics stability and growth in Hong Kong, relative to the role played by the “US dollar peg” exchange rate regime that has been in place since 1983. It shows how, by virtue of the peg, Hong Hong was made subservient to US monetary policy, and how unsynchronized business cycle with the US resulted in spiralling wage and land costs to trigger a mass exodus of Hong Kong's manufacturers across the border to China. The article analyses in detail to what extent the economic base of Hong Kong's export industries has been expanded as a result of the relocation; and measures, in particular, by how much the cost-savings has helped to lower Hong Kong's overall export costs and thus enhance the viability of the peg that is so crucial to such a small and entirely open economy. The analysis extends through the Asian financial crisis and beyond, examining how the peg has fuelled deflation but the “China factor” may have helped mitigate it. Important questions are raised about the peg in light of the disastrous consequences of the Asian financial crisis for some Asian economies, and the concomitant search for a more viable exchange rate regime. It concludes that despite the increased integration of the Hong Kong and mainland China economies, the likelihood of the Hong Kong dollar being de-pegged from the US dollar and re-pegged to the Chinese currency is yet remote.