The exchange rate between the Hong Kong Dollar (HKD) and US Dollar (USD) almost always hovers around 1 USD = 7.8 HKD. The banknotes in circulation are printed not by the Central Bank - the Hong Kong Monetary Authority (HKMA), but by three major banks. This unique system can initially seem puzzling to visitors in Hong Kong.
THE HKMA'S ROLE IN HONG KONG'S CURRENCY SYSTEM
The Hong Kong Monetary Authority (HKMA) maintains this 'fixed currency peg' to the USD by relying on the 'free market.' It offers a fixed exchange rate of 1 USD = 7.8 HKD to only three banks in Hong Kong: HSBC, Bank of China, and Standard Chartered. These banks can profit by trading between the market rate and the HKMA fixed offer, adjusting the amount of HKD in circulation in response to HKD appreciation or depreciation. Consequently, the exchange rate remains within a narrow band of 1 USD = 7.75 HKD - 7.85 HKD.
For instance, if the market rate of HKD appreciates to 7.7 HKD to 1 USD, these banks can buy HKD at the market rate and sell them to HKMA at the fixed rate of 7.8 HKD to 1 USD, thus making a risk-free profit. If the market rate depreciates to 7.9 HKD to 1 USD, they can sell HKD to HKMA at the fixed rate and purchase them back at the market rate, again earning a risk-free profit.
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HOW HKMA CONTROLS THE CURRENCY IN CIRCULATION?
Control of the currency circulation in Hong Kong lies with these three banks. HKMA allows them to design and print most of the banknotes in circulation (except the $10 notes). To ensure that HKD is intrinsically backed by USD, HKMA requires these banks to hold an equivalent value in USD to support the amount of HKD outstanding in the market. This stops the banks from printing more than necessary.
In turn, this system results in almost all HKD in circulation ($20, $50, $100, $500, $1,000) being printed by these three banks, allowing HKMA to declare that it employs a "free market" to maintain a "fixed currency peg". However, with this system, the HKMA holds limited control over the money supply in Hong Kong, posing potential difficulties during a financial crisis.
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In essence, the currency peg system of Hong Kong ensures a stable exchange rate with the USD, but it also means that three banks govern the circulation of HKD. This distinctive system mirrors the complex economic and political history of Hong Kong, reflecting its position as a global financial center.
