The Limitations of Currency Boards
Jude Wanniski
October 29, 1997


Letters Editor
The Wall Street Journal
New York NY 10281

Dear Editor:

Steve Hanke's defense of the Hong Kong currency board reveals its weakness, why it is no better than the old-fashioned gold standard that required 100% bullion backing for currency in circulation. As there is universal agreement that Hong Kong's financial crisis is located in an attack on its currency board, it is of little solace to all concerned that the HK dollar remains firmly pegged to the U.S. dollar.

The first problem with a currency board is that it fixes the exchange rate of one floating currency to another. Just as Thailand imported its monetary policy from our Federal Reserve by pegging the baht to the dollar with a central bank instead of a currency board, Hong Kong imports all the benefits and all the errors of Alan Greenspan & Co. by a dollar currency board. By pegging to a basket of "hard currencies," Argentina imported an average of good and bad in managing its currency board.

When the U.S. dollar inflated against gold, to $385 from $350 in 1994-96, both the Thai baht and the Hong Kong dollar inflated along with it, by "automatically" adding reserves to the respecting banking systems. When the demand for our dollar increased last November and the Fed did not accommodate it with increased liquidity, the price of gold fell, to a low of $309 last week. It was this monetary deflation that disrupted the Thai economy, although Thailand made other fiscal and regulatory errors upon the advice of the International Monetary Fund that compounded the problems in Bangkok. The other countries in the region fell one-by-one as the economic weakness spread, with no one country region fell one-by-one as the economic weakness spread, with no one country strong enough to stand up to the pressures.

When the market first tested Hong Kong, its policymakers met the test with resolve. When signs of weakness showed up, with some Hong Kong businessmen pushing for an end to the dollar peg, the risks caused a run on the currency board. The board successfully withstood the attack, but without any discretion (except the discount window that Professor Hanke would close), the monetary authority had to engage in massive liquidation of dollar assets to acquire the dollars being demanded. The shortage of dollar liquidity caused the dollar/gold price to tumble further, compounding the original problem. The error fed back throughout the whole world, which is in one way or another guided by the value of the dollar.

A currency board is of course superior to no guideline at all, which is why it worked to end Argentina's hyperinflation. But it has its own inherent deficiencies, as do all monetary systems that ignore the signals of gold, a point the Journal's editorials and Chairman Greenspan have been making for many years.


Jude Wanniski