Mr. Yam discusses the political process of monetary management in Hong
Text of the Thirteenth Susan Yuen Memorial Lecture delivered by the Chief Executive of
Kong
the Hong Kong Monetary Authority, Mr. Joseph Yam, JP, at the Hong Kong Management
Association on 20/10/98.
...
1. I am particularly pleased to be here this evening to deliver the Thirteenth Susan
Yuen Memorial Lecture. I never had the privilege of meeting the late Mrs. Susan Yuen. But in
reading her brief history in the material published by the Hong Kong Management Association, I
found out that she and I both came to Hong Kong from the Mainland in 1949. And we both
became the first Chief Executives of HKMAs - the Hong Kong Management Association in her
case and the Hong Kong Monetary Authority in my case. But I fear that I shall never achieve the
distinction of having a Memorial Lecture dedicated in my name. And certainly at the age of fifty
I am content not to have to ponder such matters. It is a sufficient honour to have been invited to
celebrate with you Susan Yuen's distinguished record of public service.
2. I would like to talk about the political process of monetary management to fit in
with your theme of "Managing Economic Turbulence in Asia".
Controversy
3. I am sure you are aware of the controversy over how we managed the financial
turmoil that we have been facing. There have been many complaints about a wide range of
issues. Our critics have told us that we should not have squeezed so hard on interest rates last
October and that we should not have increased the cost of borrowing for business and for those
who have to service their home mortgages. We should have introduced our measures to
strengthen our monetary and financial systems earlier. We should not have departed from our
free market policy and intervened in the stock and futures markets. That there was a lack of a
"sense of crisis" in how we handled the situation. These are the more significant criticisms.
4. I can fully understand the sentiment behind these criticisms. The people of
Hong Kong have been suffering the worst conditions we have had to face for many years. Even
the most patient and understanding community will have grievances when the value of the assets
they hold has been halved while they have to pay significantly higher interest costs for their
liabilities. Furthermore, income has not been growing, and, for some, it has been shrinking. And,
worse still, the probability that they may lose their jobs has doubled in the past year.
5. So, whatever the cause of this difficult situation, whether or not it arose from
events outside the control of the authorities, it is considered, and rightly so, the responsibility of a
caring government to do what it can to relieve these grievances. Refusal or reluctance to do so,
even for very sound reasons in the larger long-term public interest, is not looked upon kindly.
Even in cases where the authorities managed to be innovative, perhaps to an extent not normally
expected of bureaucrats, and did the right thing, there is always the easy, popular but legitimate
question of why action was not taken earlier.
The Political Process of Monetary Management
6. In Hong Kong, the grievances of the community are enthusiastically and
effectively aired by politicians. Whether directly or indirectly elected, the politicians have the
mandate of the people and the people of Hong Kong are well served by them. But one of the
peculiarities of the system of Hong Kong is that the politicians, although having the mandate of
the people, do not actually have the authority to direct government policies. A consequence of
this is that the Administration is always kept on its toes, much more so than in many other
jurisdictions. There are lively debates on almost all issues of significance, not to mention those
that are controversial. This obviously has the benefit of ensuring that the Administration
performs to its best ability. But the inevitable disadvantage is simply that there can be too much
of everything, to the extent of eroding rather than enhancing the efficiency and effectiveness of
government. But this is the reality of Hong Kong today and we all have to live with it.
7. The management of any public issue of significance involves first getting the
technicalities right, then explaining them patiently and clearly to all those concerned, and then
handling skillfully the politics surrounding it. More often than not, handling the politics is the
most difficult part. You can be 100 per cent right technically and you can spend all day
explaining all the fine details, relating them to the policy objective and the public interest. But if
you are not skillful enough in the handling of the politics of the issue, particularly an issue in
whose success the confidence of the people plays a crucial part, all your efforts might be wasted.
A totally different perception than that intended could well result, undermining the chance of
success of what you are trying to achieve.
8. Let me focus specifically on the management of the political process
concerning monetary issues. I must say that this task is, for the HKMA, becoming increasingly
difficult and time-consuming. Monetary issues are unfortunately very technical and elusive, but
they affect everybody. Money is dear to the heart of everyone. We work hard to earn it. And we
use it everyday, which can often be, thank goodness, the more pleasant aspect of it. So, quite
naturally to us, the price and the value of money are things that we should be concerned about.
Here, already to a layperson or to the average politician, we are being esoteric. What is the price
of money? What is the value of money? And what are the differences between the two? Why
should we be concerned about them? These are very legitimate questions. And they are in fact
not easy questions to answer or easy concepts to put across.
9. So, imagine trying to explain, and obtain support for, the following proposal:
"to dampen interest rate volatility and lessen the interest rate pain by redefining the monetary
base to include debt paper discountable at the HKMA through overnight repurchase agreements
and fully backed by foreign reserves without departing from the monetary rule of currency board
arrangements which requires the monetary base to change only with a corresponding change in
foreign reserves". This really is a mouthful. And to some, I must have been speaking Greek. But
I can assure you that the wording of the proposal is precise and technically 100 per cent correct.
In fact, this was exactly what we did when we introduced the seven technical measures in early
September to strengthen our monetary system. And the proposal has worked well so far. But had
the proposal been presented in those terms, I think even the most learned academics would have
taken some time to figure out what we were up to.
10. The likely result is that nobody would be willing to comment on the proposal
for fear of exposing ignorance on the subject. This might be considered a good result, in terms of
ourselves being able to achieve what in our professional opinion should be done. And if the
community has faith in the HKMA, confident that we know what we are doing, we may even get
public support. But it is also a risky result. First of all, we can of course be wrong. It would be
naive to think that we can be right all the time. Nobody can be. We can only be less wrong. But
more importantly, public support should not be built merely upon faith in an esoteric and aloof
HKMA being professional and acting in the best interest of Hong Kong. Whatever reputation the
HKMA has been able to achieve, domestically and internationally, such support could never be
sustained for long. We do run a system that, at times, inflicts considerable pain on the
community. Many of the decisions taken by the HKMA are unpopular. The pain and the
unpopular decisions may become too severe to bear just on the foundation of faith, particularly in
the peculiar political setup of Hong Kong.
11. An essential part in the management of the political process concerning
monetary issues, therefore, is to promote a better general understanding on those issues. This is
not easy. Not only are those issues technical, but they are also changing all the time with the
rapid changes in the global financial scene. Financial liberalization and the globalization of
financial markets, encouraged by the advance of telecommunications and information
technology, have drastically changed the behaviour of money. On top of all this, we have the
complication that Hong Kong's monetary system has really only started to take shape in the past
ten years or so, as monetary reform measures were introduced to modernize it so it could cope
with the demands and expectations of modern finance. But these difficulties are not excuses for
not trying. And we have tried; although I must confess, on the basis of the reaction from some of
the politicians to the actions we have taken recently, that the returns on our efforts to promote a
better general understanding of monetary issues in Hong Kong have not been impressive.
12. So we must try harder, and we will. There are then the questions on how and
the areas in which we need to concentrate our efforts. On the former I shall seek advice from my
colleagues. On the latter, the recent episode surrounding our operations in the stock and futures
markets, culminating in the defeated Motion Debate in the Legislative Council on 30 September
1998 to review the HKMA, provides excellent guidance. If one filters away the noise from
political posturing, including the rather unpleasant and unnecessary personal attacks, there are
three areas that require attention.
Basic Monetary Concepts
13. The first area that requires attention concerns various concepts in modern
monetary management that need to be more effectively put across. This is essential if discussions
on the technical issues are to be more meaningful. I am aware that this is not intended to be a
lecture on monetary economics, so let me just bring out one or two of them here for illustration.
14. Under our linked exchange rate system, stability in the exchange rate is
ensured through the control on what is called the monetary base. If you were to ask any
representative grouping of the community, say, the Legislative Council, what the monetary base
is, I would be surprised if more than ten per cent of the group could come up with the correct
answer. Many would be tempted to relate this to the various definitions of the money supply,
because that is the term mostly heard in commentaries on money and finance. But they are quite
different things. The crucial part of the monetary base and the money supply, however defined,
are in fact on the different sides of the balance sheet of the banking system. Put this question to a
group of academics and you would probably, on the contrary, get as many definitions as there are
people in that group.
15. This confusion is understandable and, at least partly, in the context of Hong
Kong, a reflection of the rather peculiar institutional framework for monetary management of the
past that is now, one hopes, history, with the ten years of reforms to our monetary system. You
may be surprised to hear this. It was not until the end of 1996 that the monetary base for Hong
Kong was properly defined. This was when, on the occasion of the introduction of Real Time
Gross Settlement for interbank transactions, all licensed banks were required to operate a
clearing account with the HKMA instead of with a commercial bank. Yet we have been,
somehow, controlling, or we claimed to have been controlling, the monetary base ever since the
linked exchange rate system was established in October 1983.
16. Even assuming that the definition of the monetary base is well understood,
there is then the important question of how it should be controlled. Herein lies one of the most
interesting subjects in monetary management and that is the choice between discretionary control
with people making decisions, and automatic rule-based control with no discretionary decisions
involved. Associated with this are considerations concerning, and possibly another choice
between, flexibility in management and the credibility of the monetary system. Even the most
professionally competent central banker can be wrong. A system that involves discretionary
decisions is therefore subject to human errors of judgement that may undermine the credibility of
the system, and some would go as far as to argue that this would eventually lead to failure of the
system. On the other hand, an entirely rule-based system without any discretion is inflexible and
may not serve the best interest of the community, even though short-term interests may
sometimes be involved - witness the many calls for lowering interest rates even when the
exchange rate is under pressure.
17. Another related conceptual issue that needs to be put across clearly is that the
classical currency board system, as structured in the old colonial era, whilst still theoretically
sound, has long become impracticable in coping with the complexities of modern finance. In the
old days, transactions were conducted predominantly with the use of physical cash. And so the
focus of attention in currency board theory was merely that the issue of cash should be backed
100 per cent by foreign reserves and rather simplistically that cash arbitrage would keep the
exchange rate stable. There was nothing much about the monetary base and the adjustment
process in response to capital flows involving movements in domestic interest rates. The theory
also did not take into account the many and much larger volumes of transactions nowadays
conducted with the use of electronic money and settled electronically without the use of physical
cash. As a result, the crucial part of the monetary base is no longer the amount of cash in
circulation but a much smaller yet highly leveraged element in the form of the aggregate balance
that banks have in their clearing accounts maintained with the currency board, that is the HKMA.
18. The old theory also did not take into account the need for the currency board
to be controlling the interbank payments system and therefore performing the role as provider of
liquidity to the banking system. As a result when our currency board arrangements were
modernized through monetary reform in the past ten years, many of our actions were
misunderstood even by leading monetary economists. But to be fair, even we ourselves were not
entirely sure about a few things, as we moved into the uncharted waters of modern currency
board theory and practice.
19. Yet another conceptual issue to be put across clearly is the fact that an
inevitable cost of fixing the exchange rate through currency board arrangements is interest rate
volatility. An external shock involving any substantial flows of funds into or out of the currency
will lead to interest rate changes. The larger the flow the sharper the changes, in a manner very
much dictated by the market. And as there is little or no discretion on the part of the HKMA on
interest rates, the HKMA was in fact not responsible, for example, for overnight interbank
interest rates hitting 280% last October. We did not squeeze interest rates. It was those shorting
the Hong Kong dollar who squeezed interest rates and, on that occasion, squeezed themselves as
well, along with the innocent borrowers. Interest rate volatility can be dampened by discretionary
action, but that would undermine the credibility of the system. Alternatively this could be done
by further modifying our currency board arrangements and incurring the cost in the form of
greater fluctuation in our foreign reserves while eschewing the exercise of discretion. This was
the objective of the seven technical measures we took in early September to make our system
less susceptible to manipulation.
20. I do not wish to continue to bore you with these conceptual issues. Although
they are technical, they are essential if there is to be sensible and meaningful discussion about
monetary management in Hong Kong. I shall be stepping up the efforts of the HKMA to promote
a better understanding of them.
Transparency
21. The second area that requires attention in the political process of monetary
management concerns the transparency of the HKMA. To at least the minority of those members
of Legislative Council who supported the defeated Motion to review the HKMA, the
transparency of the HKMA was found to be lacking. Although the Motion was defeated, the fact
that transparency was an issue, even to the minority of the Legislature, is quite surprising to me.
It is perhaps not something that I can afford to ignore. However, compared with other central
banks, the HKMA must be among the most transparent in the world. In monetary management
specifically, I am quite sure that we are the most transparent in the world. I know of no other
central bank that discloses information about the monetary base, and operations affecting it, on a
real-time basis. There is also an abundance of information published in the HKMA's regular
series of monthly, quarterly and annual reports, and in the ad hoc publications on specific
monetary and banking issues. Figures on foreign reserves are published monthly and soon we
shall be publishing the balance sheet of the Exchange Fund also on a monthly basis.
22. Perhaps this minority view was based on the practice, now becoming quite
common in other central banks, that the proceedings of monetary policy committees are
published, so that the public is made aware of how monetary policy decisions are taken by those
entrusted with the authority to make them. There are the examples of the Federal Open Market
Committee (FOMC) of the Federal Reserve Bank in the United States and the Monetary Policy
Committee of the Bank of England. The minutes of their meetings are published with an
appropriate time lag. In Hong Kong we do not have an equivalent of the FOMC or the Monetary
Policy Committee. This is simply because we do not have an independent monetary policy and
an independent body making that policy. We do not have a system whereby the HKMA has to
take discretionary decisions to determine interest rates or to specify monetary targets. There has
therefore not been a need for a mechanism for public scrutiny of discretionary decisions because
there is nothing to scrutinize.
23. Our monetary system is rule-based. To the extent that there is a need to have a
mechanism for public scrutiny, it should be aimed at ensuring that the HKMA adheres to the
rules and does not indulge secretly in discretionary monetary management. We have already
volunteered this mechanism in providing real time information on the monetary base. Changes
and forecasts of changes to the monetary base are announced almost immediately after the
relevant transactions have been conducted. There is no parallel with this practice in any other
jurisdiction.
24. But the process of modernization of our currency board arrangements is likely
to be a continuous one, in the light of possible rapid and significant changes in the international
financial architecture. The Financial Secretary as controller of the Exchange Fund, and myself as
Monetary Authority under his delegated authority, are responsible for making decisions in this
area, in consultation with the statutory Exchange Fund Advisory Committee (EFAC). Recently,
with the agreement of the Financial Secretary, a subcommittee of the EFAC on currency board
operations chaired by me has also been set up to advise, among other things, on currency board
arrangements.
25. Whilst it can be argued that transparency in this area of work would help to
enhance the credibility of the system and the HKMA, it must, however, be noted that proposals
in this area are likely to be market sensitive. It will not be easy to strike a balance. But we should
obviously try. I shall shortly be making a proposal to the Financial Secretary initially for the
minutes of meetings of the subcommittee, other than those concerning market sensitive issues, to
be published, with an appropriate time lag. Consideration will also be given to the subcommittee
conducting public hearings to receive opinions and suggestions on monetary management from
members of the public. In the light of experience of this practice, consideration can later be given
to do the same for the minutes of meetings of the EFAC.
Accountability
26. The third area that requires attention in the political process of monetary
management concerns the accountability of the HKMA. Here again, there are certain
characteristics peculiar to Hong Kong. Unlike arrangements in other jurisdictions, the HKMA, as
the institution responsible for issues generically called central banking, is not a body established
by law. The legal entity is the Monetary Authority, as a person, appointed by the Financial
Secretary to assist him in the performance of his duties under the Exchange Fund Ordinance. I
have the honour of being the person who has been so appointed. That means I am accountable to
the Financial Secretary for my actions when exercising the authority delegated to me by the
Financial Secretary under the Exchange Fund Ordinance. The Financial Secretary is advised by
the EFAC appointed by the Chief Executive of the HKSAR, whose authority has been delegated
to the Financial Secretary.
27. It is through the Financial Secretary that the Monetary Authority is
accountable to third parties, and the form this takes is determined by the Financial Secretary. If
the Financial Secretary wants me to appear before the Legislative Council and formally present a
report to the Council every six months, as suggested by some, I am quite happy to do so. But the
Financial Secretary must of course make an assessment of whether the implications of such a
practice are acceptable. He must take a view on whether this would introduce an avenue for
political interference in the work of the HKMA, in particular in monetary management. He must
also take a view on whether this would undermine the effectiveness of the relationship between
the Administration, in particular himself, and the HKMA.
28. Insofar as getting things done at the technical level is concerned, for example
in achieving the broad policy objectives of monetary and banking stability, and the development
of the financial infrastructure, the existing relationship between the Administration and the
HKMA has worked well. The Hong Kong dollar exchange rate has remained very stable and the
banking system robust, and Hong Kong now has one of the most sophisticated financial
infrastructures in the world.
29. It is of course up to the Administration to consider whether, for political
reasons, the unusual arrangements for the appointment of the Monetary Authority and the
framework defining his accountability should be looked at. But it should be remembered that
those unusual arrangements had the agreement of the Legislative Council as recently as late 1992
when it approved the required amendments to the Exchange Fund Ordinance. Admittedly, the
details of the amendments then reflected expediency dictated by political considerations at the
time. But the arrangements have worked well for Hong Kong.
30. The Administration may feel that there is a need for the existing arrangements
to be replaced by a separate Ordinance establishing an institution called the HKMA, having its
own board and clearly defined functions. This appears sensible and is at least consistent with
arrangements in other jurisdictions. But it is my strong view that, should this be considered
desirable for whatever reasons, the opportunity should be taken to achieve greater and not less
autonomy for the HKMA. There should be more, and not fewer, safeguards against political
interference in the work of the HKMA. The Administration has indicated that it will take the
matter forward in due course and no doubt the Legislature will be consulted when the
Administration has formulated more concrete proposals. My advice, for what it is worth, is to
proceed cautiously and in quieter times when market conditions are less unsettled.
31. Thank you very much again for giving me the honour of delivering the Susan
Yuen Memorial Lecture.