the short - term economic crisis that ensued served to bring policies to task and to trigger lasting economic reforms in some countries, notably chile. more recent experience, however, raises serious questions about this view of the role of international capital as a robust, reliable and objective referee of the soundness of economic policies. events during the asian crisis naturally come to mind. the flight of international capital bore practically no relation to a forward - looking assessment of changes in the policies and macroeconomic fundamentals of the region. it is true that some countries were pursuing quasi - fixed exchange rate regimes that may have allowed pressures to build up for too long. but these same exchange rate regimes were in place when the funds were flowing in, which suggests that they were not viewed as a serious structural flaw by investors at that time. similarly, the underlying weaknesses in many asian economies that so many observers ( with the benefit of hindsight ) now point to — ‘ crony capitalism ’, inadequate risk management, speculative lending to the property sector — were all present at the time when the funds were pouring into the region. not only did these weaknesses fail to deter investors on the way in : the abundance of inward investment prior to the crisis tended to exacerbate the problems, rather than act as a corrective force on policies. more recently, we have witnessed what appears to be the start of a new wave of capital flowing back into the region, even though it is far from clear that these structural problems have been fully addressed. i think it is not going too far to say that these ‘ hot ’ capital flows not only failed to act in a way that policed policies effectively, but actually became a powerful destabilising force in their own right. the huge swings in interest rates and exchange rates that resulted from capital flight in this region did far - reaching damage to corporate, financial, and government sectors, which, in turn, reinforced the initial withdrawal of capital. in such an environment, it requires a very courageous investor to be willing to step in against such a speculative tidal wave, regardless of how far out of line with reality markets may have gone. pursuing sustainable exchange rate and monetary policies requires countries to devise defensive strategies against such forces. this is no easy task. capital controls have been suggested by some. in hong kong ’ s case, such controls would be anathema to our free market philosophy : they are anyway prohibited by hong kong ’ s basic law ( as they are, with effect from 20 december

some of the more lurid scenarios that are being drawn up for the first of january 2000. our topic this morning, however, is not the year 2000 problem, but the perennial question of how to devise sustainable and realistic monetary and exchange rate policies in an uncertain global financial environment. the first part of my presentation will deal with the theoretical and practical approaches to this issue, particularly in the light of the asian financial crisis. in the second part, i shall focus on hong kong ’ s experience, since 1983, of a linked exchange rate system. finally, i shall return to the regional perspective and examine the prospects for greater exchange rate stability through monetary co - operation and other routes. choice of exchange rate regime few of us, i think, would disagree with the proposition that there is no single exchange rate regime that is suitable to all economies all of the time. indeed, given the experience of the last couple of years, one may be tempted to conclude that there is no regime that is satisfactory any of the time. the difficult choices and trade - offs involved in devising a workable regime call to mind a cartoon i once saw that theorised that the dinosaurs became extinct when they tried, unsuccessfully, to devise an exchange rate mechanism. but modern governments cannot escape the choice, and it is opportune to reconsider what options are available in light of the recent experience in asia and elsewhere. it is now well understood that exchange rate and monetary regimes are inextricably linked. the days when significant barriers to capital movements allowed governments to pursue independent monetary and exchange rate policies are long gone. so any decision on an exchange rate framework is not narrowly confined to external considerations, but must reflect broader policy choices, as well as the structure of the economy in question. the practical and theoretical considerations involved in deciding on an appropriate exchange rate system can be reduced to four broad factors : the external versus domestic orientation of the economy ; the flexibility of its cost - price structure ; the exposure to financial shocks ; and the reputation and credibility of policy makers. these factors, naturally, differ from one economy to another. in theory, the choice is straightforward enough : the best system is the system that best accommodates a country ’ s “ natural endowment ” of these factors. success in practice, however, is not simply — or even primarily — a question of choosing the preferred exchange rate framework from a textbook perspective. policymakers on the ground need to address the much more demanding challenge of ensuring consistency between