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1997 Hong Kong Financial CrisisFNCE 101 001
04/24/14Group 2
Tianyu Guan, Tianran Hang, Tianni Lin, Yiran Zhang
Roadmap
• Macroeconomic Overview
• Analysis on Macroeconomic Issues & Policies Implemented
• Exchange rate
• Interest rate
• Outcome of the Crisis
Macroeconomic Overview
• Started in other Southeast Asia countries contagion
• Thailand, Philippine, Malaysia, Indonesia, Taiwan, Hong Kong, South Korea
• Hit Hong Kong on 23 Oct 1997
• 2 rounds of speculative attacks
• Lasted until end of 1998
• Pegged Exchange Rate
• Since 1983
• USD:HKD=1:7.8
Macroeconomic Overview
• GDP growth rate decreased
Macroeconomic Overview
• High inflation
Macroeconomic Overview
• Consumer spending decreased
Macroeconomic Overview
• Investment declined
Macroeconomic Overview
• Housing bubble burst
Macroeconomic Overview
• Interest rate skyrocketed
Macroeconomic Overview
• Unemployment rate rose from 2% to 6%
Macroeconomic Overview
HKD Pegged to USD
• HKD had been pegged at 7.8 to the U.S. dollar since 1983
• Benefits• Eliminates exchange rate risks
• Attracts foreign investors
Reasons of Overvalue of HKD
• High Inflation compared to the US
• Significantly higher inflation than US for a few years
• HKD devaluation
Reasons of Overvalue of HKD (Cont’d)
• Depreciation of Southeast Asian currencies
• Southeast Asian currency (e.g. Thai baht) depreciation
• Pegged floating
• USD appreciation
• HKD (pegged) appreciation
• Underlying economic conditions unchanged
Overvalue of Hong Kong Dollar
Speculative Run on HKD
• In October 1997, speculators, such as George Soros, initiated speculative attack
on HKD
• Borrowed HKD
• Converted HKD to USD at the overvalued exchange rate
• Increased supply of HKD
• HKMA had to spend reserves to maintain the demand of HKD
Speculative Run on HKD
• Speculators’ idea:
• Everyone wanted sell HKD.
HKMA needed to buy HKD, and
its reserves ran out quickly
• Fundamental exchange rate
further decreased
• Even more loss of reserves
occurred HKD devalues
profit from speculation
Speculative Run on HKD
• Speculators’ assumptions
• HKMA would run out of foreign exchange reserves
• Declining export
• Decreasing reserves
Speculative Run on HKD
• Speculators’ assumptions
• HKMA would run out of foreign exchange reserves
• Little government intervention on its economy prior to the crisis
• Chinese government was not likely to help out Hong Kong
Policy to combat the speculative attack
• Pegged floating exchange rate
• Thailand, Philippine, Taiwan
• Foreign exchange reserve shortage
Policy to combat the speculative attack
• Increase demand for local currency
• Hong Kong Monetary Authority
• More than US $80 billion in foreign reserve
• Spent more than US$1 billion to defend the local currency
• Chinese government guaranteed to maintain Hong Kong’s economic stability
• Interest rate skyrocketed
Interest Rate
Reasons of Increased Interest Rate
• Increase of US interest rate
(1+iHK)=(1+iUS)enom,t/eenom,t+1
Reasons of Increased Interest Rate
• Currency board system
Second Round of Speculative Attacks
• Short selling HK stocks
• Double-play
• Interest rate
• 15 Aug 1998
• Overnight interests rate:
8% 23%
• Briefly touching 280%
Second Round of Speculative Attacks
• Heng Seng Index
• 1997 peak: 16,673 23 Oct 1997: 9,060 Oct 1998: 6,660
Policy to save the stock market
• Government purchased US $15 billion of stocks
• Owned 7% of stock market
• Sell off in 1999
• Tracker Fund of Hong Kong
• US $4 billion profit
• HKD still pegged to USD
• All other Asian countries floating exchange rate
Outcome of the Crisis
• Took 10 years to return to GDP level before the crisis
Outcome of the Crisis
Outcome of the Crisis
• Deflation and then moderate inflation (~4%)
• Risks of future currency crisis?
• Lower inflation
• No contagion risk
• Successful defense of currency fended off speculative attacks
Outcome of the Crisis
Questions?