Dear Maietto,
As requested, here are 493 words of my own in essay format comparing
Australia's exchange rate system to that of Hong Kong. I worked as
fast as I could.
Sincerely,
Wonko
In 1983, Australia and Hong Kong exchanged roles regarding how the
exchange rate for their currencies would be determined. The
transition from a fixed exchange rate to a floating exchange rate
resulted in a 38% decline in the value of Australia's currency three
years after the currency was floated. In Hong Kong, a multiyear
period of currency depreciation resulted in a desire to implement a
fixed exchange rate. In both cases, the countries traded stability of
exchange rates against domestic control of interest rates and money
supply. Curiously, at almost exactly the same time, the two countries
made opposite choices.
Prior to late 1983, Australia practiced a highly interventionist
approach to exchange rate determination managed by the Australian
Reserve Bank. Until November of 1976, Australia fixed its exchange
rate with respect to a particular currency or a trade weighted index
of currencies. After November of 1976, Australia switched to a pegged
system, which allowed limited exchange rate fluctuations. In December
of 1983, Australia opted for a floating exchange rate, which allowed
the foreign-exchange market to determine its currency's exchange rate.
As a result, Australia gained control over its interest rates and
domestic money supply because it no longer had to manipulate them to
control its currency's exchange rate.
In contrast, in response to an increasingly rapid drop in its
currency's value resulting from the uncertain outcome of negotiations
between China and Great Britain regarding its status, Hong Kong
adopted a fixed exchange rate. Like Australia from November 1971 to
September 1974, Hong Kong elected to peg its currency to the United
States dollar. Although Hong Kong has successfully maintained its
currency at the rate of HK$7.80 to the US dollar, the absence of
controls on capital flows results in Hong Kong's domestic interest
rates being primarily determined by the United States. As a result,
domestic interest rates may not match locally prevailing economic
conditions, leading to broader swings in inflation rates than most
developed countries are accustomed to. However, as an economy based
primarily on trade, the importance of currency value stability
outweighs the disadvantages of its lack of control over other aspects
of its domestic economy.
In conclusion, the current approaches by Australia and Hong Kong to
establishing their currencies' exchange rates are opposite.
Differences in the economic development of the two countries led to
different choices, with Australia switching from a fixed exchange rate
to a floating exchange rate and Hong Kong switching from a floating
exchange rate to a fixed exchange rate. As a relatively large economy
that is not exclusively trade dependent, the advantages of having
control over the domestic money supply and interest rates outweighs
the disadvantage of a potentially volatile exchange rate for
Australia. In contrast, the small, heavily trade-dependent economy of
Hong Kong makes stability of its currency paramount to its economic
success. Therefore, despite having made completely opposite choices,
both countries appear to have made the right choice in light of
presently accepted economic theory. |
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