| Hong Kong and Mainland China are becoming economically ever more intertwined, but their money and exchange-rate systems still are separate. The exchange rates of both yuan and the HKD remain tied to the USD. However, as capital controls are gradually being dismantled on the Mainland, there is a growing potential for exchange speculation that could destroy both China's internal fixed exchange rate and Hong Kong's USD-based currency board. For instance, an appreciation of the yuan against USD would greatly reduce Hong Kong's profitability as its yuan-indexed intermediate inputs from the Mainland are far more than its yuan-indexed proceeds from final sales to the Mainland. Against this background, the dissertation explores ways optimally to achieve monetary unification of Hong Kong and Mainland China before there is a crisis and the yuan is cut loose from the USD.; The dissertation develops an original 1995--2002 dataset of three banks' daily yuan/HKD retail rates. It is used to analyze the credibility of the internal yuan/HKD exchange-rate fixity by considering the reaction of the retail rates to changes in the official reference rate and of the retail rates to each other. Granger-causality tests and variance decomposition of the VECM-based ordered prediction errors show that a bank tended to become more sensitive to its peers' quotations, i.e., more inclined to herding, when the credibility of China's fixed internal exchange-rate regime was declining.; The most desirable approach to Chinese monetary union is not to decree that HKD claims be converted directly to yuan. Doing so would abrogate Hong Kong's currency-board commitment to treat HKD claims as interchangeable with USD claims. The dissertation instead proposes and analyzes a circuitous, market-based, and property-rights preserving approach. Hong Kong should transitionally adopt US-dollarization to honor its currency-board parity, after which yuan can be safely released from its de facto peg to the USD, and then allow for free USD vs. yuan competition. Its continuing integration with the Mainland and the latter's progress in economic and financial reforms would gradually strengthen the presence of yuan in Hong Kong through market forces and accommodative government actions and eventually lead to Chinese monetary union. |
