Hong Kong's US dollar peg remains the least of all evils

Last month, American hedge fund manager William Ackman announced that he was going long on the Hong Kong dollar, which he considers 30 per cent undervalued. The rise in local inflation and property prices in the last year or so strongly suggest that he is right about the undervaluation.

Over the last 10 years, the currencies of Singapore, the mainland, Taiwan and South Korea have risen against the US dollar by 37 per cent, 29 per cent, 13 per cent and 11 per cent respectively. The Hong Kong dollar has not budged against the greenback; it has been dragged down along with it owing to the linked exchange rate system which pegs our currency to the US dollar.

Between 1998 and 2003, when other Asian currencies weakened, the peg forced us to go through internal devaluation: domestic prices and salaries came down bit by bit for 60 months of pain. Now we are in a repeat of the late 1980s and early 1990s; suffering high inflation because we cannot revalue.

The official line is that it is the price we pay for currency stability: total assurance that the exchange rate will be 7.8 to one US dollar, which is a huge help to traders and investors, and therefore our whole economy. This focuses on the positive impact of the peg. It does not consider the possibility that the price we pay could be too great and we could gain more than we lost with currency flexibility.

Officials do not want to consider any alternative - at least openly - because even talking about it could lead to market uncertainty and instability. Hedge funds would try to speculate, and we could see shopkeepers refusing US dollars, for example.

The peg is not just a guarantee of a particular exchange rate; it is a mark of credibility. This is why a supposedly one-off re-peg is impossible. No-one would trust our monetary system again. It may be possible to change the system in some way without damaging the integrity of Hong Kong's government, but it would take an extremely brave leadership to make the decision even in principle to adopt a new system.