This happens all the time with fixed exchange rates and currency boards.
The only way for banks to get ‘real’ (convertible) $HK for their depositors is to buy them from the monetary authority with $US. That usually means banks have to borrow $US to meet withdrawals of $HK, and most banks won’t have $US lines of more than a relatively small percentage of their deposits. With a strict currency board arrangement the monetary authority isn’t allowed to lend (convertible) $HK or its $US reserves, though in HK they sometimes do. But even those reserves are finite, and way smaller than total bank liabilities.
Historically the result has been a deflationary mess, with GDP dropping double digits, high unemployment, bank failures, and collapsing property and other asset prices.
At the macro level, the only way the island can get the $US it needs to buy $HK from the monetary authority is to net export (or sell assets for $US). The value of the $HK can’t go down (the monetary authority has more than enough $US reserves to buy back all the real $HK it’s sold), so the way costs of production go down is via local deflation due to the collapse in aggregate demand until prices are low enough to drive the needed exports.
Hopefully nothing comes of it this time around. But it hasn’t been that kind of year…
Hong Kong Savers Fret as Bank East Asia Fights Rumors
by Kelvin Wong and Theresa Tang
Sept. 25 (Bloomberg) For the first time since the Asian financial crisis more than a decade ago, Hong Kong has faced a bank run.
Hundreds of depositors lined up at the city’s third-largest lender Bank of East Asia Ltd. yesterday as the bank hit out at “malicious rumors,” and Chairman David Li rushed back to Hong Kong from the U.S. to reassure clients and investors. The city’s central bank jumped to BEA’s defense and police said they’re investigating phone text messages questioning its health.
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