Former monetary authority chief Joseph Yam Chi-kwong dropped a bombshell yesterday by saying it's time to review the long-standing peg between the Hong Kong and US dollars.
But Yam - who for three decades staunchly defended the peg as the best safeguard for Hong Kong's long-term prosperity and stability - was roundly criticized for calling for a review of the peg just weeks before the SAR's new administration takes over.
Senior finance and monetary officials strongly insisted they see no need to change a system that has served Hong Kong well for 29 years.
Lawmakers questioned his motives, while bankers and market watchers wondered whether any changes are indeed necessary.
The incoming administration of Chief Executive-elect Leung Chun-ying also waded into the controversy.
As Yam released his hugely controversial thoughts, outlined in an academic paper, the Hong Kong dollar swung higher by 69 basis points to 7.7535 per US dollar.
But as government officials rushed to reaffirm their support for the peg, the currency gave up nearly all its gains.
Yam, who retired as head of the Hong Kong Monetary Authority in October 2009, helped construct the linked change rate mechanism in 1983.
He is currently an executive vice president of the China Society for Finance and Banking, a think-tank of the People's Bank of China.
Yam held a press briefing to explain the unexpected departure from his long- standing defense of the peg. He said "the circumstances have changed" in that the US dollar has continued to weaken, and that monetary loosening in developed markets has sparked inflation in Hong Kong.
In a paper titled "The future of the monetary system of Hong Kong" published online less than three weeks before the new administration takes office, Yam argues that "asset bubbles have been a feature of Hong Kong's economic development [and have] unsettling and possibly debilitating consequences for society."
He wrote the paper in his capacity as a distinguished research fellow of the Institute of Global Economics and Finance of the Chinese University of Hong Kong.
Yam denied any political motives, saying the timing of the publication of the paper - shortly before Leung's administration takes office - was a mere coincidence.
He said he began writing it after campaigning for losing candidate Henry Tang Ying-yen in the chief executive election.
Yam suggested that the government may widen or remove the trading band [currently between HK$7.75 and HK$7.85 per dollar], re-pegging with a basket of currencies or even allowing the currency to float freely.
"There is a need to address the question as to whether the monetary system, as currently structured, can continue to serve the public interest," he wrote.
Other than exchange rate stability - which the peg guarantees - price stability, high employment and sustained growth are all in the public interest, and monetary policy can help achieve them.
It is also unrealistic to expect the monetary system to serve the domestic needs of its seven million people, while continuing to serve the needs of international financial intermediation between China and the rest of the world while at the same time maintaining monetary and financial stability, Yam wrote.
The peg, he said, has also caused growing concerns about the "yuan premium" getting bigger all the time, leading to mainlanders "eroding the respect" of Hong Kong people.
Moreover, he implicitly slammed the government's lack of motivation to even consider reviewing the peg and for not maintaining appropriate fiscal prudence. "Frankly, I have worries [whether there is] political willingness to pursue prudent macroeconomic policies."
He added: "I don't see financial discipline ... for example, the HK$6,000 [per head given away by Financial Secretary John Tsang Chun-wah last year]."
Yam said, when expressed in Chinese, democracy, public opinion and public standing are "are all just one word away from populism."
Anita Fung Yuen-mei, chairwoman of the Hong Kong Association of Banks, said the peg has been effective over the past three decades.
The system is the best for Hong Kong as a small and export-oriented economy, she said.
Fitch Ratings said it is a fundamental basis of the city's AA+ sovereign rating.
It said Hong Kong's economy is growing well, with sustained budget surplus, and that it would be difficult to grasp what other monetary system could replace the existing mechanism.