Money chooses a safer place to go and chases higher returns. When the exchange rate is guaranteed, then the only consideration is the risk and return of the investment. That’s Obstfeld et al.’s (2015) Monetary Trilemma Story.

The trilemma is about capital mobility, monetary policies, and exchange rates. One can only choose any two of the three. For example, when the Hong Kong government decided to adopt the currency board arrangement since 1984, i.e. to peg a fixed exchange rate of HKD to the USD, and allows almost free capital mobility, then there cannot be any monetary policies of her own. It is a kind of coupling, which is prone to disruption, crisis and breakdown.

Imagine when the local economy is overheated with very high inflation, but the US Fed started the QEs and cut interest rate, which HK will basically have to follow so as to keep the exchange rate unchanged (It is the mechanism of arbitrage). Capital starts flowing in, it is like pouring gasoline onto a fire, the overheated economy would become a bubble economy! In reverse, when the local economy is gloomy, capital starts flowing out, but the government cannot increase interest rates to attract money back.

More recently, the European Central Bank’s researchers Maurizio Michael Habib and Fabrizio Venditti (2019) have confirmed the above trilemma findings of the Global Capital Flows. They “found convincing evidence of a global capital flows cycle connected to global risk. This connection is tighter among countries more financially open and adopting a rigid exchange rate arrangements [due to the monetary trilemma].” (p.22) Figure 1 shows the strong association between global capital flows and global risk.

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Figure 1 Global Capital Flows and Global Stock Market Factor. Source: Habib and Venditti (2019b)

The so-called global risks are categorized into the following 5, viz. Financial Shock, US Monetary Policy, Geopolitical Uncertainty, US Demand, and Unexplained, as shown in Figure 2. Unsurprisingly, US monetary policy accounts for a big chunk of it.

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Figure 2 Global Stock Market Factor. Source: Habib and Venditti (2019b)

Since all the 3 major factors are now co-existing, including a global recession (financial shock), the normalization of interest rate policy of the US and the US-China trade war (geopolitical uncertainty), it is said to be a “perfect storm”. Goods and services trading amounts have already been decreasing substantially, or will even be unprecedented, depending on the outcome of the negotiation between the US and China before Dec 15. There have been several bank runs in China in the past few months [1], a sharp cut in foreign lending is envisaged. Hong Kong being one of the few economies that adopt the currency peg system, has already been experiencing a recession (Yiu, 2019), and is expected to encounter a massive capital flight, but the government can do nothing. It is a trilemma!


[1] Beijing bailed out three troubled regional banks — Baoshang Bank, Bank of Jinzhou and Hengfeng Bank — earlier this year. see,


Habib, Maurizio Michael and Venditti, Fabrizio (2019a) The global capital flows cycle: structural drivers and transmission channels, European Central Bank, Working Paper Series № 2280, May.

Habib, Maurizio Michael and Venditti, Fabrizio (2019b) The global capital flows cycle and its drivers: Not only a US monetary policy story, VOX CEPR Policy Portal, Jul.

Obstfeld, Maurice, Jay Shambaugh, and Alan Taylor (2005), “The Trilemma in History: Tradeoffs among Exchange Rates, Monetary Policies, and Capital Mobility”, Review of Economics and Statistics87: 423–438.

Yiu, C.Y. (2019) Hong Kong Runs Ahead of the World to Jump Into the Global Recession First, Medium, Nov 1.

ecyY is the Founder of Real Estate Development and Building Research & Information Centre REDBRIC

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