Question

A monetary system is a scheme by which money is provided to facilitate exchanging of goods and services, and a well-functioning monetary system paves the way for effective allocation of scarce capital resources through financial markets.

(a) All currency notes and coins together represent only a small fraction of the money in a modern economy. Most of the money is in fact created in the banking system. Explain with an example how money can be created within a banking system.

(b) The renminbi will eventually crowd out the Hong Kong dollar as the preferred currency in Hong Kong as the economies of the city and Mainland China become more integrated. Do you agree with this statement? Justify your answer.

Answer 1

Answwer A) A monetary system is a scheme by which money is provided to facilitate exchanging of goods and services, and a well-functioning monetary system paves the way for effective allocation of scarce capital resources through financial markets.

The whole financial system of an economy enables ‘real’ activity – that is, the processes of trade and production of services and goods – to take place easily. Monetary and financial activities are thus part of economic growth.

Money can be created either by the central bank or by private sector institutions – in practice, mostly registered banks.

Money supply is maintained by creation of money, which is a complex and regular process to increase supply of money in an economic or monetary region. In the developed economies, the maximum portion of the money supply is generally in the form of bank deposits. Banks and other financial institutions are limited in total amount they can loan by implementation of many checks by central banks. Still by use of money multiplier approach , a bank can lend approx five times of their total deposit base.

The GDP of Hong Kong HK$2,669,009 million (nominal, 2017), total currency circulation is HK$ 440,570 million(source .censtatd.gov.hk ) clearly proves the statement of the question.

Answer b)

Hong Kong is serving as the bridge for the china trade to the world, transmission of trade as well as investments in both ways.

Mainland China had shown remarkable development in the past few decades and its trade and investment linkages with the world have greatly increased. The country stand on the position of second largest economy. The economy of Mainland China’s economy is highly integrated with the globe, the renminbi has become more widely used in trade and investment activities.

Since 2009,the Mainland Chinese authorities started a small scheme for renminbi trade settlement, the channels for the use of renminbi in cross-border transactions with Mainland China have expanded significantly.

In the current scenario, nearly all trade and transactions between Mainland China and other countries reported in renminbi. Foreign direct investment(FDI) into Mainland China, and outward direct investment from Mainland China to the rest of the world, can also be carried out in renminbi. Hong Kong is the biggest established international financial center and the premier renminbi business center.