Economic integration and the circulation of Hong Kong dollars in Southern China

As the economies of Hong Kong and southern China have in recent years become more closely integrated, the phenomenon of currency substitution has gained in importance. This article provides both theoretical and empirical analyses of the circulation of Hong Kong dollars in Mainland China. The observed phenomenon of currency substitution is first explained from both macro- and microeconomic perspectives. The empirical study then estimates the quantity of Hong Kong dollars circulating in southern China over the last fifteen years. Regression analysis indicates that the growth rate of Hong Kong's foreign direct investment in China, as well as the growth rate of trade between Hong Kong and China, and the difference in real returns between Hong Kong dollar denominated assets and Chinese renminbi denominated assets are some of the main determinants that have contributed to the widespread circulation of Hong Kong dollars in southern China.