Asia FX

Here's why the Trump administration's threat to hurt Hong Kong's dollar peg won't work

Key Points
  • The top advisors of U.S. President Donald Trump were considering proposals to strike against the Hong Kong dollar peg, according to a report by Bloomberg this week, citing sources.
  • Analysts suggested that, however, the U.S. is essentially almost toothless in hurting that peg.
  • Washington's interests are at stake, analysts say, pointing out that banning Hong Kong from buying up U.S. dollars is a "nuclear option" that would overturn global financial markets, including those in the U.S.
Hong Kong one-hundred dollar banknotes and U.S. one-hundred dollar banknotes are arranged for a photograph in Hong Kong on April 15, 2019.
Paul Yeung | Bloomberg | Getty Images

The U.S. threat to look for ways to hurt the Hong Kong dollar's peg to the greenback will not likely be realized, analysts say.

Strategists at Singapore bank DBS say the U.S. "cannot unilaterally revoke the HKD peg."

Top advisors to U.S. President Donald Trump were reportedly considering proposals to strike against the Hong Kong dollar peg, in a bid to punish China's move to implement a national security law on Hong Kong, said a report by Bloomberg last week citing unnamed sources.

Bloomberg reported that the Trump administration could undermine the peg by limiting Hong Kong banks' ability to purchase U.S. dollars.

The Hong Kong dollar has been pegged to the greenback since 1983, and trades at a tight band of $7.75 to $7.85 Hong Kong dollars per U.S. dollar. When it veers too close to either end, the city's de-facto central bank — the Hong Kong Monetary Authority (HKMA) — would intervene by selling or buying the currency.

The Chinese parliament last month voted to pass the controversial national security law — a move that drew criticism from some leaders in the U.S. and the U.K., and raised concerns the city's freedoms could be eroded. Hong Kong is a special administrative region of China.

The Hong Kong government maintains that the legitimate rights and freedoms of most of its citizens will be protected. Trump, however, said his administration was taking action to revoke Hong Kong's preferential trading status in response to the new law, as "Hong Kong is no longer sufficiently autonomous to warrant the special treatment."

U.S. can't act unilaterally

Analysts have suggested that the U.S. essentially can't do much to hurt the Hong Kong dollar peg.

"It is ... worth noting that Hong Kong has the autonomy to design its monetary regime, including exchange rate policy," analysts at asset management firm Amundi wrote in a note last month.

Strategists at Singapore bank DBS pointed to the Linked Exchange Rate System that Hong Kong implemented in 1983, which set the trading band and the currency system.

That system was in place even before the U.S.-Hong Kong Policy Act of 1992, when Washington gave Hong Kong its special trading status with the U.S., they added.

Hong Kong's Financial Secretary Paul Chan has stated that even if the US takes measures to make Hong Kong dollar settlement inconvenient, the government has a contingency plan.
Raymond Yeung
ANZ Research

Additionally, under the 1992 Act, there's a clause which states that the U.S. will continue to allow the U.S. dollar to be "freely exchanged" with the Hong Kong dollar, pointed out ANZ Research's Raymond Yeung in a note last Wednesday.

Beyond the technicalities of the law, Hong Kong is more than able to defend its currency even if Washington seeks to limit its ability to buy dollars, Amundi analysts say. The Chinese territory holds $440 billion in dollar-denominated foreign currency reserves — double the size of the city's entire monetary base, they say.

The HKMA can also call on China's central bank for U.S. dollars, Reuters cited the city's top finance official as saying recently.

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Hong Kong's dollar peg is the 'cornerstone' of its financial stability: HKMA

China has the world's largest foreign exchange reserves — at around $3 trillion, according to Reuters.

"Hong Kong and China's central government are prepared for this," ANZ's Yeung wrote, referring to the possibility of the U.S. undermining the peg. "Hong Kong's Financial Secretary Paul Chan has stated that even if the US takes measures to make Hong Kong dollar settlement inconvenient, the government has a contingency plan," he added, citing an article on Hong Kong's government news website.

Meanwhile, Washington's own interests are also at stake.

Analysts point out that banning Hong Kong from buying up U.S. dollars is a "nuclear option" that would overturn global financial markets, including those in the U.S.

To isolate Hong Kong from Wall Street and the dollar system could severely impair the HKD peg and Hong Kong's global financial center status, resulting in capital exodus.
Amundi

"Nuclear option would be costly," Amundi analysts said. It will have limited impact if sanctions are on individual institutions, while it can be "highly damaging" if extreme approaches are adopted.

"To isolate Hong Kong from Wall Street and the dollar system could severely impair the HKD peg and Hong Kong's global financial center status, resulting in capital exodus," they said.

DBS analysts said: "Given Hong Kong's importance as the third largest forex centre and its status as an international financial centre closely integrated with the global economy and financial system, it is improbable that the US would deny Hong Kong access to the USD clearing system."

HKD surging on strong inflows

Demand for the Hong Kong dollar has surged this year, despite fears the peg could be threatened on the back of those U.S.-China tensions. The HKMA intervened in the Hong Kong dollar peg at least 23 times since June 5, according to CNBC's calculation.

The Hong Kong dollar was last trading at $7.75 per the greenback — the strongest the band allows.

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The strength of the Hong Kong dollar is due to strong inflows the city has seen this year.

There have been a number of mega listings in Hong Kong, including Netease and JD.com, which raised 21.09 billion Hong Kong dollars ($2.7 billion) and 30.05 billion Hong Kong dollars ($3.87 billion) respectively.

"The multiple interventions to defend the strong limit of the convertibility band since April have been associated with the bumper crop of IPOs. This is also a testimony to HK's draw as a international financial centre and the gateway to China," Philip Wee, foreign exchange strategist at DBS told CNBC in an email.

The IPO market in greater China has been red hot this year, bucking the declining trend in the rest of the world. According to data from EY, Hong Kong and Shanghai markets drove up the number of deals as well as total amount raised.

CNBC's Vivian Kam contributed to this report.