Could the US cut Hong Kong off the dollar?

Could the US cut Hong Kong off the dollar?
Source: Reuters

As tensions between the United States and China continue to rise, the possibility that the Trump administration may adopt a “nuclear option” by cutting Hong Kong off from its supply of US dollars remains on the table.

But with experts claiming that such a move would ultimately harm the US just as much as it would China and with Chinese financial institutions already making contingency plans for such a dramatic escalation, the question is not whether the US could cut Hong Kong off from the US dollar, but whether it should.

Heightening tensions

The implementation of a long-awaited security law in the territory of Hong Kong earlier this year has seen tensions between the US and China rise dramatically. Despite claims by Hong Kong Chief Executive Carrie Lam that the new law would restore stability to the territory, protesters took to the streets in defiance of what they saw as the stripping away of Hong Kong’s remaining rights and the degradation of the “one country, two systems” compromise.

President Trump claimed that this move was part of China’s goal to “fundamentally undermine Hong Kong’s autonomy” and a move that “constitutes an unusual and extraordinary threat … to the national security, foreign policy, and economy of the United States,” given its connections to Hong Kong.

The new law also prompted US Secretary of State Mike Pompeo to claim that Hong Kong no longer possesses a “high degree of autonomy” from Chinese direct rule and could no longer be treated differently to the mainland as was traditional.

These statements came as the US adopted the Hong Kong Autonomy Act in July with significant bipartisan support. This act would impose sanctions on individuals responsible for undermining Hong Kong’s autonomy, as well as those banks and financial institutions supporting these efforts.

It is under this law that President Trump could seek to enact the “nuclear option” and completely deprive Hong Kong of its supply of US dollars.

Dollar diplomacy

As a response to Beijing’s encroachment upon Hong Kong’s autonomy, some advisers within the Trump White House have envisioned eradicating the territory’s valuable US dollar supply.

To do this, the US could cut off Hong Kong’s access to SWIFT. SWIFT (the Society for Worldwide Interbank Financial Telecommunication) is the network used by banks around the world to send and receive information about financial transactions.

Completely removing Hong Kong from the network would deny the territory access to transactions with banks on the network, effectively cutting off the supply of American dollars.

Crucially, the Hong Kong dollar has been “pegged” to the USD in value since the 1980s.

A more targeted approach, as outlined in the Hong Kong Autonomy Act, could see the US sanctioning certain individuals and institutions involved in the recent actions against Hong Kong’s autonomy.

This move is not without precedent, as Chinese companies have seen targeted sanctions imposed against them before. Zhuhai Zhenhua Group Co., the state owned oil company, was punished for breaking US sanctions with Iran and the Bank of Kunlun was also previously cut off from the US payment system.

According to the South China Morning Post, such a move would see the territory “losing its status as an international financial hub” and would undoubtedly be a significant escalation in the economic conflict between the US and China, which may prompt China to reverse course.

Some commentators see this new form of “dollar diplomacy” as an effective option to curtail China’s encroachment upon Hong Kong. According to Kenneth Rapoza, “the dollar is the weapon. China can’t survive as it does without it.”

Using such a weapon in the war of words with China has already been denounced by aides close to US government officials with experts warning that just because the US could cut off Hong Kong’s dollar supply doesn’t mean it should.

The nuclear option

The aftermath of the new national security legislation in Hong Kong, coupled with rising US-China tensions, Hong Kong protests and the impact of the coronavirus, has created an atmosphere of significant uncertainty for US businesses operating in the territory.

A survey conducted by the American Chamber of Commerce found that 76 percent of American companies in the territory were “somewhat” or “extremely” concerned about the powers of the legislation and another 48 percent worried that unknown risks associated with the new law could impact on their business operations in the city.

Yet, American business remains entrenched in Hong Kong and economic ties in general remain entangled. The same survey found that 51 percent of firms believed that the new legislation would not negatively impact their operations and only a minority, 35 percent, were considering moving their operations, capital and assets from the city.

Despite rising tensions, the US government itself still has a significant economic stake in Hong Kong. The government maintains a portfolio of US$5.2 billion in Hong Kong property and thus has significant ties to the territory that would be impacted by any action seeking to hurt the Hong Kong economy. Hong Kong also remains a significant entry point for US investment in China more broadly.

Although envisioned as a “nuclear option,” depriving Hong Kong of US dollars may not even have the effect intended by its proponents.

Chinese financial institutions are already adopting contingency plans in the event of such a drastic move and some Chinese remain cautiously optimistic that they could survive such developments. One Chinese official was quoted in the South China Morning Post as stating that such a move “would hurt China, but it would probably hurt the US more.”

Both Hong Kong and Chinese banks hold significant USD reserves, which could mitigate the impact of the “nuclear option” by cutting off Hong Kong’s access to the dollar payment system. Hong Kong itself holds more than US$440 billion dollar-denominated foreign currency reserves, which is double the size of the city’s entire monetary base. China’s top four banks also have a combined US$1.1 trillion in US dollar liabilities.

Ultimately, the move to cut off Hong Kong’s access to the US dollar has been recognized by experts as a drastic “nuclear option” but one that is still unlikely to occur.

According to Ding Shuang, senior economist for Standard Chartered PLC, cutting off Hong Kong’s access to US Dollars would have “profound and unpredictable implications not only for China’s banks, but also the U.S. banks and the global financial market.” It would, according to Shuang, be a “potentially self-defeating approach” should the US adopt it.

Given American economic ties to Hong Kong and American businesses that operate out of the city, coupled with Chinese readiness to weather this dramatic escalation of its economic conflict with the US, such a move may be ill-advised.

As Kevin Lai, chief economist for Asia, excluding Japan, at Daiwa Securities Group Inc. recognizes, cutting Hong Kong from SWIFT and subsequently eliminating its supply of US dollars would be “unlikely but not impossible.” The threat of such an unprecedented move may yet be the intention.

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