China No Longer Needs HKD

The HKD peg to the USD is central to Hong Kong’s role as a global financial centre. This role has served the mainland well after the 1997 handover but more recently has become less relevant to its economic and financial strategy. As a result, the HKD peg and full convertibility could become casualties of the growing tensions between China and the US, and the HKD could get repegged to the CNY.

One Country, Two Systems

The HKD peg establishes a credible monetary policy and supports the full convertibility of the HKD as well as the currency stability that are essential to the functioning of Hong Kong’s financial markets. Based on economic and financial considerations alone, the continuation of the HKD peg would be unquestionable.

In the aftermath of the 1997 handover, Hong Kong’s global financial role and independence under the ‘one country, two systems’ formula have supported mainland domestic and global ambitions well.

Losing Importance in the Eyes of China

More recently, however, Hong Kong’s independence and global financial role have become less valuable to the mainland, for four key reasons.

First, Hong Kong is about to lose its privileged access to dual-use US technology. Starting with the Trump administration, controls of sensitive exports to Hong Kong, a growing security concern, have been tightened. This culminated with President Trump’s 28 May press conference when he announced the end of Hong Kong’s policy exemptions, including on sensitive exports.

Second, due to mainland financial deepening as well as the growing global footprint of mainland banks and corporates, Hong Kong has become less important to China as a source of funding.

Third, Hong Kong’s role in CNY internationalization has declined as China has moved on to a global strategy to build the global footprint of the CNY. While Hong Kong still has a role to play, it is no longer a central one.

Fourth, with the development of mainland ports, Hong Kong has become much less important as a trade partner to the mainland and as a conduit for its global trade.

Consequences for the Peg Amid Escalating US-China Tensions

The diminished relevance of Hong Kong’s global role to China’s global ambitions leaves the peg more exposed to the US-China rivalry. On the US side, President Trump, who was elected in part thanks to voters hit hard by globalization, has been pursuing an agenda of economic nationalism and of containing China’s alleged unfair global competition. In addition, following the COVID-19 epidemic, Trump can no longer campaign for the November elections based on the US economic performance. Instead, antagonism towards China has become a campaign theme that could help reach the independent voters he needs to win, as US public opinion of China is at a historical low.

On the Chinese side, since taking over in 2012, President Xi has broken with the Chinese foreign policy tradition to ‘hide one’s talent and bide one’s time’ with newly assertive nationalism. More recently, China has become increasingly confrontational not only with the US but also with India, Taiwan, and over disputed territory in the South China sea, which could reflect domestic political pressures. The core of the Chinese social compact is government provision of economic stability; the COVID-19 epidemic has weakened that. The recently concluded National People’s Congress did not adopt an explicit growth number, an implicit admission that growth is likely to remain low this year.

Conflict between the two countries is set to intensify as the new security law for Hong Kong gets implemented and as the November US presidential elections get closer. The US has criticized the law as a breach of the ‘one country, two systems’ agreement and in response announced a number of sanctions, including ending Hong Kong’s special status. China has replied by claiming foreign interference in its internal affairs and by threatening reprisals on the businesses of the US and its allies in Hong Kong.

Ending the HKD peg to the USD and substituting a peg to the CNY could be a step in the escalation of the conflict because:

• As discussed above, the HK peg is much less important to China’s financial and economic strategy than it used to be;
• It would hurt the business interests of the US and its allies in Hong Kong;
• It could be viewed as a Chinese assertion of national sovereignty since the current HKD peg is supporting the global role of the USD, rather than that of the CNY;
• It would lead only to a limited escalation of the conflict with the US since the strategic or economic importance of HK to the US is limited;
• While the HKD peg and full convertibility are enshrined in the Basic Law, the imposition through decree by the mainland of a security law for Hong Kong would establish a precedent for breaching the Basic Law.