The Hong Kong currency has been pegged to the U.S. dollar for almost 30 years, even though it is a British colony. This was never a big deal until the tension between the U.S., the U.K., and China started over the autonomy of Hong Kong, drawing attention to the currency as well.
How it works
The Hong Kong central bank must keep the currency trading at HK$7.75 to HK$7.85 per U.S. dollar. The current value was set in 2005 and has never been broken, although it wasn’t always easy to keep it that way. When it gets too close to one end or another, the Hong Kong Monetary Association (HKMA) has to intervene by buying or selling the city’s dollars on the stock market.
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Why the currency always has to keep the same value
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The currency peg is considered as the primary link for financial stability and the economy. Investors put their money into Hong Kong banks because the currency is relatively safe and easily convertible; this is one of the reasons why the city became a global financial center in the first place. Breaking the peg would upset that whole “steady” economy and business situation.
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Why is Trump trying to destroy it?
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Because it’s Trump, after all, when China said it would impose new national security Hong Kong legislation, the Trump administration said the city was no longer autonomous from the mainland to vouch for the “special status” given by the U.S. for trading purposes. That is when “officially,” the trade war started. The current arrangement also allows for U.S. dollars to be freely exchanged with Hong Kong dollars, which, if revoked, would amount to what is called the “nuclear option.” This could easily backfire and have much more significant damage to the U.S. and the global financial market. The currency wouldn’t be stable, and there is an excellent probability that people would pull their money out of Hong Kong. The currency would collapse, and with it, various businesses – cash wouldn’t flow in and out anymore.
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Should we be worried?
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Authorities in Hong Kong still say no. The HKMA has an astonishing $430 billion of foreign reserves itself. China’s central bank also can provide U.S. dollars through a currency swap line if Washington decides to impose sanctions on the city. China has the world’s largest foreign-exchange reserves, starting at more than $3 trillion. The HKMA also negates the possibility of pegging its dollar to the Chinese yuan because the U.S. dollar is still the “most appropriate anchor currency.” After all, it is fully convertible and can be traded freely in large amounts on foreign exchange markets. The yuan doesn’t fit that bill. The U.S. dollar is also heavily used as an international reserve currency, and the Fed has a good record of keeping price stability. Besides, Hong Kong’s business cycles are “still more synchronized” with the U.S. than mainland China, it says.
What impacts the Hong Kong Dollar?
Often it’s interest rates, especially when local ones don’t move together with the U.S. For example, when interbank rates on the Hong Kong dollar (Hibor) remain elevated as the Fed reduces borrowing costs, it becomes more beneficial for investors to buy the Hong Kong currency than the U.S. dollar. Since March, the gap between Hibor and the U.S. currency’s Libor has been around the biggest disbalance since 1999. That pushed the HKMA in April to sell the city’s dollars to prevent a break of the peg.
