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Bloomberg reported last week that US government advisers have looked into the possibility of undermining the Hong Kong linked exchange rate system, according to sources, as a way to sanction China for imposing the National Security Law, which said to have curtailed Hong Kong’s autonomy.

However, the report added that the idea failed to gain traction, as the most obvious methods, like cutting banks in Hong Kong from getting USD funding, will hurt US banks as much as those in Hong Kong.

In general, I found the whole thing puzzling. Trying to deconstruct the HKD exchange peg with such brute force would obviously result in a lose-lose situation, as HK has been the gateway for western capital to invest in all kinds of Chinese opportunities with some protections from quasi-western style legal and social system. This means that the western economies have been reaping huge benefits from such win-win arrangement. Stopping USD funding from flowing into HK is indeed a nuclear option, which might hurt western economies’ interest even more than the NSL.

In fact, there are options that are more effective and beneficial to the US. One of them is to provide what I would call “financial refugee” to Hong Kong people.

The Backdrop

Under the linked exchange rate system, Hong Kong Monetary Authority maintains the exchange rate in the range of HKD7.75-7.85 to USD 1, with the support of its substantial holdings of foreign exchange reserves. Standing at around USD 440 billion, as of the end of May, the HKMA’s Exchange Fund is close to two times of Hong Kong‘s monetary base (about USD 228 billion), giving the central bank plenty ammunition to defend the exchange peg.

This actually, in turn, explains why the US advisers had to contemplate such blunt tools, like choking the USD funding supply to Hong Kong banks, as it is likely that without a banking or financial crisis in the city, the confidence in the exchange peg will remain high and self-reinforcing.

That’s also before accounting for a lately revealed USD swap line between the People’s Bank of China and HKMA, which, as it was claimed that, the Chinese central bank will provide short term USD liquidity to the city in case of crisis.

Hence, it is genuinely hard to break the HKD-USD with “outside” force without a major financial crisis in the city, which will likely hurt the economic interests of the west as much as those of Hong Kong and China, if not more.

But, what if the US can try to chip away the USD reserve that HKMA holds from the “inside”?


One way to achieve that is to help HKers emigrate. In fact, after the implementation of NSL, emigration from Hong Kong became a hot topic in town; The news that the UK is willing to offer a citizen pathway to holders of the colonial era British National (Overseas) passport and their direct relatives definitely added more fuel to the fire.

It has been a long-held belief among HKers that when the “one country two systems” stopped being recognized internationally, HK economy would be doomed instantly; and hence, the demise of the linked exchange rate system, as foreign capital would stop flowing into the city and HKers will send their money overseas.

That didn’t happen after the implementation of NSL, which many foreign governments claimed to have certified the death of “one county two systems”; in terms of the exchange rate, the opposite happened so far. The HKD exchange rate has been staying on the strong side of the peg (HKD 7.75 per USD), and HKMA has been selling HKD into the market to satisfy the demand.

There are many contributing factors to this “counter-intuitive” situation, including the fact that UK’s BN(O) pathway has yet been finalized and released, the same also go for other “refugee” plan from other western countries. Chinese corporations rushing to HK for IPO also help generate capital inflow to the city. And, as we wrote previously, the Fed’s QE had helped to enhance the linked exchange rate system, providing it with a new tool to help keep the exchange rate strong in uncertain times.

Also, emigration is a costly and lengthy process, and the worldwide Covid-19 pandemic created even more hurdles for HKers who plan to skip town in the near future.

This is where the “financial refugee” plan comes in the picture.

Emigrate (financially!)

The idea is for the US to give special permission to allow HKers to easily open a US-based USD bank account while they are stuck in Hong Kong. By providing such “financial refugee” accounts to HKers, who could have their wealth confiscated if deemed to have violated the NSL, it is, in effect, providing incentives for HKers to voluntarily withdraw USD from the HKMA’s Exchange Fund, and putting them into the US financial system, i.e. to chip away the tall wall that protects the HKD-USD peg.

I have to admit I don’t know enough about the US laws nor financial regulation to know if such a plan is realistic, especially it may have money-laundering implications. But I can imagine that US banks can possibly offer some sort of limited function deposit account, which can only invest in certain simple financial products, and have to declare before making large-sum money transfer, so to limit the problem.

Certainly, offering offshore deposit service alone will only have a limited impact in terms of capital outflow from the HKD financial system. If one still has to live in Hong Kong, HKD is still needed to pay for almost everything. This creates a rigid demand for HKD and limits the size of the potential outflow.

Nonetheless, if HKers can easily open US-based bank accounts, it seems likely that digital dollarization could easily follow, and recent experience in Venezuela offered an example.

Learn from VeneZelle

According to this excellent explainer by JP Koning, Venezuelan in recent years have been adopting Zelle, a U.S.-based payments network run by Arizona-based Early Warning Services, to conduct daily commerce and payments in USD. Zelle allows anyone with a US bank account to make instant fund transfer to another U.S. bank account for free, and Venezuelan repurposed it a way to make dollar payments to each other, and to retailers, supermarket and cafe.

In effect, they have digitally dollarized the economy without using physical dollar bills. They created a parallel payment network that is based in the US to serve the economic needs in Venezuela. It is very possible that a similar parallel system can work in Hong Kong if there is widespread adoption of the “financial refugee” account.

While Hong Kong doesn’t have the problem of hyperinflation, which served as a powerful incentive device for the Venezuelan to adopt the dollarization, the fact that HKD – USD peg had been well maintained at around HKD 7.8 per USD since the 80s provides a different kind of breeding ground for dollarization.

HKD prices can easily be converted into USD, simply by dividing it by a factor of 8 – the kind of mental accounting younger HKers used to when they shop on Amazon US store. HKers also have a reasonable adoption rate of digital payment, and they won’t feel much different whether the payment is denominated in USD or HKD.

If the “financial refugee” deposit accounts in the US are attractive enough, its combination with digital dollarization will create a virtuous cycle, moving a significant portion of money demand away from HKD; hence, the linked exchange rate system would be undermined, and the US would not be hurt in any way. The Hong Kong economy could also function as normal in the best-case scenario.

For sure, such an idea is just theoretical and without consideration of many real world limitations. For example, the fact that Wells Fargo decided to suspend Venezuelan customers from accessing their Zelle services last month suggests that there are regulatory and operational limitations to such digital dollarization; that’s even before we add in the equation the political implications for these banks, as their relationship with Chinese government may be “complicated” if they provide such services to HKers.

Also, even if in the extreme case that most local day-to-day payments are moved to US-based, it still doesn’t mean the HKD-USD peg will collapse. It can still stand strong as a unit of account in financial contracts — the currency you pay when you buy stock in the city, or the money you give your bank when you pay your mortgage — even if most residents decided against using it.


So, please just treat this as an unrealistic thought experiment on how the Linked Exchange Rate system can be, well, undermined. Last and definitely not least, one should note that under the NSL, I have to disclose that I condemn any vicious attempt by the US to interfere with the internal affairs of China, and I support the HK and Chinese government in defending the HKD exchange peg at all cost. Thank you!

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