As Geopolitical Tensions between Trump and Xi Escalates, Will the Hong Kong-US Dollar Peg Suffer?

As Geopolitical Tensions between Trump and Xi Escalates, Will the Hong Kong-US Dollar Peg Suffer?

Due to the lingering uncertainties, and the ongoing downward pressure from the recent stringent political response to contain the COVID-19 pandemic, the Chinese government suspended its annual GDP target for the first time, last week.

China’s GDP shrank by 6.8% in the first quarter. The fact that China discarded its GDP target shows the prevailing frustrations of the Chinese government on its economy.

And Chinese woes don’t stop there. As a creditor and promoter of its Belt and Road project, many of its partner nations have sought debt relief.

Aside from its economic turmoil, perhaps the worst part is with its growing division with the US.

Since the US government has charged that the Xi administration hasn’t been transparent with the way it handled the Covid-19 pandemic and sought damages from it, aside from the trade war, tensions from the pandemic have aggravated this rift.

Last week, the Trump administration moved to cut off China’s major telecom supplier Huawei from the global chip supply.

Later, it slapped sanctions on 33 companies for “supporting procurement of items for military end-use in China”.

The US government also condemned Beijing’s proposed passage of a 'new security law' in Hong Kong that bans "treason, secession, sedition and subversion" as a ‘death knell’ for freedom. 

Many fretted that the friction between the superpowers over Hong Kong could spillover to Taiwan.

And the Xi administration further fanned this speculation. Last Friday, in a report to the parliament about China’s plan to reunify with Taiwan, Chinese Premier Li Keqiang dropped the word “peaceful”, signaling a downward spiral in geopolitical relations. Taiwan also requested a sale of torpedoes from the US, angering Beijing.

Will geopolitical tensions centered on Asia escalate further?

If so, will this compound on strains on the Hong Kong Dollar-US Dollar peg presently afflicted by Hong Kong protests and the COVID-19 induced economic downturn?

Hong Kong’s GDP shrank 8.9% in the 1Q.

Moreover, mainland Chinese have been putting off Hong Kong investments, which has contributed to the weakness of the island’s real estate prices.  Office prices have recently been down.

And the economic recession plus price declines in real estate must have some effects on Hong Kong’s $25.231 trillion banking system (as of March) signifying a whopping  880% of Hong Kong’s $2.866 trillion 2019 GDP!  

Against the USD, Hong Kong’s dollar and the Offshore Yuan have gone in opposing directions.

Will US President Trump use the popular domestic sentiment to push for more conflicting rhetoric and policies against the Middle Kingdom to get reelected?

And if Mr. Trump does, will the Hong Kong USD peg, which has a narrow trading band between HK$7.75 and HK$7.85, survive? The decline of the Hibor’s Overnight and other rates must have been from HKMA’s boosting of the island’s monetary base since May 2019. Aside from domestic troubles, will a surge in USD outflows rattle the banking system?

And should the pressure on the HKD peg emerge, would this not escalate the volatility in global financial markets, worsen the global recession and magnify the risks of the coronavirus, trade, and cold war into a kinetic war?

We truly live in interesting times.