(July 8): Some top advisers to President Donald Trump want the US to undermine the Hong Kong dollar’s peg to the US dollar as the administration considers options to punish China for recent moves to chip away at the former British colony’s political freedoms, according to people familiar with the matter.

The idea of striking against the Hong Kong dollar peg -- perhaps by limiting the ability of Hong Kong banks to buy US dollars -- has been raised as part of broader discussions among advisers to Secretary of State Michael Pompeo and hasn’t been elevated to the senior levels of the White House, suggesting that it hasn’t gained serious traction yet, according to people who discussed the matter on condition of anonymity.

The proposal faces strong opposition from others in the administration who worry such a move would only hurt Hong Kong banks and the US, not China, they said. Another person cautioned that the idea of attacking the dollar peg is lower on the list of possible options now under discussion. Those ideas include cancelling a US-Hong Kong extradition treaty and ending cooperation with Hong Kong’s police, the person said.

The State Department declined to comment when asked about the issue on Tuesday, as did the Treasury Department. Hong Kong’s financial secretary, Paul Chan, referred queries to the Hong Kong Monetary Authority, which didn’t immediately reply to a request for comment. The People’s Bank of China in Beijing also didn’t immediately reply to queries.

Chan said early last month that China’s central bank could provide American dollars should the US impose sanctions on the territory. The dollar peg is underpinned by about $440 billion of foreign-exchange reserves, which is more than two times the city’s money in circulation, he told China Central Television.

The proposal is a “nuclear-like weapon” and risks a complete decoupling between China and the US if in use, said Xia Le, chief Asia economist at BBVA Hong Kong. “It’s technically difficult to impose, and it’ll hurt the US a lot.”

Hong Kong has pegged its currency to the US dollar since 1983, allowing it to fluctuate within a fairly strict band that has generally centred around 7.8 per US dollar. The currency has remained strong due to its yield advantage over the greenback, demand for Chinese company share sales and persistent flows into the local equity market.

Markets Steady

Currency market indicators from spot prices to risk reversals reflected little appetite amongst traders to bet that the Hong Kong dollar could break its peg with the greenback in early Asian trading Wednesday. The currency traded at 7.7501 per dollar on Wednesday, or just one pip away from the strong end of the trading band.

The very idea that undermining the peg has even been raised offers some insight into the range of discussions now underway for punishing China. It has primarily been discussed at the State Department, where Pompeo has emerged as the administration’s loudest critic of Beijing’s recent decision to impose a new national security law on Hong Kong.

Two of the people familiar with the matter said a top administration priority has been finding ways to punish banks based in Hong Kong, particularly HSBC Holdings Plc. In a statement last month, Pompeo singled out Peter Wong, the bank’s Asia Pacific chief executive officer, for signing a petition supporting “Beijing’s disastrous decision to destroy Hong Kong’s autonomy.”

“That show of fealty seems to have earned HSBC little respect in Beijing, which continues to use the bank’s business in China as political leverage against London,” Pompeo wrote in the June 9 statement. HSBC wasn’t immediately available for comment outside office hours.

‘Unthinkable Instability’

The possibility of the Hong Kong dollar peg’s demise has become a focus of major financial bets including by Hayman Capital Management founder Kyle Bass, who started a fund last month making wagers on a collapse in Hong Kong’s currency peg, according to people with knowledge of the matter.

“It’s a fairly whacky idea that they would be able to force Hong Kong off the peg by some means,” said Patrick Bennett, head of macro strategy for Asia at Canadian Imperial Bank of Commerce. “I’ve been against the idea that Kyle Bass and others trying to break the peg -- that has been a spectacularly unsuccessful idea so far, and I expect it to be the same.”

One possible way for Trump to attack the peg would be for the US Treasury to limit American banks from providing dollar funding to Hong Kong and Chinese banks, which would drive the costs for such funding “exorbitantly” higher, according to Stephen Innes, chief global market strategist with AxiCorp. But he said this is unlikely because China could retaliate by taking action against US assets including Treasuries and stocks, and it could destabilize pegs elsewhere -- especially those maintained by US allies in the Middle East.

“The unthinkable instability that it would trigger in the USD-based global financial ecosystem could drive a selloff in US equity markets -- an outcome abhorrent to the White House ahead of the November presidential election,” Innes wrote in a note.

Speaking on Monday to Fox News, Pompeo said the US was mulling the possibility of banning ByteDance Ltd.’s social media app TikTok in the US, though he didn’t explain what authority the administration would use to do so.

“We’d love to preserve the freedom in Hong Kong,” Pompeo said. “But if we can’t, we’re going to hold the Chinese Communist Party accountable.”