In the wake of Hong Kong unrest, China has passed a new security law that increases its grip over the territory. (Getty)
  • Bloomberg reported this week the US might restrict Hong Kong's access to US dollars and potentially spell an end to the Hong Kong dollar's 37-year currency peg to the US dollar.
  • One analyst, however, rubbished the threats, saying that such a move "would be an act of war" and wouldn't be implemented by the US.
  • He also said Hong Kong and China both have combined reserves of US dollars of more than 3.5 trillion, which would effectively render the removal of the currency peg pointless.
  • That's because China and Hong Kong governments could simply use their dollar reserves to prop up the Hong Kong dollar regardless.
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Tensions between the US and China ratcheted up this week after the White House reportedly threatened to remove a long standing peg between the US dollar and the Hong Kong dollar - risking widespread chaos in financial markets - in response to China passing a new security law that increases its grip over the territory.

But the chaos that a dramatic move to decouple the US dollar from the Hong Kong dollar would cause is the precise reason the US will never follow through, according to one analyst.

Jeffrey Halley, senior market analyst, Asia-Pacific at OANDA, told Business Insider that the US would "completely be shooting themselves in the foot because that would have a snowball effect through the whole financial system."

"Even the Trump administration wouldn't be that dumb," Halley said.

Bloomberg reported Wednesday that the idea to remove the peg has been escalated as high as Secretary of State Mike Pompeo.

While the suggestion is still in its infancy and hasn't gained much traction, it has still caused jitters in markets, causing many to speculate what the end of the currency-peg could mean.

The currency peg has been in place since 1983, which has paved the way for the Hong Kong dollar to trade in a strict band around 7.8 Hong Kong dollars per US dollar. Currency pegs allow smaller nations, in this case Hong Kong, to plan longer term for spending and business than with a free floating currency.

An act of economic war

"I think actually it's worked very, very well for Hong Kong because Hong Kong has always had the special trading status with the United States," Halley said.

When the system was introduced in 1983, the currency peg meant that Hong Kong imported US monetary policy and adopted all US interest rate policy decisions.

Halley said the US could never realistically go down the path of removing the peg as restricting Hong Kong's access to US dollars would create an economic divide across financial markets worldwide, with the US being in one camp and China being in another.

A confidential source told Bloomberg that changing Hong Kong's dollar peg with the US is a less popular option than canceling a US-Hong Kong extradition treaty, or ending co-operation with Hong Kong's police, Bloomberg reported.

Removing the peg would be "a declaration of economic war," Halley said.

China and Hong Kong have enough US dollars to offset any losses

He also noted that both Hong Kong and China have large US dollars reserves, meaning that even if the US did go down this route, it would effectively be pointless as they could prop up the currency artificially by buying large amounts of Hong Kong dollars

China holds more than $3 trillion of foreign exchange reserves and Hong Kong may look to use that to offset any losses due to sanctions. Hong Kong itself has around half a trillion US dollars in reserve.

Analysts have predicted any retaliation from the US could undermine Hong Kong's position as the sixth-largest financial center and prompt it to lose business to Singapore.

But the peg has been the "bedrock" of Hong Kong's financial system, and Halley said he doesn't think the US would dare meddle it with any time soon.

Halley said that previous US restrictions on dollars for countries, such as Iran, were not comparable.

"Hong Kong is not Iran. Iran was a disbarred country that's already economically and politically isolated on its own. Anyway, Hong Kong is an intrinsic part of the fabric of the world's financial system."

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