US-China dispute: watch out Hong Kong, the credit cards in our wallets are in America's pocket

These are strange times we live in here in Hong Kong, and the challenges just keep mounting. Our lives have been turned upside down by protests, the coronavirus, and the knock-on effects of the new security law. Yet the Hong Kong dollar is strong, and despite rampant price inflation in the supermarkets we can still access and afford most goods we need. So far so good. Yet I am starting to wonder if Hong Kong's vulnerable position could put us in a position where one day we might struggle to pay for the things we need. Allow me to walk you through my reasoning.

The falling-out between China and the United States - with Hong Kong stuck in the middle - has led to sanctions being imposed on 11 individuals, including our Chief Executive Carrie Lam. And although they have largely dismissed the sanctions' impact, it does raise the question of how intertwined we are with the US financial system.

And, more to the point, what would happen here in Hong Kong if the US and China descend into a financial cold war and, because of some unforeseen event, our banks' global access is restricted.

Since the end of the second world war, the US dollar has been without equal in the global financial system. With such a track record, no country has yet come up with a powerful alternative to challenge the dollar's dominance. Consequently, and because of Hong Kong's role as a global financial centre, we are heavily reliant on the Americans. Not just to trade oil, gold and major commodities, but also in our daily lives through credit, debit and prepaid cards, for example.

The slogans roll off the tongue: Life takes Visa; American Express will do nicely; and for everything else there's Mastercard. Accepted in all countries across the globe, these card issuers have been the mainstay of our personal payment systems for over 40 years. And from time to time, US government sanctions have led to the withdrawal of their services, as they are all American and have to do what Washington tells them. Aside from these, there are China's UnionPay and Japan's JCB, but they do not have the same kind of footprint.

MasterCard and Visa are both American. Photo: Reuters

Visa, which handles about 44 per cent of all general-purpose card transactions around the world, is the largest card company and is based in California. It was started in 1958 and has two very high-profile subsidiaries: Plus, a worldwide ATM network, and Verify, its global payment disputes service.

New York-based Mastercard currently ranks No 3 in the world, handling 24 per cent of transactions (behind UnionPay at 26 per cent). Started in 1966, it has 93 subsidiaries globally. The highest-profile and most important subsidiary is Cirrus, a worldwide ATM network which links Mastercard and Maestro to a global network of millions of ATMs. You often see the Cirrus logo on the back of your bank cards.

American Express, headquartered in New York, has been around since 1850 and offers charge cards, credit cards, debit cards and traveller's cheques globally.

Now, however unlikely it may be, the mechanism is in place to cut any country off from access to these American companies' services.

As the Hong Kong dollar is pegged to the US dollar, the greenback plays a significant role in convertibility between HKD and RMB for trade finance. Therefore Hong Kong banks have to move significant amounts of money internally and internationally. And like other international banks, Hong Kong banks predominantly use Swift to do this. Swift is an acronym for the Society for Worldwide Interbank Financial Telecommunication, and provides a worldwide network to send and receive information about financial transactions. You may have come across Business Identifier Codes (BICs) when moving money around; they are commonly known as "Swift codes".

Although the organisation is Belgian, it allows the US government to monitor, and interfere, as the US dollar is by far the most used currency globally. Swift handles half of the world's foreign exchange transactions through its messaging system, and, on a currency basis, the US dollar accounted for 41 per cent of all transactions last year. So if the US requests that Swift services be denied to a specific bank or to any of its 200 participating countries, it happens quickly. Examples of this include Washington's sanctions against Russia, Iran, Turkey and Cuba.

HSBC, Standard Chartered and Bank of China print the bulk of Hong Kong's money. Photo: Reuters

Hong Kong's money is unusual. The Hong Kong dollar is backed by US$449 billion in reserves, and banknotes are issued by commercial banks and the government of the SAR, rather than a central bank.

HSBC, Standard Chartered and Bank of China print the bulk of Hong Kong's money and their balance sheets stand behind them as financial instruments - they are simply zero-coupon perpetual bonds.

With that in mind, if these banks were to be sanctioned by the US, or their clients sanctioned, they may not be able to freely issue or receive banknotes, and the only money that could then be used without restriction in town would be 10- dollar notes or coins, which are issued by the SAR. The SAR may have to issue notes of other denominations in the future if only to pay its officials.

This is an extreme scenario, but the vulnerability of the Hong Kong dollar peg to outside interference is a point that has already been floated in the White House, which turned down weaponising the US dollar in such a way - for now. Still, several prominent investors and politicians are actually betting against the Hong Kong dollar peg through financial derivatives. With the threat of more sanctions, and if the peg does come under pressure from an external attack, then would Hong Kong-dollar physical cash still be welcomed overseas? After all, if relations deteriorate and banks get sanctioned in Hong Kong, what's the point of money changers anywhere taking the risk?

I believe that the sanctioning of Hong Kong individuals is going to place some weight on the scales in favour of the Hong Kong Monetary Authority (HKMA) reconsidering the format of the Hong Kong dollar peg to the US dollar. With the current dependence on the American financial system, and with all our nest eggs in one basket, diversification may be the answer and for the HKMA to peg to multiple currencies and perhaps gold.

This article originally appeared on the South China Morning Post (SCMP).

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