The end to the Hong Kong-U.S. dollar exchange is gradually becoming a reality.
Last week I wrote about why China won’t win against the U.S., with a focus on the Hong Kong issue. To summarize, it’s because if the U.S. stops the exchange between Hong Kong and U.S. dollars, the Hong Kong economy will collapse in one fell swoop. I’ll add to this explanation this week, focusing on China.
Some readers may be inclined to think that since there are so many American companies operating in Hong Kong, if they take such drastic measures such as stopping the exchange to U.S. dollars, the U.S. will be the one hurt instead.
However, this isn’t just some logical conclusion that I came up with in my head. These are very real worries held by many people over in Hong Kong.
For example, analysts at the South China Morning Post reported on June 8 that “U.S. President Donald Trump’s recent threat to penalize China and Hong Kong for Beijing’s decision to impose a national security law on its special administrative region could mark the beginning of a process to cut off access to U.S. dollars.”
This is completely in line with what I pointed out in my column last week, on June 5. This illustrates that you would arrive at the same conclusion whether you're thinking about this in Tokyo or Hong Kong, if you logically probe into the reality of how things are.
Even If There Were No Sanctions...
The SCMP writes that “most analysts do not expect the Trump administration to impose extreme sanctions,” while it acknowledges that it’s possible exchange may stop. They also argued that “avoiding a full-blown financial war with China over Hong Kong would preserve the phase one trade deal,” an agreement signed with China in January.
I view the trade deal as being in a precarious state, but I can also understand those involved hoping that the U.S. would avoid ending its dollar exchange. By the way, the owner of SCMP is Jack Ma, cofounder of Alibaba Group, one of the largest conglomerates in China.
And yet, problems remain.
Even if the U.S. does not suspend the exchange, if Hong Kong and China's supplies of U.S. dollars are exhausted, it will not be possible to maintain the HK$7.8 = US$1 peg system. As scores of companies and citizens uncertain about the future scramble to buy U.S. dollars, if authorities become unable to support the Hong Kong dollar by selling U.S. dollars, the Hong Kong dollar would immediately crash, and the economy would come to a standstill.
Therefore, even if we shelve the idea of the Trump regime imposing sanctions for now, the problem for China and Hong Kong now would be whether they can earn U.S. dollars through trade. Looking at China’s current account balance, we can see that the surplus of US$40.5 billion at the end of 2019 plummeted to a deficit of US$29.7 billion in the first quarter of 2020.
This would simply have been a case of that many U.S. dollars leaking overseas. The SCMP writes why this didn’t happen: “The shock wave caused by the coronavirus has ... sharply reduced [China’s] ability to earn foreign exchange income through exports, tourism receipts and foreign direct investments.”
China’s trade balance in May was a surplus of US$62.9 billion, but this is mainly just because domestic demand was weak and imports went down. The exports, the real earners, are unlikely to recover as their American and European partners get pummeled by COVID-19. In essence, it will continue to be difficult to obtain U.S. dollars, which are used as mediary capital.
Since this is the case, the Trump administration may not even need to end the U.S. dollar exchange. With just a small provocation, Hong Kong businesses and citizens will rush to buy U.S. dollars, which will in turn incite uncertainty and bring the real danger closer.
China Was Facing Problems before COVID-19
The truth is that China’s economy had been in trouble even before the COVID-19 outbreak.
The online edition of the American magazine Forbes efficiently summarizes China’s distress in an article dated May 26. It says that China is in the process of entirely losing its ability to attract foreign capital as the “World’s Factory.”
First off, labor wages have risen, making it difficult to obtain cheap, unskilled labor; the labor force itself has also rapidly shrunk due to the one-child policy. While lax environmental standards used to let companies get away with pumping out pollutants, those standards have now become stricter, pressuring companies to invest large amounts of capital in their facilities.
In addition, thanks to economic growth, China has run into a conflict of interest with the U.S., resulting in a new cold war. Even if companies try to export goods made in China to the U.S., they would face high sanction tariffs, making them lose their taste for foreign capital. Then, COVID-19 attacked.
Foreign companies that had been operating in China have now become fearful of over-concentrating in one area since the pandemic spread. If they rely only on China as their center for their supplies of raw materials and assembly, and if China, world production would come to a halt.
'Leaving China' Isn’t a Dirty Phrase
Therefore, the biggest issue for foreign companies now has become how to leave China quickly. It’s become essential to diversity supply chains, and Japan has come into the spotlight. A Forbes article published on April 10 shares White House National Economic Council Director Larry Kudlow’s comments on a FOX Business Network program.
Japan's Abe administration established a subsidiary payment system of 248.6 billion yen in the first stage of its revised budget for COVID-19. This is meant to support companies moving their centers of production away from China. Kudlow, seemingly provoked by this, had stated, “I would say, 100 percent immediate expensing across the board for the plant, equipment, intellectual property, structures, renovations ... In other words, if we had 100 percent immediate expensing, we would literally — literally pay the moving costs of American companies.”
It now seems that “leaving China” and “decoupling” are no longer dirty words showing the negative side of the U.S.-China standoff, nor are they simply scenarios in the minds of political leaders; they have become tangible parts of Japanese and American public policy.
Of course Xi Jinping, General Secretary of the Communist Party of China, is aware of this; that’s precisely why he is working desperately to stop foreign companies from leaving China. When Japanese companies say they need X to start production, he will immediately say he’ll make that happen.
It’s foreign companies that have supported China’s growth, but that foreign investment has started slipping away. If you’re still wondering if China can continue to grow with just domestic companies, take a look at Huawei, the tech company it’s so proud of: It’s stuck with Trump’s sanctions and can’t make the semiconductors essential for developing 5G at its own expense.
I’ll say it one more time: No matter how hard China tries, it won’t beat America.