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President Donald Trump is expected to hold a news conference on Friday to announce new measures against Beijing in response to its approval of a controversial national security law in Hong Kong. The Hong Kong government is worried that it will end up bearing the brunt of Trump’s retaliation.

On Wednesday, Secretary of State Mike Pompeo reported to Congress that Hong Kong—one of two special administrative regions in China—could no longer be considered autonomous enough to qualify for special economic treatment from the U.S., paving the way for Washington to revoke the city’s unique privileges.

While revoking Hong Kong’s special trade status is the most obvious means of retribution, it’s not the most effective if the U.S.’s end goal is to punish Beijing. In fact, it would leave Washington’s main target largely unscathed.

“Practically, in Hong Kong–U.S. relations, any sanctions are a double-edged sword that will not only harm the interests of Hong Kong but also significantly those of the U.S.,” the Hong Kong government said in a lengthy statement Thursday.

To inflict real economic pain on Beijing, the U.S. would have to trigger what experts call the “nuclear option”: cutting Hong Kong off from the U.S. dollar. But even that blow has the potential to miss its mark.

En garde

Economists at Oxford Economics say that revoking Hong Kong’s special trade status would have “major consequences” for local and U.S. companies in Hong Kong but would have “relatively little direct impact” on mainland China.

Such a move would mean that goods exported to the U.S. from Hong Kong would be subject to the same tariffs as goods from mainland China. That could hurt Hong Kong, but the relative impact on mainland China would be small. Only 8% of China’s exports to the U.S. pass through Hong Kong.

Increasing the costs of Hong Kong exports would, however, harm the special administrative region’s status as a major logistics hub, potentially hurting the local economy. But Iris Pang, chief economist for ING Greater China, says Beijing is unlikely to notice the pinch from Hong Kong’s economy getting squeezed.

“If the U.S. penalizes mainland China then mainland China will be hurt, but if the U.S. wants to hurt Beijing through Hong Kong, it will be much more difficult,” Pang said, arguing that, economically, mainland China actually derives very little from Hong Kong.

Hong Kong’s relative contributions to China’s economy have diminished significantly in the decades since the former British colony was returned to Chinese sovereignty. In 1997, Hong Kong accounted for roughly 18% of China’s GDP. In 2018, that contribution dwindled to roughly 3%

“I really can’t think of anything the U.S. can do to Hong Kong that would hurt Beijing in a serious way,” said Pang.

Dollar clearing

However, Zhuang Bo, chief China economist at TS Lombard, argues that Hong Kong’s relative GDP contributions to mainland China are not the crux of this relationship. Rather, it’s mainland China’s existing financial exposure to Hong Kong—companies listing on the Hong Kong stock exchange and the stock-connect schemes that enable international traders to invest in Chinese stocks—that matters most.

“If Hong Kong was to become marginalized as a hub for international finance, it would undermine mainland companies’ access to liquidity there,” said Zhuang. For that to happen, the U.S. would have to pull a different, heftier lever: prohibiting the Hong Kong Monetary Authority from clearing U.S. dollars—essentially cutting off Hong Kong’s access to the world’s most internationalized currency.

According to Zhuang, Hong Kong is the best place for mainland Chinese firms to raise funds as the city provides direct access to international investors. However, if Hong Kong is unable to clear U.S. dollars, those investors will be deterred, and China’s big businesses will have to look elsewhere.

Pang, meanwhile, argues that cutting Hong Kong off from the U.S. dollar would be a “nuclear option” that could ultimately hurt the U.S. more than Beijing. Without access to U.S. dollars, traders in Hong Kong would seek an alternative global currency to work with and would likely resort to the euro or Chinese yuan. The U.S. does not want the yuan to gain prominence globally—Beijing does.

“Banning Hong Kong from clearing the U.S. dollar would be an extreme case, and I don’t think the U.S. is likely to do it,” Pang says. “But then again, who knows what President Trump will do?”