This poses a serious risk to the Hong Kong dollar, which is being dragged down with it. The depreciation of the Hong Kong dollar stresses Hong Kong Monetary Authority (HKMA) reserves that have been allocated for much-needed relief for the domestic economy.

The HKMA has boosted its lending capacity to HK$1 trillion (US$129 billion) to help banks, released HK$780 billion in financing to support small and medium-sized enterprises, particularly in the hard-hit retail and transport sectors, and HK$49 billion in relief measures for workers.

Much of the increased banking system liquidity that the HKMA is providing local banks, moreover, is directly in US dollars using repo transactions, which involve selling bonds back to the US Federal Reserve to free up dollars and agreeing to buy them back later – essentially short-term loans.

Second, inflation is growing significantly because of low interest rates. The Fed has pledged to continue to buy bonds, keep interest rates near zero for the next few years, and suppress inflation during this time with an annual target of 2 per cent.

Why the US dollar is only going to fall faster and harder

Third, a long-standing issue of Hong Kong’s dollar peg is the city’s inability to design its own monetary policy in response to the above challenges. Rather, Hong Kong is pulled along by US monetary policy, for better or worse. Unlike the US, for instance, Hong Kong has limited ability to toggle its prime rate to stabilise the financial market, prices or the labour market.

Two strategies are available to ameliorate these risks. First, the HKMA can strengthen its macroprudential policies – that is, government policies meant to better manage systemic risks in financial markets through regulation.

There are significant limitations to monetary policy, as US Treasury Secretary Janet Yellen has been pointing out since at least 2014: in an International Monetary Fund speech, as Fed chair, she called for macroprudential regulation in the wake of the 2008 global financial crisis to create greater stability in the financial system and prevent similar crises.

To dampen the shocks from the US to Hong Kong through financial markets, networks or institutions, the HKMA should reintroduce stress tests for banks that were halted last year.

To limit asset price inflation driven up by credit growth and cheap money, the HKMA could toggle Hong Kong’s countercyclical capital buffer. Banks’ capital requirements need to be lowered during the pandemic but, as economic growth picks up steam, the HKMA could begin looking at higher sectoral capital requirements.

To rein in the frothy housing market, it could lower the lending caps, such as trimming the maximum loan-to-value ratio of 80 per cent to 50 per cent, and the 50 per cent debt-to-income ratio to 42 per cent for non-first-time homebuyers, as is standard in the US and elsewhere.

The HKMA could also use non-standard liquidity measures, such as stricter marginal reserve requirements on foreign funding. IMF research suggests that such measures are effective in reducing price shocks and asset inflation, having slowed house price inflation and flattened real-estate cycles in European and Asian economies in the past.

By diversifying across five sovereign currencies, Hong Kong could reduce its exposure to the dollar, mitigate the volatility and impending decline of its own currency, and improve the city’s geopolitical standing with these sovereign nations.

The 2008 financial crisis taught us painful lessons about prioritising supervisory and regulatory reforms, which we need to put into practice to avert another.

Anson Au is a PhD candidate in sociology at the University of Toronto