Why You Should Keep Your Eyes on Hong Kong

Hubris, ego, and delusion will get you into trouble every time.

And no, I’m not talking about Donald Trump, although he certainly has a healthy amount of ego. Having said that, I’m yet to see a humble president or prime minister.

I’m talking about China’s President Xi Jinping. He’s cultivated an image as a bit of a ‘hard man’ over the past few years, one that belies his benevolent exterior.

Now, under pressure from Trump, he has to live up to that hard man image. What would the citizens of China think if he did otherwise? In communist dictatorships, might is right. Dissent and threats are crushed.

From the Wall Street Journal

BEIJING—The volley-for-volley trade war between China and the U.S. is accelerating at a time when Chinese President Xi Jinping can ill afford to make concessions, raising the likelihood of a protracted struggle between the world’s two biggest economies.

Mr. Xi is ordering a celebratory run-up to the 70th anniversary of the People’s Republic in October, an event that Communist Party watchers and media say will showcase him as a strong leader of a powerful nation. With his government struggling to rejuvenate a sluggish economy and quell antigovernment protests in Hong Kong, Mr. Xi has little leeway to take steps that would undercut his strongman image.

Months ago, Trump said the US and China were working towards a trade deal. China had promised to buy more from US farmers and stop the importation of fentanyl into the US — the deadly drug behind the opioid crisis in the US, resulting in around 20,000 deaths a year.

China, apparently, reneged on this deal. This is what led Trump to ratchet up the tariff war in the past week.

Hard men don’t step down from a fight. They don’t try to appease.

In response, China weakened its currency to the lowest level since the financial crisis. Keep in mind that the Chinese yuan is pegged to the US dollar. It’s a loose peg, but China certainly manages it.

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This is where Xi must be very careful to keep all the balls he’s juggling in the air.

You see, there is this thing in monetary economics called the ‘impossible trinity’. It means you can’t have a fixed exchange rate, free flow of capital and maintain flexible monetary policy at the same time.

China has tried to do all three, with varying success over the years. It manages its peg to the dollar loosely, and it sometimes loses control of capital flows.

If China wants to deliberately weaken its currency (as it’s just done) it risks sparking a new round of capital flight (as investors anticipate more weakness).

That would not be good for the global economy. China and the US are the engines of global growth.

Now, throw Hong Kong into the mix. As you probably know, Hong Kong is experiencing significant political unrest right now. It started as a protest against the introduction of a bill that would see people extradited to mainland China if deemed to have broken Chinese law.

But it’s morphed into a battle against encroaching totalitarianism. Hong Kong flourished under English rule of law and capitalism. Its residents, rightly, now see that as coming under threat.

They are fighting for their way of life, but China is determined to impose its authority. From The Australian:

China has warned protesters that it will not allow “troublemakers” to “plunge Hong Kong into the abyss”, and threaten China’s ­national security.

In a briefing in Beijing yesterday, Chinese officials warned the protesters they should not underestimate “the immense strength of the central government”.

“We need to send a stern warning to the reckless, violent groups and black hands behind them — you will pay the price if you play with fire,” said Yang Guang, spokesman for the cabinet-level Hong Kong and Macao Affairs Office.

Hong Kong is the financial centre of Asia

Hong Kong is the financial centre of Asia. It has the most developed capital markets. Do you think global capital is going to hang around if it’s under threat of totalitarian rule?

The Hong Kong dollar is pegged to the US dollar too. If capital flight intensifies, as it will if the violence escalates, the Hong Kong Monetary Authority will need to increase interest rates to attract capital and maintain the peg.

That won’t be good for the Hong Kong market. As you can see in the chart below, stocks have already started to price this reality in. The market has plunged in recent days.

Hang Seng Index - HSI (WI) - 1 Day Bar Chart - HKD - 7-08-19

Source: Optuma

[Click to open in a new window]

If Hong Kong breaks its peg to the US dollar, it will spark another wave of selling across global equity markets. The US dollar and gold will receive an influx of capital.

So while markets may be experiencing a relief rally for now (US markets were up more than 1% overnight), keep your eye on Hong Kong. It could be the catalyst for the bear to really come out of hibernation.


Greg Canavan,
Editor, The Rum Rebellion

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Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

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