Common Cents & Hong Kong on May 29, 2020

May 29, 2020, by John Norris

Yesterday, in part-5 of Oakworth’s ‘New Normal’, I made several predictions about what the ‘new normal’ might be in regards to China and its role in the world. This past Tuesday, on our ‘Trading Perspectives’ podcast, Sam Clement and I discussed the ongoing tensions in Hong Kong and what it might mean moving forward. Today, the stock markets are mostly in the red over trade tensions between the US and the People’s Republic, as well as Hong Kong’s status as a trading partner. Finally, as we all well know, this pandemic supposedly emanated from China, and the remainder of the world is increasingly questioning Beijing’s truthfulness and transparency about the COVID-19 virus.

In short, China is this week’s headline. It is next week’s headline, and you can throw your fly as far as can our on your calendar and still hit the Chinese. They, and their role in the world, are the news stories for the foreseeable future.

To be sure, we will preoccupy ourselves with the number of coronavirus cases and related deaths here in the US. The Federal Reserve will get a lot of ink and attention, as will the Presidential Election this Fall. Pick your favorite diversion or avocation; you will spend time focusing on those things as well. Flares up and brush fires will happen throughout the year, and the public will give them plenty of notice. However, when the dust settles, 2020 will be, and is, China’s year…good or bad, but it probably won’t be indifferent.

This week’s riots in Minneapolis have overshadowed the recent events in Hong Kong, and that is completely understandable. While I am not trying to minimize the unrest there, let alone the reason for it, the next two months will be incredibly crucial in how the rest of the world deals with Beijing and how it deals with us. This has serious long-term, geopolitical ramifications.

As a little backstory, way back in December of 1984, the UK and China cobbled out what is known as the ‘Sino-British Joint Declaration (Declaration).’ This was/is the treaty which outlined the provisions of the British handover of Hong Kong to mainland China’s authority. The Chinese and British governments registered it at the Union Nations on June 12th, 1985. While I understand you may not read all of these, here, in full, is the 3rd bullet point directly from the Declaration (including the British English spelling of words):

The Government of the People’s Republic of China declares that the basic policies of the People’s Republic of China regarding Hong Kong are as follows:

  1. Upholding national unity and territorial integrity and taking account of the history of Hong Kong and its realities, the People’s Republic of China has decided to establish, in accordance with the provisions of Article 31 of the Constitution of the People’s Republic of China, a Hong Kong Special Administrative Region upon resuming the exercise of sovereignty over Hong Kong.
  2. The Hong Kong Special Administrative Region will be directly under the authority of the Central People’s Government of the People’s Republic of China. The Hong Kong Special Administrative Region will enjoy a high degree of autonomy, except in foreign and defence affairs which are the responsibilities of the Central People’s Government.
  3. (The Hong Kong Special Administrative Region will be vested with executive, legislative and independent judicial power, including that of final adjudication. The laws currently in force in Hong Kong will remain basically unchanged.
  4. The Government of the Hong Kong Special Administrative Region will be composed of local inhabitants. The chief executive will be appointed by the Central People’s Government on the basis of the results of elections or consultations to be held locally. Principal officials will be nominated by the chief executive of the Hong Kong Special Administrative Region for appointment by the Central People’s Government. Chinese and foreign nationals previously working in the public and police services in the government departments of Hong Kong may remain in employment. British and other foreign nationals may also be employed to serve as advisers or hold certain public posts in government departments of the Hong Kong Special Administrative Region.
  5. The current social and economic systems in Hong Kong will remain unchanged, and so will the life-style. Rights and freedoms, including those of the person, of speech, of the press, of assembly, of association, of travel, of movement, of correspondence, of strike, of choice of occupation, of academic research and of religious belief will be ensured by law in the Hong Kong Special Administrative Region. Private property, ownership of enterprises, legitimate right of inheritance and foreign investment will be protected by law.
  6. The Hong Kong Special Administrative Region will retain the status of a free port and a separate customs territory.
  7. The Hong Kong Special Administrative Region will retain the status of an international financial centre, and its markets for foreign exchange, gold, securities and futures will continue. There will be free flow of capital. The Hong Kong dollar will continue to circulate and remain freely convertible.
  8. The Hong Kong Special Administrative Region will have independent finances. The Central People’s Government will not levy taxes on the Hong Kong Special Administrative Region.
  9. The Hong Kong Special Administrative Region may establish mutually beneficial economic relations with the United Kingdom and other countries, whose economic interests in Hong Kong will be given due regard.
  10. Using the name of ‘Hong Kong, China’, the Hong Kong Special Administrative Region may on its own maintain and develop economic and cultural relations and conclude relevant agreements with states, regions and relevant international organisations. The Government of the Hong Kong Special Administrative Region may on its own issue travel documents for entry into and exit from Hong Kong.
  11. The maintenance of public order in the Hong Kong Special Administrative Region will be the responsibility of the Government of the Hong Kong Special Administrative Region.
  12. The above-stated basic policies of the People’s Republic of China regarding Hong Kong and the elaboration of them in Annex I to this Joint Declaration will be stipulated, in a Basic Law of the Hong Kong Special Administrative Region of the People’s Republic of China, by the National People’s Congress of the People’s Republic of China, and they will remain unchanged for 50 years.

Combined, all of these bullet points create a “one country, two systems” rule of government in Hong Kong. That or you could argue they hinder the Chinese from exercising sovereignty over their own territory. While we, in the West, would like to think the “one country, two systems” view of things is righteous, how do you feel the central government in Beijing feels about it?

Consider China’s relative strength 36 years compared to today, both economic and militarily. In 1985, accorded to accepted sources (IMF, World Bank, and UN), China’s GDP was $312.616 billion. By comparison, the UK’s was $534.244 billion. For its part, Hong Kong’s, alone, was around $35.7 billion. As such, you could reasonably argue the Chinese were negotiating from a relative position of weakness AND Hong Kong would have been an extremely big economic plum, as it would have been in excess of 10% of overall Chinese GDP. So, the Sino-British Joint Declaration makes a little more sense when you realize the chips at the time. Further, it was a WIN for Beijing at the time, as it effectively kicked the British out in 1997.

What about today? It is no secret the People’s Republic is a much different today than it was in 1985, at least in economic terms. According to the IMF, China’s nominal GDP in 2019 was $14.140 trillion. By anyone’s calculation, that is staggering growth. By comparison, UK GDP was $2.744 billion, and Hong Kong’s was $373 billion. Hmm.

Let’s think about this. In 1985, the GDP of the People’s Republic of China was 58.5% that of the United Kingdom’s. Hong Kong’s GDP was equal to 11.4% of China’s. By comparison, in 2019, Chinese GDP was 5x that of the British, and Hong Kong’s relative size had shrunk to 2.64% that of mainland China. If nothing else, these numbers suggest two things: 1) China would be negotiating from a greater position of strength if it were negotiating the Sino-British Joint Declaration today, and; 2) in 2020, Hong Kong, while still wealthy, is not quite the economic plum it was to Beijing 3 ½ decades ago.

Debate if you wish, but that is the math.

So, if you were Xi Jinping, how would you feel about the adhering to the British demands about Hong Kong from 1985? Would you feel as though you were being dictated to by a foreign power who is no longer anywhere near as powerful as you are? Hey, I am not saying it is okay to go around breaking treaties, but I am more than certain no small percent of folks in the PRC think “enough is enough.” What’s more, just as ‘kicking’ the British out of Hong Kong was a major win for Beijing back then, tearing up old colonial demands will be just as popular.

So, what is currently the problem? Why has this come to the fore now? Here are some pertinent parts from an article by Emily Feng at npr.org published earlier today:

China is moving closer toward imposing a sweeping national security law on Hong Kong, which activists and pro-democracy lawmakers say would effectively end whatever autonomy the city enjoys from Beijing.

On Thursday, China’s national legislature approved a motion to begin drafting the law, which would prohibit four broad categories of activity in Hong Kong: sedition, subversion of state power, foreign interference and terrorism — as defined by China…

China’s national security forces, not Hong Kong’s, will likely enforce the law; and Beijing, not Hong Kong, will likely decide what’s legal…

Ultimately, the Standing Committee of China’s legislature (NPC) has the final say in whether a law is constitutional — meaning it could overrule any Hong Kong court decision on national security.

“The realist argument is it doesn’t really matter what anyone says because the NPC Standing Committee can interpret the Basic Law,” Cheung says, “and we have seen it will interpret it in a politically expedient matter every single time.”

Make no mistake about it. The Chinese are exerting greater power across the world because they know they can, and further know the rest of the world probably isn’t going to do much to stop them. Are you prepared to send your children or grandchildren to fight the Chinese over breaking a 35-year old treaty with the British and exerting greater sovereignty over one of its territories? What economic sanctions are we prepared to truly enforce? Are you willing to go without something or lose a loved one because NPC based a law giving it the power to define and prohibit sedition, subversion of state power, foreign interference, and terrorism in Hong Kong? Maybe, if it were someone else’s kid, right?

So, if the world does effectively acquiesce with the usual toothless condemnations, and Beijing picks apart the largely British mandated “one country, two systems” one large chunk at a time, what is to stop Xi Jinping from doing the same in Macau? From taking ownership or effective possession of assets in Africa and Latin America because the corrupt officials who mortgaged their countries’ natural resources couldn’t pay the Chinese back? Are you prepared to stop the Chinese from taking over diamond mines in Zimbabwe because Harare couldn’t pay its bills? Oil wells in Angola? If we are energy independent in the US, do we really care that much about the Spratly Islands? Do we really care that much about the claims of the Filipinos, Malaysians, Vietnamese, and Brunei over the potential oil reserves there? How does that benefit the US again? What if China flexes its muscle over the Senkaku Islands? The James Shoal? The Paracel Islands (even more than it has)? Where are those places, you ask?

You see, the COVID-19 pandemic comes at an interesting time in global history. Just as the Chinese have reached a point in their modern development, the rest of the world is preoccupied or otherwise distraction with a healthcare crisis and the accompanying economic fallout. With all that is going on at home, how much does Joe 6-pack in the US and his equivalents in Canada, Germany, France, and Italy really care about civil liberties in Hong Kong? The UK? The British will care, potentially deeply, about it. However, without meaningful support by the remainder of the G-7, especially the US, guess what? Xi probably won’t worry about Boris Johnson terribly much. The rest of Europe? Oh ho…they will try to protect their economic interests by hiding behind statements like: “it is our government’s policy to not get involved in the internal, political disputes of foreign countries with whom it has favorable diplomatic relations.”

It is all so plain to see, isn’t it? Or is it just me?

What…then…happens when Beijing decides it wants to exercise control over its breakaway province of Taiwan, also known as the Republic of China? At want point does the rest of the world ‘dig in its heels’ with the Chinese? Or, will it be just the US that cares, if it cares? Particularly IF the US uses this pandemic as an excuse to lessen its dependency on global supply chains? Whew.

All of this is why this year is China’s year. No, it isn’t just because the COVID19 virus likely started there, but that is part of it. The big reason is because Xi Jinping is going to test ‘us,’ to see with what he can get away. And why not? You would do it too, if you were in his shoes. The best part? If it all ‘goes down’ like he plans in Hong Kong, the rest of it will fall into place pretty easily…as he will have a better idea of the appetite the West has for Chinese aggressiveness. In truth, it probably isn’t a lot.

In the end, US investors will have to ask themselves a very difficult decision at some point this year: is it best to bet on the US economy and stock markets with all of the monetary and fiscal policy stimuli OR to sock it away someplace safe for when push eventually does come to shove with the Chinese?

Okay…I am not really that pessimistic about things as this implies. However, you are less likely to be surprised when investing if you explore and analyze numerous different scenarios and slippery slopes. Hong Kong is just one of them. Perhaps we could couple it with COVID19 and call it the Hong Kong flu or something, but that probably isn’t politically correct. Oh well.

Have a great, and long, weekend.

John Norris

Chief Economist

As always, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, are subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the reset of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.