Yesterday I wrote to you about Xinjiang, and the incredible things that are happening there.
Mass confinement in re-education camps for over one million Uighur Muslims. Children separated from their parents. Total surveillance infrastructure in place to monitor ever word spoken and action taken, and the probable harvesting of organs from the “prisoners of conscience” to supply China’s unbelievable organ transplant industry.
That’s probably one of the things on the minds of the protestors in Hong.
They don’t want to be next.
If Hong Kong is incorporated into China, its separatist tendencies would lead to the same response from the top: total suppression.
That’s part of the fear factor now.
The protestors have gone too far. They cannot come back from this peacefully. China will retaliate somehow – it has to. Authoritarian states cannot tolerate this level of discontent.
This is a problem for Hong Kongers, because the extradition treaty, which would have allowed the Chinese criminal justice system to get its hands on any one it likes in Hong Kong with no formal charge or reasoning, was a step too far for Hong Kong.
What happens in 2047 when they get everything – full subjugation by the Communist Party of China, no exceptions made?
Well this is part of what has driven the current protests to such lengths.
And perhaps their severity is given added impetus by the realisation that maybe they need a permanent victory if they now want to avoid Xinjiang’s fate.
Hong Kong is now in an impossible position. It desperately wants to avoid full integration into China. But China will do just about everything in its power to ensure that happens.
And China is hardly that tolerant of separatists. Look at Tibet, Taiwan, and now Xinjiang.
Like Xinjiang, the Hong Kong issue highlights a few things that make me question some big assumptions that people have.
Primarily that all we need is a trade deal and everything will be fine. I’m not saying we won’t get one, but I am saying that it may not be enough.
But secondly that continued Chinese growth is inevitable, or that China will liberalise and democratise as it becomes wealthier.
While I don’t believe China can remain communist and authoritarian forever – the will of the people to exercise the right to choose their own government has proved too powerful in all other instances – its current trajectory suggests that China has no wish to take steps in that direction any time soon. Quite the opposite. Â
But that’s a problem for tomorrow.
What’s happening today? How bad is the fallout from Hong Kong, and could it be the epicentre of a wider earthquake?
Some facts:
Jewellery, watches and clocks retail sales contracted 47.4% in August, vs -24.3% in July.
Clothing and footwear retail sales were down 32% year on year (yoy), vs -13% yoy in July.
In August, department store sales also declined by 29.9% yoy.
Total retail sales volume growth was -25.3% yoy, the largest decline on record.
Falling tourism is a key reason explaining these declines: visitor numbers from mainland China plummeted to 2.5 million arrivals in October, down 45.9% from the previous month.
The story for international tourists is the same.
There were 3.31 million arrivals to the city in October, a decline of 43.7% from the same period last year.
The number is the steepest drop in a single month since the SARS virus plagued the city in 2003.
These dramatic falls are affecting businesses, and corporate confidence.
In a normal situation, the government of Hong Kong would allow the currency to weaken, so that tourists and purchasers abroad are more attracted to coming to Hong Kong or buying its products, as they become relatively cheaper.
This isn’t possible though, because the Hong Kong dollar (HKD) is pegged to the USD. (Pegged means that its relationship to the dollar is fixed, at just under 8 HKD to the dollar.)
HK achieves this by copying the Federal Reserve’s every move – to ensure it has the same interest policy (different interest rates would cause currency flows in one direction or the other).
It cedes central bank policy to an outside nation.
It’s like Greece and Germany having the same economic policy despite having different economic circumstances – which would be mental if it weren’t already true.
And so it has proven in Hong Kong, a land of extremes. US economic policy combined with Chinese growth numbers has created a monstrous amount of growth in credit and asset valuations (property is the prime example).
The amount of bank assets (debt) there is relative to GDP is 850%. Greece’s was only a fraction of that when it fell into crisis and multiple bailout agreements.
Hong Kong house prices are also extreme – and one reason why there is such a strong youth component to the protests. They have next to no hope of owning property in the city where they are growing up. That disenfranchisement means less of a stake in the current setup.
Now don’t forget – these numbers are extreme because Hong Kong is an extreme place. Its size is fixed, so there is no commuter belt. Fixed supply plus increasing demand means higher prices rather than more houses. And the tax rate in Hong Kong is lower than mainland China, so every wealthy Chinese person is incentivised to move there. Add in more freedom, better schools… it’s a heady mix.
And London or New York’s debt-to-GDP stats would be way above their national averages too, which sadly are all we get to see. Hong Kong only seems to have an astronomical debt-to-GDP figure because it collects that data because of its special status.
So, Hong Kong is a place of extreme valuations with retail sales, tourism, and business confidence absolutely haemorrhaging, and no control over its currency or interest rate policy.
But can it last?
Kyle Bass, founder and manager at Hayman Capital Management, who is fiercely anti-China in general, has spoken at length about what’s going on in Xinjiang, Chinese intellectual property theft etc, etc. He reckons that it cannot last.
He reckons the currency peg will break because the central bank does not have enough USD in reserve to sell in order to maintain balance, as the HKD weakens. If/when it does break, the HKD will crash.
Not everyone agrees with him, because the “official” numbers don’t show the decline that he is saying must be happening.
So far though, there has been remarkably little financial fallout. A breaking of the currency peg would change that. When the Thai bhat broke its USD peg in 1996, it sparked the Asian financial crisis.
It broke its peg because it ran out of foreign currency reserves. If Bass is right, we could be in for much more of a rollercoaster than we’ve seen so far.
For the world, that’s the main threat coming out of Hong Kong. If the Hang Seng Index collapses, the peg breaks, HSBC and Standard Chartered won’t be able to help getting caught up in it, and that’s how the contagion spreads.
I don’t know how likely all this is, but currency pegs cannot last forever where economies are on wildly different trajectories.
It isn’t working for Greece or Italy, and it isn’t working for Hong Kong right now either.
The world may be worried about another Asian currency or financial crisis. With stockmarkets at all-time highs, late into a record long bull run, that could tear down our happy house of (credit) cards.
But in Hong Kong there is a more existential risk.
Hong Kong’s special status itself could be in jeopardy. Is that likely?Â
Well eventually, definitely yes. Sooner than that? Maybe. It’s certainly not out of the question that once the protests finally die down, then China will finally wade in, in force.
It is an age-old response. For example, in 1536, Henry VIII rode to Pontefract to discuss terms with the rebels of the Pilgrimage of Grace – one of the largest rebellions of his tenure, and the entire Tudor period for that matter.
He agreed to certain terms, made a few promises, gave in to a few demands, and everyone finally dispersed, happy that they had got some of what they asked for.
Once the force of tens of thousands had disbanded, and the threat of a large army was gone, he sent his army back up north to arrest the ringleaders, and kill a bunch of people who’d been involved.
It’s a trick as old as time.
In Xinjiang, it was protest and violence that made Xi Jinping decide to crack down with no mercy on the Uighur Muslims of Xinjiang. I am genuinely scared that Hong Kong could be next, and sooner than we think.
All this leads to one conclusion. Our expectations of a wealthy, prosperous and liberalised China supporting global growth through the 21st century are no longer compatible with reality.
The atrocities in Xinjiang, the huge risks bubbling under the surface in Hong Kong… China is on the rise it’s true, but it isn’t going to be a smooth ride.
In China itself, banks have been defaulting, along with huge numbers of other private sector companies.
Growth is slowing. Capital has been widely misallocated leading to empty skyscrapers with vacant flats and deserted office space. Environmentally, the record of the Chinese Communist Party is as appalling if not worse than ours was when the first cars used to create “pea-souper” smog on the streets of London.
Put together slowing growth, credit bubble, capital misallocations, accelerating bankruptcy (75 companies out of 339 that received state support in a mass bailout last August, according to yesterday’s Financial Times), environmental threats, the suppression in Xinjiang, and the financial risks in Hong Kong.
What do you see? I don’t see the engine of global growth and demand, I see a regime cracking at the seams.
How will the Communist Party justify its extreme measures for retaining power, when it breaks its bargain with the people to deliver stellar growth in place of certain freedoms?
How will algos, traders, and perma-bulls react when there is a trade deal, but with a antagonised and stuttering China? It’s time to look beyond the headlines and realise that a trade deal will not be enough.
I’m being a bit extreme, I know.
It’s famously never as bad as your fear.
But then again, it’s never as good as you hope either.
All the best for now,
Kit Winder
Investment Research Analyst, Southbank Investment Research
Category: Market updates