If Hong Kong burns, we’ll all pay the price
The island’s vital role in the global financial system means the effects of a Tiananmen there would be felt worldwide.
With all the chaos and confusion engulfing Hong Kong in recent weeks, it’s worth reminding ourselves what an extraordinary city it is — and what a loss to investors the removal of one of the world’s great safe havens would be.
Hong Kong has long operated in a culturally neutral zone somewhere between China and the world, a bridgehead between the West and the world’s rising superpower. By the time London handed it back to Beijing in 1997 after 150 years of British rule, a once barren rock had been transformed into a genuinely global city.
In the 17 years since, China has adhered largely to a set of principles thrashed out in 1984 by Margaret Thatcher and Deng Xiaoping, which allowed the city to retain its free media and independent judiciary. Indeed, if anything, Hong Kong has since handover become more cosmopolitan and vital to global flows of trade and finance. Restaurants hum to the sound of deals done in a hundred languages. The city is home to armies of enterprising Americans, Australians, French, Indians and mainland Chinese, as well as the still-ubiquitous British, all seeking a safe, reliable, low-tax place in which to work.
Yet it remains unclear how much damage has been done — and remains to be done — to the city’s reputation. As The Spectator went to press, hundreds of diehard protestors remained camped out in the city’s central business district, continuing to demand greater public participation in local elections slated for 2017, though thousands more had begun to drift away.
Hopes were rising that the worst possible outcome — the occupation by demonstrators of government buildings; local police losing control; a spooked mainland leadership sending in paramilitary forces to restore order — would be avoided. No one, least of all China’s politburo, wants to see a repeat of Tiananmen in 1989. The effect on already fragile global trade flows, and a slowing mainland economy struggling to cope with rising debts and a deflating housing bubble, is too awful to contemplate.
Let us leave aside for a moment the simple nobility behind a desire to create a fairer and more democratic society. Consider instead the vital economic and financial role Hong Kong plays in our fragile little world. It operates as a virtual sister-city for many of Britain’s largest banks, insurers and asset managers. Standard Chartered opened its first local office here in 1859, and retains a secondary listing on the local stock exchange. So does HSBC, founded here six years later as the Hongkong and Shanghai Banking Corporation. Both lenders source a generous slice of their annual earnings here — capital that flows into the pockets of British fund managers and retail investors.
These institutions are here not because Hong Kong is a great place to live — though it is — or because it offers such generous corporate and income tax rates — though it does. They are here because Hong Kong acts as a rare point of stability in an often turbulent region. Its British common law system protects investors and corporates. And it is flooded, much like London, with lawyers and accountants and merchant bankers, all helping global investors channel money into a dizzying array of mainland assets and securities.
China in turn uses the city as its window on the world. It has spent the past two decades parcelling up state assets and selling chunks of them on Hong Kong’s main bourse. Most of the country’s largest banks and industrial groups are listed here. Wealthy mainlanders, rightly fearful of the capricious urges of a one-party state, channel their life savings into local real estate, life insurance policies and school debentures. Hong Kong has become the premier offshore trading centre for the nation’s currency, the renminbi.
Now imagine this equilibrium being broken. So far, protests have passed by reasonably peacefully, a testament to the civility of most Hong Kongers. Global investors, usually so skittish, have remained admirably loyal in the face of civic unrest. Karl Loomes, an analyst at SunGard Financial Systems who tracks fund flows, has seen no sign that short sellers are betting against Hong Kong stocks. ‘So far,’ he says, ‘it’s been business as usual.’
But it doesn’t take much to imagine the events of recent weeks playing out again in the months to come — with far graver ramifications. The unpopular chief executive, C.Y. Leung, is unlikely to bow to demands for his political head. But protestors may well be mollified by a government pledge to make upcoming elections relatively more free and fair. Public fury will cool, if only for a while.
Yet few doubt that the fury will return sooner or later. Beijing is unlikely to give ground on its desire to pick the candidates for the 2017 poll. When students realise they have been granted little more than lip service, they will return to the streets. At that point, China’s leadership, facing a second loss of face on the world stage, may struggle to rein in its more belligerent instincts. An elite paramilitary service, the PAP, which has been training for a repeat of Tiananmen for decades, might well be pressed into service.
Neil McKinnon, a global macro strategist at VTB Capital in London, sees calls for democracy returning in the run-up to 2017, ‘creating a situation where protests escalate and get nasty’. Bloodshed on Hong Kong soil would change everything. Money would flee the mainland, probably leading to the return of capital controls. China’s economy would slow sharply, accelerating the hard landing many have long feared and predicted.
Hong Kong would suffer too. On 8 September the ratings firm Moody’s warned that a prolonged period of demonstrations in the city would ‘negatively affect economic growth’. As much as £60 billion could bolt the city, McKinnon believes, with ‘diminished confidence eroding Hong Kong’s standing as a global financial centre’ if discord persists.
At that point, the British lenders and fund managers that underpin the city’s financial system would need to make a decision. Should they remain in a place swathed in chaos and run by a panicking Chinese government reduced to the rank of pariah state, or should they make a calculated withdrawal from the city that helped spawn them? That same choice would be faced by many of the world’s largest investment banks and legal and accounting firms. Hong Kong’s loss would probably be Singapore’s gain.
Finally, there would be the diplomatic implications of Chinese aggression. Russia’s annexation of Crimea earlier this year was met by a slew of sanctions, choking off access to US dollar-denominated markets for leading Moscow-based lenders and energy firms. Imagine something similar playing out with Beijing. Would western governments dare to slap such restrictions on mainland lenders equally dependent on dollar funding? A slowing Russia might marginally crimp European exports, but a hard landing in China would threaten the global economy in untold and unknowable ways, tempering UK and US growth and threatening Europe’s erratic recovery.
Whitehall would face a particularly jarring decision. Sanctions would allow Parliament to duck any accusations of being willing to appease one hostile state, but not another. Yet Britain boasts a burgeoning and profitable relationship with Beijing. London is the second largest renminbi trading hub after Hong Kong. The Bank of England and the People’s Bank of China operate a thriving currency swap facility. And the UK is viewed as a place where mainland firms can do business without being vexed by nitpicking regulators (as in the US), burdensome regulations (France) or capricious tax authorities (India). To penalise a wounded China in its hour of need would be understandable, yet it would also undermine a budding special relationship. What a crushing loss to all of us that would be.
This article first appeared in the print edition of The Spectator magazine, dated 11 October 2014