Some thoughts on Hong Kong

Massive demonstrations in Hong Kong have set inhabitants of the Chinese-controlled territory (handover on July 1, 1997) against the Chinese government, with 1.7 million people involved in demonstrations on August 18, equating to 25% of the population.

The key issue at stake here is the shift in the political landscape in Hong Kong after the region’s government announced plans to amend its extradition law, as Hong Kong inhabitants fear Chinese control over the HK legal system, giving rise to concerns that they could lose their independence from Beijing. This means the risk that Hong Kong could lose some of its special status (one country, two systems since the agreement implemented in 1997), jeopardizing the personal safety of all HK inhabitants.

Hong Kong Chief Executive Carrie Lam stated on July 8 that the extradition bill was dead, but this did not appease demonstrators, who are calling for her resignation: not only was she was the instigator of the proposed amendment, but she is also not democratically elected – rather she is appointed by a 1,200-member election committee, mostly appointed by Beijing. The Chief Executive should be appointed via elections based on universal suffrage, but since the umbrella revolution in 2014, Beijing’s approach to HK has changed and the Chinese government no longer seems to want to comply with the initial democracy agreements. 
This public backlash against political changes in HK is also due to the fact that the Chinese government meddles in legislative elections, stepping in to rule against one candidate or another. 
China has taken a firm stand to quash this social unrest, and troops are barracked at the border with Hong Kong, involved in maneuvers although not intervening. 

It is interesting to look back in time to understand what is happening and gain some insight into the Chinese government’s heavy-handed reaction. 
During the UK handover of Hong Kong to China in 1997, it was agreed that there would be one country, two systems i.e. Hong Kong would remain subject to market forces and China would maintain a socialist system. China would be in charge of HK’s defense and foreign affairs, but the region would have its own constitution with a strong degree of autonomy from China, maintaining freedom of the press, freedom of assembly and the right to demonstrate, etc.
The agreement that came into force on July 1, 1997 was signed for a duration of 50 years – i.e. until 2047 – after which the one country, two systems set-up could become one country, one system.

But this is the very issue that is attracting concern in Hong Kong: the initial idea was that the two systems would converge, based on the assumption that China would develop economically and its political system would evolve towards the HK system, not vice versa. This was the idea put forward by Samuel Pisar i.e. greater economic affluence would lead to the gradual implementation of a more liberal and democratic political system.
However, judging by moves from Beijing, residents of Hong Kong look on as their system shifts and moves towards the Chinese political system. They are concerned that they will gradually be incorporated into this system and become just another Chinese province among others, which would mean access to information being more restricted and freedom of speech becoming much more limited than it is now: Hong Kong has a lot to lose.

The government in Beijing does not want to take the risk of allowing social unrest to gain a foothold, and has not shied away from repressing any demonstrations that take place across the country. To avoid this type of situation, the Chinese authorities take a very active approach to applying economic policy, and are strict in ensuring that social instability does not take root. This is one of the factors underpinning the widespread development of electronic surveillance in China, as facial recognition and the social credit system are ways of curbing these risks in a type of digital dictatorship engineered to avoid social strife.
This need for the authorities to curb unrest is exacerbated by the fact that growth is slowing and the Chinese economy is struggling to create all the necessary jobs.

In other words, the authorities in Beijing do not want the Hong Kong demonstrations to spread to the rest of China, which is fettered by more sluggish growth. This is a dangerous situation, as citizens in both Shenzhen and Guangzhou are closely watching how the Hong Kong-Beijing relationship pans out: a number of Shenzhen residents work in Hong Kong, so there is no longer a strict separation between the territory and the rest of China.

This battle of wills raises a number of questions.
Chinese military intervention in Hong Kong is one of the list of potential options, but this kind of political move could well draw parallels with the Tienanmen Square events in the spring of 1989.
This would be damaging for China as its international expansion has been exponential since 1989 and moves aimed at extending the country’s influence – such as the Belt and Road Initiative – would be threatened by military intervention. This would also be a major risk as that the country is involved in a stand-off with the US and is able to offer technological capabilities that could help skew the world balance in China’s favor: in this respect, the Huawei affair is symbolic as the company has the wherewithal to replace mobile telephone networks and swiftly migrate all European countries to Chinese 5G technology.
So this kind of move would trigger hefty risks at a time when China wants to challenge the US both economically and politically.
Meanwhile, a deterioration in Hong Kong’s status resulting from Chinese intervention and putting it on a par with other Chinese regions would increase mistrust of Beijing from all other world capitals. 

However, this mistrust may only last a short while, and China can hope that its economic and technological firepower would ensure that it emerges as leader over the years ahead, with intervention having a limited effect over time. After all, the events of Tienanmen Square did not stop China growing and extending its influence in the world over the past 30 years.

Ultimately, the issue at stake here is China’s role in the world, as the country stands against the US in a worldwide economic and political battle of wills. Technological, economic and political leadership is being played for, and Washington has not managed to put an end to its contest with Beijing after Chinese retaliation forced Donald Trump to back down last week when he delayed border tariffs on electronic consumer goods to December 15.
China is also currently finding its domestic balance, and keeping Hong Kong’s current status would mean maintaining access to the rest of the world and allowing the rest of the world to have access to China. This communication is vital, although HK admittedly only accounts for 3% of China’s GDP as compared with 20% in 1997. 
China could well be on the way to becoming the economic heavyweight it was before the industrial revolution in Europe. The choices it makes in addressing the demonstrations in Hong Kong will be a harbinger of just how it plans to act in this leadership role in today’s globalized world. 

What to expect next week ? (August 19 – August 25, 2019)

Highlights

> Discussions on trade war between China and the US have been the main trigger for financial markets last week. It will continue as China is ready for retaliation. That’s the way we must interpret the recent change in the White House measures. It has postponed new tariffs to December the 15th. It was said to ease Xmas gifts but it was more probably the consequences of the discussions between the two countries. After December the 15th, 96.8% of Chinese exports to the US will have tariffs. That’s a terrible change compared to the 5.3% seen in 2013.
The situation between the two countries and the Chinese announcement of retaliation are a source of concern and of lower interest rates. The risk is to jump into a global recession.
With the deep slide seen on interest rate this week (August 12) after the discussion on trade, the main question is to anticipate until which level they will be able to go in negative territory in the Eurozone.

> The impact of this trade war is already seen in exports figures for Japan. In real terms, the exports are already down more than 2% in YoY comparison. The figure for July (August 19) will probably confirm this trend implying new risks for the Japanese growth.

> The Markit indices for August will be released as flash estimates for Japan, Euro Area, Germany, France and the US on August the 22nd. We will look carefully at the manufacturing sector where the world index (will not be released next Thursday) is already in the contraction zone and where all indices for larges developed countries are close or below the 50 threshold.

> In the UK, the CBI survey on new orders may confirm the risk of a deep recession (August 20). The recent drop of this index is already impressive as accumulated inventories for the Brexit limit the possibility of a supplementary demand.

> The last point to look at will be the US housing market. The Existing Home Sales figure will be released on August the 21st. This is an important data as it supports a wealth effect for US households. Recent figures do not show an improvement even with lower mortgage rates. New Homes Sales will be released on August the 23rd.
> August 19 Final CPI release for July in the Euro Area. August 21, the German consumer confidence for August and CPI for Japan on August the 23rd.

The document is here
NextWeek-August19-August-25-2019

What to expect next week ? (July 15 – July 21, 2019)

Highlights


> The Chinese GDP growth number for the second quarter (July 15). During the first three months of the year growth was at 6.4% It should be lower as monthly date on industrial production and imports show a poor momentum.
> Retail sales and Industrial production in the US (July 16). They will show the strength of the US economy. These will be important benchmark that may influence the Fed’s strategy. Powell just mentioned this week that there was no improvement despite the strong labor market report.
Associated to these numbers, the Fed’s beige book (July 17) will highlight the Fed’s perception of the economy at a regional level.
> The NY Fed (July 15) and the Phylli Fed (July 18) indices on economic activity will also provide data on the business cycle strength.

> ZEW index in Germany (July 16). A weak number following weak numbers in recent months may force the government to adopt a more proactive economic policy.
> Employment numbers in the UK (July 16) and CPI in the UK (July 17)
Weaker numbers on employment are still to come and will be seen after this summer with the strong slowdown expected in the manufacturing sector.

The document is available here NextWeek-July15-July21-2019

What to expect next week ? (July 8 – July 14, 2019)

Highlights

  • External trade for Germany is the statistics I will focus on this week (July 8). Since the beginning of the year, real exports are slowing down as a consequence of the trade war. Expectations are negative and this is a source of concern for the German growth momentum. The German government may have, in coming weeks, an opportunity to boost domestic demand to cushion this disruption.
  • The Chinese external trade will also be a major indicator (July 12) as a measure of the trade war impact.
  • The German industrial production index will also show a slowdown in May (July 8). This would be consistent with expectations on its external trade and with corporate surveys that reflect pessimism.
    The other point to mention here is that the UK industrial production will show a downward trend (July 11). This would be consistent with the Markit index for the manufacturing sector. In May the Markit synthetic index was at 49.4 (from 53.1 in April).
  • The US inflation rate for June (July 11) will slow as seen in European inflation rates for June (flash estimates) while the Chinese will remain strong (2.7% in May) as food price (pork price precisely) will continue to push up the price index.
  • Financial Stability Report by the Bank of England (July 11 at 1130 CET), Minutes of the last FOMC meeting (June 18-19) on July 10 (2000 CET)  and Minutes of the last ECB meeting (June 5-6) on monetary policy (July 11 at 1330 CET)

The document is available here NextWeek-July8-July14-2019

 

What to expect next week ?

Highlights
  • Chinese trade figures, industrial production and retail sales for May are key to see how China cushions the negative international trade shock. Weak number would imply new measures to support domestic demand
  • The US economy is slowing down on industrial side. This was shown by the ISM manufacturing index in April and the industrial production index is trending downward since the beginning of the year. A negative figure on industrial production for May (June 14) may accelerate the Fed’s monetary policy change (next meeting June 19).
  • This change in the Fed’s strategy may also reflect a lower inflation rate. CPI figure will show a lower headline inflation (2% in April) and stable core inflation rate. Retail sales (June 14) are volatile reflecting a weaker domestic demand. This could add up to CPI and industrial production in the Fed’s decision in June.
  • After weak figures in the in April, the Euro Area industrial production index (June 13) will be down. May be is it the signal Draghi mentioned yesterday in his press conference to move the ECB monetary policy on a more accommodative ground

The document is available here NextWeek-June10-June14-2019

US-Chinese tension makes for a fascinating time in history

Donald Trump’s tweets on May 5 fueled tension between China and the US, dramatically triggering renewed speculation on the conditions of any fresh trade deal. China retaliated to fresh US border tariffs on its goods by applying taxes to US imports. This move interrupts a long period of calm that had kicked off after the G20 meeting on December 1 (see my blog post dated February 21 2019 here)

Donald Trump’s drive to apply fresh tariffs on China reflects his determination to bring jobs back to the US – especially in the manufacturing sector – and also ease the country’s dependence on China. 
The country had a $419bn trade deficit with China in 2018 due to hefty imports of goods into the US, while conversely American companies struggled to export sufficiently to China. The chart above makes for a perfect illustration of this tricky situation for the US.
The situation recently became a lot more challenging, as the flipside of this Chinese trade surplus with the US was its financing for the US economy via US Treasuries purchases in particular. This set-up worked for a long time and it acted as a way for the two countries to remain tied together, as Chinese goods found a market in the US while China financed the US economy to make up for Americans’ insufficient savings. The US-Chinese relationship was based on a complementary approach, but this balance is shifting as China’s contribution to financing of the US economy has been decreasing over the past several months. In March 2019, the proportion of US financial assets held by China as part of the United States’ total external financing returned to lows witnessed in June 2006. 
The balance between the two countries is changing and the US can no longer have the same influence on China that it had in the past. China is standing apart and wants to achieve greater independence.

The White House is also running out of patience with China taking its time to meet its requests. By taxing Chinese imports, Washington is seeking to dent economic activity in the country, and there is a danger that this will generate severe social tension and force the Chinese government’s hand, as it did not want to take this social risk. Sluggish Chinese economic indicators since the start of the year could lend credence to Washington’s approach, and prompt it to take an even harder line on trade, yet this approach is not necessarily the right one. 

At the beginning of 2019, the weight of the United States in Chinese exports slowed down considerably. Chinese dependence on the US is reversing, while at the same time, the Chinese are relaunching the “Belt and Road Initiative” whose objective is to further diversify the Chinese market. China is expanding its markets and is effectively limiting the influence of the United States on its economy.

The other major disagreement between Washington and Beijing is on technology, andin my view, this is the main bone of contention between the two countries. China’s technology has caught up very swiftly over the past twenty years via technology transfers and by setting aside substantial resources to facilitate this fast progress. This approach worked well, and China now has some headway over the US, particularly in 5G and artificial intelligence. 
The United States’ loss of technological supremacy is a radical change as China has the resources to develop these technologies without US support. This kind of situation could have emerged with Japan a few years ago, but Japan always remained within the US sphere of influence… the same cannot be said of China. The country has a huge domestic market, while development outside the country is vast, so this can now generate self-sustaining technological momentum. 

Washington has been particularly tense on this issue over recent months, with sanctions against ZTE in April 2018, and in particular against Huawei in December 2018 attesting to this strain. European governments have also come under pressure to steer clear of Chinese technology (read here). More recently, Donald Trump blacklisted Huawei (read herebehind paywall), while other Chinese companies no longer have access to the US market such as China Mobile (read herearticle in French).

The stakes are very straightforward – the country that decides the standards for these new technologies will gain a massive competitive advantage and be able to more easily develop innovations using these technologies. This is the stumbling block for negotiations as China has invested substantial resources to notch up this technological advantage and does not want to be dictated to by the US. Similarly, it seems unthinkable that the US would spontaneously accept China’s progress and be dictated to by the country in order to use its technologies. 

This technological battle of wills will not be resolved by itself. Neither country is set to give in, so an agreement looks unlikely, unless the Chinese economy takes a severe downturn, but this is not part of our scenario.
However, it does not stop there. Development of 5G for example is at the heart of a number of innovations and countries outside China and the US are developing businesses that use this technology. This means that developing these innovations on a mass scale will probably require use of Chinese technology, and this is set to trigger more tension with the US. Emmanuel Macron has already made his position clear on this issue (see statement at the Vivatech event here). 

The dynamics of the world economy are changing, but the new world order is not going to emerge straight away. This is the first time in history we have seen this kind of situation, and the first time that the world economy could shift towards a new region as a result of technological innovation. When the center of gravity of the world economy shifted from the UK to the US, there was still a degree of continuity, but the same cannot be said of today’s situation. And Europe will also have to find its place in this new order. 
This transformation will overturn the dynamics of the world economy and change the entire balance between the various regions of the world. 
What a fascinating time to observe world events.

Italy, the Belt and Road program, and China – My weekly column

Italy’s moves to sign a deal with China and get involved in its Belt and Road Initiative (BRI) are highly significant as Italy is the first of the European Union’s founding countries to join this program. By way of reminder, the Belt and Road Initiative aims to develop stronger trade between China and various other regions of the world. Italy is the 12th European Union country to get involved in this program. Meanwhile Greece, Hungary and Poland are not opposed to it, and rail transport between Chengdu and Lodz has increased considerably over the past five years due to trade between the two countries. However, Sweden is fairly opposed to the Chinese program, while France and Germany are reacting cautiously – probably as they see potential business and trade opportunities, but also the restrictions involved in the program as it is primarily dictated by China.

The value of the Italy-China agreement is not yet huge and does not reflect a firm commitment between the two countries, but it has already caused some strife in the Italian government between Di Maio who went all out to promote the agreement, and Salvini who wanted none of it.

China sets great store by this international drive and the country’s role in the global balance, and when Xi Jinping set up the BRI in 2012 just after he took over as President, he put this world view center-stage again. His aim then as now is to root China’s fresh phase of growth within a broader context and link it back to the country’s development more than 2,000 years ago when the growth of the Silk Road network shaped Asia, sprawling out as far as Europe. During his recent visit to Europe, Xi Jinping was keen to remind listeners of the very long-standing relationship between Rome and the Han dynasty, which ruled from 206 BC to 220 AD, and he also referred back to the rich 13th century Venetian merchant Marco Polo’s trip to China. He took great pains to mark the country’s historical ties with Italy, but also China’s long-standing influence and role across the globe.

China’s incursion into Europe via the BRI obviously raises questions on the relationship between the two regions: targeting one of the EU founder countries marks a new milestone, especially as Italy has already been on the receiving end of quite a bit of China’s investment in the region. The UK has traditionally been China’s favorite focus for investment since 2000, with a total of €59.9bn up to 2018 according to Merics, but Italy ranks third with €15.3bn, just behind Germany’s €22.1bn, while France is fourth with €14.3bn.

However, Italy’s political choice raises a number of questions.

Is this decision a way to divide Europe amidst a global backdrop where doubt already prevails over European harmony? Several countries no longer want to comply with EU rules as strictly as they did before: Italy is a case in point, but we could also mention Poland, Romania and a few others. Considering European wariness of China, could this be a way for it to drive a wedge between the countries of Europe? This is a valid question as by promoting an easing of European-led restrictions, perhaps China could gain some more leeway to implement its worldwide growth strategy while also shoring up its international position…

Well may we wonder then whether Italy’s move is also a way for Southern Europe to put pressure on Northern Europe and the European Commission, as the region could use the relationship with China to gain leverage – particularly Italy, as tension with Brussels has soared since the coalition government took over.

China has already invested in the port of Athens (Piraeus), the port of Sines in Portugal, the port of Valencia in Spain, and has taken a foothold in the industrial port of Venice (Mestre-Marghera). The country – alone or sometimes via Hong Kong – now owns or manages 10% of European ports, while there are also bids to manage even more. This is a hefty figure and these moves could fuel imbalances and pressure between European states in a less harmonious Europe.

So all this begs the question whether China’s behavior as it seeks to extend its influence is a reflection that Europe is relegated to second place. The old continent harbors strong purchasing power, but it is divided despite the European institutions and does not seem to have a role to play in the tech battle between China and the US. So is this a way for China to disrupt Europe’s supposed unity with the US and move forward in the technological war, which will ultimately lead to China’s technological domination in Europe as it asserts its worldwide position? We recently saw threats from the White House – particularly to Germany – as it sought to stop the use of Huawei equipment when renewing mobile phone infrastructure.

Lastly, the key point in the Italy-China agreement is the port of Trieste, an industrial free zone that is set to be China’s bridge into Italy. Trieste boasts major advantages that Piraeus does not have, and these explain much of why Chinese investments in the port of Athens ended in failure. Firstly, the port of Trieste is already part of a broader industrial framework: secondly, there is a much more extensive rail network than in Greece, which makes Munich closer via this route than if getting there from Hamburg, in terms of both time and distance. In other words, Trieste is close to southern Germany, northern Italy and south-east France, and the route from Shanghai to Trieste is almost 10 days shorter than the route to ports in the north of Europe. This is very important and could put Trieste in a position to rival with Rotterdam or Hamburg, and this factor could play a crucial role in shaping the new European landscape.

This post is available in pdf format My Weekly Column – 1 April