Why the Hong Kong Protests Matter to You
Out of all the market-defining events in the world right now, it’s the protests in Hong Kong that I’m watching closely.
Gold has cracked US$1,500 per ounce, Russia let off some sort of sketchy weapon, and the Reserve Bank of Australia is musing about negative interest rates…yet reading about the protests in Hong Kong is taking up a disproportionate amount of my time.
Because when Hong Kong was handed back to the Chinese in 1997, it was meant to be under a ‘one country, two systems’ style of government.
However, in the past two decades, Beijing’s presence and influence has been increasing in the democratic city.
At the same time, the people of Hong Kong feel they are slowly losing their democratic freedoms.
As Jim points out below, there are some 30,000 Chinese troops on the Hong Kong border. They’re ready to invade the minute ‘President for life’ Xi Jinping says so.
For now, Xi has held back. Not because he wants to. More because if he sends in the Chinese military, it’s proof that China is against Western ideals.
This tells us two things. Firstly, China is becoming increasingly desperate in the trade war. Secondly, the Beijing-leaning Hong Kong government and the Middle Kingdom are having their authority challenged.
Neither of these things are good for markets.
Read on for more.
Until next time,
China the Biggest Loser in the Trade War
Jim Rickards, Strategist
China’s shock currency devaluation last week begs the following questions: Is China a rising giant of the 21st century, poised to overtake the United States in wealth and military prowess? Or is it a house of cards preparing to implode?
Conventional wisdom espouses the former.
Yet, hard evidence suggests the latter.
A careful analysis means investors should watch what happened with the giant panda theory.
I made my first visits to Hong Kong and Taiwan in 1981, and my first visit to Communist China in 1991.
I have made many visits to the mainland over the past 20 years, and have been careful to move beyond Beijing (the political capital) and Shanghai (the financial capital) on these trips.
My visits have included Chongqing, Wuhan, Xian, Nanjing, new construction sites in ‘ghost cities’, and trips to the agrarian countryside.
I spent five days cruising on the Yangtze River before the Three Gorges Dam was finished so I could appreciate the majesty and history of the gorges before the water level was lifted by the dam.
I have visited numerous museums and tombs, both excavated and unexcavated.
My trips included meetings with government and Communist Party officials, and numerous conversations with everyday Chinese people, some of who just wanted to practice their English language skills on a foreign visitor.
In short, my experience with China goes well beyond media outlets and talking heads.
China’s a global superpower
In my extensive trips around the world, I have consistently found that first-hand visits and conversations provide insights that no amount of expert analysis can supply.
These trips have been supplemented by reading an extensive number of books on the history, culture and politics of China from 3,000 BC to the present.
This background gives me a much broader perspective on current developments in China and a more acute analytical frame for interpretation.
An objective analysis of China must begin with its enormous strengths.
China has the largest population in the world, about 1.4 billion people (although soon to be overtaken by India).
China has the third largest territory in the world, 9.5 million square kilometres. That’s just slightly larger than the United States (9.3 million square kilometres), only slightly behind Canada (9.8 million square kilometres) and well above Australia’s land mass (7.6 million square kilometres).
China also has the fifth largest nuclear arsenal in the world with 280 nuclear warheads — about the same as the UK and France, but well behind Russia (6,490) and the US (6,450).
China is the largest gold producer in the world at about 500 metric tonnes per year.
China has the second largest economy in the world at US$15.5 trillion in GDP — behind the US with US$21.4 trillion, and well ahead of number three, Japan, with US$5.4 trillion.
China’s foreign exchange reserves (including gold) are the largest in the world at US$3.2 trillion (Hong Kong separately has US$425 billion in additional reserves).
By way of contrast, the number two reserve holder, Japan, has only US$1.3 trillion in reserves.
By these diverse measures of population, territory, military strength and economic output, China is clearly a global superpower and the dominant presence in East Asia.
Stuck in the middle-income trap
Yet, these blockbuster statistics hide as much as they reveal. China’s per capita income is only US$11,000 per person, compared to per capita income of US$65,000 in the United States.
Put differently, the US is only 38% richer than China on a gross basis, but it is 500% richer than China on a per capita basis.
China’s military is growing stronger and more sophisticated, but it still bears no comparison to the US military when it comes to aircraft carriers, nuclear warheads, submarines, fighter aircraft and strategic bombers.
Most importantly, at US$11,000 per capita GDP, China is stuck squarely in the ‘middle income trap’ as defined by development economists.
The path from low income (about US$5,000 per capita) to middle income (about US$10,000 per capita) is fairly straightforward and mostly involves reduced corruption, direct foreign investment, and migration from the countryside to cities to purse assembly-style jobs.
The path from middle income to high income (about US$20,000 per capita) is much more difficult and involves creation and deployment of high technology, and manufacture of high-value-added goods.
Among developing economies (excluding oil producers), only Taiwan, Hong Kong, Singapore and South Korea have successfully made this transition since the Second World War.
All other developing economies in Latin America, Africa, South Asia and the Middle East, including giants such as Brazil and Turkey, remain stuck in the middle-income ranks.
China remains reliant on assembly-style jobs and has shown no promise of breaking into the high-income ranks.
In short, and despite enormous annual growth in the past 20 years, China remains fundamentally a poor country, with limited ability to improve the wellbeing of its citizens much beyond what has already been achieved.
Losing the trade war
With this background and a flood of daily reporting on new developments, what do we see for China in the months and years ahead?
Right now, we believe that China is confronting social, economic and geopolitical pressures that are testing the legitimacy of the Communist Party leadership and may lead to an economic crisis of the first order in the not-too-distant future.
In contrast to the positives on China listed above, consider the following negative factors:
Trade wars with the US are escalating, not diminishing, as I warned from the start in early 2018.
Trump’s recent imposition of 10% tariffs on the remaining US$300 billion of Chinese imports not currently tariffed (in addition to existing tariffs on US$200 billion of Chinese imports) will slow the Chinese economy even further.
China retaliated with a shock devaluation of the yuan below 7.00 to one US dollar — a level that had previously been defended by the People’s Bank of China.
Resorting to a currency war weapon to fight a trade war shows just how badly China is losing the trade war.
But this currency war counterattack will not be successful because it will incite more capital outflows from China.
The Chinese lost US$1 trillion of hard currency reserves during the last round of capital flight (2014-2016) and will lose more now, despite tighter capital controls.
The spike of bitcoin to US$11,000 following the Chinese currency devaluation is a symptom of Chinese people using bitcoin to avoid capital controls and get their money out of China.
All eyes on Hong Kong
The unrest in Hong Kong is another symptom of the weakening grip of the Chinese Communist Party on civil society.
The unrest has spread from street demonstrations to a general strike and shutdown of the transportation system, including the cancellations of hundreds of flights.
This social unrest will grow until China is forced to invade Hong Kong with 30,000 People’s Liberation Army troops now massed on the border.
This will be the last nail in the coffin of the academic view of China as a good global citizen.
That view was always false, but now even the academics are starting to understand what’s really going on.
International business is moving quickly to shift supply chains from China to Vietnam and elsewhere in South Asia.
Once those supply chains move, they will not come back to China for at least 10 years, if ever.
These are permanent losses for the Chinese economy.
Of course, lurking behind all of this is the coming debt crisis in China.
About 25% of China’s reported growth in the past 10 years has come from wasted infrastructure investment (think ‘ghost cities’) funded with unpayable debt.
China’s economy is a Ponzi scheme like the Madoff plan and that debt pyramid is set to collapse.
This cascade of negative news is taking its toll on Chinese stocks.
This weakness began in late June 2019 when the G20 Leaders’ Summit meeting between US President Trump and Chinese President Xi failed to produce substantive progress on trade disputes.
Since then, the trade wars have gone from bad to worse and China’s economy has suffered accordingly.
Our expectation is that a trade war resolution is nowhere in sight, and the trade war issues have been subsumed into a larger list of issues involving military and national security policy.
All the best,