China’s sweeping plans to strip Hong Kong of democratic autonomy spell the “death knell” for the enclave’s special trading and financial status and will have grave economic consequences for China itself, Washington has warned in a dramatic shot across the bows.
The draft law bans “treason, secession, sedition and subversion” in Hong Kong, eviscerating the zone’s ‘One Nation, Two Systems’ status and violating the Sino-British Joint Declaration of 1984, a commitment lodged at the United Nations.
Mike Pompeo, the US secretary of state, said that if Beijing presses ahead with the “disastrous proposal” and openly flouts its international treaty obligations, the US will be forced to revoke Hong Kong’s unique privileges. At stake are the essential legal exemptions that allow it to function as a global hub.
The escalating showdown between the two global superpowers – and the lack of any obvious diplomatic “off-ramp” – has begun to rattle financial markets. The Hang Seng index tumbled 5.6pc and the Shanghai Composite was off almost 2pc. Brent crude fell 4pc.
The Cold War clash overshadowed the announcement of a massive Chinese stimulus plan on Friday, equal in economic scale to the post-Lehman credit boom in 2009.
Premier Li Keqiang rolled out a fiscal package of bonds, loans, and direct spending worth over 4pc of GDP and vowed to open the monetary flood-gates, hoping to turbo-charge recovery from Covid-19. But China’s structural problems run much deeper today than they did a decade ago and hidden unemployment risks becoming a curse.
Bowing to the inevitable, Li dropped the annual growth shibboleth for the first time in the modern era, a figure universally disbelieved by investors in any case. “We have not set a specific target this year. Our country will face factors that are difficult to predict due to the pandemic and the world trade environment,” he said.
It is a symbolic moment, an admission that the era of artificial uber-growth is over. Global commodity markets can no longer count on breakneck Chinese demand.
Chris Patten, the last governor of Hong Kong, said the draft security law is a “comprehensive assault” on the rule of law and fundamental freedoms of Hong Kong agreed in the Joint Declaration.
“At best, the integrity of ‘one country, two systems’ hangs by a thread. Unless the Chinese Communist regime sees sense, this will be hugely damaging to Hong Kong's international reputation and to the prosperity of a great city.”
The move renders de jure what has already been happening de facto. Bill Bishop from Sinocism said hardline Party cadres installed last year to crush the enclave’s democracy movement have been arresting dissenters and operating beyond restraint.
“President Xi Jinping and the Party Center may believe they can act with near impunity, especially now when most countries who would oppose this move are distracted and weakened by the pandemic. They are probably right,” he said.
What markets fear is the volcanic response from Washington, where Donald Trump last week threatened to “shut down” the whole economic relationship with China. While investors have learned to discount the President’s petulant outbursts on Twitter – and Chinese state media treats them with ridicule – the political waters are now becoming more treacherous.
Trump seems to have concluded that he can no longer campaign on his economic record and that his best shot at re-election – perhaps his only shot – is to blame China for deceptively unleashing the coronavirus on the world. Far from restraining him, Congress is demanding tougher action.
Cold War fever on Capitol Hill is bipartisan. Democratic Speaker Nancy Pelosi said the crackdown on Hong Kong is “deeply alarming” and cannot be allowed to stand. A chorus of Congressional leaders have called for sanctions and a review of Hong Kong’s special status.
Congress teed up action with the Hong Kong Human Rights and Democracy Act last November, obliging the State Department to certify each year whether China is in compliance with the Sino-British accord. If Hong Kong is no longer deemed sufficiently “autonomous”, it loses its special treatment and commercial privileges under US law.
The enclave would no longer be recognised by Washington as an independent member of the World Trade Organisation. It would be treated like any other Chinese city and face the same tariffs. There is now a mounting likelihood that this will be activated.
“Hong Kong’s future as a global city is in doubt,” said Mark Williams from Capitol Economics. Loss of US recognition would be a body-blow to the city’s status as a global financial entrepot. “Without autonomy and an impartial legal system, Hong Kong risks being eclipsed by Shanghai in finance and other mainland ports in trade and logistics.”
The 1,400 US companies operating there would drift away, many to Singapore. So would the 650,000-strong army of foreign residents. The bustling enclave would risk the sort of steep decline that has befallen so many trade and banking centres over history – Venice, Antwerp, or Amsterdam – when political shifts robbed them of their unique advantage.
US sanctions – or more accurately, loss of privileges – would hit 13pc of Hong Kong’s GDP (including re-exports) and come at a critical moment when the tourist industry is on its knees. The economy contracted 8.9pc in the first quarter.
Williams said optimists have long assumed that China benefits too much from Hong Kong’s current status as an investment and technology gateway to risk jeopardising the arrangement. Two-thirds of foreign direct investment flows into mainland China through the enclave. It now appears that Beijing is willing to pay that high price in order to contain the bacillus of democracy.
China is taking a huge political risk with its ultra-nationalist “wolf warrior” diplomacy ,breaching treaties and threatening countries around the world with rhetorical echoes of the 1930s. It is a far cry from Deng Xiaoping's “lie low and bide our time” doctrine in the early post-Mao years, which served China so well.
It is also a huge economic risk because China has not yet broken definitively out of the “middle income trap” and is badly overextended. The International Institute of Finance estimates that China’s debt-to-GDP ratio hit a record 317pc in the first quarter. The potency of new credit has been falling for a decade and productivity growth has been slipping.
While the official unemployment rate is around 6pc, Capital Economics says the true rate is nearer 15pc. A fifth of the country’s 300-million strong army of migrant workers have yet to return from their villages. There are not enough jobs.
The risk for China is that it will – by its own actions – accelerate the demise of globalisation. It will risks a further “reshoring” of manufacturing plants and undermining the export development model that led to the rise of the new China in the first place – and that has not yet been fully replaced by a new model. The Silk Road may impress the gullible but it is but viewed as a farrago of mercantilist nonsense by serious global economists.
Ironically, China may be making the same hubristic mistake as Tojo Japan: overestimating its own rising strength, and underestimating the resolve of the dishevelled and unruly democracies.