The Hong Kong Domino Effect That Could Lead to Wall Street

Hong Kong’s economy and 7.4 million inhabitants are in a state of shock.

Shops are closed, tourism is down, property prices are falling. The streets are filled with rallies, protests, and lately, violence.

It all started more than 200 days ago, on the last day of March. That’s when this wave of rallies against Chinese interference began.

Despite Hong Kong being the world’s third most important financial center, this crisis is barely mentioned in the news.

But its repercussions for markets here in the U.S. could be huge…

Before we get to that, however, it’s important to know how we got here.

The Difference Between Hong Kong and Mainland China

After more than a century as a British colony, Hong Kong was handed back to China on July 1, 1997. Under British rule, the city had become a center for trade and finance, and the people of Hong Kong lived under a largely Western-style, democratic government.

China’s communist government agreed to keep this democratic system in. In what became known as the “one country, two systems” principle, China promised to take over control of Hong Kong without imposing its communist, authoritarian system on the city.

The so-called Hong Kong Special Administrative Region was to rule itself on domestic matters, at least until 2047.

But this was always a tense balancing act.

Hong Kong’s democracy was always deeply flawed, with the legislature designed to lean pro-China, and the Chinese government having an effective veto over who would be the city’s Chief Executive.

Meanwhile, the prosperity and freedom of speech in Hong Kong was always a threat to mainland China’s government. It was an example for the mainland citizens to see how China could be run differently and prosper at the same time.

This tension exploded into the so-called Umbrella Revolution of 2014 when China proposed changing Hong Kong’s election system, giving China control over who could even run for office in the city.

While that measure was withdrawn, further democratic reform stalled, and the Chinese government’s view of the city soured.

Which brings us to March 31, when people in Hong Kong began rallying against a proposal by the pro-China Chief Executive Carrie Lam. Under a bill she introduced, people in Hong Kong would be able to be extradited if they broke Chinese law in Hong Kong.

Protesters thought this would in effect remove Hong Kong’s special status, freedoms, and democracy in one fell swoop. After all, speaking out against the Chinese government is illegal in China. When you could be punished for doing so in Hong Kong too, democracy there would die.

As the Chief Executive and the Chinese government dug in their heels, the protests grew larger and larger.

The police began to use heavy-handed tactics to shut the protests down, stores were forced to close due to violence, and there was suspicion that pro-Chinese organized crime gangs were beating up protesters.

Carrie Lam withdrew the bill last week, on October 23, but by that point it was much too late.

Frustrated after months of protest yielded almost nothing, some of the protests have turned violent. Pro-Chinese businesses have been burnt, streets have been occupied, and barricades constructed. There are running battles between protesters and police almost every day now.

More than 2,000 people have been injured, with several cases of protesters being blinded in one eye after the police started shooting rubber bullets.

The protesters have added more demands, the release of political prisoners, an investigation into police violence, and completely free elections. Meanwhile, China has been signaling that it might send in the army to stop the protests.

As you can imagine, it became very difficult to do business in the city. On October 27, the city officially announced that it was in a recession, meaning its economy had shrunk for two back-to-back quarters.

While the news agencies in the U.S. aren’t covering this much, this could send shockwaves through the markets…

China’s Clampdown on Hong Kong Protests Could Rattle U.S. Markets

Most directly, the risk is that Hong Kong’s recession could spread to mainland China.

Already under pressure from a global slowdown and the tariff dispute with the U.S., in the third quarter of this year China’s economy grew at its slowest since records began in 1992.

Hong Kong has long been the place for foreign firms to set up shop for their Chinese divisions, with cities on the mainland such as Shanghai only recently becoming an alternative.

If the unrest in Hong Kong continues, foreign companies could think twice about doing that, cutting off foreign investment in China.

Remember, this comes after months of scrutiny at how U.S. companies have been censoring themselves to appease the Chinese government. The NBA was roundly criticized for not supporting the general manager of the Houston Rockets for tweeting in favor of the Hong Kong protesters. The NBA opted for compliance with China, having billions of dollars riding on broadcast rights and sales in China.

Gaming company Activision-Blizzard Inc. (ATVI) was then criticized by senators from both parties after it banned an e-sports player and withheld his tournament winnings for speaking out in favor of the Hong Kong protestors on air.

Even Disney Co. (D) caught some flak after it stopped showing Winnie the Pooh in China, as the character was banned after the country’s leader was made fun of for looking like him. With China now the largest market for movies in the world, this might mean Disney won’t be making more Winnie the Pooh movies or TV shows for some time.

This is another risk for China’s economy. If the country’s attempts at censorship of foreign companies is seen as too heavy-handed, CEOs will think twice about doing business there. Already, the boycotts and protests against Activision-Blizzard have traders looking twice at any company with ties to China:

China is the world’s second-largest economy. Any economic crisis there would quickly spread worldwide, and hit U.S. markets as well.

And if China clamps down on the Hong Kong protests harshly – or worse, sends in its army – the blowback could be huge. While the World Trade Organization (WTO) has no process by which a member country can leave or be expelled, the EU and the U.S. could push for it anyway.

If the Hong Kong protests come to a bloody end, that move is likely to gain wide support worldwide. That would result in China losing its trade status with most countries around the world almost overnight, with potentially catastrophic consequences for its economy.

While there’s a very slim chance of the dominoes falling until China gets expelled from the WTO, a more likely scenario would be U.S. and other democratic countries imposing economic sanctions on China – which would be a much bigger deal than tariffs have ever been.

Alternatively, all this turmoil could give President Trump cover to withdraw the U.S. from the WTO, which he has been signaling he’s interested in for some time.

The protests in Hong Kong may not be getting much screen time in the U.S. right now, but they are well worth paying attention to. The lack of coverage is no doubt due to large news conglomerates being reluctant to anger China’s government.

But the protests themselves could drag down China’s economy, sending shockwaves throughout U.S. and global markets.

Escalation of the protests and China’s response to them would mean that stocks with significant exposure to revenue from China (or supplies coming from China) could face limited growth. We’ll look at some companies with such exposure in a future article.

You need to see this $6 defense contractor with a mind-blowing new technology that’s designed to stop Chinese aggression dead in its tracks – before it’s too late…

For now, the U.S. / China trade accord is taking center stage and the likelihood of a near-term pop in stocks with China exposure is a higher probability than an escalation of problems in Hong Kong. But the Hong Kong issues are a much higher impact concern, so prudent traders and investors will keep the news from this important financial center firmly on the radar screen.

Great trading and God bless you,

D.R. Barton, Jr.

3 Responses to “The Hong Kong Domino Effect That Could Lead to Wall Street”

  1. hopefully the government and the protesters will come to an agreement soon. 1919 end of world war i. we are now in 2019. in these few years different lands thoughout the world did have minor protest est with the government. i just hope we won’t get into a depression by the 30’s. is history repeating itself? May G-d change our thoughts for the better and protect us from _______.

  2. GREAT article!!
    Why is the Chinese government so preoccupied with Hong Kong? Why not let HK be since it is a good economic model. Well since it (HK) does not conform to the political chinese model it stands to reason that China central power needs to get rid of it!!

  3. Jean – I’m glad you liked the article! Thanks for letting me know. You hit on the key word – power. An authoritarian government wants more of it and sooner. My belief is that they (central government) were hoping the trade negotiations would provide cover (which it largely has) and they then underestimated the protesters’ resolve. I’m hoping and praying for a peaceful solution that honors the promises and treaties already in place.

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