The Latest Hot Spot for U.S.-China Tensions Is Heating Up

China can't get enough... Trouble again in Hong Kong... The stakes are high... The latest hot spot for U.S.-China tensions is heating up... Another log on the global economic fire... Great Depression reading...

If political and economic crisis were an all-you-can-eat buffet, China is now going back for thirds...

China is already facing a rising chorus of blame over its handling of the coronavirus and sparking a potential global depression...

The Chinese government's relations with the U.S. are "at their lowest point in decades," the Wall Street Journal said last week...

And the threat of a technology "iron curtain" clouds the future of China's tech champions.

With all that said, you might think that the leaders in China would feel like they already have their hands full with global-scale challenges...

Not so much.

By its own choice, China is about to light a match on another potentially world-reaching conflict...

China is ripping the Band-Aid off from what was a coronavirus-imposed truce in Hong Kong...

As Daniel Smoot from our Stansberry NewsWire team reported on Friday, China is looking to show its democratic "special administrative region" ("SAR") of Hong Kong who's boss – again...

After years of rising tensions in the pro-democracy region of Hong Kong, China today announced it would also impose new legislation to quell the unrest.

The law would give the communist party the ability to ban treason, secession, sedition, and subversion as well as bypass Hong Kong lawmakers altogether, BBC reported.

In the short term, this move will make investing in Hong Kong and China – critical world markets – all the more unpredictable in the coming months...

And it could also have a bigger impact on global geopolitical relations, including the simmering tensions between the U.S. and China.

In today's Digest, I (Kim Iskyan) will explain this situation... detail why solving "the Hong Kong question" is critically important to the Chinese government... and what this could mean for investors.

But first, some context...

Protests against mainland China dominated the second half of last year in Hong Kong...

At the unrest's peak, as many as 2 million people took to the streets of Hong Kong... or about a quarter of the island's population.

Fears of the local government passing a bill that would have allowed extraditions to mainland China drove the protesters into action.

In the bigger picture, these folks were tired of China getting overly involved in Hong Kong's business. It's a longstanding situation that dates back to when the island ceased being a British colony in 1997 and agreed to become a semiautonomous region of China.

Under the terms of the deal, after 156 years of British rule, Hong Kong would be allowed to maintain the capitalist system and its way of life for 50 years – after which the large metro area would lose its specialness and become just another part of China.

"One country, two systems," as the arrangement was called, hid the huge contradictions between the two approaches... But it was a good way to kick the can down the road for the next generation.

Today, here we are.

In the fall, protests became increasingly violent, with a small group of demonstrators lobbing Molotov cocktails, vandalizing malls, and assaulting police – who responded with similar violence... and for the most part, surprising restraint.

For months, large swaths of Hong Kong felt more like a war zone than the Asian continent's equivalent of Wall Street. In October, the Hong Kong government formally withdrew the bill that had started the unrest. But even when I visited in December, protests were still happening pretty much every day.

Then, the coronavirus put this narrative on hold... The year of the protest met the year of the lockdown.

Social distancing and shelter-at-home don't mix well with millions of people marching for Hong Kong's autonomy.

But with COVID-19 mostly in the rearview mirror in China and Hong Kong, it's back to business...

"Is this the end of Hong Kong as we know it?" asked Foreign Policy magazine on Friday.

Chinese leaders took the initiative last week at the National People's Congress ("NPC"), the annual gathering of the country's legislature... The government said it would impose a national security law on Hong Kong to target, as the Financial Times described it, "subversion, terrorism, and foreign influence."

The Financial Times spoke with Xie Feng, one of Beijing's top representatives in Hong Kong. According to the newspaper, Xie said...

The legislation will alleviate the great concern among the local and foreign business communities about the violent and terrorist forces attempting to mess up Hong Kong... [and] will create a more law-based, reliable and stable business environment for foreign investors.

If that sounds like propaganda to you... you're not alone.

With the new rule, China will wreck a lot of what's special about Hong Kong. And that's probably the point.

Investors are taking notice, with Hong Kong's Hang Seng Index falling by as much as 5.7% on Friday. That marked the index's worst daily performance in nearly five years.

And even though the index bounced back a little bit over the past two days, more upsetting news could be coming...

On Thursday, the NPC is scheduled to force its new measure into Hong Kong's mini-constitution, the Basic Law, to bypass Hong Kong's own legislative process.

If it does, China will go back on the deal it made in 1997.

But wait, you may ask, isn't Hong Kong part of China?

Well, yes, but mostly no.

Given Hong Kong's status as a SAR, people there have a lot more freedom than people in mainland China. Hong Kong follows the rule of law and has an independent judiciary.

It's ranked as the third-easiest place in the world to do business. And it serves as Asia's financial center.

According to the nonprofit Transparency International, Hong Kong is as corruption-free as Austria or Iceland, and less corrupt than the U.S... while China is as corrupt as Argentina or Benin. And while Hongkongers may share an ethnic heritage with people from "the mainland," Texans and New Yorkers are separated at birth by comparison.

In 1997, Hong Kong was an essential economic and financial lifeline for China to the rest of the world...

Back then, Hong Kong accounted for around 20% of the Chinese economy. And its stock markets were an important way for Chinese companies to raise capital from international investors.

But since 1997, China has been steadily China-fying Hong Kong...

Kids in Hong Kong's public schools are taught Mandarin, rather than the Cantonese that is spoken in Hong Kong...

Every year, around 50,000 mainland Chinese immigrants move to Hong Kong in a stealth takeover by demographics...

And China's plan to develop a massive Greater Bay Area ("GBA") megacity to integrate Hong Kong, Macau, and Guangdong into a big, urban, technology giant will dilute Hong Kong's regional influence...

"The GBA is another way that Hong Kong is being assimilated into the fabric of the mainland," a Hong Kong-based political risk analyst told me last week. "China's ambitions are economic, but there's a political driver behind all of it for Beijing."

Hongkongers have long seen the writing on the wall, and have intermittently pushed back...

During the so-called "Umbrella Movement" in 2014, protesters occupied the downtown business district to demand free elections for Hong Kong's leader. But support waned, and the protests ended after less than three months.

In June 2019, the bill proposed by the Hong Kong government – which answers to Beijing – would have allowed suspected Hong Kong criminals to be sent back to mainland China. It motivated Hongkongers to get back out on the streets.

They were upset about more than the bill... The bigger complaints were about the China-fication of Hong Kong, and the desire for China to have bigger say in the governance of Hong Kong...

As a protester I spoke with at the time said, it was about "democracy and freedom"... or at a minimum, greater accountability for their (pro-Beijing) local government.

Critics widely deride the pro-Beijing leadership of Hong Kong as incompetent and out of touch. And more broadly, many Hongkongers have long felt shut out of the island's prosperity.

For all of its apparent wealth – Hong Kong is sixth on the list of countries with the most billionaires, although it has just 7.5 million people – many people in the region, including those with well-paying professional jobs, can barely make ends meet because it's absurdly expensive to live there... just like it is in New York or San Francisco.

And that brings us back to now...

Over the past several months, Beijing has changed some of the senior personnel charged with figuring out "the Hong Kong question," and signaled that it will take a harder line.

Last week, pro-democracy and pro-Beijing lawmakers in the Hong Kong legislature brawled over the leadership of a committee that would consider legislation to make it illegal to insult the Chinese national anthem.

The new rules regarding national security – the issue that Beijing has made clear that it's going to push now – would make it a lot easier for China to control Hong Kong.

Beijing has previously tried, and failed, on getting Hong Kong to implement national security measures. So now, the symbolism of forcing it onto Hong Kong would be another shovelful of dirt on the grave of Hong Kong's dreams of democracy and freedom.

In other words, China looks like it's saying that 23 years of the "one country, two systems" approach to the financial hub of Hong Kong may be ending.

The stakes are high for China, but maybe not for the reasons that you think...

As China's financial gateway to the world, Hong Kong helped drive China's incredible economic growth over the past few decades.

As I said earlier, Hong Kong accounted for around 20% of the Chinese economy at the moment of the handover from the British in 1997.

But today, Hong Kong's economy is less than 3% the size of China's. Hong Kong has less than a third of the population of Shanghai – and wouldn't even crack a list of the 10 most populous cities in China.

Hong Kong's stock market is a convenient way to raise capital – but Chinese companies can go to London or New York if they can't find funds on the increasingly dynamic domestic (non-Hong Kong) exchanges.

Hong Kong matters because China has to show who's boss 'internally'...

That's especially true when it's under fire from everywhere else.

China is hugely diverse, with lots of minorities struggling for a louder voice. For example, the predominantly Muslim Uyghur region of Xinjiang in northwestern China has long suffered under Chinese repression.

Then there's Tibet, which for decades has pushed for greater autonomy.

And most importantly, China has to show Taiwan – which has been independent since 1950 and is viewed by China as a rebel region – that it means business.

If China backs down on Hong Kong, it may have a half-dozen more serious Hong Kongs on its hands. For a government that prizes stability above all else, what's happening in Hong Kong is poison. The political risk analyst I spoke with told me...

China can't let Hong Kong fall out of its clutches.

But China has to tread carefully, too... It took years to wash the blood off its hands from the 1989 protests in Beijing's Tiananmen Square.

That was when – following weeks of escalating demonstrations – protesters wanting a more democratic government were dispersed with tanks and bullets, killing thousands.

So a hard crackdown on Hong Kong (say, by bringing in Chinese troops) is out of the question...

But this is what China can do: Turn Hong Kong into just another Chinese city...

With no more protests, stripped of the benefits of its SAR status, and without its international flair, Hong Kong is just another Chinese city.

A lot of people in Hong Kong would be perfectly happy with that... if it meant an end to wrecked metro stations, roving mobs, endless traffic disruptions, and the uncertainty created by the protests.

And China would be pleased if the people who don't like it would just leave. A lot of Hongkongers don't have much choice. They would suffer the most, as the country they've known would become a different place...

A lot of the people I talked with in Hong Kong when I visited back in December had an active "Plan B." Almost everyone who has options was considering where else they might live if things get worse...

Singapore, where I live, is a popular option. My kids' school here said it has gotten dozens of queries from anxious parents in Hong Kong looking for alternatives. Singapore could be a big beneficiary of multinational companies moving their Asia headquarters out of Hong Kong.

Meanwhile, Hong Kong is the latest trigger in U.S.-China relations...

The U.S. warned that Hong Kong could lose its privileged trade status with the U.S. – which exempts it from some trade restrictions and tariffs that are imposed on mainland China – if the national security law is enacted.

Two U.S. senators have said they'll introduce a bill to sanction Chinese officials who are part of enforcing the new laws in Hong Kong. China's efforts will make generationally bad relations with the U.S. even worse. As I wrote in the May 13 Digest...

In the U.S., rattling China's cage is good political business...

According to a recent poll by think tank Pew Research Center, 26% of Americans are positive about China – while 66% are downbeat on the country. In 2017, Americans were split evenly on their views of China...

So you can bet that U.S.-China relations will be a major theme of the upcoming U.S. presidential election...

We can easily see presumptive Democratic candidate Joe Biden and Trump one-upping each other on who's better placed to put China in its place... and things getting personal.

The Chinese proposal about Hong Kong prompted President Donald Trump to warn that the U.S. would respond "very strongly" if China were to pass the bill.

This is all the equivalent of throwing another 'global risk' log onto the burning economic fire...

As I wrote in the May 13 Digest, a global depression is a terrible time for a big trade war between the world's two largest economies.

And one is a lot more likely if the U.S. digs its heels in over Hong Kong.

What's more, a measure that prohibits a big U.S. government pension fund from buying Chinese stocks could be expanded if the Hong Kong issue gets bigger.

Brian Tycangco, the Asia-based analyst on Dr. Steve Sjuggerud's True Wealth Opportunities: China team, recently wrote about how Americans, most of all, would be hurt most by this development.

In the May 19 edition of the free DailyWealth e-letter, Brian wrote, "as a result of this change, U.S. pension funds will lose out... not China."

That's bad news for American consumers, who were already hurt with the 18-month trade war between the U.S. and China. Those tensions finally ended in mid-January, right when the COVID-19 outbreak began in earnest in Asia...

Months later, we're on the edge of the "trade war" story starting all over again.

China Promises to Ramp Up Spending

As Chinese leaders promise higher spending to revive the country's virus-stricken economy, Brian breaks down the sectors that investors should focus on. And he shares his thoughts on "the Hong Kong question," too...

Click here to watch this video right now. And be sure to subscribe to our YouTube page to get all of our latest free video content as soon as it's posted.

New 52-week highs (as of 5/22/20): BlackLine (BL), Cognex (CGNX), DocuSign (DOCU), Electronic Arts (EA), GrowGeneration (GRWG), Intellia Therapeutics (NTLA), Nvidia (NVDA), Sea Limited (SE), and Scotts Miracle-Gro (SMG).

In today's mailbag, recommended reading on the Great Depression, as requested by Dan Ferris on Friday, and feedback on his latest Digest. Do you have a comment, question, or concern? As always, send your notes to feedback@stansberryresearch.com.

"Dear Dan, Just read your 5/22 Digest and can recommend a great book about the Great Depression and the heady period of the 20s that led up to it: The Forgotten Man by Amity Shlaes.

"Shlaes paints engaging portraits of the major players of the period, along with their background and motives. Cheers." – Paid-up subscriber Franklin D.

"Hans Rosling, Factfulness. Look for his five fears at end of book 1) global pandemic; 2) financial crisis (not sure he connected both); 3) world war; 4) ecological issues; and 5) unknown (maybe a future black swan event as if 1, 2 and 3 was not enough)." – Paid-up subscriber Tito G.

"Great article, Dan. I'm glad someone has the guts to paint a realistic picture of the economy and investment markets...

"I could be wrong but this is the most obvious precarious economy in my lifetime, in my opinion. These Great Depressions are mostly about government making stupid decisions." – Paid-up subscriber Al M.

"'Prepare. Don't predict'. Three terrific words together in two sentences elegantly said. Words we can live by especially when thinking about the markets. I like to predict how the markets will go especially over the short term. It makes me feel smart when I'm right however I'm disappointed a high percentage of the time!

"I think your Digest today was terrific! It said to me to slow down and think about a wide range of outcomes. It also made me think back to something F. Scott Fitzgerald said many years ago, 'The test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function.' I know he wasn't talking about the financial market but it again says to me to slow down and think about a range of possibilities.

"I don't have a financial book to recommend however I finished George Friedman's newest book The Storm Before the Calm. Similar to The Fourth Turning, Friedman uses history to predict how the 2020s will bring dramatic upheaval and reshaping of the American government and economics. Like Turning the author uses cycles, 'institutional and economic,' to make his points. I thought it was a great read." – Stansberry Alliance member Bill F.

Regards,

Kim Iskyan
Singapore
May 26, 2020