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Analysts Warn: Revoking Hong Kong Status Is A "Nuclear Option" That Could Trigger US/China Split

Kissinger China
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EDITOR NOTE: An economic dichotomy--a Chinese sphere and an American one--may result from from China's revoking of Hong Kong autonomy. China appears ready to replace Hong Kong with Shanghai as economic center. 

Secretary of State Mike Pompeo declared Hong Kong to be no longer autonomous from China Wednesday, a move that further increases tensions between Washington and Beijing and could pave the way for changes to U.S. policy toward Hong Kong that could have large ramifications for the global economy.

Pompeo is required by legislation passed last year to annually certify Hong Kong’s autonomy from mainland China, and that law also asserts that such autonomy is necessary to “justify treatment” under U.S. law that is “different to that accorded” mainland China.

It remains to be seen what policy changes, if any, will result from the declaration, but if the Trump administration does move to fully revoke special economic and legal privileges granted to Hong Kong since the territory came back under Chinese control, it could devastate the Hong Kong economy and hasten a division of the global economy into a U.S. economic sphere and a Chinese one, China experts say.

“The Hong Kong economy would basically be gone,” if the U.S. were to end all privileges afforded it by the United-States Hong Kong Policy Act of 1992, Diana Choyleva, chief economist at Enodo Economics told MarketWatch.

The 1992 law allows visa-free travel between the U.S. and Hong Kong and exempts the region’s exports from most U.S. tariffs, while allowing companies based there to access “sensitive technologies” made by American firms, which face export restrictions to the mainland.

Most important, Choyleva said, is that the law mandates the free exchange of Hong Kong dollars for U.S. dollars. If the U.S. moves to restrict the Hong Kong Monetary Authority’s access to U.S. dollars, “that would be an extreme nuclear option” that could devastate the region’s banking and shipping and logistics sectors, while triggering widespread capital flight.

The impact such a move would have on the mainland Chinese economy would not be nearly as severe, said Leland Miller, chief executive officer of the China Beige Book, a firm that advises investors and corporate management on the Chinese economy. “The impact is overhyped. Most talking heads say that the Chinese can’t allow Hong Kong to lose its status as the pre-eminent financial center in Asia, but that’s not what I hear from China,” he said.

Leland argued that Beijing has clearly decided that the costs of allowing a pro-democracy, anti-Communist Party movement to flourish under its nose outweighs the benefits of a separate legal system that attracts foreign capital and know-how.

“They don’t need Hong Kong the way many people assume they need Hong Kong,” he said, adding that the U.S. should therefore approach revocation of economic privileges with a light touch. “The main problem from the U.S. side is that simply hammering back at Hong Kong doesn’t solve the problem, it hurts the people who are in opposition to Beijing, and American companies.”

More than 300 U.S. companies have regional headquarters in Hong Kong, according to a tally by Veda Partners, including 3M Co. MMM, -2.05%, Inc. AMZN, +0.13%, Facebook Inc. FB, -0.83%, Microsoft Corp. MSFT, +0.09% and Johnson & Johnson JNJ, +1.58%, to name a few.

This sort of logic, however, is waning in popularity among Washington lawmakers. Sen. Marco Rubio, the Florida Republican who has led the charge on several recent anti-China bills and laws, said on Twitter Wednesday that “it would be irresponsible for corporate CEOs and directors to not reconsider using Hong Kong as a channel to do business in China.”

Meanwhile, a flurry of proposed bills are being considered by Congress that would sanction Chinese officials and companies underscore a sea change in Washington’s stance toward China, said Clayton Allen, senior vice president for trade, policy and geopolitical risk at Height Capital Markets.

He pointed to the unanimous Senate passage of a bill that would force Chinese companies to follow U.S. auditing regulations, or risk being banned from raising money in American capital markets. While in the past there have been free-trade and corporate-aligned politicians willing to combat such legislation, that’s no longer the case. “There’s tremendous pressure on lawmakers of both parties not to appear soft on China,” he said.

The recent moves by U.S. and Chinese lawmakers may in the end be seen as indicators of Hong Kong’s loss of independence rather than catalysts, Enodo’s Choyleva said. “What Hong Kong is becoming is just another Chinese city, and what is very important to realize is that the Chinese Communist Party is not going to reward Hong Kong,” given recent protests and the legislatures refusal to ratify Beijing’s priorities.

Instead, China will continue to promote Shanghai as an international financial center and the Port of Shenzhen as a hub for international trade, and foreign firms will just have to deal with the underlying absence of a rule of law in China to protect them, Choyleva said.

“This is the process of the great decoupling,” she added. “It’s going to be a bifurcation of the world economy into two spheres of influence.”

Originally posted on MarketWatch

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