The Sword Of Damocles

Submitted by Michael Every of Rabobank

The Sword of Damocles

“It’s not the substantive crimes and their definitions that count; it’s the institutions that will investigate, prosecute, and judge them that count. Language matters only if there are institutions that will make it matter. This whole law is about avoiding the involvement of such institutions.”

This is the summary of an analysis of Hong Kong’s new national security law by professor of Chinese law Donald Clarke. China openly states the new legislation is “a Sword of Damocles” hanging over the head of its critics. The law allows life in prison for the crimes of: “terrorism” - including “serious disruption” of transport networks; “collusion” with foreigners – including advocating for action by foreign governments; “secession” – including waving pro-independence flags or banners and or shouting or singing such songs or phrases; and “subversion” – including attacks on state offices and “creating hatred” of the government among the people. It allows Beijing to prosecute complex cases directly – which was what the proposed extradition treaty which sparked Hong Kong’s recent unrest was opposed to; closed trials; trials without jury; the operation of Chinese security agents in Hong Kong – who are immune to the law in the operation of their duties; and “stronger management” of media and foreign NGOs.

The law also applies to everyone everywhere in the world. This means if one were to be seen by Beijing as breaking this new legislation in another country and then enter Hong Kong, or transit through it, or even fly in a vehicle registered in Hong Kong, then one would be at risk. Possibly this could even apply to residing in a country with an extradition treaty with Hong Kong (or one day China?). In short, it is a very large, sharp Sword of Damocles.

As such, the same Sword now hangs over markets too. What will the global response be? There has been condemnation from Western governments and steps to allow the emigration of Hong Kongers to the US (where they will be given priority as refugees) and to the UK (where the government appears serious about its pledge to allow in up to 2.9 million people). Even Japan’s newspapers are leading with suggestions that Hong Kongers should be welcomed.

President Trump has tweeted: “As I watch the Pandemic spread its ugly face all across the world, including the tremendous damage it has done to the USA, I become more and more angry at China. People can see it, and I can feel it.” Secretary of State Pompeo that: “The CCP’s draconian national security law ends free Hong Kong and exposes the Party’s greatest fear: the free will and free thinking of its own people.

The issue is if righteous (or unrighteous) rhetoric is matched with biting US sanctions.

Yet the view among the establishment in Hong Kong, and in markets, is that the US is a paper tiger and there won’t be any. Indeed, AFP journalist Xinqi Su tweeted that the de facto deputy Chinese ambassador to Hong Kong “Zhang Xiaoming dared US to “give it a try” on sanctioning China: “It’s nothing but a chance for us to show our capability to defend ourselves and hit back.”

If China and markets are right and the US does not have the stomach for real action on Hong Kong, risk remains ’on’. As with Brexit, actions we were repeatedly told could never, would never happen are absolutely fine and life just carries on (i.e., stocks go up.) Yet as geostrategists point out, so does the real-world risk that the next US-China clash will be over Taiwan. Meanwhile at the India-China border both sides are still building up their forces, with tanks now arriving. Also note Australia has not-at-all-coincidentally just announced a huge increase in its defence budget to AUD270bn over the next decade (which if funded at the short end of the curve means the RBA is ensuring remains affordable.) Indeed, PM Morrison stated today that the “largely benign security environment” seen since the fall of the Berlin Wall “is gone”. Let’s also consider the looming need for an extension of the UN Iranian arms embargo (which Russia and China oppose): imagine if it lapses and weapons start flowing to Tehran.

If China and markets are wrong and the US does have the stomach for real action on Hong Kong, risk will be ‘off’: and all the central bank action in the world is not going to suppress that particular bout of volatility. In short, risks remain either way – but with different time horizons.

Naturally, there are still many for whom all this represents events in a far-away country of which they know nothing. They can focus on what emerged from yesterday’s Mnuchin-Powell testimony in Congress instead – which was not a lot. There were no concrete details of what kind of Fed-supported fiscal stimulus might be coming next despite there being just a few weeks until some schemes run out.

Forget about free speech and free movement: take away the free money and markets will have to pay attention.

Underlining that fact, today’s Japanese Tankan survey was worse than expected at -34 for large manufacturers, down from -8, and better than expected for large services firms yet still -17, down from 8. Small firms fared worse, of course, with manufacturing down from -15 to -45 and services from -1 to -26. The Japanese manufacturing PMI was 40.1, up only slightly from 37.8 last month.

Even more shocking, Aussie Corelogic house prices were -0.8% m/m. That will be the front page today, not Hong Kong or the defence budget. Building approvals were also -16.4% m/m vs. -7.8% expected. Time to build tanks indeed.

China’s Caixin manufacturing PMI was up from 50.7 to 51.2, better than the expected dip to 50.5. It’s not clear where the real momentum is coming from, but presumably the state sector is helping a lot in the background….which means more debt and/or more excess Chinese supply, and so more global tensions ahead too.