Hong Kong's future as China's gateway to the West is under threat

The next few days could determine the future of Hong Kong as China’s gateway to western capital and a key conduit for global trade. They might also presage a major escalation of the new "Cold War" with the US that China warned of earlier this week.

On Thursday, China’s legislature is scheduled to vote on the contentious new security laws that would effectively tear up some of the key elements of Hong Kong’s separate legal status and system. Given the nature of China’s parliament, the proposals will inevitably be rubber-stamped.

Before the end of the week, Donald Trump has promised the US will unveil its response to China’s proposed legislation. He has flagged a strong response, although not one that includes sanctions at this stage.

Somewhere in the background is a report mandated by the US Congress that assesses whether Hong Kong has sufficient autonomy to justify the special economic status it has with US.

In essence, under US law that pre-dates the handover of Hong Kong by Britain to China in 1997, Hong Kong continues to be treated as if it were still a British-controlled territory. In recent times, for instance, that has meant that Hong Kong hasn’t been subjected to the tariffs the US has imposed on goods exported from China’s mainland.

If the US were to revoke Hong Kong’s special status – and it’s hard to see that not happening, given the now bi-partisan hostility towards China in the US and the impact of the fresh bouts of violence likely to erupt on Hong Kong’s streets in response to the new security laws – Hong Kong’s status as a globally significant financial centre and trade hub would be jeopardised.

All trade with the US, whether initiating within Hong Kong or transiting through it (some mainland trade has be re-routed through Hong Kong to avoid the US tariffs) would be captured by the US tariffs, and all capital flows would be more closely scrutinised and subjected to a US national security regime that is increasingly used as a weapon in America’s attempts to contain the growth in China’s economic and geopolitical influence.

Much to lose

Revocation of the special status would not only have particular significance for Hong Kong, but also for the western capital held and companies operating in the territory. It would also be highly material to China itself.

The US alone has about $US82 billion ($123 billion) of direct investment and more than 1300 companies operating in Hong Kong. Australian companies have more than $US50 billion invested in Hong Kong and there is a two-way trade approaching $US20 billion a year.

Hong Kong is China’s gateway to the global financial system; its key conduit to the west for foreign capital and trade. About $US1 trillion of trade flows through Hong Kong each year.

It also happens to be the place where wealthy Chinese, including the most senior of party officials and their families, have stored or hidden their wealth.

High-risk strategy

It is unclear why in the midst of the economic challenges China faces as a result of the coronavirus pandemic its leadership chose this moment to take actions it must have known would incite mass protests in Hong Kong and condemnation and potential sanctions from the West, and not just from the US.

It’s either because Xi Jinping sees this as a moment of weakness in the West or, in keeping with the sudden burst of belligerence from China on trade and regional geopolitics, as a distraction from the implosion in China’s economic growth rate as a result of the pandemic. Increased nationalism might be seen as a way of defusing the social unrest that could flow from rising unemployment.

Yet given the mood in Washington, and the US more generally, it is a high-risk strategy.

While Trump might have ruled out for the moment sanctions in response to the proposed new security laws, there is legislation before Congress that does involve sanctions.

Last week there was a bi-partisan measure introduced in the US Senate that would penalise Chinese individuals and agencies connected to the security laws – and any banks that conducted significant transactions with them.

The US has very effectively used its dominance of the global financial system and the threat of sanctions on banks to cut off the flow of finance and capital to countries like Iran and Russia and wealthy and powerful individuals within them. There is a range of other potential sanctions available, including visa restrictions on Chinese officials and ordinary citizens.

America has also been steadily adding to the list of China’s technology companies whose activities it regards as contrary to its national interest; it is now insisting that Chinese companies listed in the US should be audited by US auditors and is sanctioning entities it says are involved in human rights violations against the Uighurs in the Xinjiang region. The tariffs it imposed on more than $US360 billion of China’s exports remain in place.

China seems to believe the US is bluffing. It believes the strength of its own economy underwrites Hong Kong’s status as a global financial centre. It has also pointed out that removing Hong Kong’s special status would harm US companies and destroy some US investment.

'Big mistake'

It shouldn’t, however, underestimate the influence of the China hawks within the Trump administration and the US more generally, or overestimate the sophistication of an "America First" president.

Trump’s senior economics adviser Larry Kudlow said China was making a "big mistake" and the administration would welcome back American companies from Hong Kong or the mainland.

"We will do what we can for full expensing and pay the cost of moving if they return their supply chains and their production to the United States," he said. Among proposals reportedly being considered by the Trump administration is a $US25 billion "re-shoring" fund, along with new local content rules.

Diminishing Hong Kong as a financial and trade centre and the acceptable doorway for western capital and trade with mainland China, and repatriating US investment and activity would fit neatly within the administration’s trade policies and Trump’s own prejudices about trade.

Unlike the trade war with China, however, this might well be the first important moment in the Trump presidency where he might be able to gather - rather than fragment - a coalition of the major western economies to act collectively against China’s decision to effectively tear up the agreement it signed with the UK in 1997 that guaranteed Hong Kong and its people a high degree of autonomy for half a century.