Founder’s Note: Last Monday marked the 22nd anniversary of the handover of Hong Kong from British control to the Chinese. The day was met with protests and violence, underscoring recent tensions between Hong Kong and China. Our friend Joseph McBrennan is back to explain what is going on overseas and what it means for Americans. If history is about to repeat itself, as Joseph predicts, you’ll want to be prepared.
On New Year’s Day 1987, in a transpacific jet-lagged fog, I stepped off a United Air flight from Dallas and into Tokyo’s Narita International Airport.
Those shaky steps marked the beginning of my professional career in an even shakier Asia.
There could be no better place for a recently minted 22-year-old investment banker to witness economic extremes. It was real-world learning under fire.
Japan was booming, and Hong Kong was in chaos.
And while everyone expected Japan to soon conquer the world, the real action was across the China Sea… and what I saw then is a lesson we’re all ignoring today.
The Golden Goose
Just a few years earlier, Great Britain and Communist China completed negotiations for control of Hong Kong when Britain’s 99-year lease would expire in 1997.
But as I quickly found out, distrust of Communist China ran high, especially among my friends in Hong Kong. Everyone I knew, whether native or expat, had an exit strategy for when Great Britain would hand over the reins of power to the Chinese.
Sure, there were numerous promises made by China to the U.K. that Hong Kong would remain a pro-market economy.
So, many people took a wait-and-see approach and were ready to make a move if necessary.
That strategy paid off handsomely.
My contacts have grown wealthy. China didn’t kill their economic golden goose.
So imagine my surprise when these remarkably patient friends reached out several weeks ago to let me know they’re leaving a country where they can count their ancestors by dynasties, not by decades. Many of their peers have already left.
Economic history paints a dim picture when the wealthy elite lose faith in their home country’s currency or their government.
And in Hong Kong, the rich have lost faith in both.
Protest in the Streets
Hong Kong has been rocked by violent protests in recent weeks. The issue is a newly proposed law that would allow mainland Chinese authorities to extradite suspected criminals from the streets of Hong Kong without due process.
The rioting seems to have worked. Carrie Lam, China’s hand-picked chief executive for Hong Kong, withdrew the new law and made formal apologies to her citizenry.
She hasn’t, however, scrapped the law. She’s merely withdrawn the proposal.
If chaos in the streets were the only concern, my friends and associates would remain. Hong Kong citizens have always recognized that China can roll in with tanks at any time. Those tanks have stayed out because this economic engine is too valuable to tinker with.
Today, there’s a new bravado in China and the fully controlled Hong Kong government. The extradition law is the tipping point of a much bigger problem.
Black Monday Carnage
I was sitting at a trading desk, watching the global market crash known as Black Monday – October 19, 1987.
When it was all over, Hong Kong equities had lost more than 45% of their value. U.S. and British markets saw nearly a quarter of their value wiped out.
No stock market anywhere escaped the carnage.
Most blamed Hong Kong for Black Monday. You see, in 1983, China announced that, regardless of the outcome of its negotiations with the United Kingdom, it would take back Hong Kong at the end of the lease. Most thought the talks were a sham and that 1997 would be the beginning of the end.
Money headed for the exits.
To stem a near free fall in the currency, the Hong Kong central bank pegged its currency to the U.S. dollar.
It provided stability, both economically and psychologically.
But a funny thing happens when one currency glues itself to another. Local monetary control is lost. In theory, a more “responsible” economy takes charge and secures the economic future of the weaker one.
And the reverse is true. One can take down the other.
So let’s look at the events surrounding Black Monday.
- In August 1987, U.S. stocks were hitting all-time highs.
- The U.S. was in a trade war with Japan.
- Ronald Reagan was president.
- Iran had fired a Silkworm missile at the Sungari, a Libyan-flagged oil supertanker. Coincidentally (perhaps), the supertanker turned out to be U.S. owned.
- The following day, Iran hit another U.S.-flagged tanker called the Sea Isle City.
- Black Monday morning, the U.S. retaliated by blowing up an Iranian oil platform.
No doubt, these chaotic (and eerily familiar) events played a huge role in causing global uncertainty.
Consider this our first warning sign.
Let’s take a look at another…
A Louder Warning
In 2008, the United States was facing an economic crisis not seen since the Great Depression. U.S. central bankers drove interest rates to nearly zero.
Hong Kong’s dollar-based economy, because of the peg, had to mimic the move.
At the same time, China, Hong Kong’s biggest trading partner, implemented one of the greatest infrastructure and investment programs ever seen, to the tune of more than half a trillion dollars.
Stimulus from pegged central bankers and a massive stimulus from the world’s second-largest economy provided a double dose of “help” to Hong Kong.
A tsunami of near interest-free money roared into the economy.
From 2008 to today, Hong Kong’s economy has received the equivalent of an economic steroid injection – which should be used only to jump-start the heart of a dying economy – into an environment that needed no stimulus.
The Hong Kong banking system, since 2008, has grown to 8 1/2 times the size of its entire GDP. Of this astronomical amount, almost one-third of its GDP is made up of loans to mainland China.
The U.S. economic recovery over the last three years has added more fuel to Hong Kong’s already red-hot real estate market, which has continued to explode upward.
The result? Today, the price of the average Hong Kong home is nearly two times more expensive than one in London and 464% more expensive than New York per square foot. Prime real estate regularly trades hands at $10,000 per square foot.
The problem with a currency peg, overleveraged real estate and an economy based only on expansion is that it can go into a free fall… which we know all too well.
A Formula for Disaster
The 2008 crisis in the United States was created by lenders lending too much, on real estate valued too high, on property that seemed to only go up in value, to borrowers without the means to pay their debt.
When the crisis ended, the U.S. – and most of the world – was on the brink of total financial collapse.
Today, quite literally, Hong Kong is the most overleveraged region in the world, with the highest real estate prices in the world, with the most overleveraged consumers in the world, with a currency pegged to a country whose economy is no longer in sync with its own.
Making matters more volatile, its largest trading partner, China, apparently now has the will to change the former colony with British rule of law to a region ruled by law.
It’s a formula for disaster in Hong Kong… China… and the U.S.
This teetering global domino will likely come crashing down on an economy near you.