Hong Kong, ironies and all

The British seized Hong Kong in the mid-nineteenth century if furtherance of its plan to balance its trade accounts by forcing China to buy the opium it was cultivating in India.  When China announced it was not renewing the 99-year lease forced on them by British arms, Parliament vetoed the idea of granting Chinese residents of the colony citizenship.  The reason for the abandonment?   …England was too cold for Hong Kongers to feel comfortable.

Last month, however, Parliament is now responding to China’s effectively ending Hong Kong’s status as a Special Administrative Region 25 years earlier than promised by offering a path to British citizenship to all pre-Handover (July 1, 1997) Hong Kong citizens.

This at the same time Donald Trump is taking the opposite tack, fomenting anti-Chinese prejudice and apparently condoning race violence in Minnesota by quoting ur-racist George Wallace on Twitter.

The circumstances of the reintegration of Hong Kong into China are, strictly speaking, not a US diplomatic problem. The seizure of land and its return to China are an issue between China and the UK. There is a possible US connection, however. Xi may feel that both the White House and 10 Downing Street are occupied at the moment by epic incompetents, whose shelf life must be limited. So there will be no easier time than now to break the handover agreement and meld Hong Kong back into China.

Trump is framing his response to the Beijing move as opposition. In reality his opting to treat Hong Kong just like any other part of China is giving Xi exactly what he wants. Given that Trump has disavowed cooperation with international allies, he may have no choice.

In another irony, China is now discussing joining the Trans-Pacific Partnership. That’s the anti-China influence group created by the US that Trump withdrew us from early in his administration. If so, Trump will have transformed an anti-Beijing coalition into an anti-US one.

I do think the US and China are in a contest for world economic and cultural dominance. China has the advantage of a much larger population. The US has incumbency, global allies grateful for past support, the dollar, its research universities, its worldwide financial system and its dominance in semiconductor manufacturing. It seems to me that the effect so far, if not the intent, of Trump’s making America “great” again has been to blunt the US edge in all these areas without any thought of gain in return.

I think that this is forcing US-based multinationals to consider the possibility that they may not be able to remain both world leaders and American. Arguably, this train of thought runs much deeper in American society, and is the basis of the massive outperformance of NASDAQ over the Russell 2000 over the past several years.

Shenzhen Connect starts next week

…on December 5th.

That’s according to the Hong Kong Exchanges and Clearing Limited (HKEX), whose Stock Exchange of Hong Kong subsidiary signed an agreement with its Shenzhen counterpart on rules for Shenzhen Connect last month.  The agreement was just approved by mainland Chinese regulators.

what is Shenzhen Connect?

It’s a mechanism that allows investors in Hong Kong to buy or sell Shenzhen-listed stocks, up to a specified (but large) total daily limit.  It also allows China-based investors to buy and sell Hong Kong-listed stocks through the Shenzhen Exchange.

The start of Shenzhen Connect trading follows the successful establishment of a similar arrangement between Hong Kong and Shanghai, called Stock Connect, a little more than two years ago.


In a practical sense, Shenzhen Connect and Stock Connect together end the closed nature of the Chinese stock market.  Doing so is an important economic objective of Beijing.  It’s another step down the road to dismantling the central planning and control that has characterized Chinese socialism since WWII.

rising Shenzhen shares?

Will this signal a boom in Hong Kong interest in China-listed shares?  I don’t think so, but it will be interesting to watch and find out.

Stock Connect, which opened the Shanghai stock market to foreigners wasn’t such a big deal, in my view.  That exchange is dominated by state-controlled banks and by stodgy old industrials headed mostly by state functionaries with no idea of how to run a profitable business.  Beijing will protect the banks but is content to let the  gradually wither and die.  So I didn’t see any rush to be the first foreigner to arrive in 2014.

The Shenzhen Exchange, on the other hand, is home to much more entrepreneurial firms, with little or no official state involvement.  So, in theory, yes, I might want to participate.

A big roadblock for me, though:  I have no idea whether I can trust the financial reports that companies issue.

Two ways to find out: listen carefully to what local players say and do; and visit the companies that sound interesting, interview the managements–and then watch to see how what they say matches up with operating results and what the financials report.

Even then, my experience is that you may not be safe.  Years ago, I visited a small Hong Kong manufacturing company at the urging (I didn’t need much) of a friend.  The firm told me a fabulous story of its success making computers for children.  I went back to see the management some months later.  They didn’t recognize me as a person they’d spoken with before.  This time they told me an equally dollar-sign-filled story, but this time they were an auto parts firm.  Whoops.

I’m not willing/able to put in the effort required to understand how the stock market game is played in Shenzhen.  So, Shenzhen Connect won’t tempt me away from the sidelines.



cooling the Chinese stock market fever

In the 1990s, Alan Greenspan, the head of the Fed back then, famously warned against “irrational exuberance” in the US stock market, but did nothing to stop it   …this even though he had the ability to cool the market down by tightening the rules on margin lending.  This is the stock market  analogue to raising or lowering the Fed Funds rate to influence the price of credit, but has never been used seriously in the US during my working life.

The  Bank of Japan has no such compunctions.  It has been very willing to chasten/encourage speculatively minded retail investors by tightening/loosening the criteria for borrowing money to buy stocks.


We have no real history to generalize from in the case of China.  But moves in recent weeks by the Chinese securities markets regulator seem to indicate that Beijing will fall into the stomp-on-the-brakes camp.


–at the end of last month, the regulator allowed (ordered?) domestic mutual funds to invest in shares in Hong Kong, where mainland-listed firms’ shares are trading at hefty discounts to their prices in Shanghai

–highly leveraged “umbrella trusts” cooked up by Chinese banks to circumvent margin eligibility requirements have been banned,

–a new futures product, based on small and mid-cap stocks, has been created, offering speculators the opportunity to short this highly heated sector for the first time, and

–effective today, institutional investors in China are being allowed to lend out their holdings–providing short-sellers with the wherewithal to ply their trade (although legal, short-selling hasn’t been a big feature of domestic Chinese markets until now, because there wasn’t any easy way to obtain share to sell short).

What does all this mean?

The simplest conclusion is that Beijing wants to pop what it sees as a speculative stock market bubble on the mainland.  It is possible, however, that more monetary stimulus–to prop up rickety state-owned enterprises or loony regional government-sponsored real estate projects–is in the pipeline and Beijing simply wants to dampen the potential future effects on stocks.

I have no idea which view is correct.

It’s clear, however, that Hong Kong is going to be a port in any storm, and that it is going to be increasingly used as a safety valve to absorb upward market pressure from the mainland.  So relative gains vs. Shanghai seem assured.  Whether that means absolute gains remains to be seen, although I personally have no inclination to trim my HK holdings.



linking the Hong Kong and Shanghai stock markets

restricting foreigners

Every country has restrictions on ownership of assets by foreigners.  Some of this is unofficial, like when France said yogurt maker Danone was a crown jewel that Pepsi couldn’t buy, or when New York blocked Mitsubishi Estate from buying a decrepit Rockefeller Center.  Other limits–notably restrictions on non-citizens owning media or transportation assets–are set down in law.


It’s common that emerging countries restrict foreign ownership of all publicly traded locally owned corporations.  The same thing happened in Europe as it was rebuilding after WWII.  Two reasons:

–countries don’t want rich foreigners (translation:  Americans) to be able to scoop up valuable national assets for a song, thereby disenfranchising the country’s citizens and making locals into sort of tenant farmers, and

–they don’t want the potential disruption to economic activity (the currency and the money supply) caused by mad rushes in and out of local stocks by foreign portfolio investors.

two classes of stock

The most common method of controlling foreign ownership is for a country to establish two classes of stock, one to be held by locals, the other by foreigners.  The details vary widely country by country.  What makes China unusual is that, generally speaking, locals and foreigners trade shares in different venues–the letter in Hong Kong, the former on the mainland.

problems with the system

Whenever there are two different markets, and two different prices, for the same security, the party that gets the lower price is going to be unhappy.  Given that the supply of foreign portfolio capital is large and the number of foreign-designated shares is typically small, it’s almost always the local citizen who feels disadvantaged.

In addition, raising new equity capital can be awkward.  Foreigners may balk at having to pay, say, twice what a local does to buy a new share.

Invariably there’s unofficial arbitrage between the two classes.

In China’s case, it’s possible that Beijing wants inefficient state-owned enterprises to be more subject to the goad that can be provided by professional portfolio managers.

Shanghai/Hong Kong trading opened this week

This week, China opened limited foreign trading in Shanghai-listed stocks (not Shenzhen stocks, however, which make up about 40% of China’s market cap).  It is also permitting limited trading by mainland citizens in Hong Kong.  The control mechanism being used is daily limits on the cross-border flow of money in and out of both markets.  The system is called Stock Connect.

ho-hum, so far

The plan was announced a while ago–the result being that stocks identified as possible targets for fresh money in both Shanghai and Hong Kong were bid up in anticipation in recent weeks.  However, the volume of cross-border trading has been low and highly touted beneficiaries have been selling off.

For China, this initial indifference is probably the best possible outcome.  Still, this is another step in opening Chinese financial markets to the world.  And one day the ability for us to buy mainland stocks may be important.  It’s just not today.



China the largest economy in the world? ..that’s what the World Bank is saying

The World Bank has just released the findings of its International Comparison Program, derived from analysis of world economic data from 2011.  This is an update of the ICP results from 2005.

The data show that three years ago the US economy was only about 8% larger than China’s.  Given that China is growing by at least 7% per year while the US is barely expanding at all, the implication is that sometime in 2014 China will seize the #1 crown the US has worn since 1872 (according to the Financial Times).  That’s when the US surpassed the UK.

Generally speaking, the report shows the increasing prominence of emerging economies, especially in Asia.  That’s really no surprise, since that continent is home to two giants, China and India (#3 in the world).  In fact, the only news in the ICP report is timing.  Prior to this, and based on the earlier ICP data, most economic observers had expected China to pass the US within a few years.

Two caveats:

–the figures are based on total GDP.  Per capital GDP is still much higher in the US than in China, but the latter has over 4x as many people.

–the numbers are calculated using Purchasing Power Parity (PPP), not conventional GDP measures.

The difference?

Up until about a quarter century ago, economists took local currency GDP figures for each nation and converted them into a common currency, usually the US$, for comparison.   They used market exchange rates to do the conversion.  In the 1980s, however, people began to notice that this method was giving out crazy results.  China, for example, was growing at maybe triple the rate of the US at that time–but conventional GDP showed it shrinking relative to the US.

That’s how economists realized that measuring GDP through the ability to purchase internationally traded goods (which is, after all, what the exchange rate shows) wasn’t good enough.  So PPP, which measures the cost of purely domestic goods and services–like haircuts or movie tickets–as well, was born (you can find more detail in this post).


It’s probably more social and political than directly relevant to the stock market.  On the other hand, it reinforces the fact that the health (or not) of the Chinese economy is of crucial importance to the rest of the world.  As investors, China is too big, and too fast-growing, not to try to have some exposure to.  The clear way to do so, in my mind, is through Hong Kong, which is the destination of choice for legitimate Chinese firms seeking a listing that will attract non-mainland investors.  My impression is that not many US investors have been willing so far to put in the time and effort needed to learn about it.


Tomorrow Keeping Score returns, after a month’s hiatus.