Hong Kong Freedom?

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We had a volatile week and it doesn’t look like it is going to stop this week. The market has been pushed up into the high range and with the upcoming election and FOMC meeting, the market seems to be at odds on what to expect in the future. There are those in the camp that believe the Fed is going to end QE and raise rates soon, but it is just talk for now. However, concern that the Fed might be winding down has those exiting the market now, under the mantra you want to be able to get out before everyone decides to head to the exit. However, I think this may be premature and I don’t believe the Fed is nearly as hawkish as some hope, wish, or believe them to be.


Hong Kong Freedom?


Courtesy of wikipedia

What is already injecting some more volatility into the global markets and is starting to trickle over into the US pre-market futures, are the surprising and concerning developments in Hong Kong. To understand the problems and protesting today in Hong Kong, we must understand it’s history.

Birth of a Free Market
Hong Kong has been historically a very interesting city-state (nation). The birth of Hong Kong reads much like the Phoenicians and Carthage in the early Roman Republic era. The coastal town and its combination of unique geography and mountains protecting it from inland invasions and its deep water natural port and protection from the sea and Mother Nature had made it a natural location for a world trading center. From its early trade in fish, salt, and pearls in the 1200s, it later became a location for refugees from mainland wars and also those looking for jobs. It became a hub of trade in the region and even piracy – it was largely left alone from the mainland governmental oppressions because of its remote and natural mountainous protection. The city erected walls and continued to grow under the prosperity that trade brings.


Trade with the West


Courtesy of wikipedia

In the 19th century it became the largest trade sea port with the west. Ships from Europe would load up with Chinese goods (mainly tea and silks) and head back to Europe. Soon trade switched from tea to opium, which was legal in many parts of Europe. The trade imbalance was all to one-sided, as China became an export nation and yet had its own demands for silver, but unfortunately England did not possess or have access to large quantities of silver. If England were to deliver silver, they would have to trade or mine for it elsewhere and the logistics for shipping mass quantities of silver became burdensome.

There were few items from Europe, other than silver that China desired. Unlike Europe, China was a self-sufficient nation with food and their luxury items. Europe had already become a net import region since the discovery of the New World and trade throughout the world. China also limited trade to the ports and forbid trade in the interior of the nation.


Opium Wars


Courtesy of wikipedia

The opium trade began booming and becoming one of the largest exports to Europe. While initially China was an exporter, it started to become an importer of opium. Opium trade in India started booming and it was traded for silver. Soon China saw the silver trade reverse, as silver was leaving the nation to pay for imported opium from India. The rise in opium use and addiction, combined with large flow of silver exports began alarming the Chinese government. The British who were the main trading partners with China through the port of Hong Kong began making demands on taxes (tariffs) and legalization of opium. Chinese rejected the proposals and confiscated huge sums of opium and stared a trade blockade. This action quickly turned into military action and the might of the English Navy was brought to bear in a quick defeat of the Chinese. In 1842 in the rather one-sided Treaty by the British and Chinese government, gave the British indemnity and the cession of Hong Kong to the British as a colony. Trade was not going to stop and the British now brought their military to seized control of the major port. Of course the one-sided treaty didn’t sit well with the Chinese and didn’t last that long, which brought forth the Second Opium War. British had garnered French intervention and together they beat the Chinese and proposed the second treaty, which included Britain and France, as well as the U.S. and Russia to gain access to China for trade and included adding embassies, more ports for western trade, rights to the interior of China, and of course paying for British and French losses via more silver.


Japan Occupation and Hyperinflation

Hong Kong came under conflict again during World War II, as the local British defenses were overwhelmed by Japans Navy and Air superiority. Interestingly the Hong Kong dollar, which had been backed and stable for years, was now illegal and replaced with Japanese Yen. The Yen was not backed and with the over-flooded Yen and the Hong Kong dollar illegal, hyperinflation quickly grabbed hold.


Free Markets for 50+ years

At the end of the war, Hong Kong returned to British rule and from the 1950s to 1997 the nation had known its long period of stability, growth, free markets, and security. The small nation saw huge developments of both Democracy and Free Market economics. Business and trade prospered.

In 1997 Hong Kong was finally handed over to China. It has a long history that started with the birth of free-trade and free-markets. While it was fought over and occupied by varying forces, the laws of supply and demand – the will of the people, free trade, free markets, and democracy could not be extinguished. Even the British left well enough alone, perhaps they learned from the Opium Wars that even governments can’t control the laws of Supply and Demand. Britain left Hong Kong to prosper after WWII for over 50 years. Leaving the small nation to its own democratic needs and desires, people embraced free markets, free trade, and less government intervention.

China had also become well aware of the powers of the Free Markets and while there was significant concern in 1997 that China would roll in their military and turn the prosperous small city-state nation into communist rule; China was smart enough to leave well enough alone.

Hong Kong remained independent, much like it did under British rule. The stock market and business continued to prosper under China – with almost nothing changing. It was a relief and many, not only in Hong Kong, but around the world monitored the hand-over of Hong Kong to China as a test to see if China could keep their hands to themselves and embrace the free markets and capitalism. The world sat easy and China from 1997 until last week with the largest IPO in the world (Alibaba) seemed to have fully embraced capitalism and the free markets.


The End of Democracy?


Themis statue at the Hong Kong government building, courtesy of wikipedia

Then everything changed, ironically right on the heels of the largest IPO in history. Last week Chinese government wanted to ONLY allow the government vetted candidates to run in the city election in 2017 for the chief executive (like the governor or president of the city state). After decades of independence and democracy, the Chinese government seems to have back-tracked by putting their OWN selected officials on the ballet.

Hong Kong is usually devoid of protesting has seen a massive turn out of people from every corner of the city. Well over 100,000 people have taken to the streets, which has shut-down the city demanding that Chinese government keeps their hands off their democratic city state.

It looked like it was to turn violent as tear-gas and riot police took to the street and tensions were escalating. However, the local police have decided to stand-down and stay calm.
Meanwhile in mainland China the government has mustered their troops and mainland riot police which sit just outside the boarder of Hong Kong.

It is a face-off between Capitalism and Free Markets of Hong Kong vs. Communism. The leader of China is also facing opposition in the Communist party, as moderates want to leave Hong Kong alone and believe that further action will only further damage the government’s relationship with the people in mainland China.

A sympathy protest has already begun in Shanghai.

China certainly doesn’t want another Tiananmen Square, but at the same time if Hong Kong gets their way and remains a free-market democracy, it will certainly send ripples through all of China.


Watershed Moment

This could be a water-shed moment, reminiscent of the Berlin Wall coming down – if left to the people. Becoming the catalyst moment for the end of full Communist rule in the nation.

Or

This could be similar to the Ukraine situation, if the government decides to roll in the military and squash the protestors. Which could turn into a civil war and bring back the Western powers again to try to restore Hong Kong to an independent nation?


Courtesy of wikipedia

China is not a push-over country like it was in the Opium Wars of the 19th century. China now has a massive army, navy, and military power – far bigger than Britain. It is also allies with Russia and the BRICs. So the situation is far different, but I suspect regardless of outcome the U.S. will be pulled into it.

The U.S. relations with China have strained significantly. President Obama along with several members of Congress has been accusational from calling China “currency manipulators” to “spying and hacking”. While it does sound hypocritical compared to our own Fed fixing rates and printing money, along with our own NSA spying – one can’t ignore the rhetoric and saber rattling.

China can’t lose “face” in this protesting conflict, but neither can the U.S. in how it will support Hong Kong’s democracy.

The fall-out in the financial markets is already rearing its head as we saw the Asia markets come under significant pressure and that trickled over to Europe and now the U.S. markets.
Hong Kong may not be the worlds dominate trade center it once was, it is still a leading financial center and gateway to the East. It also stands as a beacon of Free Markets and Capitalism along the coast of the world’s largest communist nation. It has brought forth leadership of the new birth in free markets and trade in Vietnam, Malaysia, Taiwan, and much of South East Asia.

South Korea has been in high stress situations with North Korea, which has some supporting from China. Japan has been bickering over islands with China as well. The U.S. continues with its supposed aid and defense of Taiwan. Hong Kong could be the latest and proverbial straw to break the tension.


World is Watching

The world is watching and it is these unforeseen types of events that can cascade across the markets and drive money out of the risk trade (equities) and into cash and bonds. We are seeing the bond market rally, sending the 10-year yield below 2.5% again.

I never thought this day would come from Hong Kong and I think the Chinese government is feeling like they are losing control to capitalism and this is a stand they wish to make to show they are still relevant.

I find capitalism growth that brings down Communism and collectivism fascinating and also ironic as we see the West turns towards more collectivism. Are we seeing a shift as the West becomes more socialist and collectivist – becoming more like China, as China begins to become more like the West that once embraced capitalism and free markets?

We are in this topsy-turvy shirt as the Free Markets and Capitalism in the west are fighting against a growing central government of taxes, tariffs, more government planning, nationalism, and regulations. Meanwhile, the Communist of the east are fighting against a rise in free markets and capitalism, as they lose hold of their government central planning.
I never thought I would see the people tear down the Berlin Wall and throw off the shackles of central government and collectivism, yet it happened. Are we about to see the same thing happen in China? I hope so.


Support & Resistance

INDU 17,000
The market is under pressure from Hong Kong protesting and the future is uncertain. Watch the close.

NDX 4000 – 4100
This tech sector is certainly looking choppy with some huge intra-day volatility.

SPX 1960 – 1980
This is a volatile range we are in right now. Expect selling pressure at 1980 range and also buying support in the 1960 level. This is a volatile and uncertain range. The VIX should stay in the 15+ range for now – and will as long as Hong Kong remains an unknown.

RUT 1110 – 1130
This could be the low support and consolidation area, if it doesn’t hold I would look at the 1090 – 1110 area. If the 1100 area can’t hold we could be in for a wider sell-off in the market, however I believe the Fed will step in to curtail in broader sell off in front of the mid-terms.


Hong Kong Volatility

Hong Kong is the catalyst event right now. It impacts currencies, world trade, world financial markets, and commodities. It is one of the largest financial centers in the world – this is certainly a test of Capitalism and Democracy against mainland China.

2 Responses to “Hong Kong Freedom?”

  1. McRocket says:

    I think you are right that this could be a watershed moment.

    But, if China let’s the democratic foot in the door in Hong Kong, what is to stop it spreading? Especially if there is an economic slowdown in China?

    Personally, at best, I think China will grant the protestors limited reforms. And then as time passes, they will quietly take most of them away…a little at a time.

  2. warren says:

    Market Preview is THE BEST. Thank you Michael.