The American political scientist Edward Luttwak described his country’s trade spats with Western Europe and Japan in the 1970s as “the logic of conflict in the grammar of commerce”. Half a century later, you couldn’t come up with a more apt context for thinking about the feisty state of relations between China and the US specifically, and the West in general. In the past two years, this conflict has been described by a number of “wars”: a trade war, a tech war, an information war, a propaganda war.
Another is looming: financial. Put more formally, “financial war” is about the worrying possibility of the weaponisation of capital.
One of the many powers the United States still enjoys is financial leverage. It has the biggest, deepest, most transparent and trusted capital markets subject to the rule of law, and the world’s pre-eminent reserve currency. Until now, the US government has not tried — overtly, at least — to exploit this leverage against China. In fact, most of what has passed for recent financial engagement between the United States and China has been about possible concessions to US financial institutions wanting to do more business in China.
Then came the pandemic, which, with its origins in China, triggered an icy turn in US-China relations. Further escalation followed last week, with the Communist Party’s decision to bring Hong Kong to heel and accelerate its absorption into the mainland by imposing a National Security Law in contravention of the treaty agreed by China and the UK in 1997.
Hong Kong could be the flashpoint for a possible financial war because while it is now economically small, accounting for a little less than 3 per cent of Chinese GDP, it remains China’s window on to global finance, and vice versa. Hong Kong intermediates capital into and out of China and, importantly, serves as a conduit for much-needed US dollars into China’s financial and economic system. These dollars help finance crucial policies such as the Belt and Road Initiative.
Last Friday, President Trump warned that the US would begin the process of stripping away some of the privileges accorded to an “autonomous” Hong Kong under the US-Hong Kong Policy Act of 1992. The legal construct for action now derives from last year’s passage of the Hong Kong Human Rights and Democracy Act 2019, which directs various government departments to assess whether, according to several criteria, political developments in Hong Kong justify changing Hong Kong’s unique treatment under US law.
As things stand, the US now considers this autonomy to have been rescinded, since the application of the National Security Law will align Hong Kong with the mainland, and provide for everything from powers of arbitrary detention, and restricted freedom of assembly and expression, to political interference with the law, regulations and information as they pertain to financial and other institutions. There will be direct consequences for the operational management of firms, and for the recruitment, protection and privacy of both local and expatriate staff.
The privileges that could be withdrawn comprise favourable tax, accounting and legal treatment of financial transactions, and virtually visa-free immigration and tariff-free trade between Hong Kong and the US. The president was coy, however, saying little about details, timing, coverage or exemptions. Nor did he refer to possible actions that might be directed mainly at China rather than Hong Kong, as these might affect the current US-China truce on trade tariffs.
Yet we should be prepared for new White House initiatives.
A major political calculation is clearly under way. The consequences of a financial war, with Hong Kong in the crosshairs, could well be far-reaching and far more damaging than other tools such as tariffs, export controls, limits placed on Hong Kong’s access to US technology and know-how, and strict visa controls.
At the very least, there could be close scrutiny over all capital transactions between Hong Kong and the US, spanning both foreign direct investment and portfolio capital affecting stocks, bonds and other financial products. China may want the 37-year-old peg of the Hong Kong dollar to the US dollar to continue for a while, to provide certainty and ensure a ready supply of US dollars to itself, and to the 190 or so authorised financial institutions, including the biggest Chinese and global banks, as well as thousands of companies that have regional headquarters and offices there. Even so, the survival of the peg is basically in America’s hands.
The US authorities could, therefore, place restrictions on the transactions of specified banks and their access to US dollars, or refuse to allow US government agencies and banks to exchange US for Hong Kong dollars. In theory, this could extend to the Hong Kong Monetary Authority, which manages the peg and monetary and financial policy in Hong Kong. This, though, would be a “nuclear option”, which would not only devastate an already beleaguered Hong Kong but most likely cripple banks, including those that are labelled “systemically important financial institutions”, or SIFIs, comprising also the biggest US, UK and euro area banks.
The United States could also sanction individuals deemed to be implementing the National Security Law, for example, by freezing their assets, and financial institutions thought to be associated or complicit with them. President Trump has already sought to prevent the main retirement fund for federal employees from buying Chinese securities represented in global benchmark indices. A bill that seeks to de-list any of the 150 Chinese companies currently traded on US exchanges if they refuse to conform to US audit regulations is also in Congress.
A financial war, then, is likely to have several features that have already been identified, but also many that haven’t, including those that might subsequently be deployed by China as retaliation, and, in turn, by the US against China directly. This part of the “war” hasn’t kicked off in earnest yet, and we should hope that it doesn’t.
There are certainly interests in the United States that will lobby for measured, if cautious, engagement with China, not least Wall Street, which will have an eye on both business opportunities in China and on finance as a conduit into more engagement-oriented cadres in Chinese policy circles.
The Chinese Communist Party has been vocal in its dislike for US financial hegemony since the financial crisis, but never so more than now as it sees this as a long-term risk to China’s aspirations. With US entities and institutions firmly in the commanding heights, it is small wonder that the US sees a comparative advantage here, and China sees a threat.
Last November the former Chinese Finance Minister, Lou Jiwei, said at an industry forum in Beijing: “The next step in the frictions between China and the United States is a financial war.” He may be right, but the US Administration’s biggest hurdle in prosecuting it will be not so much Beijing, but Wall Street.
George Magnus is a research associate at Oxford University’s China Centre and at SOAS, a former UBS Chief Economist, and author of Red Flags: Why Xi’s China is in Jeopardy