Hong Kong’s demonstrations have at their core a population that is highly stressed, especially the young who are struggling to afford even the paltriest housing, while faced with declining job opportunities and a blatant rise in inequality.
This conflict is deeply intertwined with two crucial but far less noticed developments: Beijing’s inexorable march to greater control of all the levers of power in Hong Kong, and the continuing rash of real estate lending that has left Hong Kong is on the verge of a financial crisis.
Regardless of the confrontations and concessions playing out for the cameras, behind the scenes Beijing is likely to use this social unrest and impending financial crisis as a platform for taking further control of Hong Kong
Hong Kong’s leverage with Beijing, never great, is evaporating. Its once key role in China’s access to the financial world is diminishing. Its GDP has declined from 16% of China’s in 1997, the year of the transfer from Britain, to a mere 3% today. More telling, China’s ownership of Hong Kong’s banking assets has increased from 22% to 37% in less than a decade. Beijing’s liaison office in Hong Kong now owns half the territory’s bookstores. China has moved away from dependence on Hong Kong’s port and poured money into building up neighboring Shenzhen. Now much of Hong Kong’s business activity is simply real estate.
As for a financial crisis, Hong Kong’s private sector lending—much of it real estate lending—is now an out-of-control 300 percent of GDP, where levels above 150 percent are a concern. This is among the worst in the world, far worse than that of the U.S. and Western Europe in 2008. That lending growth has happened at a reckless pace—33 percent growth to GDP between 2012 and 2017 alone. (Some commentators actually laud the growth in Hong Kong’s financial sector, unaware of this overleveraging).
As a direct result, commercial and residential real estate prices have climbed by more than 200 percent in the last ten years—making Hong Kong real estate the most unaffordable in the world. The result is vast overbuilding, making this morass of real estate loans increasingly difficult to repay. The cracks in its banks and real estate companies are starting to show, exposed in turn by China’s slowdown, Trump’s trade war, and now these civic protests. Investment in machinery, building
Lenders will now be using all the tricks in the forbearance handbook to make these troubled loans appear sound: extending maturities, rolling over loans, increasing loan amounts so that borrowers can use those new funds to pay interest, improving terms, and more. Hong Kong’s highly leveraged real estate companies are now entirely dependent on the good graces of their lenders.
The Hong Kong economy has reached that paradigmatic point where buyers of commercial and residential real estate can buy not because of projected income, but instead on the belief they can sell the property at a higher price. In other words, these markets depend on the leniency of lenders’ credit policies—and the tolerance of the government regulators that watch over them.
This now an extreme case of the classic lender’s “bubble” dilemma. If lenders pull back on lending, overall real estate values will decline—values on the very real estate that is the collateral for many of their other loans. But continuing to lend will increase the overbuilding and will make the day of reckoning more arduous. China, at thirty times Hong Kong’s size, has this same problem, but in a less extreme form with a private debt-to-GDP ratio of 200 percent to Hong Kong’s 300 percent.
This is now the most precarious financial market in the world.
Beijing sits atop this, since it has the ultimate influence on regulatory policy and lender behavior. The wrong nod from Beijing and support for a given company or bank will quickly disappear.
Make no mistake; the amounts are so large that Hong Kong will not be able to financially rescue itself. But Beijing can—and will likely use this as an opportunity to show bureaucrats, businesses and the wealthy in Hong Kong how dependent on Beijing they truly are, increasing its control through behind-the-scenes changes in ownership, personnel, laws, and regulations in exchange for propping up overleveraged institutions. In some respects, Beijing may welcome Hong Kong’s growing fragility.
In the midst of this, the young in Hong Kong are continuing to mount vigorous protests. During the same ten years that lending has inflated property prices by over 200 percent, per capita incomes have increased by only 60 percent (or about 1.5 percent per year in inflation-adjusted dollars). One crucial result is that Hong Kong’s young are now faced with an acute housing affordability crisis. Some can’t even afford the city’s rising inventory of so-called “coffin apartments,” which hold only a single bed and are a mere 15 square feet in size. And they face declining job opportunities, all adding to Hong Kong’s accelerating brain drain.
Beijing’s idea of “One Country, Two Systems” has been a useful chimera, with increased control of Hong Kong over time inevitable. Beijing accomplishes much of its aims by simply continuing to increase its ownership of Hong Kong’s assets and its control and placement of office holders and functionaries. Being too heavy-handed may paradoxically weaken its position.
These protests, which have now involved live ammunition, may yet prove a powder keg that Beijing can’t manage. Hong Kong’s government, beholden to Beijing, has appeared inept, with the withdrawal of the extradition bill was a tactical concession that should have long since been made. Beijing and Hong Kong both risk a global opinion backlash, along with a legislative backlash in the form of a Rubio-Cardin bill that threatens sanctions if Hong Kong loses autonomy. This was made more precarious by the furious demonstrations on the symbolically charged seventieth anniversary of the People’s Republic.
But none of this will change in Beijing’s ultimate aims. Irrespective of what happens to the protestors, the true action—the real place to focus—will be behind the scenes. And the real outcome will almost certainly be incremental increases in Beijing’s control and a less independent Hong Kong.