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Is a Hong Kong Bubble Black Swan at Hand?

Demonstrators, seen from inside a tram, link hands along a street in Hong Kong, Friday, Aug. 23, 2019. Supporters of Hong Kong’s pro-democracy movement created human chains on both sides of the city’s harbor Friday, inspired by a historic protest 30 years ago in the Baltic states against Soviet control. PHOTO: AP/Kin Cheung

The Hong Kong protests, which have been boiling since the start of the summer, pose a potential market risk that could translate to a black swan event. In financial sector vernacular, a black swan is a major disruption that could obliterate the markets and economy. In yesterday’s tandem post, I gave the general background of the grotesque central bank-induced financial bubbles in play.

Hong Kong has also emerged as a pressure point in the US-China trade war. The West is cheer leading what is effectively a color movement. The people of Hong Kong increasingly fear that mainland control will subject them to extradition into China’s star chamber system. The following scene of protesters cutting down facial-recognition monitoring towers pretty much says it all about the cause and certainly gets our sympathy.

But ominously, protesters, as shown in the second clip below, are barricading main streets and highways, pointing to a shutdown of Hong Kong.

The third clip shows intense street battling between protesters and police in the Kowloon side of Hong Kong. The area is strategic because it is the transshipment point of the Kowloon-Canton Railway and the Kowloon Wharf, and because of Kowloon’s close proximity to Kai Tak Airport.

China has moved paramilitary troops to the border with Hong Kong. They have sent agent provocateurs into the streets of HK.

And the following video shows protesters attacked with rubber bullets fired by riot police in a train station.

Hong Kong is an accident waiting to happen even without a color revolution. It is home to one of the biggest property bubbles in the world. It also engages in a 36-year artificial dysfunctional peg to the U.S. dollar. The result has been fake wealth and fictitious capital.

Until last year, Hong Kong was a free for all of leveraged speculation and wildcat finance. There was effectively “money for nothin” in play. This fueled sky high property prices. In an effort to keep “wealth” in country, the monetary authorities in mid-2018 raised rates (HIBOR) as shown in the chart below. The problem is that most mortgages in Hong Kong float and are set to the HIBOR. So the money-for-nothin’ crowd has seen a doubling in the mortgage payments (so far). The credit-to-GDP rate of Hong Kong makes Japan and the U.S. look like pikers.

Hong Kong has also blown through a large chunck of its cash pool used to defend the Hong Kong-dollar peg. This is making banks more reluctant to lend, and lax wildcat finance is the milk and honey of property speculation bubbles.

Yesterday a Hong Kong legislator close to the banking sector was suggesting capital controls.

Kyle Bass is the best-known money manager who has large bets against the peg, and he anticipates it will break, setting off a currency crisis. The video clip at bottom of this post shows him discussing the situation, for those interested in more detail. Or Hong Kong may choose to raise rates further, which will impact the housing bubble. Having one’s street blockaded can’t be helping with property collateral.

This chart shows Hong Kong housing rolling over even before the protests.

Winter Watch Takeaway

Conditions are ripe for a large-scale, disruptive capital flight out of Hong Kong.

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