This essay details how the United States has applied coercive financial statecraft tools on China and Hong Kong in 2020-21 and assesses the impact of these punitive measures. The tools include financial sanctions on Hong Kong and Mainland Chinese officials, investment bans on Chinese companies with purported links to China’s military and pushing for Chinese corporate stock delisting from the New York Stock Exchange (NYSE). The analysis shows, however, that large inflows of money from China, Asia and Europe into Hong Kong and Mainland financial markets have acted as offsetting portfolio investment, which have buoyed Hong Kong’s capital markets, and allow the targeted Chinese companies more capital and clout. Even though US divestment in the targeted Chinese assets has occurred, the net effect is that the US coercive statecraft measures are not working, and they are not having the disciplining effect on Hong Kong and Chinese officials, or on the Chinese companies, as intended. The policy recommendation is these coercive financial statecraft measures are actually damaging the relative global position of the United States and undermining the international economic order that has provided peace, growth, and stability across the Asia-Pacific region for the last five decades. The current US presidential administration and US legislators should rethink their policies and adjust.

 

2020 marked a sharp escalation in tensions between the United States and China, across the Asia-Pacific. It was a “banner year” for the United States’ targeting of China and Hong Kong with coercive tools of financial statecraft and foreign policy. As part of its growing confrontation with China, before leaving office, the President Donald J. Trump administration removed the US “special status” treatment of trade with Hong Kong,^[1] applied financial sanctions on Hong Kong and People’s Republic of China (PRC) officials in response to the “National Security Law” on Hong Kong,1 put an investment ban on Chinese firms purportedly linked to China’s military, and pushed for China corporate stock delisting on the New York Stock Exchange. These moves aim to punish China and Hong Kong for what US officials saw as violations of freedoms in Hong Kong; mitigate the assumed national security threat from US investment in Chinese companies with purported ties to the country’s military; and promote US-China decoupling in the financial sector. As scholars have long highlighted, financial (and monetary) statecraft, or international financial relationships and arrangements can be used by states as instruments of coercive power for advancing national security interests and to affect the behaviour of other states.^[2] While the US was already moving in the direction of ever greater reliance on coercive financial statecraft, the members of the Trump administration were particularly avid practitioners of “weaponizing interdependence”, and keen to use economic leverage to extract concessions across a wide array of economic and security issues.^[3]

But what has been the actual impact or consequence of these coercive statecraft moves by the United States on China and Hong Kong? Have the outcomes been as intended, or has the balance tilted more toward unintended consequences? This essay suggests that the net effect is more on the side of unintended consequences. As we will see below, in the issue-area of capital markets, while there have been US selloffs of sanctioned Chinese firms, there have also been massive inflows of money from the Chinese Mainland, Asia, and Europe into these same stocks. Rather than punishing Hong Kong and China’s firms, the net effect has been increased inflows into the city and China’s stock markets, and a surge in demand for, and the value of, the shares of the sanctioned-Chinese firms in Hong Kong and in Mainland markets after the Trump administration enacted the sanctions and investment bans. These net effects from early to mid-2021 give reason to the United States to reconsider the wisdom of its punitive moves, from the standpoint of the relative global position of the US, and the balance of power in the Asia-Pacific, as well as the functioning of the open and integrated international economic order that the US helped to create. Posing the need for reconsideration also raises the question of whether, or what alternative measures would be possible to send a signal to China, a point we will return to, in the conclusion.

US financial coercion

The inherent economic nationalism, economic protectionism, and decoupling motivations behind the Trump administration’s removal of the “special status” for Hong Kong, and its sanctions become evident when one considers that the United States has enjoyed sustained trade surpluses with Hong Kong, whereas it has run recurrent trade deficits with Mainland China for decades. In 2019, US goods and services trade with Hong Kong totalled about US$ 61.3 billion, with exports of US$ 45 billion and imports of US$ 16.3 billion, for a US trade surplus of US$ 28.7 billion.^[4] According to US Census Bureau data, Hong Kong was the source of the largest US bilateral goods trade surplus in 2019, at US$26.1 billion.^[5] According to Hong Kong’s Trade and Industry Office, the city was the third largest export market for US wine, the fourth largest for US beef, and the seventh largest for all US agricultural products.

According to the US Commerce Department, US exports to Hong Kong supported an estimated 188,000 jobs in 2015 (latest data), with 125,000 jobs related to goods exports and 63,000 jobs related to services exports. US foreign direct investment in Hong Kong was US$ 18.9 billion in 2019, an increase of 2.6% on the previous year, and was led by non-bank holding companies, manufacturing, and information services: the current core and future of the US economy.

US companies make up more than 1,300 of the approximately 9000 foreign firms that are operating in the city as of 2019, including overseas and Mainland Chinese companies. According to the US State Department (2018), about 85,000 US citizens live in Hong Kong. US companies are a leading segment of the many Western companies and more than 1,500 companies that have picked Hong Kong as the hub for their Asian regional headquarters, encompassing China as well as Japan, Southeast Asia, Australia, and India.^[6]

However, on 14 July 2020, just weeks after China passed the “Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region” (or the NSL in short), and Hong Kong authorities started to implement the law, the United States moved to impose sanctions on Hong Kong and Mainland officials. Donald Trump signed “The President’s Executive Order on Hong Kong Normalization” (E.O. 13936^[7]) which ended the territory’s privileged economic status under US law, and the US Congress passed the “Hong Kong Autonomy Act” which paved the way for US authorities to unilaterally impose sanctions on banks and other financial institutions who engage in “significant” transactions with individuals deemed by the US to have contributed to the erosion of Hong Kong’s autonomy, and to seize their property and assets, “in the United States or in the possession or control of US persons”.^[8] On 7 August, the US Treasury Department sanctioned the Hong Kong and Mainland officials for the “National Security Law”, which US officials claim undermines the city’s “autonomy and democratic processes” and the “rights and freedoms of people in Hong Kong”.^[9] The sanctions were imposed on chief executive Carrie Lam and ten senior Hong Kong and Mainland officials, including the current and former police commissioners and the head of China’s Hong Kong Liaison Office. These officials and their immediate family members are also barred from travelling to the United States. The sanctions aim to directly punish the officials for the so-called “malign activities”, and indirectly to punish China, as well as to weaken Hong Kong’s attractiveness as an international financial centre and encourage decoupling of US/China global supply and financial networks, by sending a chill through Hong Kong’s financial industry, and to US companies and especially America’s financial institutions in Hong Kong.^[10]

When announcing the sanctions, US Treasury Secretary Steven Mnuchin gave the following line: “The United States stands with the people of Hong Kong”, and “we will use our tools and authorities to target those undermining their autonomy”.^[11] US Secretary of State Mike Pompeo called the NSL an “Orwellian move” and an assault “on the rights and freedoms of the people of Hong Kong.” Pompeo added, “President Trump has made clear that the United States will therefore treat Hong Kong as “one country, one system” and take action against individuals who have crushed the Hong Kong people’s freedoms”.^[12]

On November 12, 2020, after losing the US presidential election, Trump issued Executive Order 13959, “Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies”,^[13] to make effective on 11 January 2021, that US persons are prohibited from purchasing any publicly traded securities or derivatives of “Communist Chinese military companies” identified by the US government. A wide swath of Chinese corporate entities and industries were to be subjected, including Huawei, China Spacesat, China Mobile Communications Group, among others.^[14] These measures were purportedly in response to national security concerns posed by the PRC. EO 13959 cites the PRC’s use of publicly traded securities to finance activities of its military, intelligence, and security apparatuses, and restricts US persons from investing in US or foreign securities, including funds, such as Exchange Traded Funds (ETFs), index funds, and mutual funds that hold any publicly traded securities of a “Communist Chinese military company” listed by the Office of Foreign Assets Control (OFAC).

The deeper geopolitical reality is that these measures were aimed at promoting financial decoupling between the US and China, as part of the growing range of measures of the Trump administration’s attempt not only to contain but to “roll-back” China, the most aggressive strategy of the pre-1991 Cold War period. However, after taking over the US presidency, the Biden administration has decided not only to maintain the Hong Kong-related sanctions but to actually expand them. On 17 March 2021, just a few days before meeting Chinese counterparts for the first major bilateral dialogue between the new Biden administration and China, Secretary of State Anthony Blinken announced that the US had expanded its financial sanctions to another 24 PRC and Hong Kong officials^[15] and he stated, “yesterday in Tokyo, Japan, I spoke of the need to stand up for our shared democratic values and to work together to hold to account those who would threaten them. Today, we are again doing that. The release of today’s update to the Hong Kong Autonomy Act report underscores our deep concern with the National People’s Congress March 11 decision to unilaterally undermine Hong Kong’s electoral system… Foreign financial institutions that knowingly conduct significant transactions with the individuals listed in today’s report are now subject to sanctions”.^[16] The expansion of the list of the sanctioned persons was done in consultation with the US Department of Treasury, and Secretary of the Treasury Janet Yellen.^[17]

The process of expanding the list was actually started by previous Secretary of State Pompeo in the waning days of the Trump administration, but the decision to stay the course and then to expand the sanctions, and to seek or support other countries to join in sanctioning China is now owned by the current Biden administration. The decision to expand the list in March 2021 immediately prior to the first bilateral meeting with the Chinese counterparts in Anchorage, Alaska set the tone of continued confrontation before the meeting started. The tempestuous exchange in Alaska appears to have further upped the ante for both sides to “look tough”, which may not bode well for a US walk-back on the investment bans and the financial sanctions. But where is the financial statecraft, the confrontation, getting the United States?

Are they working?

Are the sanctions and punishments working? One test would be the effect of the sanctions and investment ban on the stocks of the sanctioned Chinese firms and stock markets in Hong Kong and Mainland China.

We do see some US divestment and sell-offs of Chinese companies in Hong Kong, Mainland markets, and the NYSE as the Trump administration intended. After the order from President Trump in November 2020 banning buying companies deemed to have links with China’s military, US fund managers such as BlackRock, the world’s largest asset manager, Vanguard, and Nuveen started to scramble to sell, though they have given few details on their divestments, and they have not detailed exactly which stocks they have sold.^[18] Nuveen, the US$ 1.1 trillion asset manager of the New York-based Teachers Insurance and Annuity Association (TIAA^[19]), has sold its holdings in the Chinese companies barred by the Trump sanctions. Stock market filings showed that BlackRock had sold almost all its stake in China Telecom in mid-January 2021. Moreover, passive investors are also reacting to the removal of more than a dozen companies from the benchmarks of MSCI, FTSE Russell, S&P, and Dow Jones Indices.

But even as US asset managers started to divest, other global investors have surged into the sanctioned Chinese firms. Reuters reported that Asian and European investors were swooping in and snatching up discounted stocks of the China-based companies in Hong Kong, the targets of the US investment ban.^[20] These global investors were finding bargains as giant US funds were divesting, and they shrugged off concerns that the sanctions could hurt the prospects of the PRC-based companies. The same week that Vanguard and BlackRock announced divestments, cash poured in to lift the Hong Kong-listed shares of Chinese telecoms by more than 15%. Swiss investment bank UBS remarked that clients were interested in taking advantage of the US sell-down. As a result, China Mobile had its best week in 12 years; Chinese state energy company CNOOC was up 16%, and chipmaker SMIC up 10%. All three are targets of the US sanctions and facing the risk of being removed from the NYSE and from the US-anchored global indexes.

The price moves and the surge in flows appear to indicate, at least for the initial period, a deeper faith abroad, including among European investors and asset managers, and especially in China and Asia, about the net worth of the 35 China-based companies, and their subsidiaries, which the US government barred from holding after November 2021. But the trends also put in question whether, or how much pain the sanctions will cause for the intended targets. UBS head of China strategy, Wendy Liu, suggested that it is “worth monitoring the market closely… because there will be forced liquidations”, but she also noted that, “We do have European investors interested in stocks blacklisted by the US”.^[21] A portfolio manager at Singapore’s Nuvest Capital says that “opportunity exists now”, and Nuvest has increased exposure to China’s state firms in the construction and energy sectors, after the US sanctions were announced.^[22] The head of Asia multi-asset quant solutions at France’s BNP Paribas Asset Management Paul Sandhu says, “I think the fundamentals don’t change. They’re still sound. The burden of these sanctions has really fallen on US investors”.^[23]

Hong Kong’s financial markets have made back the losses from the 12 months under Covid-19, plus more, despite the sanctions as Mainland investors have poured into Hong Kong looking to side-step the US sanctions. Global funds have flowed into China in search of yield, including via Hong Kong’s cross-border investment channels, the Hong Kong-Shanghai Stock Connect, and Bond Connect, while Mainland capital has poured into Hong Kong in search for value, where Mainland enterprises are priced lower than on Mainland exchanges. In some cases, the Mainland enterprises are only listed in Hong Kong. The South China Morning Post reported that money gushed into the city’s stock market during the first month of the year.[24] According to a chief investment officer at Invesco (with US$ 1.35 trillion of assets under management), “more Chinese companies are seeking IPOs and secondary listings in Hong Kong, given tightened regulations in the US. They are leaders in industries such as e-commerce, social media and live streaming. They represent great investment opportunities”.[25] These companies reflect the internet boom in China, spurred by Covid, and their listings were in New York or Hong Kong. But given the US investment restrictions on the NYSE, the Mainland’s pensions, asset managers, investment funds and wealth advisors are coveting Hong Kong trade stocks, from WeChat’s owner Tencent Holdings to new listings such as Kuaishou Technology. They have made HK$ 369 billion (US$ 47.6 billion) in net purchases in January 2021 alone, which had suddenly made them the biggest driver of stock prices in Asia’s second-biggest capital market. According to Bloomberg data, Hong Kong’s market capitalization of US$ 7.25 trillion puts it ahead of Japan.

Hong Kong’s role as the key gateway for Mainland and offshore funds seeking a springboard to Mainland Chinese stocks, and for offshore money looking to invest in some of the world’s most profitable companies and based in China, has been reinforced. One of the latest additions to HKEX makes the point. US-based investors were the second largest group of shareholders in Kuaishou Technology, the “hottest ever” IPO in Hong Kong, whose shares then tripled when they were traded for the first time on 5 February 2021. Mainland funds have been buying Hong Kong stocks at an unprecedented rate, with inflows in January from the Mainland equivalent to 55 percent of the total trading volume on HKEX for 2020. According to market analysts, there is much more demand for more fundraising in Hong Kong from onshore sources in 2021 compared to the previous year. As of the end of January 2021, Mainland enterprises accounted for 52 percent of the 2,545 listed companies in Hong Kong, and 81 percent of the market capitalization and 90 percent of the trading volume on HKEX.

At the same time, it is fair to note that it is not clear how much of the record Mainland cash inflows are fuelled by politics (i.e., patriotism) relative to market fundamentals. In China, support for the sanctioned companies runs strong, where brokers have issued buy recommendations and some retail investors mentioned “patriotism” along with profit as their motives for buying.[26] The holdings by Mainland Chinese investors in China Mobile, China Unicom, China Railway Construction Corporation, and CNOOC, have more than tripled after these companies were targeted under the investment ban. Ding Ning, a retail investor on investment website Xueqiu.com noted that these Chinese corporates already offered a good dividend, but “if you [also] take into account the political value repair [READ: patriotic investment], then supporting the share prices for the country will generate [even more] handsome returns”.[27]

Looking ahead

What are the implications and potential consequences of the US actions? On balance, instead of punishing China and Hong Kong, the net effect of the US sanctions may be opposite to what was intended. While the US financial sanctions have caused some selloffs of Chinese firms by US fund managers, these sales have also opened the door for other investors to flow in, and they have surged in, and they have induced dramatic increases in the value of the shares of the sanctioned Chinese firms. There is now talk that the 44 Chinese companies are looking to do more listings in Hong Kong. In effect, the NYSE’s loss would turn out to be HKEX’s gain.

The warning here is that the unintended consequences are outweighing the intended, and that the US is potentially undermining its own relative position in the world, and the global economic order that it has created and led, over the medium-term.[28] But if the assumption is that the United States feels obligated to do something to send a signal to China that changes are needed, is there any other action that might be more successful? After all, a sophisticated defence of the coercive financial statecraft measures would be that maybe the sanctions and bans are bad, but they may be less bad than anything else that might be done.[29] So what could be that something else?

In suggesting that the current path is self-defeating, one needs to consider the comparative question of whether there are other possible actions whereby messages can be successfully sent to China; successful in the sense that desired change is achieved, but where less damage is done to the international system that has provided for peace and prosperity across the Asia Pacific for the last five decades. Such alternative diplomatic measures, and modified messaging, national and collective, is where the attention of the United States (and its Western allies) should be directed. It is worth noting that Japan decided not to follow other members of the G7 in imposing sanctions on China, with Japanese foreign minister Motegi Toshimitsu saying, “we’ll consider more deeply how Japan should respond… There are a variety of ways to send a warning to China”.[30] For example, in late March 2021, Tokyo and Jakarta signed a pact to allow the transfer of Japanese defense equipment and technology to Indonesia, and to strengthen military ties between the two countries, largely in response to their growing concerns about China’s activity in the region. At the news conference, Japanese defense minister Kishi Nobuo said, “Together we will maintain and strengthen a free and open maritime order”.[31] Then, at his face-to-face meeting with President Biden in April 2021, Japanese Prime Minister Suga Yoshihide discussed options for cooling tensions in the Asian region, shared measures to promote a more “free and open” region, a rules-based order, and he projected unity with the US on responding to China. However, Japan was hesitant and very careful about joint statements calling out Beijing on human rights, and any wording on Taiwan, and at a speech later at a Washington think tank, Suga said that Japan would say what needs to be said to China, but also stressed the need to establish a stable and constructive relationship with Beijing.[32] Similarly, the balance sheet from the May 2021 Biden-Moon Jae-in summit also warrants careful assessment: at first glance, the Moon government appears to have gotten closer to the US (compared to its stance during the Trump administration[33]), and yet, as one expert of Republic of Korea-ChinaUS relations points out, not a word of “China” appears in the joint statement, and there are many traces of moderation, ambiguity, and subtlety. From Washington’s viewpoint, the optics and rhetoric are good, but Seoul gained room to maneuver on how it will follow-through on its commitments in the joint statement. For Seoul, the key strategic outcome was that it seemed to achieve a compromise on Moon’s Pyongyang focus and Biden’s China focus.

Considering the lack of effectiveness of the punitive US financial statecraft on China, heretofore, and the complex positioning which America’s closest allies in the region are taking toward China and the United States, it is time to ask whether it makes sense for the US to continue further with its financial warfare on China and Hong Kong, or whether it is time to try another tact, and aim for a different strategic goal. A related opening thought is whether it still makes sense for the United States to keep “maintaining overwhelming superiority” vis-à-vis its closest rival(s) as its main national security objective, as it has been since 1991, or whether it is time to reset geostrategic and geo-economic goals for the US (and the Western alliance) considering the changed global reality from thirty years ago.

I thank Mark Blyth, Benjamin J. Cohen, Giuseppe Gabusi, and Christopher McNally for their comments.

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References

[1] Under the “special status” category of the United States, Hong Kong was treated separately from Mainland China’s more managed economy, and Hong Kong exports to the United States were treated differently. Hong Kong had a zero tariff on the import of US goods. US businesses in Hong Kong opposed changes in Washington’s recognition of Hong Kong’s “special status” as a sufficiently autonomous city, where US companies enjoy access to China and Southeast Asia, and where bilateral trade flourished across the range of economic sectors from financial services to wine.

[2] Baldwin, D. (1985) Economic Statecraft, Princeton, New Jersey, Princeton University Press; Kirshner, J. (1997) Currency and Coercion: The Political Economy of International Monetary Power, Princeton, New Jersey, Princeton University Press.

[3] Farrell, H. and Newman, A. (2019) “Weaponized Interdependence: How Global Economic Networks Shape State Coercion”, International Security, 44(1): 42-79; Drezner, D. (2019) “Economic Statecraft in the Age of Trump”, Washington Quarterly, 42(3): 7-24.

[4] United States Trade Representative (2019) “U.S. – Hong Kong Trade Facts”, available online

[5] Reuters (2020) “How ending Hong Kong’s ‘special status’ could affect U.S. companies”, 22 May, available online

[6] This data is based on the Hong Kong Census and Statistics Department (2019) “Annual Survey of Companies in Hong Kong with Parent Companies Located Outside Hong Kong”, available online

[7] E.O.13936 builds on the “Hong Kong Human Rights and Democracy Act” of 2019.

[8] U.S. Congress (2020) “Hong Kong Autonomy Act”, 14 July, available online; U.S. Department of the Treasury (2020) “Treasury Sanctions Individuals for Undermining Hong Kong’s Autonomy”, 7 August, available online

[9] Ibid.

[10] BBC Business News (2020) “Should US firms be worried about Hong Kong sanctions?”, 15 July, available online; Gunia, A. (2020) “How U.S. Sanctions on Hong Kong Could Leave Banks Caught in the Middle”, Time, 13 August, available online

[11] U.S. Department of the Treasury (2020) “Treasury Sanctions Individuals for Undermining Hong Kong’s Autonomy”

[12] BBC Business News (2020) “Should US firms be worried about Hong Kong sanctions?”

[13] Trump, D.J. (2020) “Executive Order on Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies”, 12 November, Trump White House Archives, available online

[14] Bombach, K.M., Rossell M.M., Dohale, S. (2021) “U.S. Prohibits Trading in Securities of Communist Chinese Military Companies, but NYSE Reverses Plan to Delist”, GTGreenbergTraurig, 4 January, available online

[15] U.S. Department of State (2021) “Update to Report on Identification of Foreign Persons Involved in the Erosion of the Obligations of China Under the Joint Declaration or the Basic Law”, Bureau of East Asian and Pacific Affairs Report, 16 March, available online

[16] Blinken, A. Secretary of State (2021) “Hong Kong Autonomy Act Update”, United States Department of State Press Release, 17 March, available online

[17] U.S. Department of the Treasury (2021) “Hong Kong-related Designations Updates”, 17 March, available online

[18] Shen, S. and Westbrook, T. (2021) “Analysis: Sanctions-Hit Chinese Firms Surge as Global Buyers Swoop In”, Reuters, 14 January, available online; Arnold, T. (2021) “Asset Manager Nuveen Exits Sanctions-Hit Chinese Companies”, Zawya (Reuters), 21 January, available online

[19] TIAA is one of the leading retirement pension providers in the US for people in the education, not-for-profit, healthcare and government fields.

[20] Shen and Westbrook (2021) “Analysis: Sanctions-Hit Chinese Firms Surge as Global Buyers Swoop In”

[21] Ibid.

[22] Ibid.

[23] Ibid.

[24] Zhang, S. (2021) “China’s Investors Are Flooding Hong Kong’s Capital Market in Search of Value as They Dodge US Sanctions”, South China Morning Post, 7 February, available online

[25] Ibid.

[26] Shen and Westbrook (2021) “Analysis: Sanctions-Hit Chinese Firms Surge as Global Buyers Swoop In”

[27] Ibid.

[28] See also Christopher McNally’s contribution to this collection about China’s digital currency and alternative electronic payments system efforts as another response to US financial sanctions.

[29] I thank Benjamin J. Cohen for highlighting this policy logic.

[30] Kato, M. (2021) “Japan Shies Away from Sanctions on China Over Xinjiang”, Nikkei Asia, 24 March, available online

[31] Yamaguchi, M. (2021) “Japan, Indonesia Sign Arms Transfer Pact Amid China Concerns”, Defense News, 30 March, available online

[32] Bruunstrom, D., Hunnicut, T., Nomiyama, C., Spetalnick, M. (2021) “Biden and Japan’s Suga Project Unity Against China’s Assertiveness”, Reuters, 17 April, available online

[33] Yonhap (2021) “Moon-Biden Summit Agreement Broadens Alliance Amid Sino-US Rivalry”, The Korea Herald, 22 May, available online

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