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Country Risk in an Uncertain World
European Straits | Monday Note
Hi, it’s Nicolas from The Family. Here’s a Monday Note on the situation in Hong Kong and the difference between assessing country risks and dealing with geopolitical uncertainty.
The big news last week was the new security law coming into force in Hong Kong, effectively bringing the city state within the realm of the Chinese Communist Party. You might assume that it’s perfectly fine from a business perspective, since so much business in Mainland China has been done by foreigners in the past. But I think it has never been easy, and today it’s less and less so.
Doing business in Mainland China has ALWAYS been hard for foreigners, and anyone wanting to pursue those (very real) opportunities had to rely on skilled/well-connected intermediaries.
Hong Kong has long been the exception, to the point where it was considered a gateway between Mainland China and the rest of the world. But that’s not true anymore, as revealed by the latest events.
It all made me think about what it means to do business at a global level these days. Some time ago, when Brexit was still top-of-mind in London, I asked a friend in the asset allocation space how they were accounting for Britain leaving the European Union in their decision framework. Would it lead to allocating less capital or more in the British economy? Their answer struck me:
It’s not really a factor. We’re just reassessing Britain’s country risk a bit. Nothing more.
This is when I realized how much the idea of globalization has corrupted our collective brain. Like many in the financial services industry, my friend was assuming that the world economy was still a single, giant playing field, and that whatever odd thing may be happening in a given country shouldn’t really be taken into consideration when deploying capital. There are national specificities, sure, as well as the occasional asymmetrical crisis, but what unites us is stronger than what separates us.
Personally, I’m not sure that has ever been true. In my recent essay about The Great Fragmentation, I mentioned the work of Harvard economist Pankaj Ghemawat and his idea that what he calls “globaloney” is a fantasy that has never been backed with hard data.
The world, it turns out, is not flat. Some, like my friend, have the impression of being in a global world with only slight differences that can be accounted for by assessing country risk. But these people are in fact living in a fantasy world that only includes the US, parts of Western Europe and Japan, as well as China and some other emerging markets—places where you, as an investor, could long be supported by a global investment bank with a local presence.
Hong Kong is a case in point. I love Hong Kong. I’ve traveled there many times in the past, and I’m definitely looking forward to being back at some point (if only to show the place, especially Victoria Harbour, to my children). Yet I also realize it will become very different from what it used to be:
I don’t expect a reversal on the part of the CCP. The swift and merciless response to demonstrations in Tiananmen Square in 1989 was, in the eyes of Chinese leaders, vindicated by the outcome: the Soviet Union collapsed two years later, while Communist China endured. Thus, in retrospect, every Chinese leader feels they need to walk in Deng Xiaoping’s shoes when it comes to responding to unrest and democratic demands. (It’s a paradox that Deng is, rightfully, considered as the greatest reformer in modern China, yet he’s also the one who without hesitation ordered the demonstrations to be crushed in 1989.)
Hong Kong being behind the ‘Great Firewall’ means it will become more difficult to travel and conduct business there. Quite frankly, from my personal experience, using dysfunctional VPNs to go around this ‘Great Firewall’ is an almost unbearable friction. And if you don’t master Mandarin, don’t expect to be able to use the local apps. (Google, and Google Maps in particular, is what I’ve missed the most when travelling in Mainland China.)
It’s not even sure that the recent clampdown will translate into Hong Kong being revived as one of the main financial centers in China. Maybe the local civil society will prove too unruly for the CCP to be reassured, and Beijing will instead decide to suffocate Hong Kong and redistribute business assets and activities toward neighboring Shenzhen or Shanghai. When I visited Hong Kong for the first time 6 years ago, many interlocutors were already explaining that people in the know (starting with the legendary tycoons) had seen the writing on the wall (Hong Kong going down) and were busy divesting at an accelerated rate.
China seems to alternate—on a daily basis—between wanting Hong Kong to be a financial center they control and wanting to use their control to end Hong Kong’s status as a financial center.
What does the Hong Kong story tell us about country risk in today’s fragmenting world? 3 or 4 years ago, even in the context of Brexit, you could still think, like my asset allocator friend, that it was all about “reassessing country risks a bit”. But now, with COVID-19, the diverse ways in which countries have responded, Trump’s erratic behavior for the past four years, and the accelerating ‘Great Fragmentation’, it’s time to go back to economist Frank Knight’s idea of risk vs. uncertainty:
Risk applies to situations where we do not know the outcome of a given situation, but can accurately measure the odds. Uncertainty, on the other hand, applies to situations where we cannot know all the information we need in order to set accurate odds in the first place.
In other words, in the past you could confine your business within the limits of the vaguely global part of the economy in which risks could be assessed and managed. Today, the Great Fragmentation is destroying even that “globaloney” corner—starting with Britain, Hong Kong, and even the US—and forcing everyone to realize that uncertainty, not risks, rules the world economy now.
Does it mean cross-border business will become impossible? Far from it, but it calls for a very different playbook for global investors:
If you want to avoid uncertainty and can only tolerate risks, you will end up being trapped on your domestic market or in very marginal parts of the world economy.
Insights, intelligence, and perspective about what’s happening on the ground become much more important for anyone seeking an edge against widespread uncertainty.
The importance of information requires building cloud communities of like-minded people dedicated to helping each other navigate a more uncertain world.
More readings on Hong Kong:
Regulation of the internet in China: An explainer (Lotus Ruhan, University of Nottingham Asia Research Institute, October 2019)
A Walk In Hong Kong (Maciej Ceglowski, Idle Words, August 2019)
The new Committee for Safeguarding National Security in Hong Kong (Clay Chandler, Fortune, July 2020)
Hedge Funder Kyle Bass Makes a Big Bet Against Hong Kong Dollar (Mark Gilbert, Bloomberg, July 2020)
White-collar Chinese in Hong Kong face shock tax bills from mainland (Nikki Sun, Nikkei Asian Review, July 2020)
Hong Kong's Dilemma (Anirudh Pai, Dreams of Electric Sheep, July 2020)
😀 Zoom’s engineering prowess: It’s all revealed by this great thread from Natalie Sandman of Spark Capital. I can’t remember where and when I read that Facebook had beaten MySpace because the former was a company built by engineers while the latter was built by marketing people, but it definitely rings true.
🙂 Rwanda is doing (way) better than the US when it comes to beating COVID-19. Rwanda might still be an outlier in Africa, but its consistency in implementing sound policies corroborates my idea of the African continent maybe being the next growth driver for European tech companies.
😏 Everyone wants to be a VC! That includes Chelsea Clinton, the daughter of Bill and Hillary Clinton, who has launched the process of raising her own VC fund. The provisional name is ‘Metrodora Ventures’ and the focus seems to be “health and learning businesses”.
😐 The UK productivity mystery has been solved. A change in how productivity is measured has led to the realization that technological progress might have contributed to boosting productivity much more than we thought. There’s still some progress to be made, however—and COVID-19 might be the opportunity.
😒 About that, there’s a lot these days about the UK government investing in research and expecting a Silicon Valley in return. Indeed, there’s this idea that it takes a Stanford to build a Silicon Valley. But I disagree—and so do Brad Feld and Ian Hathaway, whose forthcoming book The Startup Community Way you should pre-order without hesitation. (Read my friend Chris Schroeder’s primer about the book.)
😖 TikTok seems to be caught in the middle of the battlefield between the Trump administration and pretty much everyone else. Read this explainer by Connie Loizos. Meanwhile, Bytedance is going above and beyond to try and put some distance between the social media platform and the CCP. (Also, my daughter is worried because, as she told me, most of the best content on TikTok comes from the US.)
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From Normandy, France 🇫🇷