Cyber wars and all that

May 2, 2019·Alasdair Macleod

Behind the Huawei story, we must not forget there is a wider financial war being waged by America against China and Russia. Stories about China’s banks being short of dollars are incorrect: the shortage is of inward capital flows to support the US Government’s budget deficit. By attracting those global portfolio flows instead, China’s Belt and Road Initiative threatens US Government finances, so the financial war and associated disinformation can be expected to escalate. Hong Kong is likely to be in the firing line, due to its role in providing China with access to international finance.


Huawei is hitting the headlines. From ordering the arrest of its Chief Financial Officer in Vancouver last December to the latest efforts to dissuade its allies from adopting Huawei’s 5G mobile technology, it has been a classic deep state operation by the Americans. Admittedly, the Chinese have left themselves open to attack by introducing a loosely-drafted cybersecurity law in 2016/17 which according to Western defence circles appears to require all Chinese technology companies to cooperate with Chinese intelligence services.

Consequently, no one now knows whether to trust Huawei, who have some of the leading technology for 5G. The problem for network operators is who to believe. Intelligence services are in the business of dissembling, which they do through political puppets, all of which are professionals at being economical with the truth. Who can forget Weapons of Mass Destruction? More recently there was the Skripal poisoning mystery: the Russians would have been bang-to-rights, if it wasn’t for Skripal’s links through Pablo Miller to Christopher Steele, who put together the dodgy dossier on Trump’s alleged behaviour in a Russian hotel.

The safest course is to never believe anything emanating from a government security agency, which does not help hapless network operators. They, and the rest of us, should look at motives. The attack on Huawei is motivated by a desire to impede China’s technological progress, which is already eclipsing that of America, and America is using her leadership of the 5-eyes intelligence group of nations to impose her geostrategic will on her allies. The row in Britain this week escalated from a cabinet-level security breech on this subject, to American threats of withholding intelligence from the UK if UK companies are permitted to order Huawei 5G equipment, to the sacking of the Minister of Defence.

A threat to withhold intelligence sharing, if carried out, only serves to isolate the Americans. But you can see how desperate the Americans are to eliminate Huawei. Furthermore, the Huawei controversy is part of a wider conflict, with America determined to stop the Chinese changing the world’s power structure, moving it from under America’s control. When China was just a cheap manufacturing centre for low-tech goods, that was one thing. But when China started developing advanced technologies and began to dominate global trade, that was another. China must be put back in its box.

So far, all attempts to do so appear to have failed. Control of Afghanistan, seen as an important source of minerals ready to be exploited by China, has been a costly failure for the West. Attempts to wrest control of Syria from Russia’s sphere of influence also failed. Russia is China’s economic and military ally. America failed to bring Russia to her knees, so now the focus is directly on destroying, or at least containing China. China has already outspent America in Africa, Central and South America, buying influence away from America in her traditional spheres of influence. Attempts to neutralise North Korea are coming unstuck.

In truth, there is an undeclared war between China and Russia on one side, and America and her often reluctant allies on the other. It will now escalate, mainly because America increasingly needs global portfolio flows to cover her deficits.

America’s financial war strategy

Behind the cyber war, there is a financial war. In the financial war, America has the advantage of its currency hegemony, which it exercises to the full. It has allowed Americans to have lived beyond their means by importing more goods than they export, and the government spends more than it receives in taxes. In order to achieve these benefits, inward capital flows are necessary to finance them. To date, these have totalled in current value-terms some $25 trillion, being total foreign ownership of dollar assets and deposits.

America’s policy of living beyond its means now requires more than just recycled trade flows: inward portfolio flows are required as well. Global portfolios, comprised of commercial cash balances as well as investment money, periodically increase their exposure to other regions, potentially leaving America short. The problem is resolved by destabilising the region that has most recently benefited from capital investment, to encourage money to return to dollars and thus America’s domestic markets. Now that she is due to escalate infrastructure spending both in China and along the new silk roads, it is China’s turn.

This will be the opinion of Qiao Liang, who was a Major-General in the PLA and one of its chief strategists.[i] It was his explanation for the South-East Asian crisis of 1997, when a run started on the Thai baht and spread to all neighbouring countries. In the decade prior to the crisis, the region saw substantial inward capital flows, so much so that countries such as Malaysia, the Philippines and Indonesia ran significant deficits on their balance of payments. This conflicted with the US’s trade balance, which was beginning to deteriorate. The solution was the collapse of the South-east Asia investment story, which stimulated the re-allocation of investment resources in favour of the dollar and America.

Qiao Liang cites a number of other examples from the Latin-American crisis in the early-1980s to Ukraine, whose yellow revolution reversed investment flows into Central Europe. This did not go to plan, with over a trillion dollars-worth of investment coming out of Europe, most being redirected to the Chinese economy, which was the most attractive destination at that time. Through the new Shanghai-Shenzhen-Hong Kong Stock Connect, in April 2014 China facilitated inward investment and the ability for foreign investors to realise profits without going through exchange controls.

Being the gateway for foreign investors, our story now moves to Hong Kong. According to Chinese and Russian intelligence sources, America tried to destabilise it with covert support for the Occupy Hong Kong movement between September and December 2014. The Fed ended its QE that October, and international capital was needed back in the US. The Americans had also escalated the row over the Spratly Islands and Scarborough Shoal at the beginning of that year, which effectively halted free trade negotiations between China, Japan, South Korea, Macau, Taiwan and Hong Kong. The Chinese hoped this potential free trade area could be expanded to include the ASEAN FTA, which would then have been the largest in the world by GDP and an area in which they could develop the renminbi as the reserve currency.

These plans were effectively scuppered, but China was not provoked into a public response by these actions. Instead, they started reducing their US Treasury holdings in their dollar reserves from $1.27 trillion to $1.06 trillion in 2016 – not a great fall, but demonstrating they were not recycling their trade surpluses into dollars.

All that happened at a time when both the American and global economies were expanding – admittedly at muted rates. Trump’s trade protectionism has changed that, and early indications are that the US economy is now stalling. Tax revenues are falling short, while government expenditures are rising. America now urgently needs more inward capital flows to finance the growing budget deficit.

If Qiao Liang were to comment, doubtless his conclusion would be that America will increase its attack on China to precipitate disinvestment and reallocation to the dollar. And so, the attacks have begun; first by trying to break Huawei. Now, the mainstream media, perhaps with off-the-record briefings, are claiming China and Hong Kong are facing difficulties.

Last week, the Wall Street Journal published an article claiming China’s banks are running out of dollars. Clearly, this is untrue. China’s banks can acquire dollars any time they want, either by selling other foreign currencies in the market, or by selling renminbi to the People’s bank. They have their dollar position because they choose to have it, and furthermore all commercial banks use derivatives, which are effectively off-balance sheet exposure. Furthermore, with the US running a substantial trade deficit with China, dollars are flooding in all the time.

Following the WSJ article, various other commentators have come up with similar stories. How convenient, it seems, for the US Government to see these bearish stories about China, just when they need to ramp up inward portfolio flows to finance the budget deficit.

There is, anyway, a general antipathy among American investors to the China story, so we should not be surprised to see the China bears restating their case. One leading China bear, at least by reputation for his investment shrewdness, is Kyle Bass of Hayman Capital Management. According to Zero Hedge, he has written his first investment letter in three years, saying of Hong Kong, “Today, newly emergent economic and political risks threaten Hong Kong’s decades of stability. These risks are so large they merit immediate attention on both fronts.”[ii]

If only it were so simple. It is time to put the alternative case. Hong Kong is important, because China uses Hong Kong and London to avoid being dependent on the US banking system for international finances. And that’s why the US’s deep state want to nail Hong Kong.

Lop-sided analysis

Bass is correct in pointing out the Hong Kong property market appears highly geared, and that property prices for office, residential and retail sectors have rocketed since the 2003 trough. To a large extent it has been the inevitable consequence of the currency board link to the US dollar, which broadly transfers the Fed’s inflationary monetary policy to Hong Kong’s more dynamic economy. Bass’s description of the relationship between the banks, the way they finance themselves and property collateral is reminiscent of the factors that led to the secondary banking crisis in the UK in late-1973. Empirical evidence appears to be firmly on Bass’s side.

Except, that is, for a significant difference between events such as the UK’s secondary banking crisis, and virtually every other property crisis. Hong Kong is a truly international centre, and the banks’ role in property transactions is as currency facilitator rather than lender. In 2017, Hong Kong was the third largest recipient of foreign direct investment (substantially property) after the US and China. FDI inflows rose by £104bn to total nearly $2 trillion. Largest investors were China, followed by corporate money channelled through offshore centres.[iii]

So, yes, Hong Kong banks will be hurt by a property crisis, but not as much as Bass implies. It is foreign and Chinese banks that have much of the property as collateral. It is not the Hong Kong banks that have fuelled the property boom with domestic credit, but foreign money.

Bass fails to mention that a collapse in property prices and the banking system is unlikely to be confined to Hong Kong. Central banks have made significant progress in ensuring all banking systems are tied into the same credit cycle. Unwittingly, they have simply guarenteed that the next credit crisis will hit everyone at the same time. It won’t be just Hong Kong, but the EU, Japan, Britain and America. Everyone will be in difficulty to a greater or lesser extent.

Interestingly, the Lehman crisis, which occurred after Hong Kong property prices had already doubled from 2003, caused strong inflows to develop, driving the Hong Kong dollar to the top of its peg. The situation appears to be similar today, with US outward investment at low levels, but near-record levels of foreign ownership of dollar assets. Despite Hong Kong’s foreign direct investment standing at $2 trillion, the prospect of capital repatriation to Hong Kong should not be ignored.

Probably the most important claim in Bass’s letter is over the future of the currency peg operated by the Hong Kong Monetary Authority (HKMA). He claims that the “aggregate balance”, which is a line-item in the HKMA’s balance sheet, is the equivalent of the US Fed’s excess reserves, and that “Once depleted, the pressure on the currency board will become untenable and the peg will break.”

The aggregate balance on the HKMA’s balance sheet has declined significantly over the last year, from HK$180bn to HK$54.4bn currently. The decision about changes in aggregate balances comes from the banks themselves, and for this reason they are commonly taken to reflect capital flows into and out of the Hong Kong dollar. This is different from aggregate balances reflecting actual pressures on the peg, as suggested by Bass.

The HKMA maintains a US dollar coverage of 105%-112.5% of base money (currently about 110%) and has further unallocated dollar reserves if necessary. The peg is maintained by the HKMA varying its base money, not just by managing a base lending rate giving a spread over the Fed’s fund rate, not just by influencing the commercial banks’ aggregate balances, but by addressing the three other components that make up the monetary base. These are Certificates of Indebtedness, Government notes and coins in circulation and Exchange Fund Bills and Notes (EFBNs). In practice, it is the EFBNs in conjunction with the aggregate balances that are used to adjust the monetary base and keep the currency secured in the Convertibility Zone of 7.75 and 7.85 to the US dollar.

In maintaining the peg, the HKMA prioritises maintaining it over managing the money supply. There is little doubt this goes against the grain of mainstream Western economists who believe inflation good, deflation bad. Over the last year base money in Hong Kong contracted from HK$1,695bn to HK1,635bn. Does this worry the HKMA? Not at all.

How the Chinese will act in the circumstances of a new global credit crisis is yet to be seen, but we should bear in mind that they are probably less Keynesian in their approach to economics and finance than Westerners. Admittedly, they have freely used credit expansion to finance economic development, but theirs is a mercantilist approach, which differs significantly from ours. We simply impoverish our factors of production through wealth transfer by monetary inflation. We think this can be offset by fuelling financial speculation and asset inflation. China enhances her production and innovation by generating personal savings. Wealth is created by and linked more directly to production.

The objectives and effects of monetary and credit inflation between China’s application of it and the way we do things in the West are dissimilar, and it is a common mistake to ignore these differences. The threat to China’s ability to manage its affairs in a credit crisis is significantly less than the threat to Western welfare-dependent nations whose governments are highly indebted, while China’s is not.

China is sure to see the financial and monetary stability of Hong Kong as being vital to the Mainland’s interests. Apart from the Bank of China’s Hong Kong subsidiary being the second largest issuer of bank notes, the Peoples’ Bank itself maintains reserve balances in Hong Kong dollars, which in the circumstances Kyle Bass believes likely, they can increase to support the HKMA’s management of the currency peg.


It is a mistake to think the Hong Kong property market is as much of a systemic danger as it first appears. Expectations of a devaluation of the peg appear to be wishful thinking by the bears.

Far more important are the consequences of the cyber and financial war being pursued against China and Russia, its close ally, by the American deep state. Under President Trump it was accelerated by his trade tariff policies, which are fundamentally an attack on China’s economy. China will be a hard nut to crack, and the effect of America’s trade protectionism has been to trigger a diminution in international trade, which is now becoming apparent. The negative effects on the American economy appear to be being underestimated.

The attempt to destroy Huawei’s 5G global ambitions is both the current and most visible part of an undeclared cyber and financial war. Trade protectionism was only a step along the way. The financial war is now escalating with the global economy facing at least a significant recession, almost certain to trigger an overdue credit crisis. The Chinese have long been on a financial war footing, as shown by Qiao Liang’s analysis of how America needs global portfolio flows and what they are prepared to do to attract them. Western thinking that the Chinese and their Russian allies are vulnerable to American hegemony has been disproved time and again. Financial analysts consistently fail to understand the Chinese are not muppets.

China will not be provoked, and by standing firm, they are sure to protect Hong Kong and get on with diverting investment flows from a failing US economy into its Belt and Road Initiative. This will force a financial crisis on the Americans of their own making. At least, that’s how China has always seen it and they see no need for their passive financial war strategy to change.

[i] See


[iii] See

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