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Hong Kong's geopolitical threat tests China's economic drive

TOKYO -- Hong Kong's so-called umbrella revolution is starting to rock the global financial boat. The scale of the pro-democracy protest has grown to the biggest since the British colony's 1997 handover to China.

     Hong Kong stocks came under strong selling pressure on Sept. 30. This trend carried over to Japan and South Korea, after dragging down U.S. and European stocks. Market players are snapping up "safer" U.S. Treasury bonds, sending the dollar higher against other major currencies.

     Amid Hong Kong market woes, mainland China's equity market remains intact. Shanghai stocks appear to be immune to the disturbance, with the Shanghai Composite Index moving at its highest level in about 18 months. Meanwhile, Beijing has tightened its online censorship, affecting everyday life of its citizens.

     The Chinese government stands by its "one country, two systems" policy, while clamping down on Hong Kong, limiting the city's political space. This has ignited the current backlash.

     Behind much of the unrest in Hong Kong is the drastic improvement in mainland China's economy over 17 years since Hong Kong was returned to China. In 1997, mainland China's nominal gross domestic product stood at slightly over $950 billion, five times that of Hong Kong's $180 billion GDP. As of 2013, mainland China's GDP was 33 times that of Hong Kong's; just under $9.2 trillion and just over $270 billion, respectively.

     This great economic prowess has allowed mainland Chinese companies and citizens to go on spending binges for property and luxury goods in Hong Kong. There has been a particular fondness for places that include the name "Central," the term used for Hong Kong's financial district -- and the current location of the protests. A local fund manager believes  mainlanders are eager to rent offices in central, according to a former Japanese official at a trading company who made a business trip to Hong Kong last week.

Not to plan

That said, it does not mean mainland Chinese are sitting easy. They have been building up wealth, but also have had to endure severe pollution and deal with corruption among government officials and companies. Up to 70% of water in mainland China is not worth drinking, the former trading company employee noted, citing an official of a financial body.

     Mainland China's capabilities and wealth are rapidly growing, and pollution and corruption are coming along for the ride. They are two sides of a coin of today's China.

    The protests in Hong Kong come just a little more than 25 years since the Tiananmen Square protests in 1989. When those demonstrations were stopped, by tanks that killed pro-democracy demonstrators, the Chinese government started to crack down on domestic pro-democracy movements in general. All the while, the country has shifted faster and faster to a market-oriented economy -- an attempt to justify good governance through distribution of wealth.

     Since the end of the Cold War, U.S., European and Japanese companies have been transferring their production sites to mainland China, sending a big wave of direct investments to the country. Today, the world's second-largest economy faces economic challenges against its overseas demand-driven growth model, which takes advantage of low wages.

     There have been the expectations of greater democracy and liberalization in China as the country's economy grows and its citizens become enriched. But doubts are being cast over this once-bright outlook. And then there is what we see now in Hong Kong. One wrong step by the authorities could trigger international criticism, and consequences could ripple through mainland China.

     On the bright side, China's "through-train program" will allow mutual stock market access between mainland China and Hong Kong from this month. With this program, overseas investors will be able to buy and sell Shanghai-listed shares through the Hong Kong bourse. Authorities and companies in mainland China probably have well-thought plans to attract overseas money through Hong Kong. However, the authorities' hard-line approach to the city's pro-democracy protesters could jeopardize these plans.

     At any rate, how long can stocks in mainland China stay strong? Will the situation further cool down direct investments in mainland China? In addition to closely watching China's economic outlook, market players cannot but also watch closely what moves authorities in mainland China and Hong Kong will make.

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