Asia Tensions Reach New Highs

North Korea’s rounds of provocation tempered with inaction continue to challenge regional powers. Sanctions appear to have had little affect on the new regime, but perhaps some additional pressure from China, one of their last remaining allies, has put the fear of complete isolation into the minds of Pyongyang’s leadership. Now that the new Kim has shown his father’s generals he’s no push over maybe he’ll move on to the real work at hand – the economy. After closing Kaesong (one of the few legitimate hard currency earners for the regime) the North now wants to talk with South Korea about re-opening the joint project.

Nothing coming out of the DPRK should be taken at face value, of course – the propaganda machine sounding war drums, or conciliatory economic gestures. The regime still has a horrible human rights record, continues to pursue a nuclear capability and remains a card carrying member of the pariah states club (including Iran and Syria), but in the world of international diplomacy, where there’s more gray than black and white, it’s high time for some serious talk. Bilateral, multilateral, whatever works. Talk is cheap and it isn’t a reward for rattling the region, but it may just create an opening for Kim to try out a new tactic – engagement. Missile firings along with the capture of an American citizen have failed to gain him the audience he wants, except for a repeat visit by Dennis Rodman scheduled for August.

China’s New Law of the Sea – but Might Still Doesn’t Makes Right

Meanwhile, China’s “take first, ask questions later” approach to territorial disputes in the shared waters of East and Southeast Asia continues to rankle its neighbors. We’ve reached a new low in regional relations. What started out as fishing boat bravado has escalated dramatically into full-scale military involvement. Now the cat and mouse game plays out around the Senkaku/Diaoyutai islands with Japan upping the ante, and military budget, to confront an increasingly aggressive Chinese navy. Southeast Asia hasn’t fared much better. No agreement has been reached, despite diplomatic overtures for two years running, on how to resolve overlapping claims now completely subsumed under China’s self-claimed control.

Risks of accidental firings aside its now clear to everyone in the region that China’s “peaceful rise” has given way to a long rumored, now actualized policy of regional dominance. It might not be the Cold War part 2, but it certainly looks a lot like back-to-the-future with a new Chinese imperial sense of historical retribution for past colonial ills. The rest of the world has since moved on. Perhaps the “China Dream” should include a broader vision of regional integration without any one country needing to dominate.

Unfortunately for Asia the moment for a regional security architecture passed decades ago (about when NATO was formed and former aggressor states like Germany sat down with Britain and France). Now it’s left to the U.S. and its Asia pivot to cobble together long historical “frenemies” into a semi-cohesive whole. That attempt runs head long into China’s economic leverage that so far successfully divides the region (and ASEAN in particular) by holding trade hostage (from Philippine fruit imports that suddenly show signs of infestation to rare earth metals vital to Japan’s high-tech industry).

Countries are already trying to diversify their export markets and sourcing while the infinite promise of a large and expanding Chinese market comes under new strains. If cooler heads prevail, then the benefits of a cooperative future and greater regional integration will win out over a divisive re-playing of threats and counter-threats in the age-old struggle for power and control.

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Red Lines in the East China Sea

East China Sea[Short version on CNN GPS]

In many parts of the world the long curve of history continues dragging nations back to the brink of war. Take Northeast Asia where recent tensions between China and Japan risk erupting into conflict. The Senkaku/Diaoyu islands, home to rocky outcroppings and resource rich waters nearby has become the latest potential flashpoint.

What started as a manageable confrontation in the East China Sea between Chinese fishing vessels and Japanese Coast Guard cutters has now escalated well beyond natural resources. Chinese fighter jets have shadowed Japanese planes in the skies above. Japan has threatened to fire warning shots. A hawkish Chinese general has warned that would be their only shot while Beijing announced plans to formally survey the islands. The U.S. has weighed in against any unilateral action that challenges Japan’s administration of the area.

If there’s a red line where rhetoric and posturing turns into open conflict (intended or otherwise) we’re close to crossing it.

Neither side shows any signs of compromise with Shinzo Abe back as Japan’s Prime Minister, and Xi Jinping inheriting an increasingly nationalistic country in transition. In a January International Crisis Group report  Stephanie Kleine-Albrandt notes that:

“While neither Beijing nor Tokyo desires a major conflict, their tacit agreement to set aside the dispute has been broken and there is deepening pessimism on both sides over the prospects of a peaceful settlement.”

As Bill Bishop points out in his daily Sinocism report, stepping back from the brink becomes increasingly difficult.

“China’s relentless media campaign since the summer, the anti-Japanese teachings so prevalent in the Chinese education system and the imperative of any new leadership to not look weak, especially toward the Japanese, could mean that if an accident did occur, especially one that resulted in the death of a Chinese citizen, Beijing might have so painted itself into a corner that it would have respond with force…”

The spiral of escalation, once started, can be difficult to unwind including any real shots fired by the increasing number of naval ships (both Chinese and Japanese) now plying the nearby waters or jets flying overhead. Similarly if either side attempts to land on the islands the other side will counter with a landing of their own. Calls for retaliation will be hard, if not impossible, to resist.

Complicating this current territorial flare-up is a centuries old rivalry. An economically emboldened China, with a military budget to match, has begun reasserting itself as a regional power. For centuries it was the trading hub of the region and an imperial power coercing its neighbors into paying annual tribute for peace and security. To be fair, the long arc of Chinese history also includes imperial dynasties that eschewed regional intervention – a fact currently lost on current policymakers.

Schools to this day continuing painting the country as a weak, aggrieved nation. The lesson: China must defend itself against a mythical recurrence of exploitation at the hands of foreign powers. These slights of history dating back to early 1900’s treaty ports (a time of unequal trading relations) are re-lived as if they were yesterday. Yet, the more recent reign of Mao Tse Tung driving the country into devastating famine, financial ruin and global isolation gains barely a footnote.

The cognitive dissonance between present day reality: China as the world’s second largest economy, with one of the world’s largest militaries and more than equal inclusion in the global trading system; and views of a distant, weakened past continue influencing China’s foreign policy. In Japan as well, historical revisionists continue celebrating war criminals at Yasakuni Shrine. The current administration has also contemplated changing its account of the use of sex slaves during World War II.

On a limited but positive note Japan sent, and China received an official delegation to discuss the territorial dispute. Former Japanese Prime Minister Hatoyama visited China’s Nanjing Massacre memorial which marks Imperial Japan’s World War II atrocities. And U.S. Assistant Secretary of State for East Asia and the Pacific Kurt Campbell has been making the regional rounds calling for dialogue.

For now at least lines of communication remain open while both sides try to reign in their political extremes. Space for rational discussion, however continues shrinking under the pressure of nationalistic vitriol. If push comes to literal shove the damage to the region and international trade could be devastating.

Conflict has never been pre-ordained. It is the result of decisions, by people, to follow a course into crisis. New histories can and have been forged. Consider the U.S.-Vietnam relationship of today versus forty years ago. Trade has replaced hostilities and Americans travel to tourist destinations in straw hats rather than as soldiers in helmets. The past should not be forgotten, but neither should it be allowed to replay itself in an endless, self-destructive loop. Hopefully that’s not a lesson lost on Beijing and Tokyo in 2013.

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The Once and Future Beijing Blues

China_tmo_2012346

Remember the Beijing Olympics of 2008? A world-renowned stadium. An opening ceremony of unparalleled power and vibrancy. Beautiful blue skies. It was a picture-postcard moment.

At the time visiting reporters regaled the wonderfully clean air, some even claiming the government could make the skies rain on command to wash away the pollution. But to Beijing residents accustomed to temporary prevailing winds, and more importantly subjective policy enforcement, clear skies were a welcome illusion. No one really expected them to last after the games concluded.

And soon after brown became the new blue. Skies darkened. The sun faded behind a familiar beige-orange haze. Factories, forced to shut soon made up for lost time clogging the skies with pollution. The “fog” had returned, though in truth it was an unnatural cousin to moisture trapped by cold fronts against a ring of nearby mountains. (See this China Air Daily/Asia Society slider  of June 2009 bad air vs. blue sky days).

Over the last week or so Beijing has suffered under an extraordinarily bad pollution epidemic with air quality measurements soaring to over 800 according to a U.S. Embassy monitoring station (“safe” levels hover closer around 35-75 depending on U.S or Chinese standards respectively). Even using lower Chinese government readings the numbers were staggering (note: just before the Beijing Olympics official monitoring equipment was moved further outside the city center and to no surprise air quality numbers improved dramatically so doubts remain about “official” statistics.)

Since 2008 two significant changes have occurred. The Chinese government finally decided to report measurements at the far more dangerous PM 2.5 level where particulates small enough to invade lung tissue can cause respiratory disease. The media has also been given extraordinary leeway (at least for the moment) to report on the pollution problem.

What doesn’t seem to have changed is the enforcement of Chinese environmental laws passed years ago meant to protect the public against this very kind of devastating human-made air disaster. Are state-owned enterprises, some of the worst polluters with coal-fired power plants and cement factories, using the scrubbers they supposedly installed? Apparently not, or maybe only when inspectors come to visit.

Have state or national level environmental protection bureaus dramatically increased staffing, equipment and enforcement actions against polluters, despite the billions of dollars spent in pre-Olympic pollution control? Doesn’t seem like it.

Political will remains the major determinant of blue skies over Beijing and elsewhere. In today’s changing China where tens of thousands of people increasingly protest over polluted water and unsafe plant emissions the status quo can’t remain unchanged indefinitely. Absent the power of the vote, physical demonstrations are the only outlet for an increasingly victimized populace. Postcards of 2008 are fading fast. The only key decision left is whether to raise public health above breakneck growth and entrenched economic interests. Slightly less than phenomenal profits in the service of breathable air doesn’t seem like too great a compromise.

Image: NASA satellite imagery 12/11/12 (taken before the latest record pollution levels)

Asia Integration Leaves U.S. Behind

Asia Integration Leaves U.S. Behind

You can’t blame them for trying. U.S. trade negotiators have been at it for years but conclusion of the Trans-Pacific Partnership (TPP) keeps receding over the horizon. A June deadline was floated and then passed quietly by. The end of 2012 came next (here and almost gone). Japan and possibly even Korea thought of joining when news broke that Mexico and Canada, already NAFTA members with the U.S., were signing up. Neither has committed.

Meanwhile, Asia is moving ahead with its own far less stringent version of free trade in two proposals: the Regional Comprehensive Economic Partnership (RCEP) launched at the annual ASEAN gathering in late November; and a trilateral China-Japan-South Korea free trade agreement announced in May (negotiations started in November.)

Holding a press conference and successfully completing negotiations are, of course, two very different animals. No doubt recent regional tensions over disputed islands in the East and South China Seas involving mostly China, Japan, Vietnam and the Philippines make any agreement extremely difficult to achieve. Still, all countries involved appear to be forging ahead despite the obstacles in their way.

Asia has taken a decidedly different approach regarding free trade in the region from the U.S. Starting with the lowest common denominators (goods) and through successive agreements working their way up the value-added ladder (limited, then expanded services, broader non-tariff barriers to trade, rules of origin, etc.) This incremental approach, especially when economies at significantly different levels of development are involved, has worked especially well for both China and South Korea in their agreements throughout the region.

The U.S. on the other hand seeks “high standard” agreements encompassing a variety of non-tariff barriers to trade, intellectual property rights protections and labor and environmental standards, all in one comprehensive Free Trade Agreement (FTA).

These are noble goals and of particular interest to U.S. companies who have an enormous number of laws regulating their business at home and abroad. For many with extensive intellectual property to protect the graveyard of international business is littered with the remains of products that have been copied and sold at lower prices. To truly level the playing field they need the additional protections offered in high-standard FTAs.

The problem lies in strategy, not substance. This all-or-nothing approach leaves potential deals on the table while U.S.-based firms continue losing out to their counterparts based in Asia. U.S multi-nationals are increasingly incentivized to locate production overseas where they can source and sell within a tariff-free zone. Even a few percentage points off duties can have a tremendous effect on profitability.

No solution to this problem is in sight. U.S. trade policy has focused almost exclusively on the TPP and purely defensive measures (e.g. WTO cases to remedy unfair trade practices). Asia meanwhile forges ahead. When RCEP comes to fruition India, China, Japan, South Korea, Australia, New Zealand and the ten countries of ASEAN would become one integrated free trade zone. If current strategy doesn’t change soon (or the TPP keeps being delayed) the U.S. won’t even be on the map.

 

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Photo: Yang Shan Deep Water Port, China.

China’s Questionable Market Recovery

Money has to stay fit. It gets soft just lying on the couch, feet up on the coffee table, flipping through reality TV shows.  And this week the money looks like its running back to Asia.

The Shanghai composite index jumped 2.87% on Wednesday prompting a flurry of reporting on the re-awakening of China’s stock market. What a jump. Better days here we come . . .

Chart Source: Yahoo Finance

But before we get ahead of ourselves, take a look at the year-to-date chart.

Chart Source: Yahoo Finance, annotations added.

Yes, it’s that little blip at the bottom edge of the chart. The same uptick that occurred once in October, twice in September, and once in August and June as we climb backwards up the downward facing slope (not a yoga move).

 

For even greater perspective take a look at the last five years while the collective West was supposedly entering inevitable decline, imploding under the weight of its own capitalistic excesses. The mole hill made mountain is just barely visible, way down there in the corner, like the raw unamplified light of a distant galaxy.

Chart Source: Yahoo Finance, annotations added.

Even more illustrative than all the hype surrounding this minor bump is the shape of the longer Shanghai curve. The “V-shaped recovery” ended unceremoniously in July 2009 turning into a long, sustained slump (losing over 40% of its value in the last three and half years.) Compare that to the S&P 500 in the “declining” U.S. over the same period (in orange). The S&P elongated “U”-shaped recovery just keeps going (a rocky road, but climbing), and up 20% from Shanghai’s July 2009 peak.

Chart Source: Yahoo Finance, annotations added.

Fundamentally little has changed in the Chinese economy to warrant sustained optimism about stock market recovery. There has been excessive infrastructure investment which will have questionable returns going forward. Local governments are saddled with rising debt. Land development projects increasingly go unfilled or unfinished.  And accounting scandals continue to rock the boat of listed companies, several of which are leaving U.S. markets because of detailed reporting requirements (read investor protection).

Talk of a Chinese soft landing and bounce-back have been de rigeur for some time. There wasn’t a mortgage market bust or banking crisis like in the U.S. (though there are signs of significantly under-reported bank liabilities, off-balance sheet transactions, “alternative” funding schemes, and real estate inventory backlogs of staggering proportions.) But then again, soft-ish landing doesn’t rule out slower days ahead. The U.S. hard landing actually resulted in a far stronger market recovery it turns out. For a sober analysis of China’s financial predicament see Michael Pettis’s “Three cheers for new data?“.

None of this means you can’t make a mint on short-term trading (full disclosure, I am not a short-term trader), but a small spike in an otherwise downbeat cycle hardly marks a trend. Money keeps running the treadmill in the basement to try and stay fit. Funny thing about home exercise equipment, after a few good runs it rarely gets used again.

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Five Quick Fixes to Grow China’s Economy – Quartz Article

Five Quick Fixes to Grow China’s Economy – Quartz Article

The veil has finally been lifted on China’s leadership mystery. Questions now loom large over what, if any, reforms are likely over the next decade. So far critiques of the new seven-member ruling body point to a more conservative streak (don’t expect a democratic thaw anytime soon.) Those with the strongest reform credentials were either left out of the standing committee selection or reassigned. And no one knows for sure what Xi Jinping has in mind beyond platitudes not unique to the political class.

One certainty still stands out. Without significant reform China’s best days may be behind it as growth slows and opportunity stagnates. Five areas of low-hanging fruit would have a significant near-term impact including: ending the hukou residency permit system; opening the financial sector; building a social safety net; equitable tax collection; and an independent judiciary that can fight corruption.

Read the full article on Quartz.

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Excerpt: © 2012, Brian P. Klein, as first published on Quartz.

100 Minutes of Lip Service – Quartz Commentary

100 Minutes of Lip Service – Quartz Commentary

China’s political transition is in full swing in Beijing, replete with lengthy speeches and obligatory internet crackdowns. Outgoing President Hu Jintao’s lengthy reading of the most pressing issues facing the party—in oratory second only to Castro’s multi-hour monologues (minus the Cuban’s fiery delivery)—went on for a good 100 minutes. He made an ominous warning over corruption spoiling the party and threatening the state.

By western media accounts you’d think China was finally getting serious about graft in the world’s second largest economy. That this was considered news in the US says more about the inability to separate propaganda from policy than it does about any new crackdown in China.

Read the full commentary on Quartz.

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Excerpt: © 2012, Brian P. Klein, as first published on Quartz.

Ten Foreign Policy Priorities for Obama – CNN Commentary

Ten Foreign Policy Priorities for Obama – CNN Commentary

(From CNN GPS – full list here.) Barack Obama has won reelection as America’s president. But while the economy – and avoiding the so-called fiscal cliff – will inevitably take up much of his time, there are numerous foreign policy challenges facing the next administration. GPS asked 10 leading foreign policy analysts to name 10 things that Obama should focus on next. The views expressed are, of course, the authors’ own.

Drop China ambiguity

By Brian Klein

Brian P. Klein is a global strategist and former U.S. diplomat. He blogs at Klein’s Commentary.

China’s economic rise and increasing military assertiveness have pushed U.S. strategic ambiguity to its limits. If a decisive position isn’t taken soon, allies and friendly countries will question whether the U.S. can back up its Asia pivot talk with action. Focusing on realistic trade liberalization, increased military contacts with China and firm engagement rather than the blame and shame tactics of the past must become a priority.

Meanwhile, the once vaunted Arab Spring, so full of promise and democratic zeal, shows signs of entering a long dark winter. Egypt’s President Mohamed Morsy whittles away at reforms in the marginally secular republic, while Syria’s civil war now threatens regional stability, with conflict overflowing into Turkey and Lebanon. Boots on the ground may not be an option, but a focused effort to influence, if not completely resolve these destabilizing trends will be essential to restoring peace.

China’s Global Leadership Gap – CNN Commentary

China’s Global Leadership Gap – CNN Commentary

(Also on CNN’s Global Public Square here.)

In a rare and telling diplomatic snub this week China refused to send People’s Bank of China Governor Zhou Xiaochuan to the IMF/World Bank meeting held in Tokyo. The slight, related to the continued stand-off with Japan over a disputed island chain in the East China Sea says more about China’s prospects for greater global leadership than a bilateral territorial disagreement.

For several years running China’s economy has grown along with its ambitions for recognition. Internationalizing the yuan as a reserve currency, more influence over international lending institutions and respect as a leading business and financial center have been chief among them.

The meeting boycott marks the latest in a string of retaliatory acts, including using informal trade measures meant to punish countries acting in ways China dislikes. Imports from the Philippines were suddenly subjected to enhanced inspection and quarantine over a dispute in the South China Sea Rare earth exports critical to Japan’s electronics industry were also suspended in a 2010 island conflict. These steps mark a troubling and regressive tendency in Chinese foreign economic policy.

Since joining the World Trade Organization back in 2001 Beijing has enjoyed many of the benefits of membership while at the same time using protectionist measures to give domestic industries significant advantage. Trade has been used increasingly as a political tool contravening over a decade of engagement to keep these two policy spheres apart.

Refusing to attend the annual international finance meeting will further damage China’s hopes for greater recognition. At a time when the risks of global recession are increasing retrenchment adds doubts about a potential leadership role. While Beijing might think its status as the world’s second largest economy makes it increasingly vital to any discussion, the world continues to turn without it.

Xi Jinping and the rest of China’s new leaders in waiting inherit a country in transition. Rising domestic wage pressure, a slowing economy, and renewed doubts about the security of joint venture intellectual property suggest China’s global economic influence may soon be waning, not continually rising. If slower growth becomes a trend rather than a temporary blip and anti-Japanese business sentiment grows into a broader missive against foreign companies, the lure of China’s growing market would dim significantly.

Embracing the complexities of international discourse rather than shying away from them mark an important maturing stage. Equally important are policies that further opening and reform increasing international participation in China’s domestic economy. This enhances both the perception and reality that China is dedicated to continued global integration. Pulling a no-show at an international gathering in a neighboring country does not.

 

Photo: Tiananmen Square looking north to the Forbidden City. Brian P. Klein.
Slogan by Mao’s portrait reads “May the Communist Party of China Live for Ten Thousand Years” (a former imperial saying re-purposed after the 1949 revolution).

 

If China Televised a Presidential Debate

If China Televised a Presidential Debate

(Sometime in the future . . .)

Moderator, internationally-renowned artist Ai Weiwei: Thank you all for coming to the National Center for the Performing Arts in downtown Beijing for this first ever, internationally televised CCTV – China Presidential Debate. There will be no opening remarks, only questions submitted by Weibo users whose names will be concealed. Our first question comes from a real estate developer.

What do the candidates believe the role of government should be in the economy?

Candidate on the left podium – The government should have more state control, more direction over the economy and more of a focus on the poor. State-owned enterprises stabilize the country. My opponent believes the free market and western economic ideals should be slavishly followed. I believe China should follow its own development path and bring back the ideals of our founding father.

(We hear mild applause. Several in the audience are holding pictures of Mao and waving small Chinese flags.)

Candidate on the right podium – The government should facilitate greater reform and opening. That is how China will take its rightful place as a global economic and political leader in the 21st century. Private enterprise will drive future growth in leading industries. Government can and must enforce the rule of law to create a positive environment for business to flourish. Corruption must be stamped out. Consumers, not elites should drive growth.

(More applause, a little louder and longer than the first.)

Second question comes from a graduate student at the China Foreign Affairs University.

China was invaded many times in the past. Now we are a strong country. Why shouldn’t we take back what is rightfully ours including Taiwan, the South China Sea and the Diaoyu islands?

Candidate (on the left): China is a strong nation and will defend its national interests wherever they may lie.

Candidate (on the right): China is a strong nation and will defend its national interests wherever they may lie. Let me add that we believe in a peaceful rise.

Okay. Our third and final question, well more of a comment and a question, comes from a factory worker in Guangdong.

My husband and I both work 10-12 hours a day, 7 days a week at a Chinese-owned factory. The owner often doesn’t pay the overtime we are promised, even after we’ve paid the manager to get the extra hours. Many of my co-workers have gotten ill from the chemicals we use to clean computer screens. The company said they would pay for medical costs but the local hospital insist on cash. If we want to see the actual doctor we have to pay more. Even with receipts we never get reimbursed. I went to complain to the union. The union boss told the factory manager and now I’ve lost all of my overtime and have to work the overnight shift.

Since I do not have a residency permit my daughter can’t attend school here. She lives 200 kilometers away with my parents. Local officials took their land. Now they live in a small apartment in a new building many miles away that is already falling apart. The money they received wasn’t enough for the apartment so they had to use up all of their savings. While we earn more than we used to both of our salaries barely pay our parent’s doctor bills (they have no insurance), my daughter’s school fees (even though she goes to a public school) and our company housing and food. I do not feel better off than I did ten years ago. What are you going to do about it?

(Large thunderous applause fills the auditorium.)

The microphones are suddenly cut and the candidates whisked off stage. Ai Weiwei pulls out his own bullhorn just as television screens across the country go black. A few seconds later images of fireworks appear from the 2008 Summer Olympic Games.