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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Down but Not Out – Japan’s Economy in Recession

Down but Not Out – Japan’s Economy in Recession

While Europe’s troubles continue making headlines Japan’s economy slipped back into recession in late 2012 with barely a mention. Why the difference? Perhaps the island economy shows no hope of recovery after twenty plus years of stagnation, its quiet fade into economic history a near certainty. That would be a decidedly misguided interpretation.

After the go-go years of the “Japan that could say no” (it never really did) and buying sprees in the U.S. including Rockefeller Center sold at a loss several years later, the land of the rising sun entered a period of relative economic darkness. That didn’t mean there wasn’t a ton of money circulating within and increasingly from Japan. Growth stalled but the country itself remained rich. Japan, still the world’s third largest economy  is expected to keep its strong position with a solid $6 trillion in estimated GDP according to the IMF.

Economic stagnation is hardly news for Japan, but coverage has steadily declined largely eclipsed by China’s seemingly unending rise. Add to that the Kabuki-esque political drama where Prime Ministers enter and exit the stage with alarming speed (roughly every 1-2 years) and government paralysis casts a long dark shadow over growth. The latest major economic debate centered on a consumption tax while government debt has risen to over 200% of GDP.

Demographics don’t help either. Alexandra Harney in the New York Times details Japan’s rapidly aging population and its effect on  future economic trajectory (spoiler alert – it doesn’t look good.) Unless there’s a baby boom, immigration increases dramatically to make up for the worker gap or productivity rises there will be a skills shortage.

An increasingly insular Japan also means robust debate has stagnated. In decades past the number of Japanese studying abroad rose considerably. These days it has been reduced to a trickle. Life, it turns out, isn’t so bad in declining Japan. Crime rates are low. The food is good, and public services abundant. A culture of perfectionism keeps the subways running on time and the streets clean. You’d be hard pressed to find more efficiently running cities anywhere else.

Japan’s middle class though has taken the slowdown exceptionally hard over the last several decades. Life-time employment, at one point an unbreakable social contract, has almost ceased to exist with replacement contract work yielding lower salaries and little to no benefits. Housing costs remain high and most singles, even well into their thirties, live at home with their parents to save on rent.

All this might change if a culture of entrepreneurship and an end to the slavish demands of late night corporate culture spreads.

A glimmer of sunlight  has emerged with Rakuten’s founder Mikitani Hiroshi’s creation of an alternate industry lobbying group made up entirely of new economy companies. The Japanese Association of New Economy (abbreviated in Japanese to Shinkeiren) aims to bring innovative policy solutions focusing on the needs of small fast-growing companies. This is a marked departure from the strategy of Japan’s biggest, and most powerful business lobbying group Keidanren representing the country’s conglomerates.

Time will tell if the new group gains any traction with national level policies. If past is prologue they’ll need deep pockets to influence Diet members mostly concerned about occupying seats rather than planning for a brighter future.

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Photo: Tokyo in spring time. BK.

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.

Asia by the Numbers

Asia by the Numbers

(UPDATE 10/8/12: Both the World Bank and Asian Development Bank have lowered 2012 growth forecasts for China and Asia.)

Remember those halcyon days of unending Asia growth and the re-birth of a Silk Road century? Cherish the memories.

Nothing but negative news keeps flowing out of regional giants these days. Expert debates rage on about China’s hard vs soft landing while recent data just keep disappointing. HSBC China Manufacturing Purchasing Manager’s Index wallowed below the critical 50 threshold again. Political intrigue aside, China’s next generation of leaders are facing significant economic headwinds and challenges unknown to their predecessors.

From the September 29th HSBC Purchasing Manager’s IndexTM:

 

“Data in September signalled a stronger decline in Chinese manufacturing output, as the volume of new orders fell for the eleventh consecutive month. New export orders declined at the sharpest rate in 42 months amid reports of weak international demand…”

 

 

Historical numbers show a long decline since late 2010 (and a wild ride starting with the 2008 U.S.-led financial crisis).

Japan’s Tankan business sentiment survey showed more general weakness (negative views of business for the past 12 months and worsening in the last quarter). Unsurprising considering the weak overseas demand, yen troubles making exports more expensive and now troubles with China over the East China Sea. ANA airlines reported 40,000 cancelled flight reservations for September through November sparked by dueling territorial claims and violence on the mainland targeting Japanese factories, stores and restaurants.

Add to that Australia’s struggles with shrinking exports and a surprise Reserve Bank of Australia rate cut to 3.25% (Philippine’s central bank has cut rates as well), Vietnam’s slowdown, and rising South Korean consumer debt.

With the U.S. caught in a “slow-growth” trap of its own making and greater Europe still flirting with renewed recession, trade is now a back seat driver for most of Asia. The slowdown in China is especially concerning for southeast Asia’s and Australia’s resource-intensive exports since China became their main market over the past several years.

Prospects aren’t all negative of course, though finding bright spots in an increasingly overcast night’s sky is tough. Indonesia keeps generating solid six plus percent growth. High investment and sustained consumer demand (accounting for over 32.9% of GDP last quarter ending in June) are driving economic expansion.

Jakarta has so far managed to avoid the massive over-building in China which will drag down the middle kingdom for some time to come. The infrastructure needs throughout the island nation of over 200 million people, if well managed, might provide sustained growth for a while.

Prognosis: Substantial western growth isn’t coming back anytime soon. For Asia to prosper domestic demand (read: consumers) has to expand and that means further market liberalization and access to capital that has often been denied, mainly for political reasons.

The China model of controlled growth and U.S.-style unchecked market excess both have their discontents, but policies favoring middle class growth and expansion remain key. Balance will be the buzzword going into 2013.

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Occupy East China Sea – China, Japan Face Off Over Disputed Islands

Occupy East China Sea – China, Japan Face Off Over Disputed Islands

Chinese fishing fleets continue pressing their claims to the resources of a disputed island chain in the East China Sea while Japan considers what it can do with a Coast Guard fleet to protect their administrative control. The Senkaku/Diaoyu or Diaoyu/Senkaku island debate rages on with an occupy movement in full swing.

With the Japanese government’s decision to buy the islands from its private owner, rather than let right–leaning Tokyo governor Ishihara do the same (and escalate tensions further), a wave of anti-Japan protest spread in China. In addition to the anticipated demonstrations against Embassies and consulates, large crowds looted, set fires and attacked civilians (Japanese and Chinese, some in Japanese made cars).

The question over sovereignty of the islands has revolved around two main arguments from China –  historical precedent and geographical rights. Neither holds much sway in the international community of today rather than say several hundred years ago when imperial dynasties ruled.

For the history defense, China claims the islands were never Japanese territory and show up on several ancient maps of the region. History converges around 1895 after the Sino-Japanese war when the Japanese government began to control the islands. Han Yi-Shaw, guest writing in Nicholas Kristof’s New York Times opinion blog dives deep into the historical record and concludes:

“Collectively, these official documents leave no doubt that the Meiji government did not base its occupation of the islands following “on-site surveys time and again,” but instead annexed them as booty of war. This is the inconvenient truth that the Japanese government has conveniently evaded.”

Whatever the reasons espoused by Japan’s rulers at the time, war was (and in some places continues to be) the main arbiter of establishing control over physical territory. If history was the gauge to judge international decisions over territorial disputes Mongolia could claim rights over China, India and vast swathes of the Middle East and Europe. Iran would have overlapping claims from their Persian empire. Mexico re-gains the American Southwest, but perhaps Spain, France and Britain would like to carve out the rest of the U.S.

Historical precedent also shows Japan did administer them, unchallenged, then lost them in World War II to the U.S., and then re-gained them afterwards. If China doesn’t recognize the end of war agreements (to some of which they were not a signatory) then far more lies in question than just a few islands.

Geography also plays a weak role. China is looking to the UN Convention on the Law of the Sea (UNCLOS) to arbitrate a claim that the islands belong to their continental shelf. Since they lie outside of the standard 200 nautical mile limit the government is setting in motion a review to extend the range of the shelf.

While this is certainly better than waging war to win back the islands based on an over one hundred year old conflict UNCLOS doesn’t settle national sovereignty issues, it attempts to resolve conflict over exclusive economic zones.

Neither historical precedent nor length of continental shelf is going to ultimately win favor with the international community or gain the credibility China wants for its claims over these islands. Maintaining the status quo by both sides has been the accepted norm. Increased interest in potential natural resources, rising nationalism on both sides, and China’s rapid military expansion threaten that tentative peace. Japan’s purchase from a private citizen may appear to upend the status quo, but not necessarily. It largely prevented more hawkish factions from attempting to fire up nationalistic sentiments.

For now both sides will need to look strong domestically without crossing a red line into open conflict. As long as neither country builds on the island, begins drilling operations at sea or aggressively restricts access to fishing grounds, a tentative calm can be maintained. The only peaceful way to resolve the dispute is for both sides to negotiate directly. Otherwise we’re back to the days of might makes right in Asia, and that didn’t go well at all.

Photo: Wikimedia Commons

Mid-Day Note: Global Economic Data Disappoints

Mid-Day Note: Global Economic Data Disappoints

U.S. economy still lags.

Today’s U.S. housing and consumer confidence figures failed to signal a real economic rebound. This after Moody’s downgrades of fifteen banks last week, including Goldman Sachs, and earlier Federal Reserve data* showing U.S. household net wealth plunging over 40 percent between 2007-2010. That’s an entire generation of wealth creation gone in three years. On a slightly positive note net wealth has been growing slowly since then, but for whom? Mainly shareholders and executives. Corporations continue to sit on cash ($1.7 trillion give or take) while the middle class, hit hardest by the downturn remains worst positioned to recover.

The temperature continues rising on a host of ills begging for resolution (jobs, insurance, income gaps), but as election season shifts into full gear expect more political paralysis in Washington, not less. Still, some growth, any growth, is better than contraction even at a paltry 1.8%. Lower gas prices may pump a few extra dollars into pockets over the next few months. Major concerns of course remain. Where will growth emerge if consumers continue to face pressure from all sides – stubbornly high unemployment, marginal home price increases, expiring tax breaks and soaring healthcare costs. Expect a long, hot summer.

Europe – Cyprus and Spain join the bailout line.

Moody’s downgraded Spanish banks in a widely recognized crisis of financial confidence. Now one of Europe’s larger economies officially joins the bailout que. Add Cyprus’s estimated 5-10 billion euros, a pittance compared to Greece, and Europe’s southern rim continues unravelling. Brussels won’t yield money without constraints. The only question left, at what cost in the short term versus broader integration later. The focus needs to remain firmly on the moment as the European Union will need plenty of time to hash out new monetary rules among its 17 member countries and 23 official languages.

Japan – Nuclear power returns but jobs may not.

Nuclear plants are coming back online absent energy alternatives (including a fragmented electrical grid and untapped geothermal resources). That will at least avoid production shutdowns that hobbled 2011 electronics and automotive manufacturing. Tepid recovery following last year’s disaster remains on track, but a track to where? Longer trends still point downward. Major manufacturers are off-shoring in droves, responding to light domestic demand, a troublesome exchange rate (making exports exceptionally expensive for overseas buyers), and greater growth prospects elsewhere. With all three of the world’s traditional growth engines stalled or sputtering, sources of new growth remain a mystery.

China – Slower growth than expected.

Serious headwinds continue to mount in China’s struggle to maintain history-defying growth. HSBC’s June flash purchasing manufacturer’s index fell to 48.1, it’s eighth consecutive month of contraction staying below the critical 50 mark. Accurate statistics continue to be problem, but if electricity consumption and coal inventories are any gauge, especially in China’s southern production heartland, then a slowdown has been building for some time. Power generation is barely growing as it approaches early 2010 lows, and this time absent a major global economic shock like the U.S. financial crisis. Strains in Europe alone don’t account for this slowdown. Chinese stimulus efforts are expected to fall far below their previous $550+ billion injection during the leanest years (2008-2009). Officials know that only so much demand exists for infrastructure and construction projects, their preferred stimulus sectors of the past.

Bottom Line:

Tepid U.S. recovery continues but rising risks suggest more slowing ahead. Europe’s ills are the near term weight, but China has a long way to go towards structural change and real consumer-driven demand. With their own power transition incomplete until the end of the year don’t expect dramatic upside surprises any time soon. If/when politicians on any continent finally resolve to get more money into the pockets of the middle class, then recovery prospects will finally brighten.

* For Federal Reserve household wealth data see:
htp://www.federalreserve.gov/releases/z1/current/z1r-5.pdf

Photo: Brian P. Klein

Can China Lift Japan Out of Recession?

Hopes are high and rising that a near-term China recovery, fueled by an estimated $587 billion stimulus plan and massive bank lending, will be a boon to Japan’s ailing export sector. This new demand is expected to lift China out of recession even before the United States and Europe recover. China’s stimulus, however, is neither large enough nor necessarily supportive enough of foreign imports to have a significant short-term impact on Japan’s rapidly deteriorating economy.

Full article.