Is Abe Starting to Treat the Obama Administration as a Lame Duck?

And is Joe Biden the Designated Whipping Boy?

There has always been an implicit contradiction between Shinzo Abe's declared desire to "bring Japan back" and the US wish to lead "Free Asia". The divergence of aims has been obscured by the eagerness of the US defense establishment to encourage Japan's increasing heft as a "security" "defense" "active pacifist"; well, let's just say "military" power, in order to add to the credibility of US hegemony in the Western Pacific, and Japan's awareness that US military backing - if properly exploited by invoking the US-Japan Security Treaty - can give Japan a significant leg up in its confrontation with the People's Republic of China.

The Abe administration has performed exactly as desired by American military strategists, both in its willingness, nay eagerness to build up its military and endorse the concept of "collective self defense", and on the highly contentious issue of shoving the Futenma airbase relocation down the throats of the resisting Okinawan people by a combination of financial blandishments and crude political pressure.

However, there are signs that the are tensions in the US-Japan romance, largely because the Obama administration is serious about exploiting the potential of its "honest broker" role to carve out a role for itself as the even-handed interlocutor between Japan and China - a role that the PRC is encouraging in order to drive a wedge between Tokyo and Washington - and is therefore not giving Prime Minister Shinzo Abe the full-throated support that he believes he needs and deserves.

Also, the Abe administration may consider the current moderate Asia policy of President Obama, Vice President Joe Biden, and Secretary of State John Kerry to be a fleeting, transitory dream of an administration entering its lame-duck phase, to be carefully defied in expectation of a more militant and pro-Japanese successor.

One of the less-noted ramifications of US Asia policy has been the marked divergence between US and Japanese responses to the Chinese declaration of its air defense identification zone or ADIZ in the East China Sea. Prime Minister Abe immediately jumped into Churchillian "this shall not stand" rhetoric and declared that no Japanese aircraft - including Japanese civilian carriers that had already declared their intention of complying with the Chinese declaration - would respect the ADIZ.

The United States, perhaps conscious that it maintains a ferociously defended ADIZ over North America, decided to defy the ADIZ only to affirm the right of United States military aircraft to fly anywhere they wanted outside of Chinese airspace, and sent two B-52s lumbering over from Guam into the ADIZ unannounced. The United States, however, did not recommend that US civilian carriers ignore the ADIZ. South Korea took advantage of the ruckus to expand its own ADIZ, which it apparently has been trying to do for a long time, gained the acquiescence of the PRC, and it appears that ROK civilian carriers now respect the zone.

This left Japan pretty much out on a limb by itself, a state of affairs that the Western press tactfully decided to ignore but that seems to have awakened some resentment towards the United States, perhaps by the Abe administration and certainly by its confront-China sympathizers in the US.

Although Prime Minister Abe had failed to summon up a united front against the PRC over the ADIZ, he took another crack at it at the global elite confab in Davos, Switzerland.

International affairs boffin Ian Bremmer and a suspiciously large contingent of think-tank poobahs were primed to love the speech (the text of which was, by Davos practice, not made available to the common herd), and they did.

First, Bremmer:

And Prime Minister Abe just came, he gave a great speech. Folks are optimistic about the economy. The one part of the speech that people were really concerned about was Japan-China. And understandably. He's criticizing the Chinese as being aggressive and militaristic. He compared Japan-China relations explicitly to relations between Germany and the UK in 1914, where the economic relations were good but the security tensions, let's say, were not so good. And we saw what happened there.

I wouldn't say that Abe was directly raising the specter of war, but he was saying that China is acting in a manner that's unacceptable and Japan won't tolerate it. [1]

Bremmer also implied that the PRC was taking advantage of a certain lack of American testicular fortitude on the China question:

So clearly the Chinese want to engage with Americans in a serious way. There are a lot of reasons for that. The US economy is picking up. But also they see a window here because all of the hawks on China are gone from the US administration. Hillary's gone, [former assistant secretary of state for East Asian and Pacific Affairs] Kurt Campbell's gone, [former Treasury secretary Timothy] Geithner, much more focused on this region, is gone, and [former National Security Advisor Thomas] Donilon's gone. And so they see an opportunity with Biden effectively leading US-China relations right now to build the US-China relationship while really changing the rules on the ground with Japan.

Contemporaneously, two worthies from the Center for a New American Security, a "left of center" security think tank, declared their concern that peace might break out between the US and the PRC, and advocated for heightened tensions instead, with an assist from Japan and other Asian allies:

US officials have been careful to avoid provoking a China that appears increasingly willing to flex its newfound military muscle. Perhaps that's why Biden invoked his father's advice in warning on the eve of his Beijing visit that "the only conflict that is worse than one that is intended is one that is unintended". But an overemphasis on stability can be dangerous.

The point is simply that a country with the power of the USSR or China, unsatisfied with features of the existing order, motivated to do something to change it, and skeptical of the resolve of the United States, could well pursue a policy of coercion and brinkmanship, even under the shadow of nuclear weapons.

[T]he United States needs to inject a healthy degree of risk into Beijing's calculus, even as it searches for ways to cooperate with China. This does not mean abandoning engagement or trying to contain China, let alone fomenting conflict. But it does mean communicating that Beijing has less ability to control escalation than it seems to think. China must understand that attempts to roil the waters could result in precisely the kinds of costs and conflicts it seeks to avoid.

To make this work, the United States should pursue policies that actually elevate the risks - political, economic, or otherwise - to Beijing of acting assertively. ... [T]he US military needs capabilities and plans that not only prepare it for major war, but that also offer plausible, concrete options for responding to Chinese attempts to exploit America's perceived aversion to instability. Leaders throughout Asia will be watching. Too much caution, especially if China is clearly the initiator, may be read as US weakness, thereby perpetuating rather than diminishing China's incentives toward adventurism.

The United States can further raise the stakes by deepening its military ties with Japan ... [2]

Senator John McCain, whose confidant Roy Pflauch handles the Abe administration's careful and extensive informal outreach to the American right wing, also invoked the 1914 analogy during the confirmation hearings for new ambassador to the PRC, Max Baucus, an indication perhaps that Abe's allies in Washington are all determinedly singing from the same hymnal.

Wow, looks like everybody's ready to join Japan and stand up to China except that Chamberlain in VPOTUS clothing, Joe Biden! Well, almost everybody.

President Obama's relations with Prime Minister Abe are considered cool at best.

Abe, it should be pointed out, is an unreconstructed Cheneyite when it comes to admiration and emulation of Dick Cheney's Manichean worldview, especially where it pertains to China. (In passing, it might be noted that Cheney's loyal aide Scooter Libby introduced Abe for his September 2013 speech to the Hudson Institute).

Abe has also been insistent in his quiet outreach to Republican, hawkish, and anti-Obama elements in Washington, most recently in an effort to obtain US acquiescence for his Yasukuni shrine visit, and, as a result, is reportedly no particular friend of the White House, let alone the amiable and often-maligned as "soft on everything" Joe Biden.

Maybe the Obama team did not appreciate the implication that they had to stand beside Japan right now! 1914! (I guess World War II analogies are a bit awkward) - in an anti-PRC alliance, or risk getting tarred with the brush of appeasement, and made its displeasure known.

In any case, Abe quickly backpedaled on the 1914 analogy, lamely blaming the misunderstanding on an interpreter's interpolation and going into full-court spin mode. He didn't mean war was possible if the world didn't stand up to China. He meant war was impossible! Per Japan Times:

The government has repeatedly said that what Abe wanted to convey is that a war between Japan and China is not possible because it would cause devastation not only to the two countries but to the world as a whole.

"We will convey what the prime minister meant through diplomatic channels," Chief Cabinet Secretary Yoshihide Suga told a press conference.

When meeting with journalists at the World Economic Forum in Davos, Switzerland, Abe was asked whether a war between Japan and China is conceivable, and in response he compared the current tensions between the countries to the rivalry between Britain and Germany in the years before World War I.

Abe called it a "similar situation", according to the Financial Times and some other media.

By Friday morning, the government had briefed the BBC about Abe's intention, a Foreign Ministry source said. The British public broadcaster was among the media outlets that were reporting intensely on the prime minister's comments. Tokyo will also brief Reuters soon, the source said.

Many media reports "left the impression that Abe had not denied (the possibility of) a military clash (between Japan and China) and this caused misapprehension," a different government source said. [3]

Then Abe jetted off to the welcoming environs of India, where he served as guest of honor at the Day of the Republic celebrations and concluded a passel of agreements - and there were no dissenting voices when it came to advancing an anti-PRC Japanese-Indian security alliance.

The trip was apparently arranged at the last minute and at the cost of Abe missing the preparations for the opening of the Diet. One is free to speculate that his disappointment at the hands of the Obama administration provoked him to make a statement that Japan was not by any means solely reliant on its US patron to make its way in 21st century Asia.

Abe described the Japan-India relationship as "the greatest potential of any bilateral relationship anywhere in the world". Insert crying bald eagle graphic here, since it's another indication that the Abe administration's rejection of the "victor's justice" of World War II is not just a matter of cheesing off China; it's a rejection of US diplomatic and security tutelage and an announcement that Japan will give priority to pursuing its own interests, instead of sacrificing them as America's loyal ally.

The visit was marked by an Indian pundit writing in the Nikkei Asia Review and explicitly making the case for an Indian-Japanese alliance to contain China and, in fact, touted security ties as the most stable foundation for economic ties.

As in:

Japan and India, natural allies strategically located on opposite flanks of the continent, have a pivotal role to play in ensuring a regional power equilibrium and safeguarding vital sea lanes in the wider Indo-Pacific region - an essential hub for global trade and energy supply. ... The logic for strategic collaboration is no less compelling. If China, India and Japan constitute Asia's scalene triangle - with China representing the longest Side A, India Side B, and Japan Side C - the sum of B and C will always be greater than A. It is thus little surprise that Japan and India are seeking to add strategic bulk to their quickly deepening relationship.

Indeed, the world's most stable economic partnerships, such as the Atlantic community and the Japan-US partnership, have been built on the bedrock of security collaboration. Economic ties lacking that strategic underpinning tend to be less stable and even volatile, as is apparent from China's economic relations with Japan, India, and the US.

The transformative India-Japan entente promises to positively shape Asia's power dynamics. [4]

Upon Abe's return to Tokyo, it was promptly leaked to the Kyodo news service that Vice President Biden had fruitlessly attempted to persuade Abe not to visit the Yasukuni Shrine in December.

This is an interesting state of affairs, since the previous version of the story was that Prime Minister Abe had received mixed messages from a mixed bag of formal and informal Japanese envoys in Washington on the official US government attitude toward his visit.

A one-hour phone call from VP Biden saying "Please don't go"; on the other is a pretty unambiguous message.

And, I might add, that Prime Minister Abe disregarding Biden's call and going to Yasukuni anyway is also a pretty clear message that he does not want to buy whatever Biden is selling.

As AFP put it: "But the news that personal overtures from Joe Biden, who has enjoyed a good working relationship with senior Japanese figures, were rejected will be an embarrassment to the White House."

It is possible that Abe believed that he deserved to be lobbied on this vital issue personally by President Obama and declined to heed American intentions out of pique; however, it's more likely that he wanted to make it clear that the United States is not going to receive automatic fealty from Japan on matters that Abe believes to be against Japan's interests.

Also, he may wish to send the message that a US administration that does not back Japan's China gambits to the hilt is no real ally - and no real leader of the Asian coalition.

It will be interesting to see whether Abe and his allies regard President Obama as a lame duck, and will concertedly criticize his China strategy - by attacking the convenient cut-out Joe Biden - while waiting for more a more militant administration come 2016, either under pivot architect-helmswoman and China-basher Hillary Clinton or a suitably anti-PRC Republican administration.

Key indicators of the Abe administration's attitude might include a spate of op-eds in the US that the Obama administration is too circumspect in confronting the PRC, and more than the usual sniggering at Vice President Biden as an amiable foreign-policy lightweight (the latter theme has been greatly assisted, in the media at least, by the PRC's high-handedness in refusing to provide visas for two New York Times correspondents assigned to China, despite the earnest presentations of Biden to the Beijing leadership.)

A more significant assertion of an independent Japanese regional policy in the waning years of the Obama administration would be unilateral contacts with North Korea, thereby breaking the PRC-ROK-US united front that is the hallmark of the current negotiations. Abe's chief cabinet secretary has already been called on to deny reports that Japanese envoys met with DPRK representatives in Hanoi.

Also, the Indian embassy in Pyongyang - potentially a eager and supportive cut-out for Prime Minister Abe, since direct Japanese diplomacy is hindered by the demand that the abductee issue be resolved first - and the DPRK regime have been suspiciously fulsome in their expressions of mutual regard. According to North Korean media, the Indian ambassador hosted a reception at the embassy for DPRK worthies and stated:

[I]ndia would value and boost the traditional friendly ties with the DPRK, hoping that the country would prosper and make dynamic progress.

He referred to the fact that the two countries, member nations of the Non-Aligned Movement, have common views on many international issues.

He hoped that tensions would be defused and Korea be reunified peacefully through dialogue, adding that India would send every possible support for this.

He said that the Indian people revere President Kim Il Sung and leader Kim Jong Il, eternal leaders of the Korean people.

Noting that Marshal Kim Jong Un, supreme leader of the Korean people, is paying deep attention to the development of the bilateral friendly relations, he expressed the belief that thanks to his wise leadership, the cause of building a thriving nation would be successfully accomplished. [5]

Anyway, expect surprises in the evolution of the Japanese security posture in its "near beyond". And, for the United States, don't assume that all the surprises will be pleasant ones.

Notes:
1. Ian Bremmer Explains What's REALLY Going On Between China And Japan And The One Issue No One Is Talking About, Business Insider, January 24, 2014.
2. Roiling the Waters, Foreign Policy, January 21, 2014.
3. Abe's remarks on WWI parallels to be clarified, Japan Times, January 24, 2014.
4. Japan and India: a transformative entente, Nikkei Asian Review, January 23, 2014.
5. Indian Ambassador Hosts Reception, KCNA, January 23, 2014.

Two Steps Forward Two Steps Back in Abe's Contain-China Initiative

The week started well with Abe in full regional statesman fig delivering a “China must be contained” speech at Davos (Yes, I know, nobody openly uses the "C" word, "containment" but if anyone can come up with a better descriptor, let me know).  Ian Bremmer and a significant contingent of think-tank poobahs seemed primed to love the speech, and they did.

First, Bremmer:

And Prime Minister Abe just came, he gave a great speech. Folks are optimistic about the economy. The one part of the speech that people were really concerned about was Japan-China. And understandably. He’s criticizing the Chinese as being aggressive and militaristic. He compared Japan-China relations explicitly to relations between Germany and the U.K in 1914, where the economic relations were good but the security tensions, let’s say, were not so good. And we saw what happened there.

I wouldn’t say that Abe was directly raising the specter of war, but he was saying that China is acting in a manner that’s unacceptable and Japan won’t tolerate it.

Bremmer also implied that the PRC was taking advantage of a certain lack of American testicular fortitude on the China question:

So clearly the Chinese want to engage with Americans in a serious way. There are a lot of reasons for that. The U.S. economy is picking up. But also they see a window here because all of the hawks on China are gone from the U.S. administration. Hillary’s gone, Kurt Campbell’s gone, Geithner much more focused on this region is gone, and Donilon’s gone. And so they see an opportunity with Biden effectively leading U.S.-China relations right now to build the U.S.-China relationship while really changing the rules on the ground with Japan.

Contemporaneously, two worthies from the Center for a New American Security, the “left of center” security think tank, declared their concern that peace might break out between the US and the PRC thanks to the same lack of testicular fortitude, and advocated for heightened tensions instead, with an assist from Japan and other Asian allies:

U.S. officials have been careful to avoid provoking a China that appears increasingly willing to flex its newfound military muscle. Perhaps that's why Biden invoked his father's advice in warning on the eve of his Beijing visit that "the only conflict that is worse than one that is intended is one that is unintended." But an overemphasis on stability can be dangerous.

The point is simply that a country with the power of the USSR or China, unsatisfied with features of the existing order, motivated to do something to change it, and skeptical of the resolve of the United States, could well pursue a policy of coercion and brinkmanship, even under the shadow of nuclear weapons.

...

[T]he United States needs to inject a healthy degree of risk into Beijing's calculus, even as it searches for ways to cooperate with China. This does not mean abandoning engagement or trying to contain China, let alone fomenting conflict. But it does mean communicating that Beijing has less ability to control escalation than it seems to think. China must understand that attempts to roil the waters could result in precisely the kinds of costs and conflicts it seeks to avoid.

To make this work, the United States should pursue policies that actually elevate the risks -- political, economic, or otherwise -- to Beijing of acting assertively.

…

[T]he U.S. military needs capabilities and plans that not only prepare it for major war, but that also offer plausible, concrete options for responding to Chinese attempts to exploit America's perceived aversion to instability. Leaders throughout Asia will be watching. Too much caution, especially if China is clearly the initiator, may be read as U.S. weakness, thereby perpetuating rather than diminishing China's incentives toward adventurism.

The United States can further raise the stakes by deepening its military ties with Japan…

Wow, looks like everybody’s ready to join Japan and stand up to China except that Chamberlain in VPOTUS clothing, Joe Biden!  Well, almost everybody.

Abe, it should be pointed out, is an unreconstructed Cheneyite when it comes to admiration and emulation of Dick Cheney’s Manichean worldview, especially where it pertains to China.  (In passing, it might be noted that Cheney's loyal aide Scooter Libby introduced Abe for his September 2013 speech to the Hudson Institute).  Abe has also been insistent in his quiet outreach to Republican, hawkish, and anti-Obama elements in Washington, most recently in an effort to obtain US acquiescence for the Yasukuni visit, and, as a result, is reportedly no particular friend of the White House, let alone the amiable and often-maligned as "soft on everything" Joe Biden.

Maybe the Obama team did not appreciate the implication that they had to stand beside Japan right now! 1914! (I guess WWII analogies are a bit awkward) in an anti-PRC alliance or risk getting tarred with the brush of appeasement, and made its displeasure known.

In any case, Abe quickly backpedaled on the 1914 analogy, lamely blaming the misunderstanding on an interpreter’s interpolation and going into full-court spin mode.  He didn't mean war was possible if the world didn't stand up to China.  He meant war was impossible!  Per Japan Times:

The government has repeatedly said that what Abe wanted to convey is that a war between Japan and China is not possible because it would cause devastation not only to the two countries but to the world as a whole.

“We will convey what the prime minister meant through diplomatic channels,” Chief Cabinet Secretary Yoshihide Suga told a press conference.

When meeting with journalists Wednesday at the World Economic Forum in Davos, Switzerland, Abe was asked whether a war between Japan and China is conceivable, and in response he compared the current tensions between the countries to the rivalry between Britain and Germany in the years before World War I.

Abe called it a “similar situation,” according to the Financial Times and some other media.

By Friday morning, the government had briefed the BBC about Abe’s intention, a Foreign Ministry source said. The British public broadcaster was among the media outlets that were reporting intensely on the prime minister’s comments. Tokyo will also brief Reuters soon, the source said.

Many media reports “left the impression that Abe had not denied (the possibility of) a military clash (between Japan and China) and this caused misapprehension,” a different government source said.

Then Abe jetted off to the welcoming environs of India, where he served as guest of honor at the Day of the Republic celebrations and concluded a passel of agreements—and there were no dissenting voices when it came to advancing an anti-PRC Japanese-Indian security alliance. 

Abe described the Japan-India relationship as “the greatest potential of any bilateral relationship anywhere in the world”.  Insert crying bald eagle graphic here, since it's another indication that the Abe administration's rejection of the “victor’s justice” of World War II is not just a matter of cheesing off China; it’s a rejection of US diplomatic and security tutelage and an announcement that Japan will give priority to pursuing its own interests, instead of sacrificing them as America’s loyal ally.

The visit was marked by an Indian pundit writing in the Nikkei Asia Review, who explicitly made the case for an Indian-Japanese alliance to contain China and, in fact, touted security ties as the most stable foundation for economic ties.

As in:

Japan and India, natural allies strategically located on opposite flanks of the continent, have a pivotal role to play in ensuring a regional power equilibrium and safeguarding vital sea lanes in the wider Indo-Pacific region -- an essential hub for global trade and energy supply.

…

   The logic for strategic collaboration is no less compelling. If China, India and Japan constitute Asia's scalene triangle -- with China representing the longest Side A, India Side B, and Japan Side C -- the sum of B and C will always be greater than A. It is thus little surprise that Japan and India are seeking to add strategic bulk to their quickly deepening relationship.

     Indeed, the world's most stable economic partnerships, such as the Atlantic community and the Japan-U.S. partnership, have been built on the bedrock of security collaboration. Economic ties lacking that strategic underpinning tend to be less stable and even volatile, as is apparent from China's economic relations with Japan, India, and the U.S.

     The transformative India-Japan entente promises to positively shape Asia's power dynamics.

I might point out that the original Cheney recipe for Asia--endorsed by Abe in his first term in 2007--was a "diamond" of Japan, the United States, India, and Australia containing the PRC, so it looks like the geometry of Asian security is not exactly evolving in an Anglo direction, pivot notwithstanding.

This got me thinking about a variety of issues, some of which played out over Twitter (you can follow China Matters on Twitter @chinahand):

First, I understand why advocates of the Japan-India alliance want to make the “security” argument despite the fact that the two countries are rather far away from each other and have vastly different security priorities, even with determined efforts to define India as a Pacific power.  A tight security relationship purporting to contain the “Chinese menace” is a good basis for economic pushback against the PRC, especially for Japan, which would not only like to develop the Indian market as an alternative to the Chinese market, which is falling victim to the war of words between Beijing and Tokyo—it would like to go after markets in Vietnam, Myanmar, and Thailand at the PRC’s expense and with Indian help.

Second, containment is a shaky foundation for economic ties.  It’s zero sum, based on grabbing China’s pie instead of growing and sharing the whole regional pie among all the diners.  

Third, a doctrine of PRC containment will inevitably lead to initiatives, or the threat of initiatives, to mess with the PRC’s energy supplies from the Middle East in order to tame the Chinese dragon.  That is not a recipe for regional stability, reduced tensions, and economic growth, unless one is a fan of the militarized energy security policy the U.S. has been practicing in the Middle East for the last two decades.

Fourth, containment will probably bring out the worst in China, Japan, India, and the United States, empowering the defense/security industry and encouraging the pursuit of confrontational/deterrent/coercive military options instead of regional economic cooperation.

Fifth, it should be understood that Abe has placed his eggs in the polarization/contain China/zero-sum basket.  He has a vested interest in goosing the Chinese at Davos and elsewhere in order to justify and advance his strategy.  China is also happy to contribute to tensions in order to bring the United States into the fray as a restraining influence, but the key destabilizing factor is that Japan has decided that a strategy of confrontation with China is the happy high road to national renaissance.

Sixth, my sense (as an outsider to the august councils of the US government) is that the White House and the civilian leadership at the Pentagon are not enthusiasts for the Abe strategy and its implications for US leadership in Asia; but the uniformed services are all in, since the only plausible way to sustain a dominant US military position vis a vis China in East Asia is with the help of a Japan that is willing to pursue a confrontational policy with the PRC, twist the Okinawans' arms on basing, and take the lead in wrangling an anti-China alliance of the smaller Asian democracies.

Seventh, I have a certain admiration for the discipline and energy of Abe’s press management operation (though he might get a free ride from journalists irritated by the PRC’s authoritarian regime and its serial abuse of Western journalists).  When he opines that China must  “foster trusting international relations, not tensions”, nobody points out that Japan’s more assertive Asian profile relies on fostering tensions with China.  When a Kyodo poll shows across the board disapproval of collective self-defense, nuclear power, the new secrets law, and Abenomics, nobody picks it up, and Ian Bremmer instead says “Folks are optimistic about the [Japanese] economy” at Davos (I’ve reproduced the poll’s findings as an appendix to this post).

Eighth, on a side note, my current personal hobby horse is that Japan and India are working together to advance the Japanese agenda in North Korea, in order to take advantage of the tilt away from the PRC after the execution of Jang Song-thaek (and the rather hostile public PRC response, typified by the Chinese media’s willingness to pick up and thereby amplify stories like the notorious “Jang fed to dogs” hoax and the also somewhat dubiously sourced “Jang’s entire family executed” story now playing in the Western media thanks to Yonhap and sina.com). 

 Abe is limited in what he can do directly with the DPRK thanks to his emphasis on the abductee issue and the generally negative mood toward his administration on the peninsula. But I wouldn’t be surprised if he asked India to pitch in.

Admittedly, I don’t have a lot of data points for this (who does, when dealing with the DPRK), but I could not help but be struck by the appearance of not one but two instances of passionate adoration between the North Korean and Indian governments as recorded in the virtual pages of Rodong Sinmun, employing the encomia usually reserved for love-feasts between North Korea and Cuba and Venezuela.

China to Obama: “Nice T-Bill Auction Ya Got There…Hate to See Anything Happen to It”

The Chinese government fired a shot across the bow of the Obama administration this week, with pointed statements by Chinese Premier Wen Jiabao at the World Economic Forum in Davos, and a coordinated backgrounder in the Wall Street Journal.

Without directly naming the United States, Wen accused you-know-who of fouling its own economic nest, endangering the world financial system, and negatively impacting China’s economy.

That’s at cross purposes with the meme the United States is struggling to get out. But Premier Wen’s message has immediate, real-world and potentially near-term consequences that the United States can’t afford to ignore.

Politics, ideology, and human nature being what they are, there is an ongoing effort to minimize U.S. culpability for the dent in China’s pocketbook, and even blame the current economic crisis on systemic abuse by the Chinese, and not a systemic failure of the free market system.

As University of Wisconsin economist Menzie Chinn noted on the blog Econbrowser, outgoing Fed Chairman Bernanke’s swan song, the last Economic Report to the President, blamed our epic economic bellyflop on the (in economic circles) notorious “savings glut” in China, the oil producing states, and other emerging countries.

The shorthand version of the “savings glut” brief is that China and other countries rolled up huge surpluses and threw them into the Western economy. This tsunami of money pushed down the cost of debt even for risky investments and sparked an orgy of injudicious lending that is now experiencing its tragic denouement.

In China’s case, as opposed to Saudi Arabia’s, the accumulation of savings is regarded as somewhat less than virtuous, coming as it did from the immense forex reserves the PRC accumulated by a) undervaluing its currency to achieve large trade surpluses and b) closing off its domestic capital markets to foreigners and buying the resultant forex surplus from its citizens to put in the People’s Bank of China vault instead of letting it roam the world freely and efficiently through the mediating genius of the world’s investment banks.

However, as Dr. Chinn points out, all these surplus savings could be sucked into the vortex of the U.S. debt tornado because the U.S. government was asleep at the regulatory switch when it came to managing the risks inherent in an environment of converging interest rates for all kinds of risk.

I would also add that, in China’s case, purchases of U.S. mortgage-backed debt were miniscule. The risk averse PRC shunned subprime investments; furthermore it struggled to find significant private sector blue-chip harbors for its US$ stash despite the heroic efforts of America’s investment banks (remember CNOOC’s abortive attempt to buy Unocal?).

Instead, the PBOC dumped its foreign exchange holdings largely into U.S. Treasury bonds, courtesy of the Bush administration’s willingness to cut taxes and run rather sizable deficits covered by issuing government debt—debt that was not purchased by American savers, who instead had become borrowers courtesy of a global debt binge and real estate bubble.

In the World Economic Summit at Davos this week, Premier Wen made these points as he implicitly scolded the U.S. for driving the world economy off a cliff:

Mr Wen made scathing comments about the "inappropriate macroeconomic policies" of some unnamed countries and the "unsustainable model of development characterised by prolonged low savings and high consumption".

He attacked financial institutions' "blind pursuit of profit" and their "lack of self-discipline".

Undoubtedly, the China-screwed-us explanation will provide aid and comfort for Republican and free-market hardheads looking for a comforting explanation/excuse for the crisis. But the Chinese aren’t going to buy it, I don’t think many economists will be comfortable accepting it as the full explanation of our woes, and the American public will probably find the Lolcats version of the theory—“Chineez made me spend there munee…Waaah!”—somewhat bewildering.

Behind Wen’s remarks was a more direct sense of anger and betrayal involving the potential loss of billions of dollars of Chinese assets in American institutions—and feelings of suspicion shading on paranoia that should be of concern to President Obama’s foreign policy and economic teams.

Economist—and China forex reserve guru—Brad Setser posted concerning a detailed backgrounder by the Wall Street Journal coinciding with Wen’s remarks at Davos.

To me, at least, the report was clearly prepared with the full assistance of a pissed-off Chinese government, and provides a behind-the-scenes account of Beijing’s exciting trip through the Wall Street meatgrinder, courtesy of Henry Paulson and the Bush administration.

The article describes in detail China’s efforts to diversify its portolio into “safe-as-houses” American instruments beyond Treasuries in recent years, including about $400 billion in Fannie Mae and Freddie Mac paper and multi-billion dollar strategic investments in some big, blue chip money market funds by China’s sovereign wealth fund, the China Investment Corporation or CIC.

The article amply describes the Chinese sense of frustration when many of these investments went south, adding the detail that China’s withdrawal from the Fannie Mae/Freddie Mac auctions in the fall of 2008 was most likely a factor in forcing the U.S. government to step in to prop up these two institutions—something the Obama administration is no doubt chewing over.

I think Mr. Setser is off the mark when he takes the Chinese to task for unreasonable command economy expectations for the risk inherent in any free market economy asset, and for selfishly pulling out of the Fannie Mae/Freddie Mac market and not lending their Treasuries to other (foreign) banks to serve as security for further lending:

China’s leaders believed that China’s investments in the US financial sector would be protected, perhaps because that is how things are done in China. They weren’t. At least not consistently.
…
Fair enough. China owns the Treasuries after all, and has no obligation to lend them out. But, well, its actions in both the Treasury and Agency markets weren’t exactly stabilizing.

What Mr. Setser and the WSJ miss, perhaps, is the Chinese framing of their expectation in making these investments—that they were encouraged by Treasury Secretary Hank Paulson, the fattest of Wall Street fat cats—and were not merely parking their excess dollars in some convenient slush fund. They wish to send the message they were making a strategic investment as a sovereign nation, consciously conforming to U.S. government policy, sluicing cash where President Bush, Secretary Paulson, and their Wall Street buddies wanted it, buying a let-up in China-bashing from a grateful Bush administration, and getting some of that risk insurance that the Republicans extend as a matter of course to their well-heeled buddies.

Therefore, I believe, China is making the case that it is entitled to some special consideration (for itself and its investments) now that things have gone pretty bad.

Instead, the whole process has turned into a chaotic muddle, with the Chinese angrily waiting their turn with all the other schlubs who got suckered into these collapsing investments.

Furthermore, in the Chinese reaction—encapsulated in an angry report circulated among the Chinese leadership essentially accusing naïve members of China’s financial team of happily and foolishly colluding with Mr. Paulson—I hear echoes of another source of Chinese frustration: pushback against the Bush administration concept of “responsible stakeholder” which was invented by Robert Zoellick at the State Department and invoked incessantly in an effort to get the Chinese government to subordinate its narrow national interests to the greater good, at least as it was defined by the West.

Well, now the Chinese are no doubt telling themselves that “responsible stakeholder” was the height of American hypocrisy, and a dangerous snare and delusion for China—something else the Obama administration had better note.

Mr. Setser professes himself bewildered by the statement,

One passage charged that Mr. Zhou "colluded with Henry Paulson to buy U.S. bonds, forced [Chinese yuan] appreciation, attached China's economy to the U.S. and broke China's economic independence."

presumably, because it conflates two mutually exclusive economic priorities: dumping dollars and putting pressure on the yuan to appreciate.

Politically, on the other hand the charge makes perfect sense: that people inside the Chinese economic technocracy injudiciously went along with Paulson’s policy prescriptions for smooth U.S.-China relations--allowing the yuan to appreciate and buying U.S. securities to prop up Wall Street--and the Chinese government got shafted as a result.

It’s a clear indication that the honeymoon is over for the wizards of Wall Street and their wannabe counterparts in China’s financial institutions, as far as the Chinese leadership is concerned.

A final warning for the Obama administration can be gleaned from these concluding paragraphs in the Wall Street Journal article:

Then Washington allowed Lehman Brothers Holdings Inc. to collapse, further shaking Beijing's faith. One casualty was CIC's nearly $5.4 billion investment in the Reserve Primary Fund, the money-market fund that "broke the buck" in September as a result of the Lehman collapse.

CIC had placed money in the Primary Fund because "money market funds are supposed to be very safe," said a Chinese official in an interview late last year. But on Sept. 16, the Primary Fund's managers announced that they were delaying redemptions.

CIC officials emailed Reserve asking to withdraw all of its money from the fund, and promptly received a reply agreeing to the request, says the Chinese official.

CIC officials believed the agreement meant that CIC had become a creditor to the troubled fund, and therefore was entitled to all of its money.

A Reserve spokeswoman says the company doesn't comment on individual clients.

Later in the day on Sept. 16, Reserve announced that the Primary Fund's net asset value had fallen to 97 cents a share, below the standard $1.00 level.

Reserve initially said redemption requests received before 3 p.m. that day would be honored in full, but has since said that the net asset value already was down to 99 cents a share by 11 a.m.

As Reserve further delayed payments, CIC began to fear that it might not get all of its money.

The Reserve issue "is causing a lot of concern with a lot of financial institutions in China," said the Chinese official.

Some officials expected that the U.S. and its financial institutions would better protect China from loss.

"If the U.S. is treating us this way, eventually that will be enough cause for concern in the stability of the [U.S.] system," the official said.

A CIC spokeswoman declined to comment on the current status of the dispute. [emphasis added]

Translation (to me): China wants the Obama administration to get CIC’s money in the Primary Reserve Fund to be treated as debt, not equity, thereby confirming a special, protected quasi-sovereign character for China’s large strategic investments in the U.S. financial sector.

This might simply be a hail-mary plea from the technocrats at CIC, begging their sympathizers in the U.S. financial system to save their bacon.

At the very least, the existence of this demand shows that the free-market/globalization believers in China are on the defensive.

But it also might be a warning from China’s leaders, not just the embattled bureaucrats of CIC.

If the Obama administration allows financial nature to take its course and lets CIC lose its stake, then, well maybe the Chinese government will have to let nature take its course and take its dollar-investing business elsewhere…for instance, away from the U.S. Treasuries market, let alone any shaky private or quasi-private or half-assed nationalized U.S. financial institution that’s looking for a foreign sugar daddy.

In other words: “Nice T-bill auction ya got there…hate to see anything happen to it…and, by the way—make sure that Primary Reserve Fund thing works out for us, willya?”

Beyond the world of government debt and Wall Street, the Main Street issue of the undervalued-RMB, a perennial of the U.S.-China policy debate, threatens to complicate the high-octane dispute over high finance between Washington and Beijing.

During his confirmation hearing, Treasury Secretary Geithner passed on a message that President Obama believes China was manipulating its currency. Still a step away from a formal finding of intentional manipulation for the purpose of gaining an unfair trade advantage, but at the very least an indication that the Obama team will be pounding the trade issue more than the Bush administration did.

And the Chinese will be pounding right back, painting calls for RMB revaluation as backward-looking protectionism by an Obama administration anxious to placate its union base.

As a matter of personal opinion, I do think that the RMB is undervalued.

I think the Chinese government, as a matter of practicality, has maintained a dollar peg for its currency in order to provide a stable economic environment for its exporters (instead of making them to manage their forex risk through the complicated free-market frou-frou of currency futures markets, derivatives, etc.), and that’s a legitimate national economic goal;

I think the peg was set on the high side, to give Chinese exporters a bit of a leg-up;

I think the Chinese government believes that its forex structure—the dollar peg, enabled by sale of forex to the government bank and severe limits on cross-border flows of capital—has worked pretty well, especially in light of the financial disaster sweeping the open markets of the United States and Europe;

And, given the pain that an RMB revaluation would cause China’s exporters, already battered by the global recession, and the disruption caused by speculative hot money sneaking into China to buy RMB by hook or crook in anticipation of a revaluation, I don’t see the Chinese government heeding international political pressure right now to make more than incremental adjustments to the exchange rate and the overall capital account regime.

Having said that, I think that the Chinese government is desperate to revive the world economy and get its export factories humming again, so it will be prepared to do its bit to help matters along—like pissing away its government reserves buying more U.S. Treasury debt and hope that the Obama administration’s stimulus package jumpstarts the world economy.

And I believe that the Obama administration will decide in the end that Chinese cooperation on the stimulus package will be more important than a political struggle over the exchange rate, especially as the recession causes imports from China to sag.

The question is, will China consider a de facto climbdown on RMB valuation enough? Or will they harp on the losses they suffered in U.S. securities that were implicitly government-backed?

And, will U.S. opinion cut the Obama administration any slack on accommodating China?

Despite the theoretical and practical obstacles, however, there will be continued across the board ideological enthusiasm for continuing to bash China.

Right-wing commentators, it seems, don’t like the Chinese rubbing our noses in our recession because they consider the PRC an imperfect and dishonest exploiter of the magnificent capitalistic system the West has bequeathed to the world.

Left-wing commentators, in my view, consider Chinese macroeconomic activity as an extension of the regime’s immoral policies, as the CCP tramples on the environment, Tibetans and Uighurs, Darfurians, and the world’s working poor with equal gusto in its headlong pursuit of profit.

There is a certain amount of hoping and wishing that the Chinese economy would suffer a spectacular collapse as divine punishment for its government’s malfeasance.

These expectations have been complicated and, perhaps, exacerbated by the fact that it was the advanced free market economy of the West that went into the tank first, and not the inferior Oriental model.

As to whether the inadequacies of Chinese forex regime will lead to the systemic crisis of the Communist regime that many seem to anticipate, there are, as I understand them, two major critiques:

The first is that the forex surplus produced by the undervalued RMB must be purchased by the government and will create inescapable inflationary pressure—or unsupportable levels of debt as the government sells bonds to soak up the extra cash.

As far as I can see, inflation—the ultimate bugbear of China’s Communist rules, much more than an economic downturn—has not been an issue up until now. With the Chinese economy growing at a clip of about 10%, apparently there was enough productivity there to soak up the increase in the money supply.

Of course, growth is slowing to a crawl in China—if not going negative—but the trade surplus will also dwindle. Given the worldwide recession and slump in demand, I think the inflation argument is headed, at least for now, to the dustbin of history.

The second argument is that the undervalued RMB has distorted economic decision-making in China. Money pours into a) export projects for obvious reasons and b) into real estate (and the ancillary steel, cement, and construction and building material industries) and stock market bubbles as asset plays because domestic savers lack other suitable domestic and international destinations for their RMB holdings.

Certainly, sectoral imbalance is a big headache for the Chinese economy, and the government’s command economy response (throttling back on lending and materials to overheated sectors, coupled with state investment in industries and locales of dubious economic viability) isn’t pretty. And, as the economy deflates, foreign investment dries up, real estate values collapse, and major industries confront the specter of overcapacity, it will get pretty ugly.

And it could get very, very ugly if the Chinese government perversely decided to let its weak banking sector rise and (inevitably) fall on its free market merits, at the same time the West is engaged in the wholesale subsidizing and/or nationalizing of its financial sector.

However, the state-run banking system in China has so far shown itself resistant to foreclosure and immune to bankruptcy, despite perhaps a trillion dollars in non-performing loans (NPLs).
And that’s unlikely to change in the current environment.

In an eyebrow-raising development, the Chinese government reported that NPLs had declined from RMB 700 billion in 2007 to RMB 500 billion at the end of 2008, an indication either of miraculous luck in the midst of a multi-year lending binge, statistical legerdemain by the Chinese government meant to befuddle foreign analysts, a bureaucratic fiat to cook the books, a genuine sub rose injection of capital to enable the banks to lend through the recession, or All of the Above.

My bet is that the Chinese banking system, thanks to the recession and government intervention, manages to dodge the well-deserved fiscal bullet again.

I think observers who anticipate that the Chinese Communist party is going to spend itself into oblivion as the Soviet Union did (gorging on the fatal apple of shopping malls instead of armaments) will be disappointed.

Systemic financial failure--hyperinflation or the annihilation of people’s savings through the collapse of China’s state run banking system that terminally discredits the CCP regime and destroys the legitimacy of its rule--doesn’t appear likely.

The recession—and millions of impoverished Chinese returning to their villages from shuttered factories along the coast—will certainly exacerbate the simmering resentment against the Party’s serial corruption, oppression, and arrogant incompetence, especially at the local level.

However, the greatest threat to the Chinese Communist government has never been popular unrest provoked by economic suffering.

It has been the threat of fissures within the ruling elite, of the kind that nearly destroyed the CCP during the Cultural Revolution, is typified by the assisted suicide of the CPSU under Gorbachev, and provoked Deng Xiaoping’s ferocious wrath against Zhao Ziyang during the 1989 democracy movement.

Currently, the CCP ruling cadre in Beijing is riding high, coming off a decade of economic growth with a fair amount of money in the bank, reveling in its Olympic triumph, and enjoying the apparent vindication of its managed, nationalist economic model over the open-market nostrums peddled by the West. The United States, instead of representing a triumphant and destabilizing alternative, is mired in political and economic problems of its own.

If and when popular unrest does occur as a result of the recession, the Party will confront it with an effective combination of ingenuity, unity, and brutality—and the sacrifice of as many flagrantly incompetent and corrupt local officials as it takes--unhindered by the example or effective condemnation of the West.

I expect that, instead of threatening the existence of the CCP, the global financial crisis has enhanced the legitimacy and prolonged the life of the current Chinese Communist regime.

That’s not an endorsement or a value judgment, by the way. It’s just how I see it—and how I think the Obama administration might weigh economics in its China equation.