Trade Drives Shifting Alignments Of Northeast Asia

LET US LOOK at President Xi Jinping’s visit to Seoul and Japan’s embryonic rapprochement with Pyongyang in the hard light of commerce. To this Bystander, it is that more than politics that is reshaping the alignments of the region.

China has been South Korea’s leading trade partner for the past decade. It now accounts for a quarter of South Korea’s trade, and a larger share than that of the U.S. and Japan combined. China-South Korea trade will if anything grow, as a result of a forthcoming free trade agreement between the two countries and a new agreement to make more yuan and won directly convertible.

In raw numbers, China-South Korea trade is more than 40 times greater than China’s trade with North Korea, $247 billion vs. $6.6 billion, even though the latter has trebled since 2007 as Beijing has sought to ease Kim Jong Un’s regime back from the brink of Beijing’s nightmare — an economic collapse of the North triggering a flood of refugees across the border into Jilin and Liaoning provinces.

A new generation of leaders in Beijing views Pyongyang differently than its predecessors. More than half a century on from the end of the Korean War, unwavering support of comrades-in-arms just seems outdated and especially now China, South Korea and Japan have become economic powers in their own right. Beijing wants to distance itself from Pyongyang, though not by so much it allows room for Tokyo and increasingly Moscow to step in. It is telling that Xi’s recent visit to Seoul was his fifth meeting with his strongly pro-U.S. South Korean counterpart Park Geun-hye since becoming president though he has yet to visit Pyongyang.

Japan’s latest promise to ease some minor sanctions against North Korea in return for Pyongyang re-investigating abductions of Japanese nationals by North Koreans in the 1970s and 1980s is a sign of how Tokyo is working the new folds in the regional landscape. Continuing concerns about Pyongyang’s nuclear programme in the unpredictable hands of Kim Jong Un will limit how far Tokyo will want to carry its rapprochement, and Washington won’t let it go too far for the same reason.

The North’s nuclear ambitions remain the elephant in the room for China, too. Xi is unlikely to push Kim as hard on this as Park would like. In Seoul, he avoided any sign of support for Park’s criticism of the programme and stuck to Beijing’s line of calling for the denuclearization of the peninsula.

Nor will the U.S. want relations between one of its two main Asian allies and China to become too cosy. On that front, it will take some comfort in the fact that Park rejected Xi’s proposal of a joint celebration of next year’s 70th anniversary of Korea’s liberation from Japan at the end of World War II. Every leader in the region has a middle against which he or she needs to play two ends. In contrast to the dangerous eddies of northeast Asian geopolitics, the course of commerce runs swiftly and truer.

Japanese Companies Rethink Their China FDI

September’s Japanese trade figures underlined the economic impact of the maritime territorial dispute in the East China Sea that Tokyo is embroiled in with Beijing. Exports of Japanese cars to China and imports of Chinese tourists in particular were sharply reduced, compounding the difficulties Japan’s exporters, like their Chinese counterparts, are suffering in the sluggish global markets for their goods.

The trade effects of the dispute may be transitory, but a new Reuters survey points to a more permanent breaking of some of the many ties between the two economies. One in four Japanese companies, the survey finds, are rethinking their investment plans in China, either delaying or scaling back new investment; one in six said they were considering switching investment to other countries. The more than 250 Japanese companies surveyed were from both manufacturing and non-manufacturing industries, from electronics to apparel and retailing.

Japan is the leading source of foreign direct investment in China (excluding that from Hong Kong and Taiwan). The Japanese government reckons that some 20,000 of its country’s firms have invested a combined $1 trillion in China over the past two decades.

Some of what these Japanese companies are now thinking may be a political convenience for economic necessity. China’s cost advantages in low-end manufacturing are eroding. Supply chain and worker efficiency advantages decreasingly offset that. That would suggest that low-margin businesses like apparel and low-end consumer electronics, already being produced mainly for export, will move off- off-shore first, to places like Vietnam, Myanmar and Malaysia. Japanese companies that are counting on domestic Chinese sales, like the carmakers and retailers, have little choice but to ride it out, hoping that the diplomatic tensions will ease, and along with them this latest bout of anti-Japanese consumer sentiment in China.

This Bystander recalls that in 2005, when Sino-Japanese relations were going through one of their periodic low-points, Japanese executives started to consider the need to put some of their regional manufacturing capacity elsewhere than in China. By last year, they were putting three yen of new investment in Southeast  Asia for every two they put in China. Now they have double cause to step up that trend.

China, Japan, South Korea Free Trade Talks Suspended

The maritime sovereignty dispute between China and Japan has derailed discussions about creating a free-trade zone involving the world’s second and third largest economies plus South Korea. Chen Yulu, a People’s Bank of China advisor, broke the news at a meeting of central bankers from the three countries. He said he hoped the suspension of the free trade discussions was temporary. “It will be a big loss for Asia if the process is terminated,” he told the Reuters news agency.  Leaders of the three countries have been discussing creating a free-trade zone for some years, certainly through several cycles of ebbing and flowing relations between Tokyo and Beijing. This Bystander expects the free trade talks to survive this latest nadir.

When The Economic Elephants Of East Asia Fight

If war is to be waged between China and Japan on the economic front, it is China that starts from the stronger position. Japan is far more dependent on China for its growth than China is on Japan. China is Japanese companies’ largest export market. Japan is Chinese companies’ fourth largest. China’s exports to Japan last year, by its own count, were worth $148.3 billion whereas Japan’s exports to China were worth $194.6 billion. That tots up to some $340 billion-worth of trade at risk as a result of the territorial dispute in the East China Sea.

Foreign direct investment by Japanese companies has been growing apace, up 19% to $4.7 billion in the first seven months of this year, compared to the same period of 2011. That is one reason that there are so many Japanese factories, stores and other businesses for protesting Chinese to ransack. With violent anti-Japanese protests taking place in 50 cities, Japanese businesses from Qingdao to Chengdu have been vandalized–with plenty of marquee brand names’ local operations to go after, including those of Honda, Nissan, Toyota, Yamaha, Panasonic, Canon and Ito-Yokado.

They, and hundreds more of those that have not been attacked, or not yet, have shuttered up shop, waiting for this gale of nationalist fury to blow itself out, as previous such storms of anti-Japanese sentiment have done. Sept. 18th is the anniversary of the infamous Mukden Incident in 1931 which triggered the Japanese occupation of Manchuria. It may prove the most volatile day yet for this particular outburst. Beijing won’t want matters to get too far out of hand on the streets beyond that, but domestic Chinese politics in the run up to the leadership transition may constrain the voices of reason.

While the initial economic cost may be limited, the unintended long-term casualty of all this could be growth throughout the region, especially if Tokyo or Beijing take formal action such as imposing sanctions. The two countries economies have become so entwined, and their supply lines reach so far into East and Southeast Asia, that, as the east African proverb has it, when elephants fight, it is the grass that suffers.

Beijing, Tokyo and Seoul Chat Chummily About An FTA

Despite the diplomatic tensions over disputed islands in the East China Sea, trilateral talks between China, Japan and South Korea on setting up a Northeast Asia free-trade agreement (FTA) are continuing. The second round of working talks among officials from the three countries was held this week in Qingdao. The goal remains to start the formal negotiations on the agreement by the end of this year.

As is always the case with free trade agreements there are plenty of potential pitfalls ahead as domestic vested interests rear their heads. One example is Japan’s farmers who have stalled a mooted bilateral deal between Tokyo and Seoul for almost a decade. But Tokyo won’t want to be cut out if Seoul and Beijing  complete their proposed bilateral deal. Nor will Beijing want to do anything to drive Tokyo towards the Washington-led TransPacific Partnership.

The three countries are already closely tied by trade and investment as well as physical proximity. No matter how rough the diplomatic waters between the three get, all have an interest in plainer sailing on trade.

Nationalism Aglow

The embers of anti-Japanese sentiment are always smoldering in China. It doesn’t take much by way of political oxygen to bring them forth in full flame. Thousands of Chinese took to the streets on Sunday across several cities to protest against  Japanese nationalists landing, albeit briefly, on one of the specs of rock in disputed waters of the East China Sea known as the Senkakus in Japan and the Diaoyus in China. Japanese flags were burned in several cities and some Japanese restaurants ransacked. In Guangzhou, the Japanese embassy was picketed. In Shenzhen, demonstrators overturned Japanese cars, including a Honda in the service of Chinese police, no doubt an unintended piece of symbolism.

Both governments have tried to keep a lid on the worst excesses of nationalist expression on both sides since 2010 when Japan arrested in 2010 the captain of a fishing boat after it collided with Japanese Coast Guard ships near the islands, chilling diplomatic and economic relations. Yet at the same time, both governments are keen to assert their sovereignty. It is not a combination that will douse the flickering embers of nationalism for good. Not that politicians in either country really want to, providing it doesn’t get out of hand. The risk is that one day it will.

Signs It Is An Anniversary Of The End Of World War II

Ways to tell it must be the anniversary of the end of World War Two:

• Japan arrests Chinese activists who land on one of the Senkakus, known as the Diaoyus to China, the islands in the East China Sea islands whose ownership is disputed by the two countries;
• Beijing lodges a strong protest with Tokyo;
• Japanese cabinet ministers make their annual controversial visit to the Yasukuni shrine for the war dead in Tokyo;

This year, add something new to the list: South Korea’s president making remarks about Japan’s Emperor, drawing a protest from Tokyo that they were insulting. Lee Myung-bak told a group of teachers that if Emperor Akihito wants to visit South Korea (something that is apparently in no one’s travel plans) he should apologize more sincerely than his 1990 expression of “deepest regrets” over the war.

More than six decades on, the war in East Asia still casts a long shadow over the region. Tapping into anti-Japanese sentiment remains a surefire way to seek public support in South Korea and China. This particular year, with tensions rising over territorial claims in both the East and South China Seas, its shadow risks being darker and heavier than usual.

Yuan-Yen Direct

Direct trading between the Chinese and Japanese currencies starts Friday, cutting out the dollar as an intermediary. Rates will be posted in Tokyo and Shanghai, with China’s monetary authorities allowing a 3% daily trading band for the yuan against the yen (the dollar gets a mere 1% band).

And so Beijing takes yet another step along the long road to the internationalization of the yuan. How long before the won joins in, a likely next step given the plans for a free trade agreement between China, Japan and South Korea?

There is no particular reason for trade not involving the U.S. to be exposed to the potential volatility of the dollar. Direct currency settlement should increase yuan settlement of China’s imports and exports, as it lessens the currency risk for Japanese and South Korean buyers of goods denominated in yuan. The same idea is behind plans for an agreement between China and its fellow Brics, Brazil, Russia, India and South Africa, to make loans in their own currencies to facilitate trade. The five Brics plus Japan and South Korea account for about 30% of world GDP, compared to 45% for the U.S., the U.K. and the Eurozone.

Greater use of the yuan in trade could eventually grow into full convertibility of the currency. Before then, though, there will need to be a loosening of China’s capital controls and more opening of China’s capital markets. Both represent a greater political challenge than expanding trade finance. Opponents of reform have been able to argue that China’s national interest has been well served by cross-border capital controls and the ring-fencing of the country’s financial system. Only beyond that still distant horizon lies reserve currency status.

The Shipping News

Much has happened this week since Beijing and Manila announced mutual temporary fishing bans that lower the tension in their dispute over territorial claims in the South China Sea that came to a head with a stand-off near the Scarborough Shoal (Huangyan Island to China). In summary:

• Vietnam has repeated its rejection of China’s imposition of the above mentioned seasonal fishing ban in the South China Sea.
• Beijing and Tokyo are holding a first round of talks on their maritime dispute in the East China Sea.
• China is putting 4,000 islands to which it lays claim under real-time 3-D ariel surveillance, including 45 islands described as being “along baseline points of China’s territorial waters”.
• Filipino oil company, Philex Petroleum, says it is seeking rigs to drill for natural gas near the Reed Bank off Palawan, waters disputed with China. China’s CNOOC might supply them.
• North Korea has seized three Chinese trawlers in the Yellow Sea, apparently for ransom.

Beijing, Tokyo and Seoul To Start Formal Free Trade Pact Talks

As regular readers will know, we have been following the progress on a potential free trade agreement between China, South Korea and Japan for some time–and the shadow play for economic influence in the Asia-Pacific region being acted out through trade agreements by Beijing and Washington. The leaders of the three Asian neighbors have now agreed to start formal negotiations. We thought it timely to republish our post from last December.

China, Japan and South Korea have been discussing creating a free-trade zone for some years. Every time their leaders meet, in pairs or collectively, the language used to describe progress is increasingly purposeful. Prime Minister Wen Jiabao and his visiting Japanese counterpart, Yoshihiko Noda, now say the discussions have reached the point where formal negotiations could start next year.

The three countries are already closely tied by trade and investment as well as physical proximity. Japan and South Korea are China’s largest trade partners after the U.S. and the E.U. The agreement to settle yuan-yen trade currency conversions directly, also announced during Noda’s visit, will only help boost economic ties.

Similarly Beijing’s approval for the Japan Bank for International Cooperation (the old Ex-Im Bank) to issue yuan-denominated bonds in China–a first for a foreign government agency– and Tokyo’s plan to hold a small amount of Chinese government bonds in its official reserves support the internationalization of the yuan, and thus provide a growing alternative to the dollar as the working currency of any trilateral free-trade zone.

Those existing and coming economic links make it more likely that a free trade agreement can be stuck between the three before agreement is reached on setting up the much larger proposed Trans-Pacific Partnership (TPP) that the U.S. now wants to join and promote but from which China is being excluded. Indeed the TPP may have provided some impetus to China, Japan and South Korea’s discussions. Together the trio account for 16% of world GDP, so a free trade agreement between them would create a formidable bloc just by dint of their economic size alone.