Beijing holds whip hand over slowing
US By Jephraim P Gundzik
Relations between Beijing and Washington have become increasingly strained.
China is strengthening its ties with Iran, Syria, Venezuela and North Korea -
the Bush administration's arch-enemies. As the US economy falls into recession
in 2007 and economic growth slows in China, relations between Beijing and
Washington could completely unravel - which poses much greater economic risk to
the United States than to China.
Enemies and friends
The administration of US President George W Bush has made no
secret of its hostility toward Iran, North Korea, Syria and Venezuela over the
past several years.
Iran and North Korea became charter members of Bush's infamous "axis of evil"
in January 2002 for their supposed pursuit of weapons of mass destruction and
sponsorship of terrorism. That May, the Bush administration formally added
Syria to the axis of evil for supporting Hezbollah and its unhelpful role
against the US in Iraq. At about the same time, the administration was aiding
Venezuela's opposition political groups in their attempt to overthrow President
Hugo Chavez, whose independent regional-trade and oil-price policies clashed
strongly with Washington's own policies.
Since 2002, Washington's hostility toward Iran, North Korea, Syria and
Venezuela has become more intense. Eschewing diplomacy, Washington has
repeatedly tried and failed to marshal international support for sanctions
against Iran at the United Nations - accusing Tehran of building nuclear
weapons. In the past month, the Bush administration has begun to implement
financial sanctions on Iran unilaterally to squeeze Tehran out of the
international banking system.
Washington also implemented financial sanctions against North Korea late last
year, just days after reaching what appeared to be a monumental breakthrough in
the doddering six-party talks on Pyongyang's civilian and military nuclear
programs. These undiplomatic sanctions, which were recently strengthened and
taken up by Japan and Australia as well, provoked the collapse of the six-party
talks and have greatly increased the probability that Pyongyang will conduct a
nuclear test in the near future.
Syria also became subject to US economic sanctions in 2004, with Washington
halting all US exports to Syria and freezing Syrian officials' assets in the
United States. Early this year, the US Treasury forced all commercial banks in
the country to sever their correspondent banking relations with Syria's largest
banks. During the war between Israel and Lebanon, the Bush administration
heavily criticized Damascus for its role in supporting Hezbollah.
The Bush administration imposed export sanctions on Venezuela - first in 2005
and again early this year - preventing Caracas from importing military
equipment and dual-use technology from the US. Washington has regularly accused
the Chavez government of being "a negative influence" in Latin America. Though
the US and Venezuela have considerable - though waning - oil-trade relations,
diplomatic relations between Washington and Caracas are in effect non-existent.
The Bush administration's efforts to isolate Iran, North Korea, Syria and
Venezuela economically are implicitly designed to promote "regime change" from
unfriendly to friendly government in each of these countries. Beijing has
explicitly worked against Washington's isolation and regime-change endeavors by
deepening its relations with Tehran, Pyongyang, Damascus and Caracas.
Beijing has greatly strengthened its relations with Tehran. China has signed
several long-term energy exploration, production and delivery contracts with
Iran worth more than US$100 billion since 2004. This year, China invested in
Iran's domestic oil-refining industry, agreeing to expand the country's
gasoline output significantly - investment that will greatly undermine economic
sanctions on Tehran that target Iran's fuel imports.
In the past several years, military-equipment deals between China and Iran have
increasingly focused on missiles and missile technology. Early this year,
Tehran successfully test-fired two new, sophisticated cruise missiles that were
developed with Beijing's assistance. In August, Tehran test-fired numerous
high-tech short- and long-range missiles. Iran's missile tests this year were
part of larger war games designed to test the country's ability to blockade the
Strait of Hormuz.
China's increasingly close relations with Iran have thwarted Washington's
efforts to isolate and weaken the country. Nowhere is this more apparent than
the protracted debate at the UN over Iran's nuclear-energy program, where
Washington has led the charge for sanctions against Tehran. The Bush
administration's weak attempt at diplomacy, which proposed several shallow
incentives to Tehran in return for abandoning its nuclear-energy program, did
nothing to change Beijing's mind about Iran.
On the contrary, China last month forcefully rebuffed Washington's efforts to
coordinate UN-backed sanctions against Iran. Unlike the US, France and Britain,
China, along with Russia, supports Iran's right to nuclear enrichment and
nuclear power. China's outright opposition to sanctions against Iran and its
actions to undermine Washington's efforts to isolate Tehran have bolstered the
Islamic Republic commercially, militarily and diplomatically.
Beijing and Pyongyang have long been close allies. However, many analysts
mistakenly believe that China will abandon its relationship with North Korea to
appease Washington, which wants to dismantle Pyongyang's civilian and military
nuclear programs. After Pyongyang's missile tests in July, Washington, along
with Japan, ratcheted up pressure on North Korea, calling for UN-backed
sanctions. Beijing has repeatedly stated that it does not support sanctions
against North Korea. When North Korea conducts a nuclear test, probably by the
end of this year, China will continue to support Pyongyang, greatly inhibiting
Washington's ability to strike back.
China has had diplomatic relations with Syria for more than 50 years. Damascus
has long supported Beijing's policy vis-a-vis Taiwan and has stood by China
when it regularly comes under fire by Washington over human rights. In return,
China has supported Syria's territorial claims against Israel and the notion of
"land for peace" in the Middle East. In contrast, the US supports Israeli
occupation of Arab land in general and has spurned the notion that Israel
should relinquish land taken in various wars against Arab countries - making
peace in the Middle East impossible.
In addition to close diplomatic ties, China and Syria also have strong
commercial ties. China has invested substantially in the development of Syria's
transportation infrastructure, as well as in energy exploration and production.
China is also a key supplier of military equipment to Syria. Syria has deployed
several sophisticated Chinese missile systems, including the M-9 and M-11
medium-range type. Chinese technicians are believed to have assisted Syria in
upgrading its arsenal of Scud missiles as well. China's close ties to Syria
have made it impossible for Washington to isolate Damascus and weaken the
government of President Bashar al-Assad.
Hugo Chavez has visited China four times since becoming Venezuela's president
in 1999. These visits, as well as several return visits to Venezuela by China's
leaders, have greatly deepened commercial and diplomatic ties between the two
countries. China has become a major investor in Venezuela's energy sector and
is also investing in the South American country's transportation
infrastructure, including railroads, ports and crude-oil tankers. Beijing and
Caracas have also recently signed agreements paving the way for Chinese
investment in Venezuela's telecom, mining and agricultural sectors.
In return for investment in its energy sector, Venezuela is directing more and
more of its oil exports to China. In 2004, Venezuela exported just 12,000
barrels of oil a day to China. At the end of this year, these exports will
amount to about 200,000bpd. Venezuela plans on shipping 500,000bpd to China by
2009.
In August, Beijing announced that it would support Venezuela's bid for a seat
on the UN Security Council - a bid that is strongly opposed by Washington. By
investing in its energy sector and supporting its UN aspirations, China is
undermining US energy security and Washington's international influence,
especially its influence in Latin America, which has turned increasingly
anti-US over the past several years.
Foundering trade relations
Growing economic interdependence between China and the United States has been
mutually beneficial for both countries. Nonetheless, trade tensions between the
two countries have grown.
Early this year, the Office of the US Trade Representative (USTR) released a
report called "US-China Trade Relations: Entering a New Phase of Greater
Accountability and Enforcement". As suggested by the title, the report
lambasted Beijing for failing to honor its World Trade Organization (WTO)
commitments, particularly in regard to safeguarding intellectual-property
rights, ongoing protection of domestic industries, and failure to open its
domestic markets fully to foreign competition.
The report called for the creation of a China Enforcement Task Force within the
USTR. Why Washington would need to police China's WTO performance is difficult
to understand given that the global trade body has its own enforcement
mechanisms. But rather than a multilateral issue, trade disputes between China
and the US are bilateral in nature. Few other countries in the world would side
with Washington against Beijing over China's slow implementation of its WTO
commitments or the even hotter issue, for the US, of the yuan's value.
Washington would find it very difficult to build a case against Beijing for
failing to fulfill its commitments to protect intellectual property and
liberalize domestic trade within the WTO. In addition, there are no WTO
regulations that dictate exchange-rate values. Beijing has its own laundry list
of trade-related problems with the United States. These include implicit
restrictions on Chinese investment in the US, and tight control over dual-use
high-tech exports to China.
While US companies have been allowed to invest billions of dollars in China,
Chinese companies are in effect barred from investing in anything other than US
Treasury and corporate bonds. Chinese companies have been forced to abandon
investments in US companies because of intense political pressure from
Washington.
In July, the US Department of Commerce approved new export rules for China that
will control many items that have previously been unregulated. Officials in
Beijing have called these new controls "unreasonable obstacles" to trade. Trade
tensions between Beijing and Washington, coupled with foreign-policy tensions,
could explode next year if, as appears increasingly likely, the US economy
falls into recession and economic growth slows in China.
Escalating conflict
Economic recession in the United States will lead to much weaker export growth
in China and slower economic growth. This economic weakness could escalate
protectionist and nationalist sentiments in both the US and China, provoking
significant confrontations between the two countries.
An economic recession in the US, led by falling personal consumption
expenditure, would sharply reduce America's imports from China, helping to
rebalance bilateral trade. However, Washington can be expected to turn to
export growth as a way of revitalizing domestic demand in the US. Boosting
exports to Canada and Mexico, the largest and second-largest US export markets,
respectively, will be difficult as these countries are very likely to follow
the US into economic recession. The same is not true for China, which has
enormous foreign and domestic resources it can use to stimulate domestic
demand.
In addition to the world's largest foreign-exchange reserves, which will be
well over US$1 trillion before the end of this year, China can use its broad
control over the financial system and its considerable fiscal resources to
ensure that domestic demand remains strong. This will keep economic growth in
China relatively buoyant. As a result, the Bush administration and the US
Congress are likely to work harder to increase market access to China, which is
America's third-largest export market. Washington is also likely to intensify
pressure on Beijing to revalue the yuan against the dollar as another way of
increasing US exports to China.
Between 70% and 80% ($700 billion to $800 billion) of China's foreign-exchange
reserves consist of US-dollar-denominated assets such as US Treasury
securities. With such large dollar assets, it is ridiculous to believe that
Beijing will undertake any large revaluation of the yuan against the dollar. A
25% revaluation of the yuan against the greenback would reduce the value of
China's foreign assets by $175-$200 billion.
Washington appears oblivious to the asymmetrical increase in economic risk to
the US from deteriorating relations with Beijing. Rather than succumbing to
intensifying export and exchange-rate pressure from Washington, Beijing could
retaliate by liquidating its massive holdings of US Treasury securities,
pushing US interest rates higher and the value of the dollar much lower against
other major currencies.
Though the impact of such retaliation will prolong any US economic downturn,
China's enormous resources will help to insulate its economy from a protracted
period of weak growth in personal consumption expenditure in the United States.
With a foreign-policy battle already raging between Washington and Beijing, it
is only a matter of time until a battle over economic policies also erupts.
Jephraim P Gundzik is president of Condor Advisers. Condor Advisers
provides investment risk analysis to individuals and institutions worldwide.
For more information, please visit www.condoradvisers.com.
