Monday, February 21, 2005

The recent �good news� for the US current account � if you can call financing CA deficits well over 6% of GDP � is political rather than narrowly economic: the East Asians [1] can�t get along and [2] show no prospects of getting along much in the future.

China issued a stiff protest Sunday over an updated U.S.-Japanese strategic agreement, saying its reference to Taiwan violates China's national sovereignty and its criticism of China's military buildup is "untenable."

The complaint, issued by the Foreign Ministry, reflected deep concern in the Beijing government over Japan's evolving decision to lean toward closer security cooperation with the United States in East Asia, including Taiwan. Although Japan has not spelled out what military assistance it might provide, to Chinese ears the accord sounded like a promise to help the United States defend Taiwan in the event of war. . . .

The revised U.S.-Japanese strategic understanding, issued Saturday after a meeting of Secretary of State Condoleezza Rice and Defense Secretary Donald Rumsfeld with their Japanese counterparts, for the first time included security in the area around Taiwan as a "common strategic objective" shared by Japan and the United States. This was described by U.S. officials as a new element in a close military association that dates from World War II.

In addition, the U.S.-Japanese statement called attention to China's rapid military modernization program, calling it a matter of concern, and urged Beijing to be more transparent in its military planning and weapons procurement. "While we should maintain good relations with China, we must also pay attention to its military moves," Japanese Defense Agency Director Yoshimori Ono was quoted as saying by the Kyoto News Service. . . .

North Korea also bristled at the U.S.-Japanese understanding, which expressed deep concern over North Korea's refusal to continue negotiations on its declared nuclear weapons arsenal. The Pyongyang government, through its KCNA news service, said Japan's defense policy changes amount to a plot to "reinvade" -- a reference to Japan's World War II occupation of Korea -- and showed Japan was joining Washington's "vicious, hostile policy" toward North Korea.
It looks like the US is stirring the pot this weekend in all the right ways, bringing Japan, Taiwan and Korea (ROK) closer to it and pushing them further away from China and North Korea. While China�s positive relationship with the US is primarily economic, the other three East Asian Big Eaters of dollar denominated assets � Japan, Taiwan and Korea in that order � all depend on the US for more than just markets. They are all heavily dependent on the US for military security and all desperately afraid of China.

Japan continues to build its foreign reserves. As recently as February 2002 the Bank of Japan held �only� �36.5 trillion in foreign currency assets, but beginning in March the BOJ entered into a new asset building regime. On a twelve-month cycle beginning in March and ending in February of the next year, the BOJ builds and builds reserves, drawing down in March and then building consistently again until February of the third year, and so on and so on. From March 2002 to February 2003, the BOJ built its reserves from �41.8 trillion to �43.0 trillion; from March 2003 to February 2004, �42.1 trillion to �43.5 trillion; and most recently from March 2004 to January 2005 (latest data available), �41.7 trillion to �44.4 trillion. Thus January 2005 stands 2.5% larger than January 2004 and 3.9% larger than January 2003.

That�s nothing, of course, in comparison to total Japanese purchases including the BOJ and �private� investors. Altogether Japan is amassing US treasuries at a 29% clip from December 2003 to December 2004 and 46% from December 2002 to December 2003. I put private in quotes because the Japanese government has a long and successful track record of pressing Japanese banks and insurance companies into buying US assets, even in the face of marked exchange rate risk.

Taiwan�s Central Bank of China continues at a healthy build-up rate as well. At the end of January 2005 the CBC had $242.7bn in reserves, 12.9% higher than January 2004 and 47% higher than January 2003. Finally, the Bank of Korea, which at the end of January 2005 had $199.7bn in official reserves, 27% larger than January 2004 and a stunning 62% larger than January 2003.

Brad Setser rightly notes that the Koreans don�t like being forced into amassing ever larger numbers of dollar reserves in order to keep the won down. In fact, they�re working the hardest of the three, but surely the Japanese and the Taiwanese feel the same way. Unfortunately for them all, as long as China is unwilling to dramatically alter the peg and the US is unwilling to restrain its demand for more capital inflows, what can these three do? They�re caught between the Chinese Scylla and the American Charybdis.


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