John H. Makin: America's interests lie with Abe's new Japan

March 24, 2014

JOHN H. MAKIN

The economic and geopolitical interests of the U.S. are far better aligned with Japan's goals than with China's. Now Japan is at an important turning point, and Washington needs to take notice.

World War II has been over for nearly 70 years, at least two full generations. A new, forward-looking generation of Japanese leadership has emerged, spearheaded by Prime Minister Shinzo Abe. Abenomics in 2013 brought a fresh set of policies -- the so-called "three arrows" aimed at ending deflation, rationalizing Japan's fiscal stance and deregulating industries and financial institutions.

Deflation has been halted. The attendant 20% weakening of an overvalued yen has been accompanied by world-beating stock performance. Japan's market soared 57% in 2013, surpassing not only all other industrial countries' markets but also China's Shanghai index, which fell 5.4% despite the accession of new leadership promising both reform and steady growth. 

Meanwhile, Northeast Asia -- a "dangerous neighborhood," to recall Herman Kahn's description -- has recently seen a sharp escalation of tension between Japan and China. The friction centers on the Senkaku (Diaoyu) Islands, a group of islets strategically located close to large, underwater oil and natural gas reserves. China does not possess the naval strength to prevail in an open conflict over the islands, yet it is taking a provocative stance in the Pacific against Japan and the U.S. In November, China radically expanded its air defense identification zone to include the Senkakus. On Dec. 5, a Chinese naval vessel reportedly passed within 90 meters of a U.S. Navy cruiser in international waters, forcing it to alter course in order to avoid a collision.

The U.S. wavered on openly opposing China's cheeky ADIZ gambit while Japan outright refused to recognize the new zone. The American response to the near-collision was also somewhat passive, confined largely to a U.S. defense secretary's report on the incident and the potential dangers it entailed.

It has been suggested that China's rising "military adventurism" is due to a perception that the 2008 global financial crisis signaled a collapse of American power. China late that year unleashed massive fiscal stimulus amounting to 14% of gross domestic product, financed by easy money. The aim was to make China a bastion of growth in a world where financial crises had presumably weakened the leading capitalist economy.

That said, China continued to invest trillions of yuan in U.S. Treasury securities. The idea was to store excess savings in a safe place while simultaneously selling yuan for dollars, boosting net exports with an undervalued currency.

But five years later, the U.S. economy, having struggled and stabilized, is sustaining 2% growth while China is confronting the problems of overinvestment, financial instability and labor unrest. A Chinese financial crisis sometime in the next several years, triggered by the bursting of a real estate bubble, cannot be ruled out.

Great distraction

In this context, it is not inconceivable that China's new, more aggressive geopolitical posture is aimed at deflecting attention from its own considerable economic problems. In the past, China has sought to create such distractions by whipping up internal anti-Japanese sentiment. Now, with more at stake and "Japan is back" rhetoric being heard around the globe, China feels the need to turn global opinion against Japan.

It may even be that Chinese President Xi Jinping and his politburo colleagues have been caught off guard by Abe's push to re-establish Japan as a major power in Asia and the world. This was not part of Beijing's long-running plan. Hence the ADIZ expansion, the hovering around the Senkakus and the challenges to American vessels.

But the U.S. reaction has also been something of a surprise. As recently as two years ago, who would have predicted Japan's response to China's new air zone would be more forceful than the White House's "we wish you wouldn't" stance? Abe is providing U.S. President Barack Obama with an object lesson on true leadership.

The time has come for the Obama administration to remind China that the U.S. is treaty-bound to come to Japan's defense in the event of an attack by any sovereign force. Presently, some in Japan doubt the U.S. would promptly honor that obligation against an economic and military power as large as China. Having witnessed Obama's waffling on Syria's use of chemical weapons, China's leadership holds the same view; otherwise, why all the bluster against the U.S. and Japan? 

With its rejuvenated economy, Japan is emerging as an equal partner for the U.S. in the "dangerous neighborhood" of Northeast Asia.

The Chinese have also been emboldened by the way the U.S. responded to Abe's visit to Tokyo's Yasukuni Shrine in December. The shrine, established by Emperor Meiji in 1896, is dedicated to the souls of nearly 2.5 million Japanese who have since died for their country, including 14 Class-A war criminals from World War II. Controversy over Japanese leaders' visits to the shrine has become routine. This time, in muted fashion, the U.S. expressed concern that visiting the shrine could elevate tensions between Japan and its Asian neighbors.

The American statement might have pointed out that the tensions have been exacerbated by China's provocations and somewhat hyperbolic response to Abe's appearance at Yasukuni.

Luster restored

Japan's fiscal consolidation is proceeding slowly, as it should, while aggressive monetary policy is aimed at permanently ending deflation and energizing growth. Critics say Japan's attempt to restructure its economy through deregulation and increased foreign investment is "too little too late," but progress is being made.

Wages are likely to rise this spring. Japanese companies are starting to streamline in ways that are forcing overseas investors to give them another look. American investors, including some high-profile hedge fund managers like Daniel Loeb, are putting money in the country.

Perhaps more importantly, American investors are starting to work cooperatively with Japanese managers. Some are investing in promising young companies, while others are placing larger macro bets. The point is, Japan is back in play for global investors.

For nearly two decades, Japan has struggled to return to persistent, positive nominal growth -- vital for boosting profits and wages. By the third quarter of 2013, Japan's year-on-year nominal growth rate had recovered to 2%, well above the 1% contraction in the first quarter. Allocation of capital and labor within Japan is improving. It surely is fair to suggest that Japan's medium- to long-term growth outlook has improved relative to that of the U.S., where policy uncertainty remains high and regulation in the financial and industrial sectors is tightening. That is to say nothing of the troubled health care sector.

Under Abe's leadership, Japan is clearly moving toward the full nationhood it relinquished during the American Occupation and never regained in the postwar era of passive Liberal Democratic Party rule. During the 1970s and 1980s, Japan's renaissance was economic, not political. Today, the Abe-led LDP is signaling that an economically rejuvenated Japan stands ready and able to defend itself as a truly sovereign nation.

The choice the U.S. has to make in Asia is straightforward: pick a winner. And the new big winner is Japan, which is developing a stronger economy and cultivating a new role as a nation that can be America's equal partner in maintaining regional peace.

A stronger, more clearly articulated U.S.-Japan alliance -- a mature version of what Senator Mike Mansfield once described as "the most important bilateral relationship in the world, bar none" -- need not threaten China. It need only remind China that while it can continue to develop as an economic and geopolitical power, progress at the expense of American and Japanese interests will not be tolerated.

John H. Makin is a resident scholar at The American Enterprise Institute. He directed AEI's U.S.-Japan Defense and Economics Program from 1990 to 2010. In 1988, he was a visiting scholar at the Bank of Japan, and from 2000 to 2005 he served as chairman of the Japan-U.S. Friendship Commission. He writes frequently on Japan and China; he also serves as a senior adviser at Cornwall Capital.