Beijing holds whip hand over slowing US

By Jephraim P Gundzik

10/04/06 "Asia Times" - --- 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.

Copyright 2006 Asia Times Online Ltd.