Posted on: Sunday, July 8, 2001

Commentary
We're going to need China if shoe drops

By Thomas Plate

Never make one more enemy than you absolutely have to.

In 1998, with Asian economies in bad shape, the United States and China worked out an understanding to mitigate the regional effects. Washington and Beijing, despite their differences, decided to play ball on an unprecedented economic scale.

For its part, China maintained a steady currency course against pressures from the torrid undertow of Asian devaluations, including the influential and sinking Japanese yen, and resisted pressure from exporters at home who wished to increase their foreign sales by lowering prices and increasing volume.

In return, the United States, led by then-Secretary of the Treasury Robert Rubin, worked to cushion the biggest shocks, using U.S. billions to put a floor under the yen and reducing the competitive pressure on other currencies, especially the Chinese renminbi.

This dramatic backstage cooperation, engineered largely by China's Premier Zhu Rongji, as well as Rubin and his ace deputy, Lawrence Summers, bears recalling anew.

An even bigger problem may occur, again requiring China's intimate economic cooperation. But elements within the Bush administration appear to be advocating an Asian course that would chill relations with Beijing and erode bilateral trust.

Here's the problem: The trigger of the 1997-99 Asian financial crisis was the collapse of the baht of Thailand, a small economy whose gross national product isn't much greater than one-third the market value of General Electric.

Now experts increasingly worry that the next meltdown in Asia could be triggered by the collapse of the yen. And unlike Thailand's, Japan's economy is second only to that of the United States.

"This potential crisis," says Kenneth Courtis, vice president of Goldman Sachs for Asia and a well-known Asian seer, "is the biggest one to surface since the 1930s."

Courtis, who is based in Tokyo, was one of the few economists to have foreseen the implications of the 1997 Asian financial crisis. For the last several years, he has been predicting a regional economic earthquake if Japan fails to tackle its mounting problems. And Tokyo's latest numbers indicate further stagnation and decline.

Everyone hopes that the now-popular Koizumi government will concoct the right prescription for Japan. This would have to involve a complex brew of fiscal stimulation and structural reform. The shortfall in the banking system has now reached the $400 billion level, and new bad debt is accumulating faster than Japan's banks can write off the old.

If the yen erodes further, warns Courtis, this could trigger "the mother of all devaluations," putting severe pressure on other East Asian currencies, including China's, creating a massive U.S. dollar bubble and ushering in possible worldwide recession, or worse.

From the Courtis perspective, Washington's policy shift in Asia from active engagement with China to something more like a hot peace (formerly known as a cold war) seems misconceived and ill-timed.

"The reality," Courtis says, "is that we're going to have to work hand in hand with Beijing to address the huge spillover from the Japan crisis.

"Trust between the two governments will be the most precious and necessary asset. There's nothing to gain from poking China in the eye. This is not a defense-military game anymore. It's much broader."

And how, indeed, the international risk scene has changed. When heading to Beijing for consultations, Clinton Treasury officials Rubin and Summers used to pack printouts of export flow charts and monetary yield curves. But today's back-to-the-future Washington hawks trundle to their basement war rooms with printouts of the best new weapons programs, U.S. troop deployments and missile defenses — largely with China in mind.

Yet the real strategic threat these days is less an exploding missile than an imploding yen.

Savvy Bush officials, such as Treasury Secretary Paul O'Neill, understand that a crisis like Thailand's can come out of left field at any time — and that the next crisis may not be a Thailand, but a Japan.

When the time comes to pick up the world's fiscal pieces, let's hope American policy hasn't inadvertently converted China into an enemy, when in fact it is the one economic ally that might be able to help the most.

Thomas Plate, a columnist for The Honolulu Advertiser and the South China Morning Post, is also a professor at UCLA. You may reach him at tplate@ucla.edu.