- The Washington Times - Thursday, April 21, 2005

There’s a lot of bad political and economic blood developing between China and Japan, and China and the United States. None of it will lead to any good.

Anti-Japanese demonstrations have broken out in Shanghai and Hong Kong, with Chinese authorities looking on with winks and nods. The Chinese want Japan to apologize for aggression in the 1930s and 1940s, although Japan has done so about 40 times in recent years. The Chinese also claim not to like Japan’s newly revised history textbooks on the subject. Then there’s the ongoing squabble about oil and gas reserves on some offshore islands and the matter of permanent Japanese membership on the U.N. Security Council.

But the problems run much deeper. China doesn’t much like Japanese Prime Minister Junichiro Koizumi pulling his country even closer to the U.S. in the world terror war. This renewed U.S.-Japan alliance also implies protection of a free and democratic Taiwan against Beijing’s new “anti-secession” law.

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Japan firmly supports U.S. efforts to stop North Korea’s military and nuclear buildup. China dominates North Korea, so it could really put the pressure on Kim Jong-il to renegotiate a nuclear agreement. But China only says it will help with the North Korea problem and never seems to do very much.

China shows its two faces all the time. It praised the late Pope John Paul II upon his passing and then promptly jailed a Catholic bishop and a priest. It has been liberalizing its economy and reforming local government but remains a dictatorship with no free national elections. Though it has taken steps to join the community of nations, it now appears to be launching a new program of militant nationalism, with a sizable military buildup. Japan may be the proximate target, but one ultimately suspects all this is aimed at the United States.

The U.S., however, isn’t helping matters by threatening to launch a currency- and trade-protection war against China. The U.S., Japan, and the rest of the Group of Seven leading industrial nations are putting the heat on China to revalue, or “up-value,” the yuan and end its peg to the U.S. dollar.

This is supposedly done to correct global trade imbalances and stop “cheap” Chinese exports from flooding U.S. and European markets. Any meaningful currency adjustment would revalue the yuan at least 25 percent. This would significantly tighten Chinese monetary policy, which in turn would cause a major Chinese economic slowdown. Do we really want that?

The threat of a currency war could be an unnoticed factor in the recent U.S. stock market plunge. A much slower China economy would take a percentage point or two off U.S. economic growth, especially in areas like commodities, cyclical industries, tech, transportation, shipping and trucking. These are the market sectors getting hammered on Wall Street.

Have the U.S. Treasury, the G-7, and the International Monetary Fund forgotten recent, misbegotten currency manipulations? When several Asian currencies were forced to de-link from the dollar in the 1990s, world deflation followed. Floating exchange rates were a big mistake then, and could be a big mistake now.

Treasury Secretary John Snow insists on floating rates worldwide, but he forgets that emerging-country currencies don’t float — they sink. Are we not yet persuaded that nations cannot devalue their way to prosperity, or that currency stability is better than currency chaos?

China, remember, has a shaky banking system plagued with bad state-sponsored loans to failing nationalized firms. A floating yuan might rise short run but crash in the medium term as foreign investors withdraw capital flows for fear of instability.

Fortunately, when Secretary of State Condoleezza Rice recently visited China, she avoided mentioning a forced currency change. But Mr. Snow, encouraged by congressional Republicans, keeps pressing the unpopular point. Where’s the policy coordination inside the U.S. government?

Protectionist pressure on the Chinese is also rising. A trade-opening textile agreement has resulted in a temporary burst of Chinese clothing exports to the United States. American clothing makers had years to prepare but instead are suing the U.S. government on so-called “anti-dumping” grounds. The Chinese government is meanwhile accusing the U.S., rightly, of reneging on the free-trade textile deal.

Why does the U.S. threaten economic warfare against China? Currency protection and trade protection not only blunt economic growth but sour international political relations. If you add in the vexing North Korean nuclear proliferation problem and the historic ill-feelings between China and Japan, you have a real geopolitical and economic mess brewing in northeast Asia. And there is no apparent solution in sight.

Lawrence Kudlow is host of CNBC’s “Kudlow & Company” and is a nationally syndicated columnist.

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