Nafta: Why the US car industry is trapped in Trump’s trade crossfire

The Toyota Tundra looks every inch the all-American truck, but even it risks falling foul of rules touted by the Trump administration

Shawn Donnan in San Antonio, Texas



Blunt-nosed, broad-shouldered and towering on 20-inch chrome wheels, the latest Toyota Tundra roars to life as it turns into the final station of tweaks and checks that will wrap up a 20-hour journey down the production line. Polished to a sparkle by the robots in the paint shop, the pick-up truck has a swagger worthy of its birthplace, a 2.2m square foot state-of-the art factory emerging from the scrub of a former cattle ranch just a 25-minute drive from the Alamo, spiritual birthplace of Texas.

“When we decided we wanted to build a pick-up truck we thought where better than Texas,” says Mario Lozoya, a former Marine sergeant and line supervisor who handles external relations for Toyota in the Lone Star State.

But the Tundra is also an example of how international supply chains and business investments come up against global trade rules and how President Donald Trump’s vision of the American economy is already helping to reshape the global economy even as the world nervously eyes the prospect of a US-China trade war.  
Like every other car produced on the continent the Tundra sits in the crossfire of Mr Trump’s plans to renegotiate the North American Free Trade Agreement. The US hopes there will be a deal in the weeks to come, but the prickliest issue by far in Washington’s discussions with Canada and Mexico is over how and where vehicles should be made.
The Trump camp argue that Nafta’s current rules, which require 62.5 per cent of a vehicle to be made in North America in order to qualify for the tariff-free trade the pact enshrines, have fuelled the relocation of much of the US auto industry to Mexico, costing thousands of American manufacturing jobs. They have proposed lifting that threshold to as much as 85 per cent and requiring a 50 per cent US-production quota for vehicles sold in the US, by far the region’s largest auto market.





Almost 130,000 Toyota Tacoma's are built at the Texas plant but more are produced across the border in Mexico © Company


Such a move, the US auto industry argues, would hurt its global competitiveness by removing its ability to access cheap labour in Mexico much as the German car industry does in eastern Europe or Japan does in China. It has also added an unwelcome distraction.

“[Preparing for a new Nafta] takes [executive] time away from other stuff,” says Bruce Belzowski, managing director of the University of Michigan’s Automotive Futures group. “They could be doing R&D on electric vehicles if they didn’t have to worry about what to do with their supply chains.”

The Tundra looks like an all-American beast of a truck. And yet its story is heavily global: its bodywork is stamped out of US steel at the Texas plant, its 5.7-litre V8 engine is built at a Toyota factory in Alabama, but it all sits on a frame shipped in from Mexico.

According to the National Highway Transportation Safety Administration 65 per cent of the Tundra’s components — exceeding Nafta content rules — originated in the US or Canada. Yet even it risks falling short of the 85 per cent threshold that Mr Trump’s top trade negotiator, Robert Lighthizer, has been seeking, raising questions about how Toyota might have to reconfigure its supply chains to meet the higher quota.

Canada and Mexico, both of which have their own politically influential motor industries, have resisted the US demands. The result has been a search for compromises ranging from how to include research and development costs (most of which are in the US) to how to account for the higher salaries paid to US autoworkers compared to their Mexican counterparts.




Production values


A Toyota Tacoma pick-up truck moved through final inspection at the company's plant in San Antonio, Texas © Bloomberg


8.5% Of the $17.5tn global annual trade in goods is made up by vehicles and auto parts


62.5% Of a vehicle has to be made in North America to qualify for tariff-free status in the Nafta region . . .
85% . . . but a proposal from the Trump administration would see that figure rise to as much as 85%  



The discussion has led major producers to freeze investment decisions and Mr Trump to hail moves by companies like Ford to shift production to the US. “We can negotiate forever,” he said last week. “Because as long as we have this negotiation going, nobody is going to build billion-dollar plants in Mexico.”

The Trump administration has already altered the path of globalisation in a way likely to be felt for decades, by abandoning the move towards bigger regional blocs.

Vehicles and auto parts account for 8.5 per cent of the $17.5tn worldwide annual trade in goods and since the 1990s the industry has become dependent on global just-in-time supply chains.

That scale helps explain why Mr Trump, when he vents his trade frustrations, often focuses on the gap between the 2.5 per cent levy charged by the US on imported passenger cars and higher tariffs in the EU or China as he did last week when he pointed to the corresponding 25 per cent Chinese tariff in a tweet.



Xi Jinping, China’s president, a day later used a high-profile speech to reiterate an offer to lower China’s auto tariffs. He hinted that Beijing could revisit investment restrictions that force foreign carmakers into joint ventures with Chinese counterparts to enter what is now the world’s largest auto market.

The international trade in cars has long been governed not just by tariffs but by a jumble of pacts like Nafta. Rules of origin, as well as safety and other regulations, present further barriers to trade.

Before Mr Trump entered the White House the world was on a path toward a significant reduction of those regulatory barriers and the introduction of far-broader regional trade rules that would have boosted the global market in cars.

The Trans-Pacific Partnership with Japan and 10 other economies, including Canada and Mexico, was negotiated by his predecessor Barack Obama. It would have established new content rules across not just Nafta but almost 40 per cent of the global economy. It would also have liberalised the trade in cars between two of the world’s three largest economies, eventually putting big Japanese carmakers like Toyota and Honda and US counterparts like GM and Ford under the same set of trade rules wherever they operated in the bloc.

Mr Trump made pulling out of the TPP one of his first acts in office, though he last week raised the possibility of rejoining. His administration has also frozen talks over a pact with the EU that would have had a similar impact.

Among the biggest areas of focus in the so-called Trans-Atlantic Trade and Investment Partnership, which would have covered almost half the global economy, was finding a way to lower regulatory barriers for cars. These ranged from the colour of headlights to regulating emissions that most in the industry argue are a far greater barrier to transatlantic trade than tariffs.



President Donald Trump shows the executive order that withdraws the US from the Trans-Pacific Partnership © Getty Images

US and European officials considered the pact a way to solidify transatlantic standards and counter a rising China with ambitions to dominate emerging areas like electric vehicles as part of Mr Xi’s “Made in China 2025” plan. By building a stronger transatlantic market, the argument went, both European and US carmakers would be in a better place to repel the competition from emerging Chinese rivals.

By abandoning the TPP and suspending the discussions with the EU Mr Trump has ceded the US’s ability to lead efforts to set the global rules for things like the auto industry, critics argue.

Yet his desire and effort to put the brakes on globalisation has not stopped the push for greater economic integration. It has just scrambled the roles of the actors, argues Philip Levy, who advised former president George W Bush on trade policy.

“All the fundamental forces that were there before are still there,” says Mr Levy who adds that the EU and others have started taking the lead, building the de facto networks of economies that come out of trade agreements.

The US is still finding ways to make its influence felt. EU talks with Mexico to update their existing trade agreement have stalled, largely due to uncertainty surrounding Nafta. But the EU and Japan last year concluded negotiations on a trade deal that will cover a third of the global economy and reinforce the lead in the Japanese market that European carmakers have over US rivals.

“That momentum is going to continue,” Mr Levy says. “The problem for the US is that if we continue taking President Trump’s approach we’ll just be sitting on the sidelines.”





The fact Toyota is producing the Tundra in Texas is the result of a longstanding US trade barrier that Mr Trump has embraced as part of his greater adventures in protectionism. “I’m here to protect,” the president told a news conference in March as he defended new tariffs on steel and aluminium imports. “I’m protecting our workers. I’m protecting our companies.”

As Mr Trump keeps pointing out, the US tariff on passenger car imports is low at 2.5 per cent but the tariff on light trucks has remained as high at 25 per cent since the 1960s. That has helped protect domestic producers from competition in a lucrative part of the US auto market where one in six of the more than 17m new vehicles sold last year were pick-up trucks like the Tundra.

It has also forced foreign manufacturers like Japan’s Toyota to produce pick-up trucks in the US. When the US and South Korea announced that they had reached an agreement in principle last month to rewrite their 2007 trade deal the main concession that the Trump administration extracted was a 20-year extension on the 25 per cent tariff on light trucks, thereby protecting US-based carmakers from a possible assault from Korean rivals like Hyundai.

The benefit of forcing overseas carmakers to build factories in the US, the Trump administration argues, is the securing of American jobs like the 7,000 at Toyota’s Texas plant.



Donald Trump's trade representative, Robert Lighthizer © EPA


The first version of the Toyota Tundra came off a production line in Indiana in 1998 and manufacturing was moved to Texas in 2003. Last year, the Texas plant, where robots do 90 per cent of the welding and autonomous vehicles ferry parts to the assembly line, produced more than 136,000 Tundras and more than 129,000 of the smaller Tacomas, with the trucks coming off its assembly line at the rate of one a minute.

Many of the suppliers that work out of Toyota’s Texas plant are the product of international partnerships with local entrepreneurs. One of the biggest, Avanzar, which provides most of the interiors for both the Tundra and the Tacoma, is a joint venture between Michigan-based Adient, the world’s largest car seat-maker, and Shanghai-based Yangfeng Automotive and a San Antonio-based company. In addition, many of the Texas suppliers work with another Toyota plant in Mexico, adding to their reliance on Nafta.

For Frank DuBois, a business professor at American University in Washington DC, who publishes an annual Made in America auto index, globalisation has turned determining the origin of parts in cars into “an accounting nightmare”.

The complexity of 21st century auto supply chains, with up to 15,000 individual parts going into a single car, highlights another reality. With his quest to rewrite the rules for the auto industry Mr Trump appears to be tilting at windmills, Mr DuBois says, particularly in an era where factories are increasingly automated and even nationalist voters are willing to embrace foreign brands.

“I see a hell of a lot of Trump stickers on Toyota pick-up trucks,” Mr DuBois says. “Trump is living in this antiquated view of auto manufacturing where it is a lot of Joe Lunch Boxes going to work every morning and operating a piece of machinery . . . Those days are gone.”



Nafta talks open the way to a Trump trade win

Donald Trump’s bid to launch a trade war against China may be dominating headlines but in his quieter efforts to renegotiate the North American Free Trade Agreement may lie his first major trade success.

After threatening repeatedly to pull the US out of the 24-year-old agreement the indications are that Mr Trump is nearing at least a preliminary deal with Canada and Mexico.

A similar “agreement in principle” with South Korea announced in March saw another trade pact that the president had threatened to rip up survive with what in the end amounted to relatively minor tweaks.

But Nafta is a bigger beast. The US’s $1.1tn in trade with Canada and Mexico last year was almost twice its trade with China and 10 times that with South Korea.

The Nafta renegotiation had an acrimonious start last August and plenty of barbs have been traded since. In recent weeks, however, the talks have accelerated becoming more focused on securing at least the broad outlines of a deal — including the stricter auto content rules, a rewriting of Nafta’s dispute provisions and a review of the pact every five years — before Mexican elections in July.

Mr Trump continues to argue that he would rather pull out of Nafta and negotiate something from scratch but he has bowed to pressure from his own Republican party and business not to do something so disruptive.

“We’re going to make it great. And we’re getting pretty close to a deal,” the president said last week in a meeting with farm state politicians. “It could be three or four weeks. It could be two months. It could be five months. I don’t care.

“In fact, if everybody in this room closed their ears, I’d say I’d rather terminate Nafta and make a brand new deal, but I’m not going to do that because I want everyone to be happy in this room, OK?”


The End of the Debt-As-Currency Era

by Jeff Thomas




Gold is the currency of kings, silver is the money of gentlemen, barter is the money of peasants, but debt is the money of slaves.

—Norm Franz, Money and Wealth in the New Millennium


We are nearing the end of the debt-as-currency era.

This is quite a broad statement and, of course, since debt is the foremost currency of our day, it would be quite understandable if the reader were to regard such a prognostication to be utter nonsense.

Indeed, many would say that, without debt, the world couldn’t function. Debt has always existed and always will. However, in eras past, debt often played a much smaller role, and those eras were marked by greater progress and productivity.

We’re now living in the era of the greatest level of debt mankind has ever created. In fact, we’ve come to regard it as “normal.” Most governments are far beyond broke. And they won’t be saved by confiscation or taxation, as their people and corporations are just as heavily in debt. For this reason, a collapse is inevitable. And, since the severity of a collapse is invariably directly proportional to the severity of the debt, when it arrives, it will be a collapse that eclipses all previous collapses.

The present uncontrolled level of debt is made possible through the ability of central governments to create more currency at will. And this is only possible through the existence of a currency that is fiat in nature—that has no inherent value.

Aristotle was right on the mark when he stated that for something to be appropriate as money, it must have intrinsic value—independent of any other object and contained in the money itself.

The great majority of what passes for money today is digital, although, for daily use, paper currency is still widely used. But it must be said that paper currency is also fiat, having a far lower intrinsic value than the denomination printed on it.

In 1971, the US dollar went off the gold standard—it ceased to be redeemable in precious metal.

From that date on, it existed as a promise only—a promise from a government. (Promises from governments tend to be somewhat less redeemable than promises from, say, loan sharks or used-car salesmen.)

In time, the rest of the world followed. Today, no national currency is redeemable in anything that has intrinsic value.

Doug Casey has rightly called the dollar (since going off the gold standard) an “I owe you nothing.” Exactly correct. He also describes the euro as a “Who owes you nothing?” since no one country in the EU is responsible to redeem the euro with anything that possesses intrinsic value.

It’s hoped by many today that cryptocurrencies will be the salvation of the soon-to-collapse monetary system. Unfortunately, cryptos can accurately be described as “You have no idea who owes you nothing.”

Cryptos have distinct advantages over other fiat currencies—they allow quick transactions between parties anywhere in the world, independent of any reliance on banks or governments.

Unfortunately, though, they in fact have even less inherent value than paper currency. Their inherent value is exactly zero.

This does not mean that they won’t become more popular, as people seek to extricate themselves from the control of banks and governments. However, cryptos only have a perceived value. Throughout history, whenever the perceived value of a form of fiat currency has collapsed, the currency has returned instantly to its intrinsic value.

An excellent example is the tulip mania of 1637, when the perceived value of some tulip bulbs became inflated to the degree that some were sold for ten times the annual income of a skilled craftsman.

Whilst we, today, might find this laughable, at the time all that mattered was the general consensus that tulip bulbs would keep increasing in price. As a result, everyone jumped on the bandwagon… and inevitably, rode it over the cliff.

In every such case historically, whether it be tulip bulbs, the 1923 Reichsmark, the 2008 Zimbabwe dollar, or the more recent Venezuelan Bolívar, once the collapse comes, no one will subsequently touch the failed fiat currency with a bargepole.

What this boils down to is that we’re living in an era in which there are more forms of fiat currency in use than at any other time in history… and more are being formed as we speak. So many cryptos are being created at present that we may soon begin to speak of “junk cryptos” as we once spoke of “junk bonds” to hopefully elevate the more reliable cryptos from their cousins. We may even come to speak of “investment grade cryptos.”

Returning to the subject of debt, the wise investor, when considering entering a debt relationship, should always ask himself, “Who issued the debt? What is it really worth? What is the likelihood that I’ll get paid?”

If the answer to these three questions is, “I have no idea,” it doesn’t mean that he shouldn’t become involved, but he should recognize that he has passed from speculator into gambler. Some gambles are worth the risk involved, but it’s a gamble, nonetheless.

Paper currencies have proven to be very risky indeed, particularly as central banks have printed so recklessly in recent times. And, should deflation occur (as seems likely) they’ve committed to printing as much as it takes to offset the deflation… endlessly devaluing the currency and very possibly leading to hyperinflation (again, as in Weimar Germany in 1923, Zimbabwe in 2008, and Venezuela in the present day).

Similarly, bitcoin, regardless of the fact that it’s always pictured as a gold coin, is actually an algorithm. It’s been promised to be “finite”—to be capped at 21 million. However, this is once again, a “promise”—and a promise from an anonymous creator.

Tangible Versus Promissory Collateral

At present, we’re in the deepest trough of debt-as-currency that the world has ever seen. However, the writing is now on the wall that the end of this era is about to begin, and it may begin in the field of energy. Russia, one of the world’s foremost suppliers of energy, has agreed to sell energy to China, one of the world’s foremost purchasers of energy. However, it is to be paid, not in US petro dollars, but in yuan, redeemable in gold. This is the first major step in a return to the world of tangible versus promissory collateral.

From that point forward, the trend will unquestionably expand to other forms of trade and, I would project, to currencies themselves.

But, assuming that the above is true, why should that mean the end of the debt-as-currency era? Surely, debt has always existed and will continue to exist. Quite so. However, in other eras, debt was commonly treated as dangerous and was avoided as much as possible.

The acceptance of a currency as real money only exists as long as confidence allows it to. Once that confidence has failed, it’s very difficult to sell anyone on the idea of accepting it again. (After the tulip mania collapsed, no one trusted tulip bulb speculation anymore.)

National debt is fraud. It creates no wealth. Debt is the monetary equivalent of the emperor’s new clothes. The ruse is only maintained as long as people have faith in it.

Those who survive the coming collapse will be those who have created an economic insurance policy for themselves, in the form of tangible assets.


As ECB Contemplates Rate Move, Storm Clouds Gather Over Eurozone

Bloc’s economy appears to have slowed, coinciding with mounting tensions over trade and the strength of the euro

By Tom Fairless

A general view of the European Central Bank under dark clouds in Frankfurt, Germany. Analysts have in recent weeks dialed back their forecasts for when the ECB might increase short-term interest rate. Photo: Armando Babani/EPA/Shutterstock 



FRANKFURT—Trade disputes and a stronger currency are threatening a hard-fought economic recovery in the 19-nation eurozone, potentially delaying a move by the European Central Bank to follow the Federal Reserve in increasing short-term interest rates.

Trade conflicts are a particular concern for the ECB because the region escaped the lingering effects of its debt crisis in part due to the strength of its export sector.  
But the bloc’s economy appears to have slowed early this year, coinciding with mounting tensions over possible U.S. tariffs and a fresh increase in the euro’s value against the dollar. A gauge of German business sentiment for April suggested on Tuesday that the slowdown may not be due to one-off factors.

ECB officials, including President Mario Draghi, have indicated that the bank will move only cautiously to withdraw its large monetary stimulus in light of trade disputes and a volatile currency. The ECB isn’t expected to take any policy action when its top officials gather in Frankfurt on Wednesday and Thursday, but the bank might indicate how worried it is about the latest economic data.


“We are all aware that an escalation of protectionist threats from the United States would dampen growth everywhere,” said the head of France’s central bank and ECB rate-setting committee member François Villeroy de Galhau in London on Tuesday. “The recent uncertainty is probably already having some negative effects on investment.” 
Analysts have in recent weeks dialed back their forecasts for when the ECB might increase short-term interest rates, which are currently minus 0.4%. Economists had until recently anticipated a first ECB interest-rate hike as soon as this year, but many now expect the bank to wait until the second half of next year—possibly only after Mario Draghi steps down as ECB president in October 2019.


At the heart of the concerns is trade, which accounts for a much larger share of the eurozone economy than those of the U.S., China or Japan. The eurozone exports goods and services worth 44% of its economic output each year, compared with less than 12% for the United States, 16% for Japan and around 20% for China, according to 2016 figures from the World Bank. 


TRADING PLACES


Exports of goods and services as a percentage of GDP

Note: 2016 Data
Source: World BankNote: 2016 data



Mr. Draghi warned in Washington last week that rising protectionism might already be hurting business or consumer sentiment.

“Trade disputes could potentially have a serious impact on the eurozone economy, particularly Germany, which has in many ways been driving the region’s recovery,” said Stefan Gerlach, a former deputy governor of Ireland’s central bank who is now chief economist at EFG Bank in Zurich.

German Chancellor Angela Merkel and French President Emmanuel Macron are both expected to lobby President Trump this week on trade. French Economy Minister Bruno LeMaire described proposed U.S. tariffs on steel and aluminum imports last week as a “sword of Damocles hanging over our heads.”

To be sure, the eurozone economy appears to be growing robustly for now. The International Monetary Fund this month increased its forecast for the bloc’s growth rate to 2.4% for 2018, from 1.9%—not far off the expected U.S. growth rate of 2.9%. Economists suggest a range of one-off factors may have hurt the economy early this year, from strikes to an outbreak of flu. Businesses may also be struggling to recruit enough skilled workers as the unemployment rate falls, a development that could be viewed positively by the ECB if it helps to push up wages and inflation.

Still, the closely watched Ifo gauge of business sentiment in April slumped to its lowest level in almost a year, Ifo said Tuesday. Germany’s main business lobby, the BDI, warned this week that trade tensions between the U.S. and China represent a big economic risk for German firms.




The strength of the euro—which has appreciated around 15% against the dollar over the past year, to $1.22—partly reflects U.S. policy decisions, according to Ewald Nowotny, who sits on the ECB’s 25-member rate-setting committee as governor of Austria’s central bank.

Investors may be worried about the large U.S. current-account and budget deficits, and consider the euro and yen to be more secure currencies, Mr. Nowotny told reporters in Washington on Sunday.


—Paul Hannon in London contributed to this article.


The Return of Japanese Marines

By Phillip Orchard

 

More than 80 years ago, Japan unleashed one of the finest amphibious fighting forces in history, going toe to toe with the Americans in the Pacific and very nearly prevailing. But the country had gone without a dedicated amphibious force in the decades since – until last weekend. On April 7, Japan activated its first marine unit since World War II. Some 2,100 troops are being shifted to what will be known as the Amphibious Rapid Deployment Brigade, based out of the southern port city of Sasebo (conveniently, the new home port of the USS Wasp amphibious assault ship) and tasked with defending Japan’s remote southeastern islands. The move is just part of the largest overhaul of the Japan Ground Self-Defense Force since its founding in 1954.
That Japan – a country of 6,852 islands in a perpetually hostile neighborhood and utterly dependent on open sea lanes – allowed its amphibious capabilities to decay in the first place sheds light on the way that legal, political and budgetary constraints can hinder Japanese efforts to face up to burgeoning maritime security challenges on its doorstep. These aren’t going away, complicating Japan’s resurgence as a dominant military power in the Western Pacific. But Japan has always found ways to adapt when compelled to do so by outside forces. The revival of the Japanese marines merely underscores the weight of the concerns driving the country to reinvent itself again today.
 
Toeing the Line on Article 9
The erosion of Japan’s amphibious capabilities is, in large part, a legacy of World War II. Article 9 of Japan’s pacifist constitution – which the occupying Americans imposed on Japan, but which the country has generally embraced ever since – prohibits the use of military force for offensive purposes and effectively requires that any weapons acquired or developed by the military must be intended for defensive purposes. Article 9 hasn’t stopped Tokyo from building up considerable military firepower; the Japanese Self-Defense Force has superb defensive capabilities. But the law and accompanying political sensitivities, plus varying degrees of pressure from the U.S., have deterred the government from pursuing offensive weaponry such as long-range bombers or missiles, aircraft carriers and so forth.

Amphibious forces have generally been tagged as offensive, the rationale among Japanese pacifists being that their primary value would come in the sort of invasion that Tokyo had sworn off. But this label was hardly self-evident or binding. If the military had considered amphibious capabilities a priority, it likely could have worked to soften public opposition or find ways to sidestep it altogether. After all, Japan’s outer islands have always been vulnerable to seizure by hostile forces, not to mention natural disasters. (The military proved ill-prepared to respond to damage wrought by the 2011 Tohoku earthquake on remote islands, for example, helping generate political momentum for the revival of the marines.) Moreover, Japan has routinely toed the line on Article 9 with “defensive capabilities” that could certainly be used to wage war abroad. It has long maintained sophisticated fleets of fighter jets and attack submarines, for example. More recently, it launched a new class of flat-decked helicopter carriers that could serve as prototypes for a bluewater aircraft carrier. The line between offensive and defensive could be blurred when the military found it necessary to do so.

But Japan’s military buildup during the latter half of the 20th century took place amid tight budgetary and political constraints. There was only so much political and fiscal capital to go around, and Japan was reluctant to defy public opposition to capabilities that much of the military considered lesser priorities. Allowing capabilities such as amphibious warfare to languish was tolerable so long as Tokyo could rely on the U.S. to fill in the gaps. As a result, Japanese Self-Defense Force resources were devoted overwhelmingly to its main strategic priority – deterring a Soviet invasion of Japan’s main islands from the north – at a time when vital sea lanes to Japan’s south faced little threat. (An indigenous amphibious force was not considered vital to these war plans.) It just so happened that this was the Americans’ top priority as well. This meant the advocates of an amphibious force within the JSDF lacked the bureaucratic and public backing to shift the country’s strategic focus south and toward amphibious capabilities until well after the threat of Soviet invasion had evaporated. Japan had some of the assets needed for amphibious warfare, but momentum toward filling in the shortfalls and developing operational know-how – say, via joint training with U.S. Marines – didn’t begin to pick up until the past decade or so, particularly since the 2011 earthquake.

Japan is certainly still feeling the heat from the north and in the Sea of Japan. Just seven months have passed since North Korea last test-launched a ballistic missile over Hokkaido, after all. Moreover, Russia has been stirring tension over the Kuril Islands, for example by landing fighter jets on the disputed isles last month, staging exercises nearby, and generally stonewalling Tokyo’s efforts to forge a diplomatic solution. (Japan and Russia have never signed a World War II peace treaty because of the Kurils dispute.) But Japan’s strategic priorities are clearly moving south, owing overwhelmingly to China’s rapid military modernization, uncertainties about U.S. treaty commitments, and Japan’s enduring core imperative of deterring threats to indispensable import routes. As a result, Tokyo has found ways to shrug off the internal constraints on amphibious development that weren’t considered effectively insurmountable before.
 
Confronting a New Reality
The center of gravity of Japanese military planning is settling firmly over the East China Sea, particularly a string of uninhabited but hotly contested islands known in Japan as the Senkakus (called the Diaoyus in China). Located just over 100 miles (160 kilometers) northeast of Taiwan, the Senkakus may be where Chinese and Japanese geopolitical imperatives intersect most directly. Japan controls the Senkakus, but it has good reason to think China cannot abide this status quo. This is, in large part, because of China’s own dependency on the free flow of imported raw materials and exported goods. The Senkakus make up a small but important part of what’s known as the first island chain, stretching from Japan to Indonesia. Should a foreign navy (read: Japan or the U.S.) use this chain to block Chinese access to the Pacific or Indian Ocean basin, China would descend into economic and political chaos. Thus, China needs to push outward, whether by force or by striking a political arrangement with a foreign government like the Philippines, to blow a hole in any line of containment set up by the U.S. and its allies.
 
The Senkakus themselves have only limited military value – far less than Okinawa, for example, 250 miles to the northeast. The same is true of China’s artificial islands in the South China Sea. But they could certainly host the sorts of surveillance and radar installations; missile defense, anti-ship and anti-aircraft emplacements; or network of seabed sensors that would restrict the Chinese navy’s ability to operate in its littoral waters. Inversely, installing its own assets on the Senkakus would bolster China’s own anti-access/area denial capabilities and complicate U.S. operations in the region – or perhaps even frustrate U.S. efforts to come to Taiwan’s aid in the event of a Chinese attempt to retake its prodigal province. Moreover, operating freely in the East China Sea is critical to Chinese nuclear deterrence. China needs long-range submarine-launched ballistic missiles to ensure a second-strike capability against other nuclear powers. But submarine warfare is perhaps China’s biggest naval weakness, with both Japan and the U.S. having substantial technological superiority, not to mention decades more real world operational experience.

Taking the Senkakus wouldn’t eliminate China’s shortcomings here, but it would make it riskier for the Japanese or U.S. to deploy air and surface fleet assets in support of anti-submarine warfare operations. This becomes particularly important with longer-range Chinese submarine-launched ballistic missiles coming online, allowing China greater second-strike assurance even if Chinese subs can’t yet evade their Japanese and U.S. counterparts in waters farther from Chinese shores. (Again, the same is true of China’s artificial islands in the South China Sea.)

In other words, China’s need to one day seize the islands is clear. Indeed, China hasn’t exactly been shy about its intentions. It declared an air defense identification zone over the Senkakus in 2013, and Japanese warplanes were scrambled to intercept incursions into Japanese airspace (mostly by Chinese aircraft) a record 1,168 times in 2016. Chinese fishing fleets (which would be used as a maritime militia in a conflict) and coast guard vessels (the largest of which are basically lightly armed frigates) have become regular visitors to the islands. In January, a new Chinese nuclear submarine surfaced alongside a frigate just off the Senkakus. Thus, Japan’s need for an amphibious force equipped to retake them is likewise becoming abundantly clear.

For Japan, the issue centers on the country’s fundamental and enduring weakness: Its near-total dependence on commodity imports, particularly those arriving from the Middle East and Southeast Asia through oft-contested waters. Japan has an extraordinary dearth of natural resources. If China or another hostile power were to use islands like the Senkakus or those in the South China Sea to sever this lifeline, Japan’s economy would wither on the vine. Japan’s grand strategy has revolved around this vulnerability ever since it industrialized in the late 1800s. It drove Japan’s imperial expansion into China and Southeast Asia in the 1930s-1940s, and it sparked the war in the Pacific shortly thereafter, with U.S. threats to Japanese oil supplies leading to the attack on Pearl Harbor
For decades afterward, U.S. security guarantees and China’s weakness allowed Japan to focus elsewhere. But such a posture was never going to be permanent. Even if warily, Japan is facing up to its uneasy geopolitical reality.


Buttonwood

Catching the bitcoin bug

A new study offers cold comfort for crypto-investors


SINCE the heady days of late 2017 and January of this year, crypto-currencies have gone into retreat. Bitcoin, the best-known example, is now worth just a third of its value at its peak (see chart).

But there remain plenty of true believers in digital currencies. They point out that prices are still well above where they were in 2016. And interest from institutional investors is still strong enough for analysts to want to make sense of the crypto-phenomenon.

The latest bank to take a shot is Barclays, which devotes a lot more of its “Equity Gilt Study 2018” to the impact of technological change on finance and the economy than it does to either equities or gilts. Its report describes crypto-technology as “a solution still seeking a problem”.

It identifies four challenges in particular. The first is trust. In most countries, consumers and businesses have faith in the currencies issued by the government. The second is sovereignty: the potential for tax avoidance and loss of financial control means that neither governments nor central banks will be keen to see private crypto-currencies take off.



A third challenge is privacy. Although they can be used pseudonymously, crypto-currencies are less reliably anonymous than cash since the blockchain that lies behind them records all transactions. If a pseudonym is cracked, the user��s purchase history is revealed. A fourth relates to the ability to undo a transaction in cases of error or fraud—blockchain transactions are hard to reverse.

On top of all these problems is the fact that existing alternatives seem to work perfectly well. It is easy to make payments and transfer money in an instant.

So what is the appeal of digital newcomers? Private crypto-currencies can be attractive in societies where trust is low, or where governments are unwilling or unable to provide reliable means of exchange—in wartime or during periods of sovereign default, for example. Barclays also suggests that in countries where opportunities to invest are limited, “crypto-currencies may be one of the few ways to diversify savings out of domestic assets.”

None of these conditions applies in rich countries. But they hold in some emerging markets. There could also be demand in the developed world from criminals (although they now strongly favour cash). By making generous assumptions about the size of these low-trust and criminal markets, Barclays comes up with a maximum total value for all crypto-currencies of $660bn-780bn. That is roughly where they were priced at the beginning of 2018.

Maximum value is not the same as fair value. Surveys indicate that most people who buy bitcoin are doing so as an investment. Just 8% of Americans who hold bitcoin do so for purchases or payments. That suggests the main motive for buying crypto-currencies is speculation, which also explains their spectacular recent rise and fall, as with so many bubbles before them, from tulips to dotcom stocks.

Speculative bubbles are hard to model—how to find a rational way to assess irrationality? But Barclays uses the ingenious parallel of an infectious disease. A bubble starts with a small number of asset owners (the “infected”). New buyers are drawn in (or catch the bug) because they witness price increases and fear they will miss out. A large share of the population is immune and will never succumb.

Buyers use a combination of the current price and an extrapolation of the recent increase in price to estimate their expected target value. The faster the price rises, the wilder investors’ hopes and the more the infection spreads. Eventually the market runs out of potential participants and the price rise slows. Once it starts to fall, holders lose hope of big gains and start to sell. The epidemic dies out.

The Barclays model fits the history of the bitcoin price pretty well. And it suggests that the long-term outlook for the value of crypto-currencies is bleak. After all, plenty of people will have bought in the past few months, when enthusiasm was at its height. Some will have taken extra risk to buy the currency, via spread betting or other types of gambling. Instead of the riches they expected, they will be nursing losses. Some will be keen to sell their holdings. But new buyers will be harder to tempt now that crypto-currencies no longer look like a one-way bet.

All of this is good news. Perhaps the blockchain will turn out to be useful for other purposes—for example, recording property transactions. But it has been hard to think about such potential innovations when all the attention was focused on an ever-rising price. The crypto-fever has finally broken.