China, Japan, Taiwan and US: Four to Party in Diaoyutai

By EconMatters [14]

With Bin Laden and Gaddafi out of the picture, the geopolitical headline is now shifting to Asia/China. The most recent excitement came from a 3-way bitter territorial feud over eight small and uninhabited islands in the East China Sea.

Historically, these uninhabited islands are rich fishing grounds with military strategic importance. It was also discovered in 1968 that there could be oil and gas reserves under the sea near the islands. It is estimated that the East China Sea region may hold as much as 160 billion barrels of oil. Today, these islands have different names depending on whom you talk to - Diaoyu in China, Diaoyutai in Taiwan, and Senkaku in Japan.

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Chart Source: FT.com (h/t Mark Turok [16])

Duel in the East China Sea

[17]Physically, Taiwan is the closest to Diaoyutai among the three; however, China and Japan have been portrayed as seemingly the only two players by the western media in this island row. Taiwan has always maintained a low profile in most international or diplomatic matters. But that changed about two weeks ago when Taiwan officially asserted its claim on Diaoyutai by dispatching 12 coast guard vessels along with some 50 civilian fishing boats to the islands. The resulted water cannon duel between the vessels of Taiwan and Japan has officially landed Taiwan squarely on the map of Diaoyutai, so to speak, before the eyes of world media.

Japan Purchase Angers Chinese

The history of this dispute has been a regional “undercurrent” that could be traced all the way back to Qing Dynasty [18]. But tension erupted high above surface after Japan’s attempt to “nationalize” these islands by purchasing them from a private owner for 2.05 billion yen ($26.18 million). This tactic, not that much different from the provocation by Japan to start the previous two Sino-Japanese Wars, has brought up lots of bad memories. Needless to say, Chinese (from both sides of the Strait) are livid and large scale anti-Japan protests have broken out in a dozen of cities in Mainland and Taiwan.

Japan Sales Crash

China was Japan’s largest trading partner last year, and Japan is China’s second-biggest trading partner after the United States with two-way trade totaling $342.9bn. China is also the largest auto market in the world and represents one significant “life line” for Japanese automakers. The renewed anti-Japanese backlash in China has already caused the “disastrous” decline of Japanese auto sales [19] of up to 50% YoY in China last month.

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Chart Source: China Daily, Oct. 10, 2012

Japan's loss is another rival's gain as BMW, GM and Korea’s Hyundai are reporting surging YoY sales in September. China Daily quoted [19] IHS Automotive that output and sales for Japanese automakers in China is estimated to be cut by 200,000 units this year, or 20% of sales. China communist party also threatened that Japan's economy could suffer for up to 20 years if China chose to impose sanctions over the escalating territorial row.

The Role of U.S. in Diaoyutai

Based in historical documents, Diaoyutai Islands were formally part of China, but Taiwan (along with the associated islands including Diaoyutai Islands) was ceded to Japan by the Qing Dynasty in 1895 via Treaty of Shimonoseki [21] after losing the First Sino-Japanese War. Taiwan was returned to the Republic of China formed by the Nationalist Party (KMT) in 1945 after the end of WW II in accordance of Cairo Declaration [22], and Potsdam Proclamation [23].

However, Diaoyutai was not returned to China along with Taiwan. And in the aftermath of a civil war in China, and two treaties between the US/Allied and Japan--without the presence of China--the U.S. somehow ended up “administering” the Diaoyutai Islands from 1945 before transferring the “administration” to Japan in 1972, which is part of the basis of Japan’s claim and in essence the direct cause-and-effect of the current 3-way row.

Further Reading: The Inconvenient Truth Behind the Diaoyu/Senkaku Islands [24] (NYT, Sep. 19, 2012)

Communist China did launch a protest at the time of the administrative transfer by the United States to Japan. So a logical question would be:

Why did the U.S. return the “administration” of Diaoyutai to Japan in 1972 with China protesting knowing full well there was an unresolved territorial dispute?

How “Neutral” Can The U.S. Be?

So far, the U.S. has tried hard not to get involved by simply asserting “a neutral position on the competing claims of Japan and China over the islands.” However, the U.S. also affirms that it will protect Diaoyutai as part of "the territories under the administration of Japan" according to the US-Japan Security Treaty. With that gold-plated safety blanket in the back pocket, it is not a surprise that Japan resorts to anything less than the so-called “diplomatic blunder” to force the claim over Diaoyutai via an outright purchase? It is also part of the reason China is calling the United States to “walk the talk [25]” regarding being neutral on the China-Japan territorial dispute.

Global Multi-lateral Implications

Now, this regional diplomatic row has evolved into a global multi-lateral economic and geopolitical event when China’s Finance and Central Bank officials, along with several Chinese major bankers, boycott IMF and World Bank meetings in Tokyo this week.

Ratings agency Standard & Poor’s already warned that “if the political confrontation [between China and Japan] drags on and further worsens ties between both countries, it may hurt Japan’s macro economy and affect the credit quality of rated Japanese companies on a large scale.”

Alarmed by the recent development, Christine Lagarde of IMF also warned that China and Japan should not be distracted by territorial division as “the current status of the global economy needs both Japan and China fully engaged."

China & Taiwan - Not Nemesis on Diaoyutai

China and Taiwan have remained hostile to each other ever since the separation some 60 years ago. Both sides disagree on almost anything and everything for decades. However, the common bond of defending Chinese sovereignty from Japan seems to have pushed them closer.

China asked Taiwan to have a joint sovereignty claim (which was turned down by Taiwan), and said it will continue vessel patrols and will extend protection to Taiwan civilian fishing boats around Diaoyutai. Then interestingly, after China Daily taking out full-page ads in New York Times and Washington Post to broadcast and support its claim over Diaoyutai, Taiwan also took out ads [26] in four major U.S. newspapers to assert its claim as well.

China’s First Aircraft Carrier Worries Many

What has raised quite a few heart beats from the Kremlin to the Pentagon was that as a show of force to Japan, China put its first aircraft carrier--Liaoning—into commission right in the middle the Taiwan-Japan vessel showdown.

Partly in response to the Chinese carrier launch as well as the increasing tension over Diaoyutai, two nuclear-powered aircraft carrier strike groups of the US Navy's 7th Fleet have been deployed [27] since mid-September to the Western Pacific

Backing Down Is Politically Incorrect

Right now, the political environments in Taiwan, China and Japan would suggest it is highly unlikely any of them would back down from their current stance.

Many are keeping a watchful eye as China has been beefing up its military defense budget with quite a sizable naval fleet in the Pacific region to boot. Meanwhile, the U.S. has been preoccupied with the Middle East region, particularly since 9/11, leading to a much diminished presence in the Asia-Pacific.

However, with so much more at stake, it is now almost impossible to really have a third Sino-Japanese War. Nevertheless, when push comes to shove, China still has the bigger gun over Japan on many other levels, and the U.S. most likely has to at least sit in the bed it’s made so far. And also don’t discount the potential wild card role of China’s nemesis – Taiwan either.