How Obama can change the game with Japan

Japanese Prime Minister Shinzo Abe arrives in Washington today with a long shopping list. First, he'll want to be assured of solid U.S. backing, including willingness to go to war on Japan's behalf if necessary, in Tokyo's face off with China over control of the Senkaku islands. Next, he'll want U.S. agreement  to his policy of devaluing the yen to promote exports and growth of the Japanese economy. Finally, he'll want to politely refrain from joining the U.S. sponsored negotiations for a Trans Pacific Partnership free trade agreement (TPP).

Here's what the White House should give him.

Although in the light of history, China's claims to the Senkakus are arguably as good as Japan's, there is no way that Abe can accede to Chinese pressure to cede sovereignty over the islands in the face of Beijing's military threats. Because the United States has recognized Japan's administrative authority over the islands and guarantees Japan's security under the terms of a security treaty with Japan, Washington is obligated to back Japan in resisting any threats of force regarding the islands. At the same time, the United States desperately wants to avoid war with China and would like to get some negotiation or global inquiry going. The problem is that to their own publics both China and Japan would appear to be backing down if one of the proposed submitting the dispute to the World Court. One way around this would be for Washington publicly to voice support for Japan, but at the same time to persuade the World Court to invite Japan and China to submit their dispute to it. In this way, neither side would lose face by accepting the invitation.

On the economy and the yen, the White House, unfortunately, has already pretty much spoken. Undersecretary of the Treasury Lael Brainard voiced U.S. support for Japan's policies to stimulate its economy at the recent G-20 Finance Ministers Meeting. This, in effect, constituted a White House blessing on Abe's efforts to drive the yen lower as a way of creating jobs by reducing the price of Japanese exports.  In his personal meeting with Abe, President Obama should make it clear that Brainard had gone rogue and was not voicing White House policy. Indeed, he should emphasize that the opposite is the case -- the United States strongly opposes Japan's efforts to manipulate the value of the yen and may be forced to take countervailing action if such efforts continue. Some will argue that Japan is doing nothing more than imitating the Federal Reserve's easy money, quantitative easing policies. But this is not entirely the case. The Fed doesn't talk the dollar down or call for greater U.S. exports as a main driver of rising GDP growth. But Abe does all of this (and the Bank of Japan is acquiescing) in his drive to stimulate the Japanese economy. What Japan desperately needs, and what Abe assiduously avoids mentioning, is to undertake far reaching structural reforms of its economy. Japan has been pursuing easy money and high stimulus policies for twenty years without much to show for it. Yen devaluation will not provide a long term fix but it will disrupt U.S. markets and reduce U.S. employment at a moment when Washington very badly needs to create jobs and make America more competitive. The president should make this crystal clear to Abe while emphasizing that he can't expect enthusiastic U.S. geopolitical support while indirectly subsidizing exports.

As far as the TPP is concerned, the White House should forget about it with regard to Japan. Tokyo is unlikely to join because of the opposition of its farmers and other domestic groups and also because at this stage of the negotiations (scheduled to end in October) Japan would be unlikely to be able to obtain many concessions. More importantly, bringing Japan into the TPP would increase the U.S. trade deficit and by reducing tariffs in key industries such as autos without gaining reciprocal reduction of non-tariff barriers in Japan that effectively keep many Japanese markets closed despite the absence of tariffs.

Instead of a futile and probably counter-productive effort to get Japan into the TPP, the president should go for something big that would be good for both economies while also reinforcing the geopolitical ties. He should propose that Japan join the North American Free Trade Agreement (NAFTA) and that NAFTA be developed into a true economic union with a common trade policy, currency coordination arrangements that prevent currency manipulation, and a common anti-trust and competition policy, as well as a high level of regulatory coordination. Eventually, a common currency -- the yelarso -- might be adopted along with a single financial system.

If the president truly wants to change the game, and do something for the history books, this is it.

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