Asia's Stockpiles of Dollars Pose U.S. Economic Risks

[VV o n g B a]

HONG KONG — A massive buildup of U.S. dollars held by Japan, China and other Asian countries is fueling increasing unease among analysts and policymakers, who fear it poses risks to the fragile American economic recovery and global financial stability.

Collectively, Asian countries hold foreign exchange reserves — mostly in dollars — valued at more than $2 trillion, nearly triple that of just seven years ago, according to the Asian Development Bank. Those dollar holdings continue to grow rapidly, with the Japanese and Chinese governments particularly heavy buyers.

Asian governments buy dollars because it helps boost their export-led economies. Snapping them up keeps the greenback's value high and the value of regional currencies low, giving Asian countries a vital competitive edge in foreign markets.

Though this strategy makes a Chinese-made toy or a Japanese TV set cheaper for Americans and other global consumers, it has serious side effects. The dollars that Asian countries rake in as payments for those exports further boost their already bloated reserves while the record U.S. trade deficit grows even larger.

But that's not all. Asia's dollar purchases also effectively finance the huge and growing U.S. budget deficit as central bankers in the region invest most of their dollars in U.S. Treasury bonds and other securities. They have done this with such gusto that Uncle Sam doesn't even have to offer higher rates to move the average $1.5 billion of Treasury securities it must sell each day to sustain the current year's deficit.

Without that demand, the United States would have to offer higher interest rates to lure buyers — a move that would drive up rates on mortgages, business loans and more.

more... (http://www.latimes.com/business/la-fi-dollar6apr06,1,6876656.story?coll=la-home-headlines)

[AliBabaIncorporated]

Foreign-currency traders report that the frenetic pace of Japan's dollar buying during the initial months of this year has eased noticeably during the last couple of week
Only due to legislative holdups. The dollar jumped from JPY104 to JPY107 so far this week because of Japanese government dollar buying, and as a result, the Nikkei jumped to a 3-year high. The HK dollar has also weakened against the US dollar since the beginning of the year ... when I got here, the rate was pushing below HKD7.75 on speculation about revaluation, now it's back up to the middle of its usual range at HKD7.78.

Personally though, I'm staying away from anything remotely dollar-linked in my investments.

[SunWuKong]

the HKD and USD exchange rate really doesn't change that much because the HKD is pegged to the USD.

[Craig]

We need to get more Asians diversifying and investing in Euros ;-)

[Shogun Empress]

HONG KONG — A massive buildup of U.S. dollars held by Japan, China and other Asian countries is fueling increasing unease...A massive buildup of U.S. dollars held in my piggy bank would increase my spending habits.

[Craig]

A massive buildup of U.S. dollars held in my piggy bank would increase my spending habits.With that kind of attitude, isn't it obvious why such a scenario won't happen ?

[AliBabaIncorporated]

We need to get more Asians diversifying and investing in Euros ;-)
Well, with jet-setters like Kim Jong Il in the lead, I'm sure it'll just be a matter of time before everyone wants to be as cool as him :tongue:

[ellsworth81]

so *what does* America export these days? I can't help but think there's more to the trade deficit than currency value imbalances....

[VV o n g B a]

so *what does* America export these days?
services, technology, entertainment/culture, armaments/weapons... there's still lots of stuff the US exports.

[yoMAMA]

those massive foreign currency reserves are gonna come handy when there's another financial crisis.

With the state of the world economy right now...you never know.

[VV o n g B a]

^ i should have posted the entire article b/c its gone now on the latimes site. anyways, the article highlighted the potential dangers of holding lots of dollars. finance ministers in asia are currently reevaluating their policy of propping the dollar up w/o regard to the dangers. basically, the situation is stable right now but there is no free lunch... there are risks to holding lots of low interest rate dollars and funding US debt.

[Faithless]

The rest of the article?

...
That, experts say, is the danger.

Any significant drop-off in Asia's seemingly insatiable appetite for the greenback would trigger a rise in interest rates that could slow U.S. growth and depress a job market only now showing its first signs of recovery. "Right now, it is Asians who are helping keep U.S. interest rates low," summed up Kenneth Courtis, Asia vice chairman for American investment firm Goldman, Sachs & Co. The connection between Asia's central bank policies and America's economic well-being stands as a startling -- and, for some, unsettling -- example of how the fates of people living oceans apart have become so closely intertwined by the forces of globalization. In an age where an American thinks little of getting an update on a credit card balance from someone sitting in Bombay, it is now the Finance Ministry bureaucrat in Tokyo and the banker in Karachi who influence mortgage rates for homeowners in Phoenix or Des Moines.

Asia's "dollar habit" also poses other risks to Americans, experts say. By allowing the U.S. to pile up record deficits without having to pay the usual price of higher interest rates, Asia has effectively encouraged Congress and the Bush administration to amass even more debt. If U.S. budget deficits continue to grow unchecked, they could, among other things, eventually endanger the government's ability to finance Medicare and Social Security programs once baby boomers begin retiring.

Though few economists believe it will go that far, they agree that bigger deficits could lead to tougher and more painful adjustments for Americans. "The longer this goes on and the larger the debt becomes, the more likely it is that it will lead to a recession in the U.S.," declared Geoffrey Barker, chief international economist for Hong Kong & Shanghai Bank Ltd. in Hong Kong.

Lately, hints have emerged that Asian governments may be reviewing their positions. Foreign-currency traders report that the frenetic pace of Japan's dollar buying during the initial months of this year has eased noticeably during the last couple of weeks. And there are signs that some countries have begun to divert investments into their domestic economies rather than buying so many Treasury securities. But these movements remain small. Historically, most foreign countries have held some dollar reserves to pay for imports and to serve as a cushion in time of crisis -- much as a family would maintain a savings account. Asia's dollar reserves were already at an all-time high two years ago when the region's central banks began buying the currency to prop it up as it began to fall under the weight of the growing American deficits and uncertainty surrounding the war in Iraq.

Many Asian countries see dollar buying as a matter of economic survival -- the price they must pay to keep the greenback high, their own national currencies low and their export goods priced competitively in a dollar-dominated world. "From India to Japan, Asia adheres to a strategy of export-led growth and that requires an undervalued currency," noted Tim Condon, chief economist for ING Financial Markets in Hong Kong. The strategy has worked. According to Federal Reserve statistics, the greenback lost 8.4% of its trade-weighted value against world currencies over the year ended in February, an amount that international economists suggest is about half of what it would have fallen without Asia's interventions. Because its goods have remained cheap for Americans, Asia as a whole enjoys a large and growing trade surplus with the U.S.

Asian countries also have another incentive to accumulate dollars.

By amassing greenbacks, Asian governments could quickly convert that money into their own currencies, helping stabilize them in the event of a financial crisis. In this way, dollar reserves become a tool for avoiding a repeat of the speculative attack in 1997 that sent the Thai baht into a frightening tailspin and quickly spread throughout the region. Eventually, the International Monetary Fund was forced to step in and impose draconian measures as part of a massive bailout package. The harsh medicine administered by the IMF turned out to be both economically ill-suited and politically disastrous, delaying recoveries and, in the case of Indonesia, leading to the fall of the nation's leader, Suharto. "Politicians with a survival instinct vowed never again to be forced into a position where they had to deal with the IMF," noted Ifzal Ali, respected chief economist of the Asian Development Bank in Manila. "For them, large dollar reserves were a firewall to guard against this. It became an obsession."

Last month, Taiwan put the strategy into action. U.S. dollar holdings allowed Taipei to ride out the sharp sell-off of its local currency that accompanied a post-presidential election crisis. Central bank Chairman Perng Fai-nan told a legislative committee four days into the political turmoil that he had an "unlimited" ability to spend dollars to buy back the local currency from all those wanting to sell. Even in Asia's poorest countries, dollar reserves have jumped. Pakistan, for example, which counted $535 million in foreign-exchange reserves at the end of 1996, boosted that to $10.6 billion at the end of last year. The pattern is similar in other countries.

In the first quarter of this year, Japan alone bought about $145 billion in additional dollars and recently won parliamentary approval to buy $360 billion before year-end. China last year added about $160 billion to its reserves. While nations keep their reserves in various currencies, roughly two-thirds of these holdings are believed to be in dollars.

At one level, this represents a very real loss of U.S. government control over the national currency, one with genuine national security implications. Any carefully organized dollar sell-off by these countries or a traumatic event that stampeded them into panic selling could send the dollar -- and the global financial system -- into chaos.

Such a scenario, however, is widely dismissed as highly improbable because central bankers and government policymakers in the region know that, as the world's largest international dollar holders, they would lose more than anyone from an attack on the American currency. But there are growing reasons that Asian nations might want to pare their dollar habit, experts say. As Asian economies continue to grow briskly and export growth begins to ignite domestic economic strength, many policymakers are coming to view huge dollar holdings as an inefficient way to use national wealth. "The reserves now held [in Asian central banks] far exceed the optimal level," noted economist Ali. "It's only now dawning on policymakers that there's a very high cost to this." Ali noted that Treasury bills offer some of the world's lowest rates of return -- far below what fast-developing Asian economies could earn putting those dollars to work in their own economies. There is already evidence this may be starting to happen, albeit in relatively small amounts.

South Korea and Taiwan are reportedly preparing to invest some of their reserves directly into their domestic economies, and a major debate is underway in India about making better use of reserves that recently topped $100 billion for the first time. "This is money that isn't working with any efficiency at all," said Deepak Lal, an international development specialist and economist at UCLA. "It's a real loss." Even a slowing of dollar buying or a measured unwinding of reserves in Asia would be felt in the United States, which must sell such large volumes of dollars to finance a federal deficit projected at more than $500 billion this year.

While Ali has maintained that Asian countries should diversify their reserves more evenly among a basket of currencies, central bankers claim there are few choices. They say the yen is not an option because it effectively shadows the dollar, while the stability of Europe's euro remains unproven after barely two years in circulation. "At the moment, there's no way out of the dollar," explained Rafael Buenaventura, governor of the Central Bank of the Philippines. Because of this, Asia's dollar buying continues despite mounting disquiet about the buildup. If Japan moves ahead to buy the additional $360 billion recently authorized by parliament, it would push that country's dollar reserves above $1 trillion. That prospect makes some Japanese analysts nervous.

"They've accumulated such a huge amount [of dollars] already that it will be very difficult to sell them quickly," Sayuri Kawamura, chief researcher at the Japan Research Institute in Tokyo, said of the government. "It takes time [and] I'm afraid it will be too late once they notice, or if they miss the timing, to start selling." At some point, economists are convinced, the U.S. will be forced to take corrective action to rein in its deficits. But these experts also believe the political costs are probably too high for the administration to act on its own prior to the November election. Still, they stress that developing a plan that can steer the world economy through an orderly adjustment must be among the first tasks for whoever resides in the White House next year. A delay well into the year could easily undermine confidence in the greenback, spook central banks in the region and possibly start a wave of uncontrolled dollar selling, the experts say.

"Eventually, the United States will have to address the deficits," Buenaventura said. "Once this happens, things can get back to normal. Meanwhile, Asia can't afford to let the dollar drop further."
Makes one wonder how hampered we are to speak up because of our debt to Asia.

Maybe that's why we favor the One China policy. We say that because it would put us in good stead with the Chinese government.

[yoMAMA]

you need us and we need you: the co dependence relationship between america and its asian creditors (http://economist.com/agenda/displayStory.cfm?story_id=3834261)


here's one about the dollar in new yorker:

THE FINANCIAL PAGE
IN YUAN WE TRUST
by James Surowiecki

In the 2004 Hollywood comedy “EuroTrip,” which chronicles the adventures of a group of American teen-agers on a debased modern version of the Grand Tour, our heroes end up trapped in Bratislava with a mere $1.83 in their pockets. Things look bleak, until they discover just what a dollar and change will buy: a luxury suite, massages, three-course meals with champagne, and assiduously servile service. Feeling flush, they toss their waiter a five-cent tip. He turns to his boss and says, “A nickel! You see this? I quit! I open my own hotel.”

If only. Nowadays, when you’re abroad, you’re lucky if $1.83 buys you a cup of coffee. In the past three years, the value of the dollar has fallen by more than fifty per cent against the euro and twenty-five per cent against the yen, and, a recent rally notwithstanding, most analysts say that the dollar is only going to get weaker in the months to come. Europeans now routinely fly across the Atlantic to go shopping, and they have also started to nose around in the American real-estate market. You know the dollar’s in trouble when our puffed-up real estate starts looking cheap.

The dollar has fallen for a simple reason: Americans spend a lot more than they save. American consumers, of course, are known for living on credit, and they buy hundreds of billions of dollars’ worth a year of foreign goods—cars, TVs, T-shirts, khakis. In addition, since 2001 the American government has been running giant budget deficits, thanks to the magical combination of tax cuts and spending increases. We don’t have enough money at home to pay for all this spending, so we borrow from foreigners to make up the difference. Because we keep piling on this foreign debt—more than three trillion dollars so far—and have no clear strategy for paying it back, people are made anxious about the United States economy; this anxiety encourages them to sell dollars, and that drives down the value of our currency.

The dollar’s decline, grim as it seems, has so far had little impact on the everyday lives of most Americans. To be sure, there are new burdens: the price of truffles is up sharply, and the cost of a trip to Paris now rivals that of a semester in college. But inflation and interest rates are still low, the stock market is above where it was three years ago, and Americans have had no trouble slaking their appetite for foreign-made goods. Doomsayers have been predicting for a while that the profligacy will lead to serious trouble. So why hasn’t it?

One answer is that Asia won’t let it. Last year, Asian countries invested almost four hundred billion dollars in the United States, mostly in government bonds. China is effectively taking most of its excess national savings and lending it to the United States. The Japanese, who despite their creaking economy remain flush with savings, bought a quarter trillion dollars of American debt last year, even though the interest is lousy and the assets themselves are losing value. More than any other nation in history, the United States depends, economically, on the kindness of strangers. Right now, Asian investors appear very kind.

Markets are hardly known for their tenderness. Usually, you can assume that everyone in a market is trying to make as much money as possible, with as little risk, but the currency market isn’t like most others. In the market for the dollar, many of the players have other things on their mind. China needs to go on selling Americans hundreds of billions in exports in order to keep its economy humming. A weaker dollar makes that harder. Asian central banks also already own trillions of dollars in American assets. As the dollar falls, so does the value of those assets. There are plenty of other traders in the currency markets—who have the luxury of being single-minded regarding profit—but the Asian banks are powerful enough to be, in effect, the lenders of last resort. As long as it’s in their self-interest to keep America afloat, the dollar will not crash.

Of course, the Chinese and the Japanese could decide that the costs of the falling dollar are too great, and suddenly stop (or, at least, cut back sharply) their lending to the United States. This would lead to a so-called “hard landing” for the U.S. economy: high inflation, punitive interest rates, collapsing stock prices and housing prices. It would also lead to bedlam for China and Japan. Their best customers would effectively be unable to afford their wares. To paraphrase John Paul Getty: If you owe the bank a hundred dollars, you’ve got a problem. If you owe the bank three trillion dollars, the bank’s got a problem.

There’s a good chance, then, that the landing will be soft—we lose the truffles but keep our homes—as long as everyone involved in keeping the dollar aloft continues to play the same game. No one, in Asia or anywhere else, wants to be the last guy out. What the Chinese and the Japanese do depends in large part on what they think everyone else is going to do. If the Chinese get the idea that Japan’s commitment to the dollar is wavering, or if they decide that the United States has no interest in altering its deadbeat ways, then they may try to make a run for it. Then again, that threat could act as a prod to keep the Americans in line. The currency market is a great example of what George Soros calls “reflexivity”: people’s predictions about what will happen to the dollar end up having a major impact on what actually does happen to the dollar. Our lenders are trying to strike a delicate balance: they’d like the dollar’s predicament to seem dire enough to make us change, but not so dire as to spark panic. So be afraid. Just don’t be very afraid.

[Faithless]

Oo, I read that.

I also heard that our indebtedness to China makes a weak financial target, too.

I guess the idea is that there was this fear that China would bury us, militarilly. But with the way China has been buying up our debt, if you believe in the "China could get us" idea, then what better way than doing so financially. :frown:

[yoMAMA]

Oo, I read that.

I also heard that our indebtedness to China makes a weak financial target, too.

I guess the idea is that there was this fear that China would bury us, militarilly. But with the way China has been buying up our debt, if you believe in the "China could get us" idea, then what better way than doing so financially. :frown:

No worries, mate. :biggrin:

China needs an economically strong USA to export her products, so it's in the interest of China to have an economically strong USA.

[Faithless]

No worries, mate. :biggrin:

China needs an economically strong USA to export her products, so it's in the interest of China to have an economically strong USA.
Maybe "she" does. Maybe she doesn't. (Why are countries referred to in the feminine?)

Anyway -- China seems confortable in dealing around the US as well:

Bush’s new ‘axis of evil’—Castro and Chavez (http://www.finalcall.com/artman/publish/article_1913.shtml)

They have a deal working to buy oil from Venezuela. The US does not favor Venezuela, and would like to isolate the country. But won't say much to China to stop her from buying oil from Venezuela.

Washington is also increasingly worried about the larger geo-strategic implications of Pres. Chavez’ petro-policies. The United States currently imports about 1.5 million barrels of oil a day from Venezuela—or about 60 percent of Venezuela’s total oil exports. But Pres. Chavez, who has warned that he will cut off the oil supplies if Washington tries to overthrow him, has been trying to diversify his customers.

In recent months, he has signed contracts with France, India and China. To help with his diversification efforts, he further alienated Washington by commissioning Iranian technical assistance. Earlier in March, he hosted Iranian President Mohammed Khatami, to whom he expounded on Teheran’s right “to develop atomic energy and to continue its research in that area” and voiced his “profound rejection of the imperialist desires of the U.S. government.”

[yoMAMA]

Maybe "she" does. Maybe she doesn't. (Why are countries referred to in the feminine?)

for whatever reason, people like to link their country to motherhood, thus the phrase motherland :biggrin:

[shakuhachi]

China, Japan and Korea are paying for America's indulgence. When they decide to dump the dollar, Americans will find their lifestyles severely curbed.

[yoMAMA]

China, Japan and Korea are paying for America's indulgence. When they decide to dump the dollar, Americans will find their lifestyles severely curbed.

yeah, never live beyond your means.

[Faithless]

A good a thread as any for this article:

(I know, I know -- consider the source.)

America's "China Policy" Is in Urgent Need of Definition (http://www.heritage.org/Research/AsiaandthePacific/hl874.cfm)
by John J. Tkacik, Jr.
Heritage Lecture #874 * April 19, 2005

The sudden emergence of China's "Anti-Separation Law" (also called the "Anti-Secession Law") this past December was a surprise because, even by Chinese standards, it was unnecessary. Just six days before its announcement, legislative elections in Taiwan reflected waning political sentiment on the island for constitutional reforms affecting Taiwan's de jure status as the Republic of China.

That China went ahead and initiated a "legislative" process to put this law on the books was a clear indication that China has moved away from its "fundamental policy of striving for peaceful reunification" and toward a posture of military threat to Taiwan. It is a development that reveals a dangerous weakness in our current China policy: It rests on slogans that have no substance.
Slogans of China Policy

Let me explain. Three core elements of America's China policy are:

* "Our One China Policy";
* Our opposition to unilateral change in the Taiwan Strait's "status quo as we define it"; and
* Our "non-support" of Taiwan independence.

These three core elements literally have no substance in the sense that none of them is defined anywhere in the official lexicon of American diplomacy. And insofar as anyone has any idea about what they really mean, their meaning has no relationship to the actual words that U.S. policymakers use to describe those elements.

Consequently, when confronted by actions, either by China or Taiwan that tend to annoy or upset the other, no American Administration has possessed a coherent policy framework within which to manage the controversy. Over the years, this lack of coherence has had the unfortunate effect of confusing both the President and the Congress. Our China policy has become an impressionistic fabric similar to Justice Potter Stewart's view of pornography; that is, "I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description [of pornography]; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it...."1

In short, our China policy is so vaporous that to call it a "policy" would invest it with a level of thought that is entirely absent.
A Policy of Non-Definition

Since the end of the Second World War, it has been the official policy of the United States government that the post-World War II status of Taiwan is "an unsettled question subject to future international resolution." Taiwan was a former colony of the Empire of Japan to which Japan abjured in the document of surrender all "right, title and claim" in perpetuity. However, Japan pointedly did not designate any of its victorious enemy nations as the recipient of Taiwan, leaving it for the allied powers to sort out in the fullness of time.2

The Korean War and the Cold War intervened to prevent the allies from designating "China" (either Chiang Kai-shek's government-in-exile on Taiwan or Mao Zedong's new "People's Republic of China" in Beijing) as the new sovereign over Taiwan, and the matter went unsettled when the final peace treaty with Japan was signed in San Francisco in September 1951. The USSR refused to sign the treaty. It objected, among other things, to the provision regarding Formosa and the Pescadores:

[T]his draft grossly violates the indisputable rights of China to the return of integral parts of Chinese territory: Taiwan, the Pescadores, the Paracel and other islands.... The draft contains only a refer-ence to the renunciation by Japan of its rights to these territories but intentionally omits any mention of the further fate of these territories.3

The "unsettled" status of Taiwan remains the policy of the United States government to this day, except that constant repetition of the phrase "one China policy" has given America's political leaders, in both the Congress and the executive branch, the vague impression that somehow the United States formally recognizes that Taiwan is a part of China.

Compounding the confusion is the Administration's resolute refusal to be clear on the matter (and this is not just a problem with the present Administration, but with all previous ones dating back to President Nixon's first term). For example, just one year ago, before the House Committee on International Relations, Assistant Secretary of State for East Asian and Pacific Affairs James Kelly had the following exchange, redolent of a certain Stewartesque syntax, with Representative Grace Napolitano (D-CA):

REP. NAPOLITANO: The next question, then, is can the evolution of full-fledged democracy on Taiwan and the clear emergence of a sense of Taiwanese identity meld with the principle of One China, or are they in stark contrast with each other?

MR. KELLY: There certainly is a degree of contrast. The definition of One China is something that we could go on for much too long for this event. In my testimony, I made the point "our One China," and I didn't really define it, and I'm not sure I very easily could define it.

I can tell you what it is not. It is not the One-China policy or the One-China principle that Beijing suggests, and it may not be the definition that some would have in Taiwan. But it does convey a meaning of solidarity of a kind among the people on both sides of the straits that has been our policy for a very long time.4

Indeed, Secretary Kelly was one of the few diplomats in the State Department who actually understood what our position on "One China" really was, and tried his best to differentiate it from Beijing's "One China Principle" by calling it "Our One China." But the net effect at the end of that day was to leave Representative Napolitano--and everyone else on the committee, I suspect--just as uninformed about U.S. policy as they were at the start of his testimony.

In his testimony of April 21 last year, Secretary Kelly also listed another core element of our China policy: "The U.S. does not support independence for Taiwan or unilateral moves that would change the status quo as we define it." No one on the committee had the presence of mind to ask Secretary Kelly just how the Administration defined the status quo in the Taiwan Strait, but six months later, members of the press engaged his deputy, Randall G. Schriver, in the following Stewartesque exchange:

QUESTION: Randy, how do you define Taiwan independence? Would a change of the name of the country be--or change the national flag--be considered as independ-ence? Thank you.

MR. SCHRIVER: I don't think it's useful for me to get into a variety of hypotheticals, and I think, actually, it's fairly obvious and fairly clear what we mean by our non-support for Taiwan independence. I mean, you could throw out a range of things, and I just don't want to address them one at a time about the implications, and "is this independence or is that independence?" I think the statement, and our intent behind it, is quite clear.5

In fact, it was not "quite clear." Clarity was precisely the quality that Secretary Schriver hoped to avoid when he answered the question.

In general, a democracy cannot have a coherent foreign policy if it refuses to define the core elements of that policy. These two core elements--"One China" and "status quo in the Taiwan Strait"--are central to America's China policy, yet they are undefined and internally contradictory.

I consider our China policy to be fatally flawed in the sense that the key terms used to describe it are precisely the opposite of what the words mean on their face. That is, "one China" does not mean that the United States recognizes that Taiwan is part of China, but only that the United States only recognizes one government of China at a time. And "status quo as we define it" is nowhere defined either in public or within the confidential proceedings of the executive branch.

A third misconceived element of our China policy, which Secretary James Kelly enumerated at his testimony last year, is that "the U.S. does not support independence for Taiwan." There is an obvious incongruity between this "non-support" for Taiwan's independence and America's devotion to the "expansion of democracy" in Taiwan and our sales of hundreds of millions, indeed billions, of dollars in defense articles and services to Taiwan each year since 1979. Why, pray tell, are we selling Taiwan the instruments to defend themselves with if we do not support Taiwan's continued separation from China--and hence Taiwan's independence?

The answer is quite sound. Assistant Secretary of Defense Peter Rodman pointed to the congressional mandate of the Taiwan Relations Act to "maintain the capacity to resist the use of force against...Taiwan" and averred that "the United States takes these obligations very seriously." He explained:

[T]he President's National Security Strategy, published in September 2002, calls for "building a balance of power that favors freedom." Taiwan's evolution into a true multi-party democracy over the past decade is proof of the importance of America's commitment to Taiwan's defense. It strengthens American resolve to see Taiwan's democracy grow and prosper.6

That sums it up nicely. Why, then, can't the United States government say this out loud? Why do American diplomats blame the Taiwan Relations Act for our support of Taiwan? Why cannot even Secretary of State Condoleezza Rice tell the Chinese that our arms sales to Taiwan are to enable Taiwan to defend its democracy against the threats of tyranny?7

The reasons for this are historical, but, truth be told, they are simply force of habit. Dr. Henry Kissinger apparently gave a secret assurance to Chinese Premier Zhou Enlai in 1971 that the State Department would no longer refer in public to the status of Taiwan as undetermined.8 Apparently through some misplaced loyalty to Dr. Kissinger's secret assurances to Beijing 34 year ago, State Department officials still refuse to say in public that U.S. policy is that Taiwan's legal status remains "unsettled."

Over the decades, on occasion, the State Department has actually hinted at this unsettled state of affairs on Taiwan's legal status in its correspondence and responses to the Congress. However, rather than adhere to a rigorous and precise vagueness, executive branch spokesmen, and indeed the President himself, betray constant and pervasive befuddlement when it comes to matters of Taiwan and China. The President has on occasion referred to Taiwan as a country in its own right,9 and the Secretary of State has called Taiwan a "part of China."10 A scandalous lack of precision in our policy terminology has led to the confusion of otherwise intelligent policymakers.
A Policy of Pretense

Very early in the U.S.-China relationship, both sides realized that they could not sustain a cooperative strategic partnership against the Soviet Union if each insisted that the other side foreswear core tenets of its foreign policy. From 1971 through 1989, U.S.-China relations were built on an unspoken but very real understanding that enabled both sides to ignore the paramount conflict in their essential interests. It was an understanding based on pretense: China pretends to have a "policy of peaceful unification with Taiwan," in return for which the United States pretends to have a "one China policy."

The Congress of the United States was clearly frustrated by the fact that this understanding was unspoken and insisted that it be made explicit. It did so in a profound and direct way in 1979 in the Taiwan Relations Act, which declared it the "policy of the United States...(3) to make clear that the United States decision to establish diplomatic relations with the People's Republic of China rests upon the expectation that the future of Taiwan will be determined by peaceful means."11

President Ronald Reagan was equally perplexed by the bureaucracy's aversion to spelling out this linkage. In August 1982, coincident with the announcement of the U.S.-China Joint Communiqué of August 17, 1982, on the question of Taiwan arms sales, President Reagan issued a presidential statement that declared "the Taiwan question is a matter for the Chinese people, on both sides of the Taiwan Strait, to resolve. We will not interfere in this matter or prejudice the free choice of, or put pressure on, the people of Taiwan in this matter.12

But President Reagan went one step beyond this public statement to mandate this linkage in a confidential presidential directive designed to guide executive branch dealings with China and Taiwan. Indeed, President Reagan declared this linkage was to be a "permanent imperative of U.S. foreign policy."

As you know, I have agreed to the issuance of a joint communiqué with the People's Republic of China in which we express United States policy toward the matter of continuing arms sales to Taiwan.

The talks leading up to the signing of the communiqué were premised on the clear understanding that any reduction of such arms sales depends upon peace in the Taiwan Strait and the continuity of China's declared "fundamental policy" of seeking a peaceful resolution of the Taiwan issue.

In short, the U.S. willingness to reduce its arms sales to Taiwan is conditioned absolutely upon the continued commitment of China to the peaceful solution of the Taiwan-PRC differences. It should be clearly understood that the linkage between these two matters is a permanent imperative of U.S. foreign policy.

In addition, it is essential that the quantity and quality of the arms provided Taiwan be conditioned entirely on the threat posed by the PRC. Both in quantitative and qualitative terms, Taiwan's defense capability relative to that of the PRC will be maintained.13

The Challenge of the Anti-Separation Law

China's pretense of a "peaceful policy" toward Taiwan has eroded significantly since 1993.

* In August 1993, with the issuance of a "white paper" on Taiwan relations, Beijing reiterated that "any sovereign state is entitled to use any means it deems necessary, including military ones, to uphold its sovereignty and territorial integrity" and asserted flatly that "the Chinese Government is under no obligation to undertake any commitment to any foreign power or people intending to split China as to what means it might use to handle its own domestic affairs."14
* From 1992 to the present, China's military spending has increased at double-digit rates, something one might not have expected following the collapse of the Soviet Union. Virtually every other country threatened by Soviet expansion cut its defense spending significantly in an effort to reap a "peace dividend."
* In July 1995, China's hostile intentions toward Taiwan were manifest when Beijing closed the heavily trafficked Taiwan Strait to commercial shipping for several days while it conducted unprecedented "missile tests," generally viewed as an expression of anger at efforts by Taiwan's President Lee Teng-hui to improve his country's international standing.
* In March 1996, the Chinese People's Liberation Army tested nuclear-capable short-range ballistic missiles in the Taiwan Strait, again closing that important sea-lane to international traffic, in an effort to intimidate Taiwan's voters during their first-ever presidential elections.
* In August 1999, Chinese high-performance jet fighters, for the first time, began to patrol the Taiwan Strait at the "center line," challenging Taiwan jet fighters and raising tensions.
* And in February 2000, China issued another white paper which called for the use of "all drastic measures possible including the use of force" if Taiwan did not declare itself part of China and agree to negotiations by a certain date.15

If the United States had possessed a coherent and consistent China policy, these separate Chinese challenges to the status quo would have been countered by calibrated "restatements" from Washington about our "one China" policy. But they were not.
China's Anti-Separation Law and the U.S. Reaction

It is to the Bush Administration's credit that it is finally doing so as it confronts the Anti-Separation Law. The ASL is a convincing indicator that China's commitment to peace in the Taiwan Strait is weak at best.

Early unofficial draft iterations of the ASL--which had initially been referred to as the "National Unification Law"--had been floating around on the Internet at least since 2002 and included all sorts of strange stipulations. Dr. Yu Yuanzhou of Wuhan University proposed legislation that would require the Chinese People's Liberation Army to attack Taiwan as soon as it is able (no need to await any Taiwanese independence), beginning with bombard-ments of Quemoy and Matsu, which, according to Article 27 of his draft, "would not be limited to conventional weapons."16

Understandably, the Bush Administration was dismayed when the ASL was announced on December 17, 2004. The Administration's perplexity was heightened because it followed hard on elections in Taiwan that indicated sentiment for new constitutional revisions had cooled, and hence, Beijing had no justification for stirring the pot with this new legislation.

At first, the Administration's major worry was that China would try to "define" the status quo in the Strait beyond its existing vague guideline. State Department spokesman Richard Boucher told the press on February 15 that the "U.S. Government has been quite clear that we don't think either side should take unilateral steps that try to define the situation further or push it in one direction or another."17 For consistency's sake, the Department of State doesn't want to confine just itself to avoiding definitions, but seems to extend its aversion to defining the status quo to all the players. Again, to the Administration's credit, U.S. officials have maintained a consistent and tough line with all their Chinese interlocutors on the ASL.18

When the Chinese went ahead and passed the law on March 14, the week prior to Secretary of State Rice's visit to Beijing, the Secretary was even tougher. "We've made very clear that the anti-secession law was not a welcome development because anything that is unilateral in this and that increases tensions, which clearly the anti-secession law did increase tensions, is not good."19 I have been told that Secretary Rice was even more blunt in her private meetings with Chinese leaders.

The reason for her unhappiness is clear. The central mandate of Beijing's new "Anti-National Separation Law" (Fan Fenlie Guojia Fa or, literally, "Law against Splitting the Nation") is the declaration that China "shall" use military force against Taiwan whenever the Chinese leadership decides that all possibilities for "peaceful reunification" with Taiwan have been exhausted.20 But the Anti-Separation Law makes no pretense of defining either what would constitute an act "entailing" secession or what it might mean to exhaust "all possibilities" for peaceful reunification.

As such, the ASL serves as a free-standing, permanent casus belli against Taiwan and the United States. In short, the ASL is an open-ended declaration of war against Taiwan in which the Beijing authorities reserve the right to launch "non-peaceful" actions against the people of Taiwan whenever they wish and without forewarning.

This pre-legitimization of war is a very real change in China's stance toward Taiwan--and indeed toward the United States, which sees the preservation of Taiwan's democracy and autonomy from Beijing as in both its political and strategic interests.

In presenting the draft ASL to the National People's Congress on March 8, 2005, NPC Vice Chairman Wang Zhaoguo asserted that China's constitution stipulates that "Taiwan is an unalienable part of the sacred territory of the People's Republic of China."21 In this context, it is ironic to note that the only piece of the world's geography that the Chinese constitution declares is an unalienable part of the PRC is Taiwan. Not Beijing or Shanghai or Xinjiang or Tibet.

It is also ironic that the Chinese government insists that the English-language rendering of fan fenlie guojia fa is "Anti Secession Law." Of course, Taiwan has never been administered by the People's Republic of China, and it seems an oxymoron to suggest that Taiwan could secede from a country to which it has never belonged in the first place.
How the U.S. Should React to the ASL

Let me suggest a few ways in which the Congress might remedy the flaws in U.S. policy.

Define Our Policy. Recognizing that a problem exists is the first step to finding a solution. In its oversight role, Congress should insist that the Administration actually define its Taiwan policy.

This does not necessarily mean that the Congress should force the Administration into a public enunciation of a policy toward Taiwan that directly antagonizes Beijing. But at the very least, the Administration should be required to develop internal "terms of reference" for Taiwan. What exactly is the "status quo" in the Taiwan Strait? What is "our" one China policy? If we don't support Taiwan's continued separation from China--a separation that has already lasted for 107 of the last 110 years--then why has the Congress mandated in the Taiwan Relations Act that national policy is "to maintain the capacity of the United States to resist any resort to force or other forms of coercion that would jeopardize the security, or the social or economic system, of the people of Taiwan"?

Maintain the Linkage. President Reagan's "permanent imperative" of a linkage between China's peaceful policy toward Taiwan and our support for Taiwan's defense, and hence its continued separation from China, is clearly in America's interests. Therefore, any step Beijing takes that casts a cloud over its so-called peaceful policy must be matched by a concomitant U.S. step in support of Taiwan's democracy.

If the Administration finds it diplomatically inopportune to react to some act of Chinese bellicosity in the Taiwan Strait, there may well be instances where a congressional reaction would give the Administration leverage with Beijing. Beijing's Anti Separation Law, which Chinese diplomats insist is merely a restatement of existing Chinese law and policy, could be balanced by new U.S. legislation--perhaps along the lines of the Taiwan Security Enhancement Act (H.R. 1838), which passed the House of Representatives with a veto-proof margin of 341-70 on February 1, 2000. The TSEA, after all, was also a restatement of existing U.S. policies toward Taiwan.

I myself am personally fond of President Reagan's 1982 commitments to Taiwan's president known as the "Six Assurances."22 Because they are already a part of existing U.S. policy, enshrining the "Six Assurances" in a future House resolution would also be a very effective counter to future Chinese actions that might challenge the stability and peace of the Taiwan Strait.

Demand a Strategy. The Cheshire Cat's first dictum is that if you don't know where you're going, any road will get you there. If the United States has no idea what it wants China or Taiwan to look like in five years (let alone 10 or 20), then it doesn't matter what policies it adopts. As Dr. Condoleezza Rice wrote in Foreign Affairs five years ago, "China is not a `status quo' power but one that would like to alter Asia's balance of power in its own favor."23 This assessment makes it absolutely essential that the United States understand what its own strategic interests, goals, and objectives are in Asia.
Conclusion

Sadly, there is no such vision guiding U.S. policy toward China or Taiwan. The Congress should therefore require one. In particular, the Administration must be attentive to America's interests in Taiwan. Not only is Taiwan a thriving democracy, and not only is it America's tenth largest export market, but Taiwan has also been an important security partner for the United States.

The executive branch must be required to conduct a strategic survey--confidential if necessary--of U.S. interests in the region and to consider the possible ramifications to America's strategic posture in the Western Pacific should Taiwan be forced into a relationship with China that would preclude continued U.S. strategic cooperation with Taiwan. Thereafter, policy decisions regarding China and Taiwan must be made to conform with U.S. goals.

John J. Tkacik, Jr., is Senior Research Fellow in Asian Studies in the Asian Studies Center at The Heritage Foundation. These remarks are adapted from testimony prepared for delivery at a hearing of the House Committee on International Relations.