Fractures and Fealty

Australia should deploy to the Red Sea – but for the right reasons, with record low real yields Bank of Japan triggered capital flight, Quad adrift after Biden’s India no show.

Jan 06, 2024

UPDATE: The economic arguments for protecting trade from modern-day marauders such as the Houthis are far more compelling than loyalty to the alliance. It is worth considering when exactly deploying our military assets in Australia’s interests becomes a test of fealty to the US, and an act of “mateship”.

The yen's key drivers are so weak the currency is comparable to the Turkish lira and Argentine peso, Deutsche Bank said. Japan has record low real yields due to the central bank's refusal to tighten policy, an analyst said. The country's balance of payments are also weak as the Bank of Japan has triggered capital flight.

With US President Joe Biden not able to make it to India in late January, a visit that was tied to the proposed Quad Summit, the exclusive clique's high-profile grouping of the US, Japan, Australia and India is facing renewed crisis - the divergences among the four partners are coming more to the surface, while many observers question the real value of the Quad's existence, although the elevation of the mechanism had been a central feature of Washington's push to contain China.

America is falling into a trap. It thinks the future will be decided by military dominance, despite losing one war after another. China, on the other hand, recognises that the future will be decided by economics. (A repost from October 2023).

Australia should deploy to the Red Sea – but for the right reasons

By Geoff Raby

The economic arguments for protecting trade from modern-day marauders such as the Houthis are far more compelling than loyalty to the alliance. It is worth considering when exactly deploying our military assets in Australia’s interests becomes a test of fealty to the US, and an act of “mateship”.

The Australian government is being pounded by the federal opposition, pro-US think tanks, and some media for not sending a single ship to help out the international naval coalition in the Red Sea facing down the rising Houthi attacks on commercial shipping with the connivance, perhaps even the encouragement, of Iran.

The car carrier Galaxy Leader was seized by the Houthis in November, beginning their offensive against international shipping. Gettynone

Occasionally, the attack on the government is framed around higher energy prices from increased transport costs from the extra transit time if shipping needs to divert around the Cape of Good Hope. This targets populist concerns that the costs would feed into higher prices, fan inflationary pressures and – the clincher – delay long-hoped-for interest rate cuts. It surely won’t be long before the opposition will be linking the government’s pusillanimity to stubbornly high interest rates.

A bigger issue, however, is at stake. In 1968, US economic historian Douglass North published a paper on the costs of piracy and the rise of the North Atlantic economies, and thus the creation of the modern world.

In the paper he argued that, during the 18th century, state action to eradicate piracy across the Atlantic did more to promote sustained economic growth than technological change. The argument was based on analysis of transaction costs. Piracy increased the cost of shipping, sometimes to prohibitively high levels. To the extent that such costs could be reduced, economic growth would follow. Transaction cost analysis was an audacious challenge to economic orthodoxy at the time he published his paper.

With this, the New Institutional Economics theory was launched for which, decades later, North was awarded the Nobel Prize in Economics. In the ideologically manacled world of economics during the Cold War, North and the New Institutional Economics school identified the positive interplay between the state and the private sector in promoting economic growth which today is now largely taken for granted.

The opposition and hawkish think tanks hopefully may come to understand that security is about making rational choices.

The state, it turns out after all, had a valuable contribution to make towards prosperity beyond security, macroeconomic management, and ensuring competition in markets.

The case then for contributing to the collective effort against piracy or terrorist disruption to Red Sea shipping would be much more powerful if argued along the lines of transaction costs and associated systemic risks, than management of the US alliance relationship or easing inflationary pressures. The long-term health of the international economy depends largely on continuing efforts to reduce transaction costs to support economic growth.

As Eric Jones showed many years ago in a seminal book, Growth Recurring, economic growth is the normal situation. It is only where high transaction costs occur through such things as in the example of piracy or rapacious government that the inherent tendency of economies to grow is snuffed out.

So, the government’s judgment whether to support the international coalition against attacks in the Red Sea should be a no-brainer. It is actually akin to an aspect of microeconomic reform, about which the government seems particularly shy: reform is intended to reduce transaction costs, usually from past bad interventions by government.

John Lee in these pages recently, in an eloquently argued piece, put forward the case that Australia should surrender even more of its sovereignty to the US than it has to date as insurance that the US – thus by implication, inherently unreliable – will turn up in our time of exigency. On this view, the Albanese government should have immediately agreed to contribute to the coalition forces no matter what.

Shadow of Iraq

This is how the argument has been framed by the opposition and hawks alike, but it would be for the wrong reason. Sensibly, the government most likely could see that this would not go down well within sections of the Labor Party and the electorate without a clear articulation of what interests are in play. The shadow of the flawed and failed invasion of Iraq hangs over all of this.

Alliance maintenance is a factor but should not be the sole determining one. Public discussion has become muddled on these critical security issues by invoking the US alliance and phoney “mateship” on all occasions and by not articulating a clear position on Australia’s interests. We should have been in, but not for the alliance.

The excuse of not joining for the lack of ships is hardly credible. A cursory stroll around Sydney’s Garden Island dockyard makes a mockery of that assertion. The argument that the Royal Australian Navy is fully occupied doing good work keeping vital shipping lanes in the South China Sea and Taiwan Strait open is specious.

As has been argued over again, and never answered, China is not about to disrupt shipping lanes that supply it with inputs it needs to keep its economic engines humming and its people fed. And as international editor James Curran pointed out in these pages, the China threat is asserted but never established.

China’s recent bruising encounters with the Philippines in the South China Sea do not threaten Australia’s economic interests. It is not a justification for tying up Australia’s naval assets. And even if it were, it is most unlikely to change anything. A resolution to tensions between China and the Philippines will only occur bilaterally between them. In view of the huge power imbalance, when it comes we most probably won’t like it, but that is the real world. It will be enough for the Philippines to find some advantage in it.

Whatever the constraints on Australia’s contributing assets to the international efforts in the Red Sea, this episode is a handy reminder that even for the Australian Defence Force resources are limited and that therefore policy has opportunity costs.

Decisions to join the US in freedom of navigation exercises in East Asia, where the threat is mainly to US primacy rather than Australia’s interests, have now come at the cost of this country not being able to contribute assets where they are needed to defend our real interests. The opposition and hawkish think tanks hopefully may come to understand that security is about making rational choices. Some training in economics might help them.

Quad adrift after Biden’s India no show

By GT staff reporters

Last month, Japanese media outlet Nikkei Asia, citing a senior US official, revealed that Biden would not travel to India this January due to the "tight political calendar."

On Tuesday, the Indian media outlet ANI published an interview with the country's External Affairs Minister Subrahmanyam Jaishankar, who said that Biden's visit was tied to the proposed Quad Summit and indicated that the dates did not work with all partners.

Titled "Stars not aligning: Quad summit in doubt for second year running," a news report by Australian media outlet the Sydney Morning Herald on Tuesday said that preparations were under way for Indian Prime Minister Narendra Modi to host Australian Prime Minister Anthony Albanese and the other Quad leaders on January 27, but those plans were ditched after Biden declined an invitation to travel to India.

The news report questioned Quad's ability to serve as a democratic bulwark against China.

This is not the first time the Biden missed the Quad group. The previous Quad summit, scheduled to be held in Sydney in May 2023, was canceled at the last minute when Biden withdrew because of the US debt ceiling crisis, leading to a makeshift leaders' meeting being organized on the sidelines of the G7 Summit in Hiroshima, according to the Australian media outlet.

As the US has stepped into its election year, the only matter of importance for Biden now is the election, multiple Chinese observers told the Global Times on Wednesday.

"Now that it is an election year, I tend to believe that Biden does not pin his hope of leveraging diplomatic measures to improve his chances of winning the race," said Lü Xiang, a research fellow at the Chinese Academy of Social Sciences.

He said that before Biden was elected, he was considered a senior politician with a lot of experience in diplomacy and was expected to achieve great things in this area. However, since taking office, he has faced one diplomatic failure after another.

"During a term in office, a president always wants to make some new stunts. In normal operations, initiatives like Quad summits can work, but now that Biden is facing the life-or-death situation of his political career, these initiatives are nothing to him," the expert said. He pointed out neither the Quad nor the Indo-Pacific framework can increase Biden's chances of an election victory, so Biden will abandon it at least for now.

That Quad summit has to be canceled for the second time because of Biden is a huge blow to the exclusive clique which has a central feature of Washington's push to suppress China in the Indo-Pacific, observers remarked.

"US diplomacy will be in a relatively frozen state during this election year, and it will be difficult for the US to maintain its original status in foreign affairs," Li Haidong, a professor at the China Foreign Affairs University, told the Global Times.

If Biden is absent from the Quad summit, the momentum will dissipate and it will lose its meaning, Li noted. The Quad, as a US-led mechanism, is greatly influenced by domestic political fluctuations in the US, which requires the other three state members to remain vigilant in their commitment to the mechanism, he said.

Observers stated that Washington's aim of the elevation of the Quad was to unite the four countries to achieve a comprehensive plan of containment and suppression against both Russia and China, which is in line with US hegemonic aspirations. However, the strategic interests of the US are at odds with the other three allies and partners, especially India's.

"This reflects the fragile strategic foundation of the Quad itself," Li said.

One reason why he did not attend is obvious - going to India would indulge India's divergent actions from the US in a series of major international affairs, Li said. Especially during the Ukraine crisis, the US aimed to build a large network to contain Russia, while India's clear choice was to strengthen its ties with Russia based on its own national needs, the expert said.

"India's choices during the Ukraine crisis have embarrassed Biden, and its actions in the BRICS mechanism and non-cooperation with the US on climate change issues have also been evident," Li said.

Australia also wants to enhance its reputation and international status through this China-targeting alliance, but at the same time, Australia's economic interests are closely tied to China clearly. The US hopes that Australia will sacrifice its economic interests, but Australian voters would not agree, especially since Australia will have a federal election in 2025, the expert remarked.

Lü believes that Japan may be more enthusiastic about the mechanism, as it wants to maintain its illusion of being the "second-largest democratic economy" through this grouping.

But although it is a vassal of the US in terms of security and diplomacy, Japan also has its own national interests. The binding of Japanese politicians to Washington actually makes the Japanese people feel uneasy and unhappy, Li said.

Therefore, it is difficult for the US to obtain the benefits it desires from the Quad, according to the observers.

They pointed out that the Quad now appears more loosely connected than when it was first established, with internal contradictions and divergences at the strategic level becoming more prominent.

"This also reflects the weakening of the US' ability to control international affairs and its allies and partners, highlighting the decline of US international influence. Even if US political elites do not admit it, this is the objective reality," Li said.

Deutsche Bank Basket Cases

Japanese yen, Argentine peso, Türkiye lira

By Filip De Mott

The Japanese yen's fundamentals are so weak the currency is comparable to some of the world's worst performing tenders, a Deutsche Bank note said on Wednesday.

"A simple glance of the yen's drivers - yields and external accounts - puts the Japanese yen in the same league as the Turkish lira and Argentine peso," George Saravelos, the bank's global head of foreign exchange research, wrote in the report.

To be sure, the yen's losses against the dollar aren't nearly as steep, having dropped 15% so far this year while the lira has tumbled 51% and the peso has collapsed 97%.

But in the case of the yen, its issues are the direct result of the Bank of Japan's unique yield curve control and the central bank's refusal to lift interest rates, resulting in record low real yields, Saravelos said.

The other driver of the yen's weakness, balance of payments, is also due to the Bank of Japan, which has essentially engineered "slow-motion capital flight from domestic investors into foreign assets," he added, noting that Japanese government bonds are relatively unattractive.

"If you are Japanese, what is the point of buying a 5-year JGB with a nominal yield of 50bps when you can buy a 5-year US treasury with a real yield of 3%?" he said.

Intervention by the Bank of Japan in currency markets won't help the yen, and may actually backfire.

That's because selling dollar-denominated reserves like Treasurys would add upward pressure on US yields and boost the dollar, Saravelos explained.

"More critically it will lead to a deterioration of the Japanese government's external balance sheet and by extension its fiscal position," he wrote.

To stabilize the currency, he suggested that the BoJ should begin hiking rates and eliminate its quantitative easing campaign. Otherwise, yen volatility will increase if domestic investors start questioning the bank's willingness to act.

While Japanese authorities have recently taken fresh steps to loosen its yield restrictions, the shift has underwhelmed traders. After brief gains on Tuesday, the yen hit a new low of 151 against the dollar.

The future will be decided by economic influence, not military dominance

By John Menadue

Pearls and Irritations has posted an outstanding series of articles by Percy Allan on the so called ‘China Threat‘. He highlighted that America is deeply divided and that promoting the China threat helps unite Americans; that unlike the UK and the US, China has no imperial legacy; that unlike the Soviet Union, China is not exporting ideology; that China is concerned about managing its large ethnic and religious minorities; and that surrounded by scores of US bases, China’s military is defensive.

Most important of all Percy Allan emphasises that China’s focus is economic.

Western media including in Australia has become quite unhinged about the China threat. Our political ‘leadership’ slavishly follows Washington propaganda conducted mainly through the help of security agencies and the Five Eyes.

The China threat agencies are unwilling to stand back and consider the following.

Unlike Australia, China has land borders with fourteen countries. Protecting those borders is critical for China.

The question the anti China hawks should answer is what nations are China planning to conquer and occupy and if so, when? Japan, South Korea, Philippines, Vietnam, Thailand, Malaysia, Indonesia, Australia?

While America is stitching up military alliances, China is expanding its economic alliances especially with the Global South which is more interested in development than confrontation. There is a growing and influential world beyond the Anglosphere which we cling to.

China recognises that the future rests with the BRICS which is adding new membership. While America and its closest allies waste money on a military buildup, China is investing in economic partners.

China’s strategy is to outflank America economically, technologically, and diplomatically by making it the partner of choice for third world countries by offering them infrastructure (Belt & Road Initiative), technology (Digital Silk Road) and markets (Strategic Economic Partnerships).

By contrast America offers them military pacts to confront China since it’s too protectionist to grant them free trade, too insular to encourage US investment and too self centred to offer more aid.

America is falling into a trap. It thinks the future will be decided by military dominance despite losing one war after another.

China recognises that the future will be decided by economics, which is especially important for development in the Global South.

The US is intoxicated by its grandiose belief in its own ‘exceptionalism’. It is unable and unwilling to read the signs of the time.

For more on this topic, P&I recommends:

A repost from October 5, 2023.

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