Tag Archives: China

Alibaba and the $21 billion IPO

On September 18th, Alibaba is expected to complete its IPO process and officially become a listed company on the New York Stock Exchange. If the company’s stock price remains in its expected range by the time it is listed, the IPO is expected to raise approximately $21 billion; the largest in US history following Visa’s $19.6 billion IPO in 2008. Before I proceed to discuss the IPO, there may be those of you who have never heard of Alibaba before and think that I’m talking about a Middle Eastern restaurant. No, Alibaba isn’t raising $21 billion to open up a new shwarma stand so let me start off by explaining what Alibaba is.

Alibaba is a Chinese e-commerce firm that was founded in 1999 by Jack Ma, who was previously an English teacher. Similar to Amazon, Alibaba operates a business-to-consumer retail website named Tmall where established companies sell directly to customers. Additionally, Alibaba also runs a website called Taobao.com, which is a consumer-to-consumer e-commerce site where individuals and small businesses sell goods to one another. Finally, Alibaba offers an electronic payment system called Alipay, just like Ebay’s Paypal. Thus, Alibaba is somewhat of a combination of Amazon and Ebay.

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The biggest difference between Alibaba and Amazon is that whereas Amazon facilitates the sale of merchandise between companies and consumers by handling the shipping, Alibaba merely brings the two parties together in an online marketplace. So it doesn’t ship anything. Amazon’s main source of revenue is the commission it charges to companies on every transaction completed through its website. However, Alibaba does not charge any commissions on Taobao. Instead, it charges sellers to advertise on the website in order to stand out among the millions of other sellers on the website and increase their chances of selling their product.

Since its founding, Alibaba has been growing at a rapid pace and has gained control of 80% of the Chinese e-commerce sector. Currently, the company is extremely profitable and nearly unchallenged in its hegemony in China. In the 3 months ended June, the company’s net income increased to $1.1 billion, 42% more than the net incomes of Amazon and Ebay combined. To look at a statistic further up the income statement, Alibaba’s EBITDA margin in the latest quarter was 54% compared to Ebay’s 26.7% and Amazon’s meager 5.7% Currently, the company is owned by Jack Ma, Joe Tsai, who is the vice president of Alibaba, and various other investors including Yahoo who made a very profitable investment in the company by purchasing a 40% stake back in 2005 for only $1 billion.

Here is a short video by the New York Times that gives some more information on the company.

Besides efficient management and a determined vision, Alibaba’s success can be traced to two important factors present in the Chinese economy. First off is the rise of the Chinese middle class. While Chinese income per capita may still be lower than other developed economies due to its large rural population, it can’t be denied that the Chinese are getting richer. As the graph below shows, disposable income has been growing at a steady pace in line with the nation’s economic growth. In January of this year, disposable income rose 9.7% on an annual basis and reached 26,955 yuan. Thats about $4400.

china-disposable-personal-income (1)Yes you’ve probably heard stories and read on this blog that the growth in Chinese economy has been slowing down when compared to its past pace. However, incomes in China continue to rise and the middle class continues to mature. That means that the Chinese are willing to spend more, especially on higher quality retail goods that can be found on Alibaba. The rise of the middle class in China also means that internet usage is increasing rapidly, something that is vital to Alibaba’s business. As more of China’s 1.3 billion population gain access to the internet, the more that Alibaba’s revenues are likely to increase. Here’s an infograph provided by the China Information Network Center that depicts the increase in internet usage across China. As you can see, although internet usage is frequent in China’s large coastal cities, it is rapidly spreading to the Chinese countryside. With a consumer base that is already unmatched in size, Alibaba can expect to be even more profitable as more people in China gain access to the internet.

Alibaba_china-map

The other reason why Alibaba and e-commerce has been so successful  in China is because of the lack in the physical retail market. Despite being greatly populous, China’s less developed cities do not have the large shopping malls and well known brands that larger cities such as Beijing has.  This is where Alibaba steps in. The company creates a bridge between the hundreds of millions of Chinese who want to spend their money but want to purchase something other than cheap replaceable products.

As the video stated, Alibaba is set to be valued at approximately $167 billion if it is listed at the expected share price between $60-65. Here is a graph provided by Bloomberg that compares the expected IPO valuation of Alibaba to other tech companies.

Ali baba infographAlthough $162.7 billion is a lot of money, analyst actually believe that Alibaba is set undervalued and set to enter the market at a discount. Market capitalization (a means of measuring the market value of a company) is calculated as share price multiplied by the number of shares outstanding. Thus, it can change as soon as the company becomes public and starts to trade. However, experts had expected Alibaba to enter with a market value closer to $180 billion. The reason why Alibaba wishes to enter the market at a relatively undervalued price is because Jack Ma wants to avoid the Facebook pitfall. Facebook was valued at $200 billion at the time of its IPO. This was an overvalued price for the company as its price plummeted after the IPO and didn’t reach its IPO price until a year later.

2123372283So should you buy into Alibaba as soon as it hits the stock markets? Is it worth committing your retirement money into an e-commerce company run by the Chinese Steve Jobs? As successful as Alibaba is and is set to be, I maintain the same opinion about IPOs as I did at the time of Twitter’s IPO. While you can check out the video below that explains why Alibaba would make a great investment, it is wise to stay weary of IPOs for the first few months. That is because generally, many institutional investors and preferred shareholders make deals with companies to hold their stock for a certain period of time following the IPO. After that period passes by, many of them dump their shares, lowering the price of the stock. So, as you listen to the following video about why Alibaba is a great buy, I recommend that you give the stock time to find itself in the market. If the fundamentals of the company are strong, you can still make a buck off of it if for the next several years even if you enter a couple months late.

“I’m not a tech guy. I’m looking at the technology with the eyes of my customers, normal people’s eyes.”
-Jack Ma

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Hard Landing?

Over the past month, the Chinese economy depressed global markets with several negative figures. In a global economic climate where slow and sluggish growth is starting to be accepted as the new normal, China has always been the safe haven of dependable robust economic expansion. However, the pace of China’s growth has slowed over the past several years and the data received over the past month has spooked investors that China’s transition from a developing to a developed economy may end in a massive failure. To put it into simpler terms for you movie fanatics out there, China’s economy is like the bus driven by Keanu Reeves in the hit thriller Speed. If it slows down below a certain speed, it will explode and end horribly wrong for everyone on board. For those of you who haven’t seen it, here is a summary of the movie in 5 seconds. The following video may contain some explicit content.

China may not have one of the most untalented actors in Hollywood to keep its economy in the right pace, but it does have the Chinese Communist Party in sole charge of the Chinese economy. Will they keep China on course? We’ll have to wait and see. I will discuss my own analysis and opinion on the state of the Chinese economy soon, but first let’s discuss the data that filled the tickers with red arrows over the last month.

The first data point is retail sales, which displayed a year-over-year increase by 11.8% in January and February and combined. 11.8% growth may seem to be a tremendous figure, but take a closer look at the graph below and you will notice that it is quite low compared to historical data. In fact, I failed to find a graph that goes back that far, but 11.8% is the slowest pace of increase in Chinese retail sales since 2004. Some experts have speculated that Chinese Premier Li Keqiang’s recent movement to crack down on corruption and extravagant spending is the reason for declining consumption. I will soon explain why I don’t think that is the main reason.

china-retail-sales-annual

The second data point which also added to the panic regarding China is industrial production. Chinese industrial production witnessed a 8.6% year-over-year increase in January and February combined. Once again, 8.6% is a dream figure for most developed nations but as the graph below proves, China has been accustomed to rapid industrial growth over the past several years. The latest figure of 8.6% is the slowest figure that China has seen since 2009. Another disappointing figure from the Chinese.

china-industrial-production

Continuing the negative trend, on March 8th, it was announced that the consumer price index (CPI), which is a general indicator of inflation, expanded by a meager annual rate of 2% in February. Like many nations, following the financial crisis of 2008, the Chinese government opened the floodgates and unveiled a large monetary stimulus package to revitalize their economy. Even though they succeeded in keeping the economy on the path of rapid growth, inflation rose significantly throughout this period. As the graph below shows, inflation peaked at around 6% in 2011. However, it has consistently fallen since that year and has reached an alarming rate of 2%. Why is deflation alarming? If consumers are aware that prices are rapidly dropping, they will save and prefer to consume in the future. This is because they are aware of the fact that in a deflationary climate, their money will be worth more tomorrow than it is worth today. Why buy a BMW today when you know the price will drop tomorrow; right? A decrease in consumption due to deflation can lead to a slowdown in economic growth, which is what investors fear might happen to Chinese economy. (On a side note, this is also becoming a serious problem in the Eurozone as well)

china-inflation-cpi

Finally, on March 7th, Shangai Chaori Solar Energy Science & Technology, a solar-cell maker, became the first Chinese company to default on its corporate bond, adding to the scare about the Chinese economy. After being bombarded with a heap of bad news from China, pessimistic investors responded as emotionally as Keanu Reeves, and rushed to sell their Chinese stocks.

So what is the current condition of the Chinese economy? The economy is the foundation of the Chinese Communist Party’s (CCP) authoritarian rule over China. Their largest way of affirming their rule has been that they have been able to engineer rapid economic growth and transform China from a poor rural nation to an urban developed nation. Given the importance that the CCP has placed on the economy, if it falters, then the government is bound to lose its legitimacy to a certain point. Before we determine if the CCP will be able to keep the bus that is the Chinese economy at the right speed, we have to take a closer look at the key characteristics that define it.

So what is the current condition of the Chinese economy? The economy is the foundation of the Chinese Communist Party’s (CCP) authoritarian rule over China. Their largest way of affirming their rule has been that they have been able to engineer rapid economic growth and transform China from a poor rural nation to an urban developed nation. Given the importance that the CCP has placed on the economy, if it falters, then the government is bound to lose its legitimacy to a certain point. In order to determine if the CCP will be able to keep the bus that is the Chinese economy at the right speed, looking at a few data points isn’t enough. We have to take a closer look at several important trends on a larger scale.

Urbanization

The Chinese economy has been in the process of maturing for over two decades now. Throughout this period, it boomed in two ways; by developing the country’s underdeveloped infrastucture (ie. roads, bridges, telecommunicaiton), and by putting underemployed peasants to work in better jobs at urban factories. Just like in England during the Industrial Revolution, a rural and isolated low income nation has been on the path to become an urban and middle class nation that is connected to the rest of the world. Initially, this process yields incredible economic growth as the rural population, especially in a country with such a large population as China, urbanizes and occupies jobs in more productive sectors such as services, technology and industry. To stay consistent with the Speed references, China’s rural population is the gasoline that keeps Keanu’s bus running. However, China is approaching what is know as “the Lewis turning point”, which is the point when underemployed farmers have already left the farms and new immigrants to the cities do not add to productivity. The slowdown in China’s population growth has had a big effect on the gradual decline in urbanization. Mao Zedong, renowned Chinese historic leader, encouraged Chinese woman to have six children, which boosted the Chinese workforce in the 1980s and 90s. After Mao’s death in 1976, party leaders turned against his ideals and institute the One Child Policy in 1979. The result of this policy is that only 5 million people between the ages of 35-54 will join the Chinese labor force this decade, versus 90 million in the previous decade. Many factors about the Chinese economy remain a mystery, but one thing is certain, China’s fountain of youth is about to run dry.

china-economy-working-class-production-line

Cheap Labor

Mass urbanization of rural Chinese workers to the cities also allowed the Chinese economy to take advantage of cheap labor costs. Because these workers used to barely make a living in rural towns, they were willing to work for very low wages in the early stages of China’s transformation. However, the transformation process is reaching its latter stages. Cheap labor costs used to be the main reason why China attracted so many foreign companies and was able to maintain its status as a net exporter. “Losing jobs to China” was a phrase used by many Western politicans. But now, the cost of labor in China has risen compared to other developing east Asian countries such as Bangladesh and Indonesia, and skeptics believe it is a matter of time before China loses its advantage on labor. The graph below displays the steady rise in Chinese manufacturing wages since 1998.

china-wages-in-manufacturing

Consumption

Many economists agree that as China’s economy matures, it will be rely less on exports and will instead be driven by domestic consumption. This belief draws its roots from the idea that until now, personal savings have been intentionally raised by the govnerment in order to fund the spending on large scale investment over the past decade. Once the savings rate drops, China will export less but the Chinese people will spend more. I approach this idea with suspicion. Over the last 30 years, Chinese consumer spending has increased at almost an average rate of 9%. This rate faster than the rate generated by Taiwan and Japan dring their peak growth years. China may also be known for being home to many cheap knock-off brands but global luxury brands are now operating in China as well. In 2010, Rolls Royce sold more cars in China than it did in Britain for the first time. In my opinion, the data just doesn’t prove the notion that the Chinese government has been intentionally keeping consumption down. If the consumption is forecasted to make up for the recent drop in Chinese investment and industry output, then recent indicator pointing to a slowdown in retail sales could be a major issue for future Chinese economic growth.

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The Future

China is much diferent than the country it was just severaly years ago. A significant Chinese middle class has emerged risen and now demands better social services, cleaner air and less political corruption. Due to the slowing economy, the CCP consistently has set a lower target for the annual GDP growth rate, with the latest being at all time low of 7.5%. In the latest annual session of the National People’s Congress, premier Li Keqiang placed economıc growth as a secondary objective and vowed to crack down on corruption and pollution. In fact, looking at China reminds me of Japan in the 60s and 70s. Following WW2, the Japanese economy also grew at a rapid pace and was also driven mainly by exports. Many Americans feared of Japan ovepowering the United Stats on the global economic stage. However, Japan was forced by the United States to appreciate its currency against the US dollar, which contributed to Japan’s gradual slowdown and eventual economic crisis.

In all honestly, I do not understand the mystery behind the future of the Chinese economy. The pessimists are as wrong as the optimists. China is obviously in the middle of transforming from a developing market to a developed and matured economy. Thus, China still has a lot of room to grow, albeit at a slower rate.  Low inflation also means that the Chinese Central Bank has more room to expand the economy with monetary easing. The recent data are symptoms of this transformation and the fact that the state is gradually releasing its hold on the economy and allowing more free market functions to operate. The default of Shanghai Chaori Solar Energy is a sign that free market principles are gaining a foothold in the Chinese economy. This is a very small company, and in an economy dominated by companies propped up and supported by the government, a bond default is a good sign. The days of +10% Chinese growth are past us.  If China moves to a 6-7% growth rate in the coming years, it might appear that China is entering a recession. However, this will hardly be a cataclysmic event. The Chinese economy is now so big (over $9 trillion) that even at a 6% growth rate, China will still be the largest contributor to global growth in the upcoming years.

breakout-nations_apr172

On a final side note, I gathered much of the information and developed my personal opinion on the Chinese economy after reading Ruchir Sharma’s book, Breakout Nations. I advise you to read through it if you want to get a better understanding of the countries that are seen as the next big players on the global economic stage.

“The biggest problem with China’s economy is that the growth is unstable, unbalanced, uncoordinated and unsustainable.”
– 6th Chinese Premier Wen Jiabao (2008)

Emerging Markets in Emergency Mode

Despite how much we prayed for a peaceful and prosperous year, 2014 has started off with a crisis; this time in the Emerging Markets. In a previous Economy in Digits post, I had discussed how India and Turkey had responded to large losses in the value of their currencies by raising interest rates. In the following days, the sell-off in stocks and currencies extended to other Emerging Markets. If you’d like to get a better understanding of Emerging Markets, feel free to check out one of my earlier posts regarding upcoming Emerging Market elections, which I will touch on shortly. As you can see from the following graph provided by Bloomberg, the MSCI has been performing very poorly. Lets take a look at what is causing all this mess in the countries that not so long ago were deemed to lead the world out of the global economic crisis.

emerging markets index

The first reason for the rapid sell off of Emerging Market stocks is a topic that my regular readers might be getting sick of hearing, but its tapering. The main reason why most Emerging Markets fared so well after the economic crisis of 2008 was that central banks in developed nations pushed interest rates to almost 0%. Seeing as how they would make almost no money on investing in developed countries, investors sent their money to do its magic in Emerging Markets where interest rates are higher. Combined with an increase in price of global commodities, which is an important source of income for many Emerging Markets, the inflow of foreign funds caused Emerging Market economies to skyrocket. However, in the last week of January, the FED decided to continue tapering by reducing its bond purchase program by another $10 billion. This is causing interest rates to rise in developed markets, especially in the United States. Thus, investors are now doing the opposite of what they did in 2008 and are now pulling their money away from Emerging Markets and are putting their cash back in developed markets such as the US and the UK.

Another reason why Emerging Markets are in trouble is because of China. China had been the poster child of Emerging Market success in the past several years. However, as the country reaches a limit on urbanization and its population transitions from rural to middle class, the government has had to enact reforms that inevitably slow down the Chinese economy. Combined with the fact that the Chinese government has also tried to reduce credit in the Chinese economy due to fears of a credit bubble, some investors now fear of a “hard landing” for the Chinese economy. These fears were strengthened in the final week of January as Chinese officials announced that the country’s Purchasing Mangers Index (PMI), a monthly manufacturing report that surveys private manufacturers, contracted for the first time since 2008.The reason why China is so crucial to other Emerging Market nations is that China is one of the world’s largest importer of commodities. On the other hand, most Emerging Markets are net exporters of commodities. Thus a slowdown in China would mean less demand for commodities from other Emerging Markets, causing a chained slow down across all Emerging Market nations. Here is a video that further breaks down whats going on in China.

Finally, we have the isolated incidents across individual Emerging Markets. In an earlier post, I discussed the political crisis created from a corruption probe in Turkey and rampant inflation in India. However, other Emerging Markets have also had their own troubles. Thailand has been in social and political turmoil since November of last year. Protesters have taken to the streets across Thailand to force Prime Minister Yingluck Shinawatra to resign and postpone the elections that was supposed to occur in the beginning of this month. Protesters see Mrs. Yingluck’s regime as corrupt and wishes her to reform the Thai political structure before elections are held again. In fact protesters managed to postpone the elections which were planned on February 2nd. To learn more about the events in Thailand, feel free to read more about it on the BBC.

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To make matters a tad bit worse, as if it wasn’t bad enough already, the Argentinian economy is rapidly deteriorating. On February 13, Argentinian inflation was announced to be at 44%. That is at levels where one would call it hyperinflation. Argentina had once been a prosperous nation. But a crisis in 2001 has left it with naively populist governments that have slowly shut itself out of global capital markets. The gradual downfall of the Argentinian economy is an issue I will cover in another post but for now check out this post by the Economist to get a better understanding.

So what happens now? Are Emerging Markets doomed for eternal decline? First of all, even though most people like to lump all Emerging Markets together, not all countries are the same and not all have suffered greatly over the past couple of months. In fact, in January, shares in the MSCI Indonesia rose by 4.6% while the market in the Philippines gained 2.4%. These countries have done well to turn the money that was invested in their economies into long term growth opportunities that improve their trade balances over the long run and increase the education and productivity of their population. However, many of the Emerging Markets  that experienced rapid economic growth in 2010 and 2010 were fueled by short term foreign investments and increasing consumer demand which required constant to satisfy. As foreign investors pull out and domestic demand cools, these economies will start looking back to 2010 and 2011 as the glory years of the past. Countries such as Turkey, India and Brazil, which were on the verge of double digit growth back in those years will now find it difficult to reach 4% let alone 5% growth. Even though Emerging Markets may not collapse and fall out of favor with all investors, I think the markets in these nations will revert to a new normal which is slower growth.

“So much of what happened to India late last year and early into 2011 is the same story we’ve seen with other big emerging markets, and that is that investors started to realize that the growth trajectory in India would have to get moderated by tightening policy.”
-Jerrry A. Webman

The Economy in Digits – 12/28/2013

Welcome to this week’s edition of the Economy in Digits. Without further adieu, here are the economic highlights from the week ending December 28th.

United States

Pending home sales, which measures contracts to purchase previously owned sales, rose less than forecast in the month of November. Pending home sales rose only 0.2% whereas economists had predicted a rise of 1%. This indicates that rising borrowing costs due to the FED tapering its asset purchases is resulting in a slowdown in the residential real estate market. When compared with the previous year, pending home sales have fallen 4%. The graph below displays an aggregate of 30 year mortgage rates in the United States. As you can see, mortgage rates dropped after 2008 but have recently been picking up.

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Since the start of the financial crisis, the US government and the FED had been artificially supporting the housing market. For example, the FED’s Quantitative Easing program had been purchasing $40 billion of mortgage backed securities since last year, leading to an artificial decrease in mortgage rates. The recent indicators displaying a slowdown in the housing sector points to the fact that the housing market is returning to its fundamental levels instead of being inflated by external factors.

Japan

In response to Prime Minister Shinzo Abe’s expansionary monetary and fiscal policy, Japanese inflation (measured by the Consumer Price Index) increased by 1.2% over the previous year, which is the largest increase over the last 5 years. In an effort to bring Japan out of a two decade long era of slow growth and deflation, Shinzo Abe promised to stimulate the Japanese economy and increase inflation with massive fiscal and monetary easing. The recent inflation figure indicates that Abenomics, as some have labeled this policy, seems to be working. The graph below depicts Japanese CPI since 2010.

japan-consumer-price-index-cpi

But as I had stated in the previous Economy in Digits post, not everything is clear sailing for the land of the rising sun yet. Monetary and fiscal stimulus devalues a nation’s currency. This usually has the effect of increasing exports. But because Japan imports a majority of its energy, devaluing its currency has the effect of increasing the value of its imports too. Additionally, the Japanese government is expected to implement a tax hike later this year which could weaken demand and bring inflation back down again.

China

Ever since the Chinese Communist Party first started opening up China’s economy to the world and adopting free market principles under the leadership of Deng Xiapoing in the 1908s, China had been experiencing extremely rapid growth,  As you can see from the graph below GDP growth had been almost 10% on average over the last decade. But over the past few years, as China enters the final stages of its transformation from a rural to an urban economy and implements the reforms to become a middle class nation, its economy has started to slow down. With that in mind, the Chinese government announced last Tuesday that their target GDP growth for 2014 would be 7.5%. As you can see from the graph below, if you exclude the crisis of 2008, 7.5% is lower than the growth numbers that China used to produce in the past. However, Chinese President Xi Jinping has promised to continue to reform the Chinese economy and the Chinese society. In line with that promise, Chinese officials have stated that they are confident that maintaining a 7.5% growth rate will help keep creating more jobs, while providing room to deepen reforms as well.

china-gdp-growth-annual

That is all for this week ladies and gentlemen. I was late in posting this week’s Economy in Digits due to an exam I had to take on Sunday. But I can assure you that it won’t happen again. So tune in next Saturday for the upcoming week’s economic indicators.

“The economy isn’t some vengeful being that takes things away from us. The economy is just made up of people, and people have just lost their faith in it. What people really should be doing is spending more. Spending is fine. People should just go outside. People should just go outside. They should buy the things they need for their friends and family”
Kyle Broflowski

Pacific Theater – Japanese PM Visits WW2 Shrine

Last Thursday, in continuation of his hawkish foreign policy and his disinterest to remedy Japan’s reputation for its acts in World War 2, Japanese Prime Minister Shinzo Abe visited the Yasukuni Shrine in Tokyo. The Yasukuni Shrine honors Japanese World War 2 veterans, including several convicted Class A war criminals, and is a blatant representation of Japan’s militaristic and imperial past. As I had explained in an earlier Pacific Theater post, Imperial Japan attacked and invaded most of the Pacific nations during World War 2. Considering the fact that World War 2 ended less than 60 years ago and that Japan still has yet to claim full responsibility for its past, most of Asia is still agitated with Japanese government.

Shinzo Abe (middle) at the Yasukuni Shrine
Shinzo Abe (middle) at the Yasukuni Shrine

Obviously, this action drew reactions from Japan’s neighbors. The first statement came from China, Japan’s main pacific rival.

“Under these conditions, not only does the Japanese leader not show restraint, but instead makes things worse by manufacturing another incident over history and creating a new political obstacle to the improvement and development of relations between the two countries. Japan must bear all the consequences arising from this.” stated Chinese Foreign Ministry Spokesperosn Qin Gang.

The United States was also frustrated with the Japanese government. Even though the two nations are close allies, America views these kinds of actions by Japan as threatening to the stability of the region.

“The United States is disappointed that Japan’s leadership has taken an action that will exacerbate tensions with Japan’s neighbors,” a statement posted on the website of the U.S. embassy in Tokyo said.

Finally, a statement came from South Korea as well.

“Our government cannot but deplore and express anger about Japanese Prime Minister Shinzo Abe’s visit to the Yasukuni Shrine despite concerns from neighboring countries and the international community,” said Yoo Jin-ryong, a South Korean spokesman.

The most likely reason why Shinzo Abe could have decided to visit this shrine is to appeal to his base. Shinzo Abe draws most of his support from the hawkish conservatives of Japan. Over the last year, Abe spent a lot of political capital to implement various economic reforms. So, this is an act of appealing to his base. The following video of  Pacific research expert on CNN breaks down Abe’s motives in greater detail.

Shinzo Abe also has also declared to reform Japan’s pacifist constitution. After its loss in World War 2, Japan had its constitution written by the United States, which limits the size of Japan’s military and the portion of the budget the government can allocate to defense spending. In order to increase Japan’s geopolitical sway in the Pacific, Shinzo Abe has promised to scrap the old constitution and write a new one.

As Japan continues to try and flex its muscles, it will be interesting to see what kind of results they achieve and how the rest of the Pacific reacts. Stay tuned for more updates on the Pacific Theater.

“The must unfortunate war[WW2] which I deeply deplore”
-Emperor Hirohito of Japan

The Pacific Theater – Chinese Show of Forces Displeases Japan and the United States

Welcome to the first post of the Pacific Theater, a new recurring segment regarding the geopolitical events currently unfolding between the nations of the Pacific region. I’ve decided to take a distinct look at this region for a couple of important reasons. Firstly, the 3 largest economies in the world: the US, China, and Japan; are all located in this region. Although many people might not consider America as a Pacific nation, its influence and power extends deeply into this corner of the globe. Even though all three nations have strong economic ties with one another, they each have different geopolitical ambitions. Secondly, ever since the debate regarding the Diaoyu/Senkaku Islands began between China and Japan over a year ago (which I will discuss soon), the tensions  between the countries in this region have been increasing at a gradual pace. Thus, it’ll be very interesting to see how events unfold in this part of the world. Before we get into the latest news however, let me give you a brief history lesson.

Relations between Pacific nations have always been uneasy and the history of the region has been riddled with tension and conflict; so much that it would put Brazilian soap operas to shame. To get a better understanding of the region, it is crucial to learn more about 3 significant historical events.

1) Japanese Incursions and Hostilities – Japan had been an empire from 1889 to 1945 when it was defeated in World War 2. As you can see from the map below, during World War 2, Japan invaded pretty much  all of the its east Asian neighbors. It was especially brutal in its invasion of China where just in Nanking, Japanese soldiers killed somewhere between 250,000 to 300,000 Chinese civilians. However, that was not Japan’s only show of hostility to its Pacific neighbors. In fact throughout its history, Japan had been at war with its neighbors, especially China and Korea, many times. I think you’re starting to see a pattern here. Japan is pretty much the Germany of the Pacific and most Pacific nations are still upset at all the havoc and destruction that Japan has caused in the past. The fact that some government approved history books in Japan don’t recognize their country’s actions during World War 2 and that the Japanese government has yet to properly apologize for those acts does not help their reputation at all. Thus, there is still unease between Japan and other Pacific nations that stem from the past.

The height of Imperial Japanese control during World War II

2) The Korean “War” – The Korean War was fought from 1950 to 1953 between the Communist nations of North Korea and China versus South Korea and the United Nations. The official war resulted in stalemate which led to the current borders of Korea. However, the two sides are still unofficially at war. North Korea is still a closed totalitarian dictatorship led by the ever handsome and charismatic Kim Jong-Un who promises every now and again to rain a fiery death upon South Korea and the United States.

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The only thing stopping a war between the two sides is the fact that the United States and South Korea are strong allies and the US has pledged to support South Korea against any possible force of hostility by North Korea. However, North Korea’s only ally and trading partner in the region is China, creating an even additional layer of awkwardness in the Pacific.

3) Chinese Claim on Taiwan – The Chinese Civil War was fought from 1927 to 1950 between the Communists and the Nationalists. The war resulted in a victory for the Communists when the Nationalists where driven out of mainland China to the island of Taiwan in 1950. Since then Taiwan has become its own nation. However, it is still not recognized by China and many other nations. Both countries in fact claim to be the actual China. The (mainland) Chinese have always had their eyes set on retaking Taiwan by force. However, just like in Korea, because Taiwan is a liberalized democracy, it is an ally of the United States. Thus, any war against Taiwan would also drag the United States into it as well. Now you might get a better sense of why I believe that the United States is one of the crucial Pacific nations. No major event or war can take place in the region without the United States’ involvement.

Recent Events

There is an island chain located between China, Japan and Taiwan called Senkaku in Japanese and Diaoyu in Chinese.  Even though the islands were first discovered by the Japanese, throughout the history, these islands have been continuously disputed between China and Japan. The area surrounding the islands is rich in fishing areas and possibly oil. Up until recently, the islands had a private owner. However, on April 2012, Tokyo governor Shintaro Ishihara announced that he would use public funds to buy the islands. Of course the Chinese were outraged and a nationalist anti-Japanese sentiment started to develop within China. Some Chinese nationalists even called on a boycott of Japanese goods and tried to slander Japanese products. The Chinese government saw this as a provocation and set out to undermine Japan’s control of the islands through incursions of surveillance vessels and patrol aircraft; to which Japan responded by scrambling fighter jets. Recently an unmanned Chinese drone flew over the islands. When Japan threatened to shoot down the next one, a Chinese general said that would be an act of war.

I told you this was just like a Brazilian soap opera.

map-locating-disputed-south

Fast forward to November 23rd of 2013, when, in effort to retaliate against the Japanese and further increase its military influence on the global stage, China declared a large portion of the East China Sea to be part of its “Air Defence Identification Zone” (ADIZ). According to Chinese officials, all aircraft that intend to enter the zone must file flight plans with the Chinese authorities and maintain communications with Chinese controllers or face “defensive emergency measures”. The map below displays the area that China claims as its ADIZ.

_71299031_china_sea_dispute

As you can see, the AIDZ clearly includes the disputed Senkaku/Diaoyu islands. The area also runs awfully close to Taiwanese and South Korean territories, causing these two nations to be spooked as well.

In an act of defiance, just 3 days after the Chinese introduced the ADIZ, the United States flew two B-52 bombers over the Senkaku/Diaoyu islands within the ADIZ. Suddenly, the United States had entered into the fray to protect the freedom of movement and to curb Chinese ambitions. Then, earlier in December, US Vice President Joe Biden traveled to China to meet with Chinese President Xi Jinping and told him that the United States does not recognize the Chinese ADIZ. However, the Chinese did not seem to budge. On a side note, it is so assuring to know that the negotiations to defuse tensions among the world’s most powerful nations are being handled by a man renowned for his gaffes. If you have 5-6 minutes to kill for a good laugh, enjoy Biden’s gaffe reel.

Response to the ADIZ by other Pacific nations have also been in a militaristic manner. On December 8th, to respond  to the Chinese ADIZ, South Korea declared its own ADIZ. Just like the Chinese ADIZ covers disputed territories with Japan, the South Korean ADIZ covered disputed territories with China. Similarly, Japan announced this Tuesday that it would invest 24.7 trillion yen ($240 billion) over the next 5 years on purchases of stealth fighters, submarines and drones. Japan’s military has been pacifistic and almost non-existent since World War 2. However, recently elected hawkish Prime Minister Shinzo Abe has stated that he wants to normalize the military of Japan. In recent years, China’s increase in defense spending has been in double digits, and as China starts throwing its weight around both economically and militarily, it won’t be a surprise to see neighboring countries strengthen their military and territorial claims as well.

On the positive side, most of these nations are crucial trading partners. So any type of direct military conflict would hurt everyone involved. Thus, the chance of an actual war is quite slim. Nevertheless, it will be very interesting to see the next step in the chess match between these Pacific powers. Stay tuned for more.

“The vast Pacific Ocean has ample space for China and the United States. We welcome a constructive role by the United States in promoting peace, stability and prosperity in the region. We also hope that the United States will fully respect and accommodate the major interests and legitimate concerns of Asia-Pacific countries.”
-Xi Jinping