Despite quarrels, business in Asia is brisk

SeongJoon Cho | Bloomberg | Getty Images

A state of heightened hostilities stemming from contested territorial claims and clashing strategic visions has not prevented China and Japan from raising the volume of their bilateral trade by 7.5 percent in the course of last year. The coming months could be even better: Japan's sales to China soared 20.8 percent in January from the same month of 2014.

That is a remarkable and a very encouraging signal. It shows that purely economic factors – such as China's sustained growth of domestic demand, the two economies' broad complementarities and the yen's 16 percent depreciation against the yuan in the last twelve months – have prevailed over serious security problems and the countries' increasingly competitive diplomacy with respect to regional and global issues.

Even more interesting is to note that similar tensions have not negatively affected trade relations between Japan and South Korea. Last year, their two-way trade was roughly unchanged from 2013, and the trade flows between these two countries continued to grow in January of this year.

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That is somewhat unexpected because, in addition to strained political ties, the Japanese and South Korean economies are directly competitive in all their major industries – automobiles, electronics, shipbuilding, steel and even consumer products. At the moment, the advantage is clearly on the Japanese side: South Korea's 3.4 percent economic growth last year and the yen's 11 percent depreciation against the won in the last twelve months have driven an 11 percent increase of Japanese exports to South Korea in 2014.

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So, if you think that this is a good time to leave East Asia for other investment destinations, think again. The region's three main economies – accounting for 25 percent of global output -- are showing that they know how to separate business from the legacy of political difficulties they will most probably solve in a patient and peaceful manner. Also, Japan's quick-fix export boosts are falling short, but China and South Korea are determined to support growth, employment and price stability.

VW's Chinese overdrive

Those of you who might be inclined to dismiss China's key economic policy options announced last week could gain useful insights by focusing on indicators of economic activity and structural changes designed to strengthen the forces of demand and supply in this closely managed mixed economy.

But if you want a shortcut, watch what the Volkswagen's boss Martin Winterkorn had to say about China on this network last Friday. VW's soaring sales in China contributed 30 percent of its last year's record operating profits and made it a number one car manufacturer in the world. (Disclosure: I don't own VW shares, and I have not driven a VW vehicle since I clocked nearly 200 thousand carefree miles during the student days on my beat up VW Beetle.) And after more than 30 years of doing business in China, Mr. Winterkorn sounds like he is just warming up: VW's 20 factories in China are expected to raise their annual production to 5 million vehicles over the next few years – just shy of half of the company's total output in 2014.

Volkswagen's success clearly means that South Korean car companies will have a tough competitor in China and beyond, partly because they are facing a significant price disadvantage of an appreciating currency.

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It, therefore, seems that the last week's 25-basis-point rate cut by the South Korean monetary authorities will be followed by additional credit easing. The purpose of such measures is not just a question of adjusting the won's exchange rate. The economy needs help; it weakened markedly during the fourth quarter of last year, industrial production fell 0.4 percent in the three months to January and the unemployment rate continued to rise.

More won and a yen for babies

With nearly balanced government accounts and a relatively low public sector debt (36.7 percent of the gross domestic product – GDP), South Korea's policy mix definitely calls for an easier monetary stance. The real short-term rate of 1.25 percent, and the won's 5.5 percent appreciation against the dollar over the last twelve months, indicate the degree of policy tightness that is manifestly inappropriate for a weakening economic activity. That, of course, does not mean that Seoul should immediately jump on the quantitative easing (QE) bandwagon, but a few more rate cuts might be in order.

In fact, the Koreans may wish to take Japan's unbridled QEs as a cautionary tale. In spite of a monetary tsunami of the last two years, the Japanese economy sank 1.1 percent in the second half of last year. The interest-sensitive components of aggregate demand – household consumption and residential investments (64.4 percent of GDP) – accelerated their decline by 2.6 percent and 14 percent, respectively, in the last two quarters of 2014. Exports (16.2 percent of GDP) were the only major segment of the economy to register a strong 9.2 percent growth during that period as a result of the yen's trade-weighted depreciation of 6 percent over the last twelve months and Japan's weak domestic demand pushing the businesses to export in order to survive.

In spite of these disappointing results of an overly aggressive monetary easing, Tokyo seems ready to continue the same policy in the months ahead. Japan's trading partners may be forgiven for suspecting that this is just an attempt to strengthen the country's traditional export-led economic activity by means of a sharply depreciating currency.

The problem is that this old-style, free-riding quick fix is not the way out. The country's leaders are probably aware that they need to do more than that. They seem to have realized that their long-neglected structural problems are affecting the choice of society and Japan's place in the world. If, for example, they started to tackle these problems with strong and sustained efforts to stop and reverse the declining population growth, they would find out that the economic and social infrastructure of a serious family policy would do wonders for household spending and residential investments – nearly two-thirds of their economy.

Investment thoughts

China, Japan and South Korea are the true engines of East Asia's economic growth. In spite of strong political and economic differences, seemingly irreconcilable territorial claims and contested views of their recent history, these countries continue to maintain open and active channels of trade and investments among themselves. Unlike in some other investment destinations, they are not settling their disputes with raging wars, bellicose exclusions, loathsome discourse and bruising impediments to trade.

Investors might wish to keep that in mind when considering their global portfolio preferences. They may also wish to note – as Volkswagen does – that East Asia's economic fundamentals and growth potential offer better profit opportunities than those in many regions competing for world capital flows.

Michael Ivanovitch writes about world economy, geopolitics and investment strategy: @msiglobal9