Trade deal failure with Japan sets back the pivot to Asia

U.S. President Barack Obama, second from left, and Shinzo Abe, Japan's prime minister, right, attend a meeting at the State Guest Houses in Tokyo, Japan, on Thursday, April 24, 2014.
Toru Yamanaka-Pool | Bloomberg | Getty Images
U.S. President Barack Obama, second from left, and Shinzo Abe, Japan's prime minister, right, attend a meeting at the State Guest Houses in Tokyo, Japan, on Thursday, April 24, 2014.

Behind the veil of reassuring Asian allies about Washington's attention, an agreement with Japan to forge ahead with the 12-nation free-trade Trans-Pacific Partnership (TPP) was easily the most important item on President Obama's tour of East Asia.

The stakes were so high and the negotiating dynamics so intense that American and Japanese trade officials were given extra time to come up with a deal until Mr. Obama had to leave Tokyo for his flight to Seoul.

Apparently, some progress was made but there was no agreement.

What happened?

Strangely enough, the Japanese did not think that their unwillingness to open up their farm and automobile sectors were the main stumbling blocks. During last Friday's press conference, Japan's Finance Minister Taro Aso said that the problem was a lack of consensus on the American side, and that any agreement was unlikely until after the mid-term Congressional elections next November.

Read More Obama reassures ally Japan; no breakthrough on trade

Implicit in Tokyo's view is the Japanese refusal to make the necessary concessions because they thought Mr. Obama could not get a fast-track negotiating authority to conclude the TPP agreement covering the 12 countries (U.S., Japan, Brunei, Malaysia, Vietnam, Singapore, Australia, New Zealand, Canada, Mexico, Chile and Peru) that are estimated to account for 40 percent of world trade and for 60 percent of American exports.

Japan's "third arrow" seems stuck

I wonder whether American diplomats knew about all that before Mr. Obama went to Tokyo.

At any rate, the danger now is that the TPP and Washington's similar project of a free-trade agreement with the E.U. (Trans-Atlantic Free Trade Agreement – TAFTA) may unravel. America's forthcoming presidential election cycle will soon be in full swing, and the next U.S. administration won't be ready to take up these issues until sometime in 2017 -- assuming that Asians and Europeans were still interested.

For Japan, however, the economic consequences of forgoing structural reforms inherent in a more open trading system could be serious. The TPP was seen as an impetus to competitive markets at home and a tariff-free access for Japanese exporters to a region that is home to nearly half of the world's population.

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Prospects of increasing export sales are of vital importance at a time when Japan's foreign trade is becoming a drag on economic growth. Last year, for example, the negative trade balance took 0.3 percent off the Japanese gross domestic product (GDP), and the trade deficit in the first quarter of this year nearly doubled from the year before.

Japan's domestic demand is also likely to continue to weaken. Real wages in the first two months of this year declined 1.5 percent from the year earlier, and the households' real purchasing power will be significantly eroded by stagnant wages, rapidly rising inflation and higher taxes.

Without a sustained pressure to open up its economy in a free-trade environment, it is difficult to see how the Japanese government could initiate and complete meaningful structural reforms that would go against deeply entrenched vested interests and powerful political constituencies.

It, therefore, seems that the changing structure of an opening Japanese economy – the "third arrow" of the government's economic program – is at best a very long shot. As so many times in the past, it will be much easier for Japan to rely on a tried and tested expedient of more monetary creation, weaker yen and a renewed export push.

Pivot to Asia or a "major power relationship"?

Investors should realize that Mr. Obama will not be able to conclude free-trade agreements with countries in the Asia-Pacific (TPP) and in the E.U. (PAFTA). As things now stand, it is unlikely that political forces in the U.S. Congress will change enough after next November's elections to give the White House a fast-track negotiating authority, which would bypass the long and uncertain foreign treaty ratification process. And the political sights will then be set on presidential elections in 2016.

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Clearly, the TPP – an essential political and economic dimension of the pivot to Asia -- is very much in doubt until the new administration in Washington takes over in 2017 – assuming that such a trade arrangement would still be of interest to the group of countries that are now willing to be a part of it.

In the meantime, China's relentless advance as an economic, political and military powerhouse will change the trade and security landscape in Asia-Pacific – and much beyond, particularly if Beijing's partnership with Russia, India and Brazil continues to progress along the lines of their current action program.

Under these circumstances, an alternative to the original and subsequent variations of Washington's pivot to Asia could be the U.S. idea of a "major power relationship" with China. What that really means is not clear, but, hopefully, it could be a more constructive modus vivendi than the hostility-driven adversarial posture we have now.

Mr. Obama talked about this new model of Sino-American ties last week. It is not clear whether that was used as a negotiating ploy to get Japan moving on trade issues, or whether that was an expression of serious policy intent acceptable to China. All the same, he seems to have raised the level of anxiety among his Japanese hosts.

But that got him no brownie points with Beijing. Indeed, China ferociously lashed out against Mr. Obama's emphatic statement that the disputed islands in East China Sea were covered by the U.S.-Japanese military alliance. While lodging a formal complaint about that with the U.S. and Japanese embassies in Beijing, China's Foreign Ministry issued a statement saying that "we urge the United States and Japan to abandon their Cold War mentality, and respect the concerns and interests of other countries in the region, and avoid further interference with regional peace and stability."

Read MoreWeek ahead for Asia: BOJ decision, China PMI

These cold war references sound ominously similar to Russian statements about the U.S. and European actions in Ukraine.

Investment thoughts

Growth-enhancing structural economic reforms in Japan are unlikely. Cosmetic moves are possible, but nothing substantive seems in the cards. Expect more of the same: A new and a probably stronger wave of monetary stimulation, a weaker yen and a renewed export drive.

Markets will continue to be unsettled by the worsening political and military tensions in Asia-Pacific, Central Asia, Middle East and Central Europe.

The economically exhausted and militarily weakened E.U. is not eager to fight these fires and to engage in the type of sanctions that would harm its vital economic interests. Equally, the U.S. public opinion is tired of foreign entanglements. Americans want more attention paid to domestic problems of slow growth, infrastructure, social welfare and a 13 percent actual unemployment rate.

Count on the Fed and the European Central Bank (ECB) to support the markets and the economy. Equities and gold remain my favorite asset classes.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

Follow the author on Twitter @msiglobal9