An economic fallout is coming from all the Asian military standoffs

  • A precarious armistice on the Korean Peninsula will set back East Asia's economy
  • The U.S. trade with that region will remain hugely unbalanced
  • The Korean crisis is a defining moment in the U.S.-China battle for Asia

    The stakes are high for the U.S. as tensions in Asia ramp up.

    The country has $1.3 trillion of two-way trade with the region, based on annualized data in the first six months of this year. That's 52.5 percent of America's total foreign trade.

    But that is only part of U.S. linkage with Asian economies. Fixed-asset investments generating those trade flows have also to be taken into account as they directly affect employment and income levels in about one-third of American aggregate demand.

    People walk past a street monitor showing news of North Korea's intercontinental ballistic missile test in Tokyo, Japan, July 4, 2017.
    Toru Hanai | Reuters
    People walk past a street monitor showing news of North Korea's intercontinental ballistic missile test in Tokyo, Japan, July 4, 2017.

    All that is now subject to growing risks and uncertainties as a result of acute security issues and seemingly irreconcilable strategic conflicts.

    The current flare-up of long-brewing war threats on the Korean Peninsula is the most serious immediate challenge to peace, economic growth and international trade. The economies of South Korea, China and Japan — about a quarter of global output — are directly affected by those events.

    And so too is the U.S. trade with those countries. America's trade deficit with them in the first half of the year came in at an annualized $432 billion and accounted for nearly 60 percent of the total trade gap. That deficit was also 2.4 percent above its year-earlier level, showing a significantly worsening trend compared with a 4.7 percent annual decline recorded in the first half of 2016.

    A 6.1 percent increase in the U.S. trade deficit with China was the main reason for the trend reversal; the deficit with South Korea dropped 32 percent and the deficit with Japan stood roughly unchanged.

    Trade outlook could worsen

    The silver lining, should you wish to look for some, is a relatively favorable compositional change in America's bilateral trade flows with those countries. U.S. exports to South Korea, for example, were soaring 22 percent in the first half of this year. American sales to China and Japan were also advancing at a fast clip, but those countries' exports to the U.S. were also maintaining strong gains.

    Things could change for the worse, though, if, as seems likely, the deteriorating security conditions in Northeast Asia were to lead to declining regional trade. In that case, the American market could become an irresistible alternative for Korean, Japanese and Chinese export sales.

    That cannot be ruled out. A precarious armistice will define the political and security state of affairs on the Korean Peninsula for the foreseeable future — excluding, of course, a nuclear Armageddon caused by accidents, miscalculations or worse. The reason is simple: The U.S., China and Russia are unlikely to agree on the terms of a permanent peace settlement between the two Korean states.

    Meanwhile, North Korea will reinforce its position as a credible nuclear power, with technically viable delivery vehicles for its warheads. At the same time, any further efforts to choke the North's economy with debilitating sanctions will be resisted by China and Russia.

    That is a serious problem for South Korea's economy. Its long years of strong economic and technological development — in spite of a permanent crisis with estranged relatives — were made possible by rapidly growing trade and investments with the U.S. and China. All that is changing now. Seoul is caught in the middle of a sort of proxy trade and political conflicts between the U.S. and China. Washington is putting trade pressure on South Korea to make sure it toes its policy line, while Beijing keeps doing the same thing to get Seoul out of Uncle Sam's tight embrace.

    Asia's elusive 'golden triangle'

    Economic analysts are harping about problems in South Korea's real estate markets and construction industries while ignoring declining tourist arrivals from China and sharply slowing export volumes in the second quarter of the year. China takes 27 percent of South Korean exports, which is double the amount of Korean sales to the U.S.

    So, what do you do when a huge neighbor and the main customer issues you a demand? Well, Beijing told Seoul last Monday to stop the deployment of the American Terminal High Altitude Area Defense missile shield that China considers a big threat to its own security.

    South Korea is also losing ground in its trade transactions with Japan. In the first half of this year, Japan's trade surplus with South Korea soared 31.3 percent from the year earlier.

    More ominously, the Japanese-Korean trade relations are now taking place in an environment of revived enmities and old grievances against Japan: a model of a Korean "comfort woman" (women forced into prostitution with Japanese WWII soldiers) riding on Seoul's buses, misdeeds suffered by Koreans during 45 years of Japanese occupation, Japan's allegedly incorrect presentations of the two countries' history, unsettled territorial claims, etc.

    A painful history is also plaguing Japan's relations with China. Most of that was in full view last Tuesday as China commemorated the 72nd anniversary of Japan's WWII surrender.

    Looking at all that from the outside, it seems miraculous that China and Japan can have any trade and investment ties amid daily attacks and mutual vilification. And yet, the bilateral trade in the first half of this year was quite strong, with China running a sizable surplus of 1.9 trillion yen.

    It is hard to see how that can continue. Last Friday, China reiterated its warnings to Japan to stay out of the South China Sea issues as Tokyo reminded Beijing that its security agreements with Washington also covered the Senkaku (Diaoyu) Islands administered by Japan and claimed by China.

    Investment thoughts

    Always very difficult, political and economic relations among China, Japan and South Korea — a quarter of the world economy — have entered a new phase with an alarming military standoff on the Korean Peninsula. That can seriously damage $1.3 trillion of American foreign trade and set back Washington's efforts to reduce its $432 billion trade deficit with those three East Asian nations.

    Since there is no military solution to the Korean political problem, extremely tense relations are bound to continue because the key players — the U.S. and China (you can add the neighboring Russia, too) — have diametrically opposed interests and objectives.

    To make this simple, you can think of the Korean crisis as a key part of the U.S.-China battle for Asia.

    China clearly wants the U.S. out of Asia, as often intimated by statements that "Asia should be for Asians," and that "outside powers should not meddle in Asian affairs." Beijing believes that time is on its side as its economy continues to forge ahead. Meanwhile, it keeps recycling its annual current account surpluses of $270 billion in huge infrastructure investments to improve what China calls "Asian connectivity."

    Washington, of course, has different ideas about all that and maintains a large military presence throughout the Asia-Pacific.

    This is a deadly serious confrontation. A top U.S. general was grimly reporting that the only "deliverable" after a meeting with his Chinese counterparts last Thursday in Beijing was "a framework agreement for a joint staff dialogue mechanism" — a 24/7 hotline to prevent catastrophic accidental mistakes and miscalculations as China and the U.S. keep chasing each other's air and naval military assets around China's maritime borders.

    Does all that make U.S. stocks, bonds and direct investments look like good bets?

    The Chinese think so. They just reclaimed the top spot on the list of Treasuries foreign holdings. Remember, they are recycling the dollars they got as the U.S. settled its trade deficit (and China's trade surplus) of $170.7 billion in the first six months of the year.

    Commentary by Michael Ivanovitch.

    For more insights from CNBC contributors, follow @CNBCopinion on Twitter.