The Korean crisis is a watershed event in American-Chinese relations

  • U.S.-China relations and respective red lines must be clarified
  • The Korean issue should be at the heart of Washington's Asia policy
  • America is neglecting the nukes it has that nobody can match

The acute security flare-up on the Korean Peninsula will show whether an acceptable modus vivendi can be found between Washington and Beijing.

The two nuclear-armed countries are pointing at each other their most lethal strategic weapons while trying to resolve the legacy of an inconclusive war they fought, with the help of their allies, on behalf of the South and North Koreas from June 1950 to an armistice in July 1953.

The immediate causes of hostilities have changed, but the fundamental reasons for the U.S.-China confrontation along the 38th Parallel North remain the same. China wants the U.S. out of South Korea – indeed out of Asia, as was constantly repeated during American intelligence gathering and freedom of navigation maneuvers around China's contested maritime borders.

More recently, China has become hugely worried about American missile shield installations in South Korea and Japan. Beijing claims that the shield is compromising its security, hinting even that its nuclear arsenal could be paralyzed. Beijing's alarm level will also go up another notch as Seoul got Washington's agreement to deploy American strategic military assets in South Korea.

And here is the deal: Washington wants China to help in forcing North Korea to immediately and verifiably give up its nuclear weapons and their delivery vehicles with debilitating economic sanctions.

Things have come to a head

China is reluctantly agreeing to do some of that. Last Saturday, Beijing announced that it is limiting oil and gas supplies to Pyongyang. Textile imports from the northern neighbor will also be limited, and then completely cut off next December.

But Beijing has no illusions that this would lead North Korea to give up its only life insurance – a credible nuclear deterrent to what Pyongyang sees as an inevitable American attack.

And here is a rider: China is reportedly on record that it would not get involved in hostilities if they were initiated by North Korea, but China would step in if the U.S. were to attack first.

The only acceptable way forward, according to China, is a negotiating process that would start with the suspension of U.S.-South Korean mock-up exercises of North Korea's invasion in exchange for Pyongyang's suspension of nuclear and ballistic missile tests.

The U.S. is flatly refusing this "double suspension" proposal put forth by China last March, and apparently backed up by Russia.

That's a brief background to the Korean crisis and where things now stand.

Diplomatic channels remain active. Washington and Pyongyang are talking directly, although the effectiveness of these discussions are very much in doubt given daily invectives and dire threats traded by the two countries' leaders.

China is playing along, apparently thinking that it might, at some point, persuade the would-be belligerents that a constructive dialog is the only reasonable way out of the current impasse.

President Donald Trump and China's President Xi Jinping will have plenty of time and opportunities to discuss the Korean problem in early November. Trump is expected to pay a state visit to China, and there will also be two regional summits (ASEAN and APEC) where they could address the issue in a broader Asian context.

By that time, the 19th National Congress of the Communist Party of China will be over. That is a crucially important, twice a decade event which usually brings sweeping leadership changes. Xi, the core leader, seems likely to emerge considerably strengthened, with more latitude for his "great power win-win cooperation" dealings.

Cut the fuzzy stuff 

It's not clear, however, what that win-win concept is – a privileged dialog with the U.S., or some kind of a global U.S.-China condominium. Xi reportedly first broached the idea during his meeting with Obama at Sunnylands in June 2013. The cool relations that followed, and attempts at containing China's growing influence in Asia, indicate that Washington did not think much of Xi's proposal. Trump may probably share the same indifference, or worse.

Trump knows that he can leverage China's large dependence on U.S. trade and investments in bilateral economic dealings and in geostrategic issues such as the Korean crisis.

Last year, China pocketed $347 billion net in trade revenue, and another $204.2 billion in the first seven months of this year. That is in addition to China's liberal access to U.S. technologies that are part of $92.5 billion of American direct investments in China during 2016.

China is trying to preserve and defend that bounty by advocating closer ties with Washington, where, Beijing hopes, things could be smoothed out to maintain a growing foothold in U.S. markets.

Will the master of "the art of the deal" fall for that?

I doubt it. China has too many red lines that are clashing with U.S. interests, and with American commitments to the security and territorial integrity of its key Asian allies – Japan and South Korea.

The nature of the American-Chinese economic relationship is also on a path of significant change. The U.S. has served notice that it would no longer tolerate its excessive and systematic trade deficits with China. Washington is also seeking to limit, or totally prohibit, China's purchases of strategically sensitive companies and technologies.

China says it will respond in kind. Its purchases of U.S. government bonds are telling part of that story. Trump's election victory last November marked the lowest point ($1.05 trillion) in China's Treasuries holdings during the twelve months to July. The Chinese, however, stepped up bond purchases after the Trump-Xi meeting in Florida last April. Still, the stock of Treasuries they held in July ($1.17 trillion) was 4.3 percent below its year-earlier level.

Investment thoughts

Speculations about Fed's policy moves have been overtaken as trading events by extremely dangerous developments on the Korean Peninsula and in the broader northeast Asian region.

People betting with their savings are realizing that the world economy is faced with an irreconcilably adversarial relationship between the U.S. and China.

They should also know that America's best Sinologists have no operational advice for the U.S. government on how to deal with that situation. Indeed, these experts' views range from warfare (the sooner the better) to bromides about cooperation in a "multipolar world and globalized economy."

I would defer to our defense scholars about security arrangements, but I would suggest again that America has no chance of winning this high-stakes contest unless it promptly breaks out of its pathetic 1.5 percent noninflationary economic growth potential.

Yes, this is an America First moment where it is urgent to (a) expand and upgrade the human capital (i.e., labor supply), (b) repair and rejuvenate the infrastructure, (c) reform the tax system to facilitate (physical) capital formation, (d) enhance market efficiency through structural changes, and (e) review foreign trade policies to stop the hemorrhage on external accounts.

Meanwhile, the Korean crisis is a litmus test of American-Chinese relations. This is the time of a long-delayed clarification where America must set its unambiguous turf markers.

But to stay the course, Washington needs to move quickly to double the economy's current growth potential. That would underpin the dollar-based global financial infrastructure and world economy's thoroughly dollarized trade and financial transactions.

Will Washington tend to these American nukes that nobody can match?