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S T R AT E G I C F O R E C A S T I N G , I N C .STRATFOR is the worlds leading private intelligence rm providing corporations, governments and individuals with intelligence and analysis to anticipate the

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ii 2005 Strategic Forecasting, Inc.

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A b o u t S t r at f o r . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i i i

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E a s t A s i a . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

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S t r at f o r S e r v i c e s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 4 1

C o n ta c t S t r at f o r . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 4 3

iii 2005 Strategic Forecasting, Inc.

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n the geopolitical system, May was a turning point. June was a holding action. Put differently, after the geopolitical deck was reshufed in May, a new hand was dealt out and the world began to play. The central game remained the same: the rest of the world

attempting to control overwhelming American power. But this round is being played in the aftermath of the collapse of one of the players: Europe. It is no longer the United States facing Russia, China and Europe; it is the United States facing Russia, China and a bunch of Europeans. Thats all the difference in the world.

H i g h l i g h t s Two Sides to the Iraqi Equation The Search for Bin Laden China: Growing Pressures and Capital Flight The Question of Oil

June was also the month in which Iraq became more visible again. The insurrection in the Sunni regions continued unabated. However, a shocking revelation was made: The United States was, and had been for some time, negotiating with at least some of the insurgents. Our readers will know that we have been talking about these negotiations for many months; however the major media, the Bush administration and the guerrillas were silent about it, until Donald Rumsfeld spilled the beans. It is understandable why the ad-ministration and the insurgents remained silent: Revelation of the talks could destroy them. Why the media missed them is the mystery. Indeed, even after the revelation by Rumsfeld, the media still did not pick up on the signicance.

Framing Questions for the Months Regional Reports What will the weakening of core EU institutions mean for business? Will intensied ghting in Iraq affect market morale and my investments? How should I position myself amid conicting theories about Chinas overseas asset-buying spree? How will the pressures coming to bear on Beijing affect business regulations? Will the ongoing political instability in Latin America have unexpected nancial impacts? What might be the effects of a strengthened anti-U.S. alliance between Russia and China?

I


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I r a qThere were two sides to the equation in Iraq during June. First, the secret negotiations with Sunni guerrillas were coming to a head. Second, the insurgents who were not engaged in the negotiations primarily Abu Musab al-Zarqawi and other jihadists were surging their attacks in order to undermine the negotiations. They were attacking Shiite leaders, foreign diplomats, Iraqi government ofcials, U.S. troops lashing out in all directions. Their goal was to convince Sunni elders that whatever agreement they negotiated would be meaningless; the jihadists could and would continue to wage the war. More to the point, if they could kill and kidnap diplomats from Muslim countries, they could kill Sunni leaders close at hand.

The Sunni leaders were not without their own cards to play. The leadership understood that al-Zarqawi was dangerous and also that al-Zarqawi, without access to the Sunni social infrastructure, would be crippled. The jihadists are, for the most part, not Iraqis. They have no roots within the community, and the Sunni elders could deny them sanctuary. In the near term, this would be dangerous to the Sunni leaders, but in the long run, the danger would be to the jihadists. On the other hand, if the Sunnis did not make a deal with the United States, they would be frozen out of the political process in Iraq and would be made the potential victims of the Shia and Kurds.

The Sunnis were in an increasingly tough place. Thus, in June, signicant factions of the Sunni leadership made a decision: enter the political process, make their temporary peace with the United States and absorb the fury of the jihadists. It is far from an irrevocable decision, and the jihadists will do everything they can to force the Sunnis to reverse their position. We expect July to be a period of intensied warfare in Iraq. The insurgents must now throw everything they have into the ght to convince the Sunnis to reverse their position but do so without creating a permanent rift in the Sunni community. That means they will attack everywhere but hold off on attacking Sunni leaders wholesale. The United States, meanwhile, will focus on the critical lifeline to Syria that pumps jihadists, along with supplies, into Iraq. If the Sunni leadership abandons the war, this line of supply will become the last pillar of the rising. U.S. operations along the Syrian-Iraqi border will intensify, as will pressure on Syria.

The Iraqi insurgents must

now throw everything

they have into the ght

to convince the Sunnis to

reverse their position.


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The general image in July will be that Iraq is coming apart, based on the intensication of warfare. In reality, the intensied ghting will indicate the success of the American political strategy. The key to watch is whether the Sunni leaders heretofore connected to the guerrillas come forward publicly to participate in the government. If they do, the insurgents will be split and the ground cut out from under the jihadists. The war will not disappear, but will contract in intensity.

S o u t h A s i aA very different situation is developing in Afghanistan. The Taliban are waging their summer offensive, and it has been modestly successful. More signicant have been the failure of the U.S. offensive into Pakistan to materialize and the failure of the Pakistanis to capture Osama bin Laden. In this direction, CIA Director Porter Goss said some interesting things last month. First, he all but said the CIA knew where bin Laden was. And second, he said the failure to capture him was due to some weak links in the war on terrorism.

The weak link he was referring to was Pakistan. The Pakistanis fought bitterly against a major U.S. incursion into the countrys northwestern regions. Covert forces were acceptable, but covert forces by themselves would not be able to seal off the region in preparation for the capture of bin Laden. The Pakistanis insisted that they could carry out the operation themselves. President Gen. Pervez Musharraf also made the case that if U.S. forces struck into Pakistan, his own government would be endangered. The fall of the Musharraf government would not be in the interests of the United States; therefore, Washington should allow Pakistani forces to capture bin Laden.

Washington waited through June for this to happen. It didnt. A great deal of unhappiness has built up within the American intelligence community over the Pakistanis failure to move aggressively against bin Laden. The Bush administration, looking at a political settlement in Iraq this summer, would like to close out the books on bin Laden as well. The view is that bin Laden is vulnerable but that the Pakistanis are blocking the end game. More precisely,

There will be intensifying

tension between

Washington and

Islamabad or a sudden

agreement and the

presence of U.S. troops,

deeply and publicly, in

Pakistan.


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the growing view in Washington is that the Inter-Service Intelligence organization remains full of pro-al Qaeda ofcials who are deliberately thwarting the capture.

If things fall apart in Iraq, the situation in Pakistan probably will be allowed to ride. If, however, a political settlement is reached and al-Zarqawi ghts on alone, the capture of bin Laden will become a major goal. That, in turn, will create a crisis of the rst order between Washington and Islamabad. The United States sees itself as having acceded to all of Musharrafs wishes in terms of the prosecution of this campaign, but believes he has allowed the campaign to be thwarted. Either he is unwilling or incapable of executing on his promise. The choice with which Washington can present him is either to allow U.S. forces to move into Pakistan, or accept that they will move in without his permission. But this must be settled before the winter if things go well in Iraq and the sooner the better. We therefore expect intensifying tension between Washington and Islamabad or else a sudden agreement and the presence of U.S. troops, deeply and publicly, in Pakistan.

July and August will be about the war against militant Islam, but it is no longer a systemic issue. By that, we mean that the war has been contained within understood and predictable boundaries. The worst case and best case are understood, and the process in all theaters is increasingly political. The world no longer pivots on this war. What the world will pivot on is the relationship between the United States and the other great powers, particularly China. That is the locus of uncertainty and criticality.

C h i n aJune was a month of increasing tension between Washington and Beijing, and of Chinese diplomatic moves to build a counterweight. With the collapse of Europe as a united political force, China lost its key option. It is building its relationship with Russia, both economically and militarily. But leaders in Beijing know that China and Russia taken together do not come close to being a counterweight to the United States. China knows that it has to deal with the United States alone.

The Chinese economic malaise drives tensions with the United States. Beneath the countrys protless growth, the deep problems of Chinas banking system continue to force the government to do three things that infuriate and frighten the Americans. First, China is surging exports by cutting prices to the bone in order to maintain cash ow for corporations that are essentially bankrupt. This, as was the case with other Asian export surges, wreaks havoc in American markets, forcing U.S. manufacturers against the wall.


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The supercial argument is that this represents Chinese efciency, and the United States will have to learn to be more like China. A more sophisticated analysis says that even if the Chinese are cutting prices to stay alive, it is to the benet of the United States, since China provides cheap goods. The latter is a good economic argument. The Bush administration, however, understands that purely economic decisions are a gment of economists imaginations. The political and long-term economic costs of the United States inability to compete with a China on an Asian suicidal blow-off need to be contained, or at least, the United States needs to appear to be making serious efforts.

Thus, Washington has acted to block imports of textiles. It also has confronted Chinas second strategy: the yuans peg to the dollar. The United States has for the most part abandoned the call for a fully convertible, market-based yuan. It is now simply asking for the yuan to be re-pegged against the dollar. Given the importance of the U.S. market to China, it would appear irrational that Beijing makes no move to accommodate U.S. sensibilities. This is particularly the case since China and its U.S. supporters have argued vigorously that revaluing the yuan would make no difference to the balance of trade. If that is the case, then China should certainly revalue to keep the political peace.

Of course, Beijing cannot revalue because it would make a great deal of difference to the Chinese. Since price is their major advantage, cutting that advantage by any amount would have unacceptable consequences. Therefore, the Chinese have not revalued nor do we expect a revaluation, except under the most intense pressure from Washington, which has not yet been brought to bear.

The third process under way is capital ight. The Chinese have been moving money overseas at an intensifying rate. In particular, they have been buying natural resources, real estate and other commodities. The latest move and the one that will become the Rockefeller Center and Pebble Beach of this Asian cycle is the bid by CNOOC for Unocal. The bid is wildly irrational from an economic viewpoint: No American corporation, including Chevron, could make the kind of bid the Chinese made. Indeed, this is the tip of the

The Chinese have not

revalued the yuan nor

do we expect them to,

except under the most

intense pressure from

Washington.


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iceberg. The Chinese have been overbidding for things around the world for months, just as the Japanese, Taiwanese and South Koreans did when they reached this point in the cycle.

The explanation that this is good business for China is simply absurd. A second explanation is that China is seeking to nail down natural resources for its economy, and in the event of political crisis. But you dont nail down resources for economic reasons by making uneconomic deals. Moreover, you cant secure resources in the event of international crisis by owning them; you have to physically secure the resources. Owning all of Australia doesnt give you access to it in the event of war.

Chinas behavior cannot be explained by most economic or geopolitical considerations. But the explanation is simple: When things go south, the insiders shift their money elsewhere. The apparently uneconomic deals make perfect economic sense if the assumption is that China has a huge amount of dollars that are at risk within the country, and that require huge deals outside of China if they are to be absorbed. If a premium has to be paid in order to secure safe haven, then that makes sense, particularly for the largest Chinese oil organization.

The perception in the United States is, of course, that a superpower has been born. But superpowers invest in themselves, not in other countries, and they do not make bad deals. Nevertheless, as with Japan, the United States is increasingly uneasy with what it misreads as an aggressive Chinese strategy, when it is actually a lifeboat drill.

In the United States, July will bring congressional action on China as well as intensifying announcements from the White House. The Chinese, of course, cannot change their behavior at this point and with the Europeans in an uncertain state and the euro falling, China urgently needs the United States and U.S.-linked markets. Beijing will continue to surge exports, it will not revalue the yuan, and it will execute even bigger mega-deals, particular in the area of natural resources.

Remember always the Rockefellers schooled Mitsubishi in New York real estate. Unocal has some of the sharpest and most aggressive operators

You cant secure resources

in the event of

international crisis by

owning them.


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running it. The Chinese have nothing to teach these guys in the energy markets. If Unocals board is thinking that the time has come to bail out of China, they know something important about the oil business and the Chinese.

The expectations of permanently high oil prices have been built into the market. It is now a commonplace. But the rate of increase for Chinas consumption has slowed, and Europe is moving smartly into recession. Certainly there are constraints on the supply side, both in Saudi Arabia and in Venezuela. But those constraints dont result in a doubling of oil prices over the past couple of years, which is what we have seen. We are a bit out of our area in forecasting oil prices, but it is hard to imagine oil doubling again in the immediate term. People talk about the housing bubble, but it seems to us that the real bubble is in energy.

July, therefore, will be dominated by war news, Sino-U.S. tensions and intense focus on energy prices. The Europeans will squabble and focus on the upcoming German election. Nothing important will happen in Europe until after that election, at the soonest. The Russians are making covert moves around their periphery, but they arent ready for a showdown. So July is about war, China and oil as far as we can see.

Dr. George FriedmanFounder

Strategic Forecasting, Inc.


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onict between traditional rivals continues in Asia as Japanese quarrels over islets and sheries, and diplomatic barbs with neighboring China, South Korea and Taiwan persist. Chinas delicate balancing act between foreign (mainly U.S.) pressures and domestic pressures shows no sign of easing. Meanwhile, South

Korean-U.S. ties remain chilled while North Korean signals of a return to the six-party talks intensify. In Southeast Asia, Vietnamese-U.S. warmth continues while the Association of Southeast Asian Nations (ASEAN) ponders Myanmar and the Philippine presidential crisis simmers.

T h i s M o n t h s H i g h l i g h t s : I n E v e r y I s s u e : Territorial Tensions in Northeast Asia Trends, Stats and Indicators South Korean-U.S. Chill Noteworthy Events U.S. Pressure On China Chinas Buying Spree Six-Party Talks Close To Resuming

C


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onict and compromise characterized June, as some traditional rivalries persisted while other former foes came together. Territorial and historic disputes ared between Japan and its traditional antagonists China, South Korea and Taiwan, manifested by shing disputes, the deployment of warships and inconclusive diplomatic contacts.

In Washington, visits by South Korean President Roh Moo Hyun and Vietnamese Prime Minister Phan Van Khai stood in near-polar contrast. The visit of the leader of the United States traditional ally, South Korea, was cold, while that of one-time foe Vietnam was warm. Further emphasizing the growing differences between Washington and Seoul, South Koreans meetings with their counterparts in the North seemed almost like family reunions, despite the long-standing conict between North and South.

But perhaps most signicant is the change in U.S.-Chinese relations. Washington is poking China with economic, political and military sticks at a time when Beijing nds itself in some of the most delicate stages of its attempts at economic reform. Already, Chinas social stability is fraying, as riots and attacks against security forces increase in frequency and size.

The change in U.S.-Chinese relations comes as Chinese rms are increasing their investments abroad in a move reminiscent of the Japanese buying spree of the 1980s. These investment moves have -- and will -- only increase resistance from the United States, strengthening American resolve to contain what is seen as a looming Chinese threat.

Strangely enough, heightening tensions between Washington and Beijing is increasing the likelihood of renewed talks with North Korea to resolve the nuclear crisis. Several rounds of bilateral discussions among various members of the six-party format already have occurred, and things are lining up for a resumption of talks in July.

In Southeast Asia, two issues are burning brightest -- the Myanmar question and political unrest in the Philippines. Though Myanmar has represented a mixed blessing for ASEAN since it joined the international association, U.S. and European pressures regarding Myanmars political and human rights record are threatening ASEANs push to create a new East Asia summit -- the precursor to a larger Asian economic bloc.

In the Philippines, what began as a fairly typical -- and exaggerated -- threat to President Gloria Macapagal Arroyo has now entered a new phase with the emergence of a potential leader around whom opposition forces can unify. This will set the stage for a tense month in the Philippines as Arroyo tries to secure her position in the face of mounting opposition.

CE x e c u t i v e S u m m a r y


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J u n e : T h e M o n t h i n R e v i e w

Te r r i t o r i a l Te n s i o n s i n N o r t h e a s t A s i aAs we forecast, tensions continued among Northeast Asian nations over issues regarding history and territory. These tensions were vividly displayed in early June, when Japanese and South Korean tugs tied to two South Korean shing vessels in disputed waters. Later in the month, it was Taiwanese shing boats causing the dustup with Japan, and Taiwanese Defense Minister Li Jye went so far as to board the Knox-class frigate Feng Yang and sail near the disputed Diaoyutai/Senkaku Islands. Both incidents ended peacefully, though both provided plenty of fodder for domestic political posturing particularly in Taiwan.

Amid the confrontations over shing grounds, Tokyo reportedly prepared to grant Japans Teikoku Oil Co., Ltd. the right to carry out test drilling for energy resources in an area of the East China Sea disputed with Beijing. Ofcial approval is expected in July or early August. Separately, Japans Land, Infrastructure and Transport Ministry placed a plaque on Okinotori Island, a rock outcropping, declaring the island part of Ogasawara Village, Tokyo. Beijing complained, since it claims the waters around the rocks and contends that Tokyo has no right to declare the outcropping an island, much less part of Japan.

Political tensions between Japan and its neighbors, however, were not limited to maritime territorial disputes. A planned summit between Roh and Japanese Prime Minister Junichiro Koizumi ran into difculties before it began; in fact, even the date and venue of the meeting could not be nalized until a week before it was held. In their June 20 conference, the two leaders spent most of their two hours together discussing historical differences; neither gave a glowing review of the meeting. The most they could agree upon was that the North Korean nuclear situation ought to be solved through dialogue.

Even Japans early June announcement that it was going to replace Ambassador to Seoul Toshiyuki Takano who created a stir earlier in the

Political tensions between

Japan and its neighbors

went beyond maritime

disputes.


J U L Y 2 0 0 5

year when he called the disputed Dokdo/Takeshima Islands Japanese territory with Shotaro Oshima, a more seasoned, less controversial diplomat, did little to soften the mood at the summit.

Separately, Chinese Vice Foreign Minister Dai Bingguo ew to Tokyo to meet with Japanese ofcials to try to ease tensions between Tokyo and Beijing a meeting that, though not quite as cold as the Roh-Koizumi summit, also failed to accomplish much. Despite the visit, the Japanese press made it clear that Koizumi and Chinese President Hu Jintao were unlikely to meet on the sidelines of the G-8 summit in early July. Furthermore, Japan continued its warnings against a Chinese military buildup a warning that echoed similar remarks from Washington.


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Chinese and Japanese relations further soured over Japans bid for a permanent seat on the U.N. Security Council something Beijing quite vocally rejected. Beijing went as far as publishing a white paper laying out its views on potential Security Council reform. For Beijing, Tokyo represents an ever-present economic and security threat, and a Japanese seat on the council would undermine one of Chinas remaining great power levers in East Asia. Japan, for its part, added to the growing international pressure on Chinas yuan valuation, and also agreed to increase missile-defense ties with the United States something directed more at Beijing than Pyongyang, contrary to common perceptions.

U . S . P r e s s u r e O n C h i n aThough Beijing was able to strike a partial deal with the European Union regarding its textile exports, pressure from Washington continued to mount not only on textiles, but also on the yuan and Chinas defense expenditures and military modernization. Washington is not letting up on China, though some Bush administration ofcials sought to temper the congressional drive to impose a blanket 27.5 percent import tariff on all Chinese goods. At the end of the month, Treasury Secretary John Snow and Federal Reserve Chairman Alan Greenspan were able to convince Senators Charles Schumer, D-N.Y., and Lindsey Graham, R-S.C., to delay their bill, giving the Bush administration more control over relations with China and buying Beijing a bit of breathing room.

Chinas social fabric is

rending and Being

lacks the bandwidth to

handle the pressure.


J U L Y 2 0 0 5

On the military side, however, Washington intervened to sink a deal between China and Israel for the upgrade of Harpy Killer unmanned drones that Tel Aviv had sold to Beijing. Washington also garnered a public apology from Israel, as well as a promise to allow U.S. review of Israeli defense deals with China and other states of concern to the United States.

These tensions provided the backdrop for two accordingly ill-timed Chinese bids for major U.S. companies. The Haier Group sought to purchase Maytag Corp., while China National Offshore Oil Corp. Ltd. made an unsolicited offer to purchase Unocal Corp. for $18.5 billion. The later deal in particular set off alarm bells in the United States, given Washingtons drive for energy security. At the same time, Beijing welcomed the $2.5 billion investment by the Bank of America in China Construction Bank (CCB) part of Beijings preparations to launch initial public offerings (IPOs) at four major Chinese banks.

Also in June, as Beijing sought to repulse EU and U.S. pressure, a series of increasingly public and apparently random riots broke out across China. Many of the disturbances were triggered by interactions with the police or other public security forces, while others were sparked by corruption and collusion among local governments and big businesses. As the urban-rural gap widens and unemployment continues to rise, Chinas social fabric is rending and Beijing does not have the bandwidth to handle the economy, society and external pressures.

S i x - P a r t y Ta l k s C l o s e To R e s u m i n gAs we predicted, June was a time of increased diplomatic trafc on the North Korean nuclear front. Amid diplomatic meetings between Washington and Pyongyang in New York and between North and South Korea in their respective capitals, it became more apparent that July will see the stalled six-party talks restart. U.S. President George W. Bush and North Korean leader Kim Jong Il both offered a softer rhetorical tone (occasionally), Beijing announced Hus imminent visit to Pyongyang, and all parties from Moscow to Washington said at one time or another that talks would restart soon, with Beijing going so far as to place the restart at the end of July. Just to Chinas east, while South and North Korea celebrated their common Korean-ness along with the anniversary of the June 2000 inter-Korean summit, Washington and Seouls relationship languished, as evidenced by the lack of warmth at Bush and Rohs summit. Emphasizing the contrast, the White


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House made front-page news in South Korea when Bush met a North Korean defector and author a week after the Roh visit for as long as the Bush-Roh meeting lasted.

P r o g r e s s , D i l e m m a s a n d T u r m o i l i n S o u t h e a s t A s i aPhan also visited Washington beginning June 19. The visit coincided with the 10-year anniversary of the renewal of U.S.-Vietnamese ties, which were severed from the end of the Vietnam War until 1995. The visit focused on the promotion of bilateral, regional and international security ties and on forging economic links between the two countries, as well as on Vietnams World Trade Organization (WTO) membership bid. Interestingly, Hanoi and Washington agreed to joint military training in Vietnam, paving the way for new military ties between the erstwhile foes.

In Southeast Asia, two other issues dominated the month: the struggle inside ASEAN over what to do about Myanmars planned 2006 assumption of its chairmanship and growing clamor in the Philippines for the ouster of Arroyo.

ASEAN is trying to put the nishing touches on a new East Asian summit that will center on ASEAN but also will bring together other major Asian and Pacic nations to increase dialogue and economic and political cooperation within Asia all while promoting a sense of Asianism. Given the battering the European Union and the sense of a common European identity took in June, however, ASEAN faces an uphill battle against seemingly losing odds. And Myanmars turn at the helm of ASEAN has forced ASEAN to seek a balance between the groups founding principle of noninterference and its attempts to make itself both relevant and an international player.

In the Philippines, a series of scandals surrounding Arroyo and her family have resurrected demands for the presidents ouster and have brought a disjointed opposition out onto the streets and onto the opinion pages of Philippine newspapers. As the month drew to a close, however, Arroyos challenge increased as Susan Roces, the widow of Arroyos former presidential competitor, the late Fernando Poe, Jr., declared her willingness to participate in the opposition movement thus offering the previously disjointed opposition a central gure around whom to rally.

ASEANs dilemma over

Myanmar and growing

clamor for Arroyos ouster

dominated June in

Southeast Asia.


J U L Y 2 0 0 5

K e y I s s u e s

For Washington, the Iraq war, while far from complete, is moving into a political phase. Washingtons attention is now being shifted to other strategic priorities particularly Russia and China. The U.S. pressure on China this strategic shift allows is compounding internal Chinese pressures resulting from difcult economic reforms and increasingly public dissent. Meanwhile, Myanmar continues to perplex ASEAN while a disjointed opposition in the Philippines continues to seek the ouster of that nations president.

D . C . S q u e e z e s B e i j i n gRelations between the United States and China have rmly moved beyond the benign co-existence characterizing the days after Sept. 11, and now are reminiscent of the early days of the Bush administration. Washington is squeezing Beijing on the economic, political and military front pressing Beijing on the yuan, on the Chinese role in resolving the North Korean nuclear crisis and on Beijings growing military.

For China, the increased pressure could hardly come at a worse time. Beijing used its brief reprieve from U.S. pressure to effect one of the smoothest genera-tional transfers of power in the Communist regimes history and to accelerate the very delicate work of economic reform, focusing on the banking sector in particular. Chinas banking system has served as the backbone of the state-sponsored life support system that kept millions of workers employed in redundant and inefcient state-owned enterprises (SOEs). As Beijing seeks foreign investment and a way to escape the Asian economic paradigm of growth without prot it is trying to wean the SOE system off Chinese bank loans while simultaneously strengthening the domestic banking system before opening the Chinese banking sector to foreign competition.

C h i n a s B a n k s G o P u b l i c , S l o w l yState-run asset management bodies, such as the Assets Supervision and Administration Commission, are now the main source of cash transfusions into the SOEs. Some of these asset bodies are now under investigation themselves, while Chinas big four banks are undergoing administrative and structural changes to prepare them for IPOs later this year or next year. The

Being seeks foreign

investment to escape the

Asian economic paradigm

of growth without prot.


J U L Y 2 0 0 5

CCB is the rst and furthest along of the main banks preparing to go public before years end. A $22.5 billion capital injection, the divestiture of nonbanking units and the removal of several key banking ofcials for corruption paved the way for a deal with Bank of America to purchase some 9 percent of CCB in a $2.5 billion deal that included an option for the Bank of America to purchase another 10 percent of CCB.

This sale represents the rst of similar deals Beijing hopes to make, and Beijing is hoping the CCBs relation with the Bank of America ups the Chinese banks market value and for a larger injection of cash through CCBs IPO. But the deal carries risks for Beijing and Bank of America, which the latter sees as an in for future credit card and banking operations in China. If the arrangement works smoothly, China will gain a condence boost for its banking system, but if problems emerge, Beijings bet on banking reform and increased foreign investments instead of on direct competition faces a serious challenge.

What China needs but does not have is time. At least two of the big four banks originally were to have completed IPOs by the end of this year. Now, completing even one IPO would represent an accomplishment. While Beijing is propping up several ailing industries and protecting strategic sectors of the economy, it is attempting some signicant systemic changes. At this stage, however, any external pressures threaten to throw off the delicate balance between carefully selected, isolated pain and a loss of control over the process.

E x t e r n a l P r e s s u r e C o m p o u n d s I n t e r n a l U n r e s tBeijing has little breathing room. Despite an initial deal with the European Union on some textile issues, China still faces additional EU pressure and the United States has yet to compromise on trade, either. In fact, while the Bush administration plays good cop to Congress bad cop when it comes to calling for across-the-board tariffs against China, Washington is unied in its push to break the yuan out of its pegged and articially low position something that could increase the cost of U.S. imports, but would hurt China much more.

The push against the yuan is coupled with increasing political pressure from Washington, which is critical of Beijing for not doing enough to bring Pyongyang back to the nuclear-negotiating table. At the same time, Washington is stepping up military pressure on China, raising a cry over


J U L Y 2 0 0 5

Chinese defense development while tightening cooperation with Japan, Australia and others in a defense alliance that has missile defense as one of its mainstays.

In the past, China turned to Europe to try to reduce U.S. pressure, but the collapse of European cohesion after the rejection of the EU constitution by French voters has left Europe a poor partner when it comes to countering U.S. might. Beijing is trying to work within an Asian framework, pressing forward with its peaceful rise policies and trying to strengthen security cooperation with traditional U.S. allies in the region, such as Indonesia and the Philippines. Beijing also is turning toward Russia, but Chinas leaders do not trust their neighbor and still are banking on using their economic clout to gain breathing room from the United States thus weakening any potential for a signicant strategic alliance with Moscow.

In essence, China has no good options. What Beijing needs is time and space, and Washington is not granting that. The result of this is being seen inside China, as localized riots and attacks against police and internal security forces increase in frequency and scale. Video footage of Chinese farmers in Hebei battling hired thugs working for a company seeking to build a power plant provided just one of the vivid examples of social structures reaching their breaking point. And in the southern province of Guangdong, several hundred people confronted police ofcers after the police stopped a bus for waiting too long to pick up passengers, while in Anhui province, several thousand people rioted after a trafc accident, attacking a police station, burning vehicles and looting stores. These incidents illustrate how the Chinese leadership is steadily losing control of the local authorities and of the masses.

As Beijing faces increasing external pressures and increasing unrest from within, Southeast Asia faces its own troubles from the ever-present Myanmar question to growing political unrest in the Philippines. ASEAN is seeking to reshape East Asia as a more integrated economic and potentially political bloc, with ASEAN at the center. But the Myanmar issue continues to plague ASEANs relations with the United States and Europe, and given that Yangon is one of the Bush administrations new outposts of tyranny, Myanmar is receiving more pointed attention from Washington. This dilemma threatens Asian unity, since ASEAN must now choose between internal cooperation and recognition, and bargaining power abroad.

Being needs time and

space, but Washington is

not granting that.


J U L Y 2 0 0 5

T h e P h i l i p p i n e O p p o s i t i o n U n i t e s , M a y b eMeanwhile, in the Philippines, what started as a series of scandals and disjointed-opposition pushes now looks more serious. Arroyo was holding her own in the face of growing pressure while the various opposition factions were unable to unite their cause or present a viable alternative to Arroyo. That is changing, and the emergence of the widow of Arroyos competitor in the last presidential election could provide the focus missing from the opposition movements, potentially seriously jeopardizing Arroyos position.

One additional notable issue must be raised that of the apparent Japanese economic recovery. All indicators are up for Tokyo, and foreign direct investment is reaching record levels. But the ride is unlikely to last, as Japan has yet to fundamentally address the structural weaknesses in its economic system. Though the malaise will eventually return, the Japanese are currently riding high.

T h e M o n t h A h e a d :F o r e c a s t s f o r J u l y

H i g h l i g h t s : Putin and Hus Central Asian Consensus Six-Party Talks Resume Australian-ASEAN Nonaggression Pact Renewed Aceh Talks Arroyos Make-Or-Break Month

Hu travels to Russia and Kazakhstan at the beginning of July for meetings that will offer insight into whether Moscow and Beijing will join to attempt to resist U.S. pressure or remain as wary of each another as they are of Washington. During Hus Moscow trip, Russian President Vladimir Putin likely will offer a pipeline to China again, but given that Moscow has reneged on previous promises made by Putin, Beijing is unlikely to place much credence in such an offer until the promised pipeline is built and running into Chinese territory.

Putin and Hu could agree more readily, however, on Central Asia at the Shanghai Cooperation Organization (SCO) summit. At the summit, SCO members probably will formalize plans for a regional rapid-reaction force, as well as offer observation status to India and Pakistan and strengthen


J U L Y 2 0 0 5

economic ties among SCO member states. For Hu and Putin, the SCO serves as a useful vehicle for jointly contending with U.S. pushes into the region. And given Central Asias location on the border of both Russia and China and the regions importance for energy security, Beijing and Moscow see little room for maneuver, and so must strengthen their ties regionally to counter U.S. encroachment.

Hu also plans to travel to North Korea in early July, amid growing signs that North Korea and the United States will return to the negotiating table later in the month. Hu will not visit Pyongyang unless he knows he will get some sort of assurance from the North Korean leadership that they will rejoin the six-party talks. But Hu also will seek to regain inuence over Pyongyang, giving Beijing greater control over the talks and increased leverage with Washington. Beijing hopes to balance U.S. concerns against North Korean nukes with Chinese concerns over U.S. economic pressure. Washington has reined in Congress, at least temporarily, and will now look for China to reciprocate.

All signs point to a renewal of the six-party talks, probably around July 25, and intense backroom negotiations already under way will accelerate as the date nears. Pyongyang and Washington will simultaneously raise the stakes, looking for maximum advantage once the negotiations restart. A resolution to the nuclear crisis is unlikely in July, but the resumption of talks themselves will alter the perception of the threat level. If things are going well, Pyongyang could even offer hints of a return visit to Seoul by Kim.

For Beijing, keeping the North Korean lever in the face of U.S. pressure is more important than ever. Inversely, it is vital for Washington to resolve the crisis to strip China of this lever, regain the trust and cooperation of the South Koreans, and present a unied face toward containing China. Nuclear talks will resume, but the main players will be Washington and Beijing Pyongyang, on the other hand, will sit back and enjoy the ride.

In the second week of July, Indonesia will restart talks with the separatist Free Aceh Movement (GAM). The easy part of negotiations between the government and GAM is over, however, and more serious tactical discussions are set to take place. Given the Indonesian governments tightened control

All signs point to a

renewal of the six-party

talks.


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over the province in particular over the distribution of aid money since the Dec. 26 tsunami, GAM nds itself in a weakened state. But with a signicant amount of pledged money failing to reach Indonesia yet, there is plenty of room for wider discontent to spread in isolated areas of Aceh as hardships wrought by the tsunami look no closer to resolution than they did six months ago.

In late July, the ASEAN Ministerial Meeting will be held in Laos. At or before this meeting, it is expected that Myanmar will ofcially waive its turn to host ASEAN in 2006 provided it can simply trade places with the Philippines. This will provide needed breathing room for ASEAN, which will then set its sights on the planned East Asian summit. Australia is likely to sign a nonaggression pact with ASEAN before the end of July, despite controversy and concerns that not only would the pact prevent pre-emptive strikes by Australian forces, but also might run counter to existing defense treaties with the United States. But such qualms are unlikely to hinder Canberra in its quest not to wind up on the sidelines of a regional dialogue.

In the Philippines, July looks to be a make-or-break month for the Arroyo presidency. She will begin the month with a Cabinet reshufe, removing ofcials linked to her husband and son and to the scandals surrounding them in an attempt to free herself from a tightening opposition noose.

In the beginning of June, the chief of the Philippine military announced that plots to destabilize Arroyos regime presumably hatched by former military ofcers had been uncovered, and said the military was on high alert to prevent any such action. Meanwhile, the trial of Arroyos son, Juan Miguel Mikey Arroyo on charges of proting from illegal gambling on the game of jueteng continued, with several witnesses directly implicating Mikey Arroyo and his father (Arroyos husband) as additional beneciaries of the prots.

On June 6, audio recordings emerged allegedly showing Arroyo, her husband, and an electoral commission ofcial speaking, thus implicating her in a scheme to rig the May 2004 election. By June 27, rising public pressure forced Arroyo to apologize to the Philippine people for speaking with the

If the opposition can rally

the dead Poe society,

Arroyo could face a

challenge she cannot

deect.


J U L Y 2 0 0 5

electoral ofcial, saying the conversation was a lapse in judgment, but she maintained that she had committed no crimes. In addition, Arroyo sent her husband into exile, saying nothing would distract her from completing election reforms.

Though several people-power revolts have shaken the Philippines in the past, opposition gures were not able to rally support to oust Arroyo in June. Their primary problem was a failure to provide a viable alternative or at least a gure that various opposition factions could rally around. But the emergence of Roces could provide the rallying point that unites the opposition. If opposition leaders can rally the masses into this dead Poe society, Arroyo could face a challenge she cannot deect. July will prove a critical month for the embattled president, who initially rose to power through a similar people power rising.


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T r e n d s , S tat s a n d I n d i c at o r s

BruneiCambodiaChinaIndonesiaJapanLaosMalaysiaMyanmarNorth Korea3

PhilippinesSingaporeSouth KoreaTaiwanThailandVietnam

N/A = not available

All data are provided by the governments of respective countries, unless otherwise noted.

1 Asian Development Bank 2 International Monetary Fund 3 Information provided by South Korea

N/A4.1390 20031,660.0 2004183.29 20044,446.5 2003N/A118.32 2004N/A19.110 200484.567 2004111.00 2004668.10 2004315.38 2004147.52 200439.045 2003

N/A12.824 20041,306.31 2005216.41 2004127.69 20055.8400 200426.128 200553.300 200422,709 200475.504 20004.8082 200448.461 200422.715 200562.799 200280.902 2003

N/A311.00 20031,271.0 2004834.00 200434,824 2003N/A4,528.0 2004N/A841.00 20041,120.0 200423,085 200413,786 200413,884 20042349.0 2004439.00 2003

N/A3.40% 20039.40% Q1 055.13% 20042.60% 20042

6.50% 20041

5.70% Q1 05N/A2.20% 20044.60% Q1 052.40% Q1 054.60% 20045.71% 20043.30% Q1 057.23% Q1 05

N/A0.1150 20041

22.370 2005 thru May4.9360 2005 thru Apr37.211 FY 20040.0170 20041

2.0740 20041

0.1280 20031

N/A0.0570 20041

5.3780 20041

12.770 2004(-5.1890) 20041

0.1000 2005 thru Feb1.6589 2005 thru May

N/A3.1% 20041

4.2% 20041

9.6% 20041

4.4% Apr 05N/A3.3% Q4 04N/AN/A8.3% Apr 054.0% 20043.4% May 054.1% May 052.0% 20045.6% 2004

N/A2.4610 2004276.40 2005 thru May69.714 2004565.38 2004N/A165.973 2005 thru AprN/A1.0200 200439.598 2004343.37 2004253.84 200458.490 2005 thru Apr42.562 2005 thru May11.969 2005 thru May

N/A3.1040 2004246.39 2005 thru May46.520 2004454.90 2004N/A132.69 2005 thru AprN/A1.8400 200440.300 200498.508 2004224.46 200458.110 2005 thru Apr48.836 2005 thru May14.555 2005 thru May

N/A1.3% Apr 05(-0.2%) May 050.2% May 050.3% Apr 0510.6% 20042.6% Apr 05N/AN/A0.5% May 05(-0.2%) May 05(-0.2%) May 050.6% May 050.8% May 050.5% May 05

N/A0.6573 Mar 052

663.19 Mar 052

34.380 23 Jun 05832.88 Apr 052

0.2250 20041

73.413 Apr 052

0.7191 Jan 052

N/A13.826 Mar 052

112.81 20041

205.25 May 05253.17 May 0547.906 Apr 056.0270 20041

GD

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J U L Y 2 0 0 5

T r e n d s , S tat s a n d I n d i c at o r s

Brunei CambodiaChinaIndonesiaJapanLaosMalaysia MyanmarNorth KoreaPhilipinesSingaporeSouth KoreaTaiwanThailand Vietnam*Closing Rates

Beginning

1.68804,257.08.28659,529.0108.5510,5803.80106.26252.200054.6101.66701,008.131.39540.68115,865

Low

1.70404,226.08.28659,476.0106.4810,5523.788.06.26252.200054.2501.64401,001.531.11839.22015,022

High

1.70804,277.08.28659,719.0110.6410,8883.80406.26252.200056.0001.68901,032.131.66541.36516,625

End

1.70404,271.08.28659,716.0110.5810,6643.80106.26252.200055.9801.68601,032.131.66541.36515,866

Regional Currency Rates


J U L Y 2 0 0 5

N o t e w o r t h y E v e n t s

June 1, AUSTRALIA/INDONESIA: The Indonesian Embassy in Canberra, Australia, closes after embassy ofcials receive an envelope that preliminary tests indicate contains a biological agent.

June 1, CHINA/U.S.: Chinese Foreign Minister Li Zhaoxing and U.S. Secretary of State Condoleezza Rice say in a phone conversation that they will make joint efforts to prepare for meetings between top leaders of the two countries.

June 1, NORTH KOREA: North Korea divides the Ministry of Metal and Machine-Building Industries into two ministries.

June 1, INDONESIA: The Indonesian Parliament issues a resolution asking the government to boycott all meetings of the Association of Southeast Asian Nations (ASEAN) if Myanmar becomes ASEANs chair.

June 1, JAPAN: Japan says it has no plans for state-sponsored prospecting in an area of the East China Sea it disputes with China.

June 1, PHILIPPINES: Philippine militant group the Moro Islamic Liberation Front rejects a cease-re proposed by the government as a precondition for the resumption of formal peace talks.

June 1, SOUTH KOREA/VIETNAM: South Korea and Vietnam agree to a bilateral trade agreement that would boost Vietnams bid to join the World Trade Organization by the end of 2005.

June 2, BRUNEI/CHILE/NEW ZEALAND/SINGAPORE: Representatives from Brunei, Chile, New Zealand and Singapore say they have reached a free trade agreement to eliminate duties on more than 90 percent of goods.

June 2, CHINA: China charges Zhao Yan, a researcher for The New York Times, with fraud.

June 2, CHINA: Chinas Sinopec Corp. acquires a 40 percent stake of the Northern Lights Oil Sands Project in Alberta, Canada, for about $122 million.


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June 2, CHINA/INDIA/RUSSIA: Chinese Foreign Minister Li Zhaoxing, his Russian counterpart Sergei Lavrov and Indian counterpart Natwar Singh meet in Vladivostok, Russia, for the fourth informal Chinese-Indian-Russian foreign ministers meeting. The three exchange views on regional and international situations and explore trilateral cooperation in the economic eld.

June 2, CHINA/RUSSIA: After 40 years of negotiations, Chinese Foreign Minister Li Zhaoxing and Russian Foreign Minister Sergei Lavrov sign a nal agreement on their two nations eastern border.

June 2, CHINA/U.S.: U.S. Commerce Secretary Carlos Gutierrez arrives in Beijing to meet with Chinese Vice Premier Wu Yi and Chinese Commerce Minister Bo Xilai.

June 2, JAPAN/INDONESIA: Indonesian President Susilo Bambang Yudhoyono and Japanese Trade Minister Shoichi Nakagawa agree in a summit meeting to start negotiating a free trade agreement by July and to step up cooperation for disaster management.

June 2, PHILIPPINES: Philippine President Gloria Macapagal Arroyo says she will call a constitutional convention to change the countrys form of government from a presidential system to a federated, parliamentary system in 2006.

June 2, NORTH KOREA/SINGAPORE: Asias defense ministers begin a three-day meeting in Singapore to discuss security, terrorism and the nuclear standoff with North Korea.

June 2, SOUTH KOREA: Trade ministers from the Asia-Pacic Economic Cooperation forum countries start a conference on Cheju Island, South Korea.

June 2, JAPAN, SOUTH KOREA: A two-day standoff between South Korea and Japan in waters off the coast of South Korea ends peacefully after both sides agree to a deal.

June 3, CHINA: Construction starts in China on what is to become the largest shipyard in the world, marking a major step forward in Chinas ambition to become the worlds leading ship builder.


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June 4, CHINA/U.S.: Chinese Minister of Commerce Bo Xilai holds talks with U.S. counterpart Carlos Gutierrez in Beijing to nd a solution to the Sino-U.S. textile trade friction and to discuss intellectual property right protection. June 5, MALAYSIA: Malaysian Islamist group Parti Islam se-Malaysia (PAS) names new liberal leaders in an effort to stay relevant. PAS elects reformist Nasharudin Mat Isa as deputy to conservative leader Hadi Awang.

June 6, NORTH KOREA/U.S.: North Korean ofcials meet in New York with Joseph DeTrani, U.S. special envoy to the six-party talks on North Koreas nuclear weapons program, and Jim Foster, director of the U.S. State Department Ofce of Korean Affairs.

June 6, JAPAN/U.S.: Japan and the United States will begin a ve-year development phase of a joint sea-based missile defense system in 2006, Japanese Self-Defense Forces Chief Yoshinori Ono says.

June 6, PHILIPPINES: A spokesman for President Gloria Macapagal Arroyo says a tape smearing Arroyos reputation is fabricated. The Arroyo administration releases the allegedly doctored tapes.

June 7, AUSTRALIA/INDONESIA: A suspicious parcel delivered to the Indonesian Embassy in Canberra, Australia, forces the embassy to close for the second time in a week.

June 7, CHINA/OMAN/QATAR/RUSSIA/UNITED ARAB EMIRATES: Chinese Vice Premier Zeng Peiyan leaves for four-nation tour of Oman, Qatar, Russia and the United Arab Emirates. Zeng will attend the second South Summit in Doha, Qatar, on June 15.

June 7, AUSTRALIA/CHINA: Two Chinese nationals seeking political asylum in Australia publicize claims that their government has a network of 1,000 spies in Australia and often engages in illegal efforts to abduct Chinese nationals in Australia and transport them back to China.

June 7, INDONESIA: A bomb threat hoax at Indonesias Trade Ministry building in Jakarta leads to the evacuation of hundreds of staff. A staff member reportedly receives the threat via mobile phone message, but a police bomb squad nds no device when it searches the building.


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June 7, THAILAND/U.S.: During his meeting with Thai Prime Minister Thaksin Shinawatra and Thai security ofcials, U.S. Secretary of Defense Donald Rumsfeld calls for more regional cooperation in ghting pirates.

June 7, BRAZIL/GERMANY/INDIA/JAPAN/U.N.: Brazil, Germany, India and Japan will delay the submission of a draft resolution on U.N. reform to the U.N. General Assembly until at least July from an initial target of June.

June 8, CHINA/U.N.: China issues a position paper on U.N. reforms, emphasizing multilateralism and urging that reforms meet the needs of developing countries.

June 8, CHINA: Chinas Shenhua Energy Co. Ltd. sells more than 3 billion shares and raises $2.95 billion -- less than it sought -- in the worlds largest initial public offering in 2005.

June 9, NORTH KOREA, U.S.: North Korea has an arsenal of nuclear bombs and is in the process of increasing its size, North Korean Vice Foreign Minister Kim Gye Gwan says. Kim adds that North Korea has no plans to attack the United States.

June 9, PHILIPPINES: The Philippine military is on full alert after receiving reports that anti-government protesters would add to the calls for President Gloria Macapagal Arroyos ouster.

June 10, CHINA/EU: EU Trade Commissioner Peter Mandelson arrives in Shanghai, China, for talks with Chinese government ofcials, including Commerce Minister Bo Xilai, regarding the increase in Chinese exports of certain textile products.

June 10, SOUTH KOREA/U.S.: U.S. President George W. Bush and South Korean President Roh Moo Hyun meet in front of reporters in the White House, where Bush says the United States and South Korea share the same goal of peace on the Korean Peninsula. June 10, TAIWAN/VIETNAM/WTO: Talks in Hanoi between Taiwan and Vietnam on Vietnamese accession to the World Trade Organization end.

June 11, BRAZIL/CHINA/INDIA/SOUTH AFRIFA/G-8: Chinese Finance Minister Jin Renqing meets with nance ministers of the G-8 nations and of Brazil, China, India and South Africa in London.


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June 11, CHINA/EU: Following 10 hours of marathon talks between top trade ofcials, China and the European Union reach a deal to settle their ongoing dispute over textile trade. The deal will limit the growth of Chinese textile and clothing exports to EU in the coming three years to secure a smooth transition before the complete opening of the European market to Chinese textile products in 2008.

June 11, PHILIPPINES: Approximately 5,000 demonstrators gather in Manila to call for President Gloria Macapagal Arroyo to step down over corruption allegations.

June 11, SOUTH KOREA/U.S.: U.S. President George W. Bush and South Korean President Roh Moo Hyun meet for 40 minutes.

June 13, AUSTRALIA/EAST TIMOR: Australian peacekeeping troops in East Timor hand over an army base in the Timorese town of Moleana, marking the nal withdrawal of Australian forces from East Timor.

June 13, NORTH KOREA/U.S.: U.S. President George W. Bush and North Korean defector and human rights activist Kang Chol Hwan meet and discuss Kangs book Aquariums of Pyongyang, which details his 10 years in a North Korean prison camp.

June 14, CHINA/AUSTRALIA: The Australian Security Intelligence Organization, Australias domestic intelligence agency, announces it will investigate claims by Chinese diplomat Chen Yonglin that China is operating a network of around 1,000 spies in Australia.

June 14, CHINA/EU: The European Union calls off plans to lift its arms embargo against China. Chinas Foreign Ministry then demands that theEuropean Union lift its arms embargo as soon as possible to help end political discrimination against China and to remove the last obstacle in Sino-EU relations.

June 14, MYANMAR: Members of the Supreme Court are assigned to set up the trial of former prime minister and spy chief, Khin Nyunt. A specic start date has yet to be set. Some 300 people linked to Nyunt face secret tribunals within Myanmars Insein prison. The court heard charges against Nyunt in an earlier secret hearing; specic charges are not known.


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June 14, JAPAN: Japanese lawmakers pass a bill allowing incoming ballistic missiles to be intercepted from Japanese territory.

June 15, NORTH KOREA/SOUTH KOREA: North Korea and South Korea conduct joint ceremonies in Pyongyang, North Korea, to commemorate the fth anniversary of the inter-Korean summit.

June 15, INDONESIA: A bomb is defused in Jakarta in the parking lot of the Tanjung Barat rail station.

June 16, CAMBODIA: Four masked men hold children hostage at the Siem Reap International School. The leader, Chea Khom, kills a two-year-old Canadian boy to show security forces that he is serious. The siege ends when Cambodian police raid the school.

June 16, PHILIPPINES: Customs agents in Manila intercept a shipment of high-powered rearms, ammunition and gun parts ofcials say was intended for groups seeking the overthrow of the Philippine government.

June 16, CHINA/U.S.: Chinese and U.S. representatives begin initial consultations regarding textile trade via videoconference and discuss import restrictions recently imposed by the United States on seven categories of Chinese-made clothing and textile goods.

June 17, CHINA/U.S.: U.S. ofcials are in sharp disagreement with Israel over its sale of military technology to China, U.S. Secretary of State Condoleezza Rice says.

June 17, NORTH KOREA/SOUTH KOREA: A man in a North Korean military uniform is found hiding in a truck at a public park in Cheorwon, South Korea, near the demilitarized zone with North Korea. The South Korean military says it believes the man, who speaks with a North Korean accent, is a defector.

June 17, NORTH KOREA/SOUTH KOREA: Two North Koreans arrive at the South Korean island of Baekryong aboard a small motorless vessel and express their hope to defect to the South.

June 17, NORTH KOREA: North Korean leader Kim Jong Il meets with visiting South Korean Unication Minister Chung Dong Young for about ve hours in Pyongyang, North Korea.


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June 17, CHINA/U.S.: Bank of America Corp. signs a deal to buy a 9 percent stake in China Construction Bank Corp., the largest acquisition by a foreign nancial institution in China.

June 18, PHILIPPINES: The smuggled rearm parts seized by Bureau of Customs agents at the Manila International Container Port on June 16 were unlikely to be used in destabilization efforts against the government, the Bureau of Customs deputy commissioner says.

June 19, SOUTH KOREA: South Korean soldier Kim Dong Min throws a grenade and res a rie at his fellow soldiers as they sleep, killing eight of them and injuring two. The attack occurred in Yeoncheon county near the border with North Korea.

June 19, CHINA/EU: Chinese and European scientists say they have identied a cure for SARS. The scientists found that cinanserin, a medicine used to treat schizophrenia, effectively inhibits the corona virus that causes SARS.

June 20, VIETNAM/U.S.: Vietnamese Prime Minister Phan Van Khai, on a one-week visit to the United States, meets with Microsoft Corp. founder Bill Gates and tours Microsofts headquarters.

June 20, CHINA: Chinese Foreign Minister Li Zhaoxing and his Israeli counterpart Silvan Shalom meet in Israel.

June 20, JAPAN/SOUTH KOREA: Japanese Prime Minister Junichiro Koizumi meet with South Korean President Roh Moo Hyun in Seoul to discuss bilateral ties and historical issues between their two countries.

June 20, INDONESIA/PHILIPPINES: Indonesian President Susilo Bambang Yudhoyono arrives in the Philippines for a three-day visit with government ofcials to discuss bilateral economic relations between the two countries and counterterrorism operations.

June 21, CHINA: Chinas government appoints veteran civil servant Donald Tsang as Hong Kongs new leader.

June 21, SOUTH KOREA/CHINA: South Korean Prime Minister Lee Hae Chan meets with Chinese Premier Wen Jiabao in Beijing, where the two discuss regional and international issues, including the situation in North Korea.


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June 21, TAIWAN: Taiwan deploys two frigates to waters near uninhabited islands in the East China Sea to protect shing boats from interference from Japanese patrol boats. June 21, PHILIPPINES: The Philippine House of Representatives begins hearings into allegations of vote rigging in President Gloria Macapagal Arroyos May 2004 election victory, stemming from recordings of Arroyo allegedly speaking with ofcials from the election commission.

June 21, PHILIPPINES: Cardinal Jaime Sin, former leader of the Roman Catholic Church in the Philippines, dies after suffering from a high fever and multiple organ failure since June 19.

June 21, VIETNAM/U.S.: Vietnamese Prime Minister Phan Van Khai and U.S. President George W. Bush meet in the Oval Ofce and discuss bilateral economic relations, Vietnamese entry into the World Trade Organization, security issues and human rights issues.

June 21, SOUTH KOREA/NORTH KOREA: A delegation from North Korea arrives in Seoul for a meeting that concludes with a 12-point joint statement announcing the parties have agreed to take substantial steps toward a peaceful resolution of the North Korean nuclear weapons program issue.

June 21, JAPAN/TAIWAN: More than 10 politicians from Taiwan sail near uninhabited islands northeast of Taiwan to show their resolve to protect Taiwanese shermen from Japanese harassment in an area claimed by both sides.

June 22, CHINA/SOUTH KOREA: Chinese President Hu Jintao agrees to cooperate closely with South Korea to revive the stalled six-party talks on North Koreas nuclear weapons program.

June 22, PHILIPPINES: A Philippine worker is freed after seven months of captivity by militants in Iraq.

June 22, SOUTH KOREA: South Korean Defense Minister Yoon Kwang Ung offers his resignation to President Roh Moo Hyun after a soldier killed eight fellow troops June 19.

June 23, CHINA: China National Offshore Oil Corp. bids $18.5 billion in cash for Unocal Corp., the ninth-largest oil company in the United States.


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June 23, CHINA: A Chinese delegation led by Foreign Minister Li Zhaoxing meets Syrian Prime Minister Mohammad Naji al-Otari in Damascus to discuss strengthening economic ties between the two nations.

June 23, CHINA/JAPAN: Chinese Vice Foreign Minister Dai Bingguo and Japanese Vice Foreign Minister Shotaro Yachi meet in Tokyo for the second round of strategic talks on bilateral relations.

June 23, CHINA/SYRIA: Syrian President Bashar al Assad, Prime Minister Mohammed Naji al-Otari and Foreign Minister Farouk al-Shara meet separately with visiting Chinese Foreign Minister Li Zhaoxing in Damascus.

June 23, CHINA/U.S.: Federal Reserve Chairman Alan Greenspan testies before the Senate Finance Committee that imposing trade tariffs on China would be misguided and would put the future of the U.S. economy at risk.

June 23, INDONESIA: Two shots are red at a Red Cross vehicle in Aceh province in the west coast town of Lamno, wounding a Chinese tsunami aid worker.

June 23, INDONESIA/OPEC: The Organization of the Petroleum Exporting Countries (OPEC) asks Indonesia to retain its membership amid rumors Jakarta is thinking about leaving OPEC.

June 23, NORTH KOREA: The United States pledges to give North Korea 50,000 metric tons of food aid. The aid will be distributed through the U.N. World Food Program.

June 23, INDIA/SOUTH KOREA: South Korean steel company Posco announces plans to build a plant in Indias Orissa state. The deal, worth $12 billion, will represent South Koreas largest foreign direct investment to date.

June 23, THAILAND: Thailand plans to send security forces into government-declared violent zones in the predominantly Muslim southern provinces of Narathiwat, Pattani and Yala to try to kill those responsible for a surge of deadly attacks.

June 23, VIETNAM/U.S.: U.S. military specialists will return to Vietnam to help train Vietnamese soldiers under a new agreement with the Pentagon, a senior Vietnamese ofcial says.


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June 24, CHINA: Chinas government will order 6,000 industrial rms in Beijing to shut down for a week during the summer and will order another 5,800 companies to give their workers days off to manage a severe power shortage, state-owned newspaper China Daily reports.

June 24, CHINA: Donald Tsang is sworn in as the new chief executive of Hong Kong.

June 24, PHILIPPINES: Philippine President Gloria Macapagal Arroyo appoints Lt. Gen. Generoso Senga as commander in chief of the countrys armed forces.

June 24, PHILIPPINES: Five thousand protesters march on central Manila to demand Philippine President Gloria Macapagal Arroyos resignation over allegedly xing the 2001 Philippine presidential election.

June 26, ASIA-EUROPE FORUM: Finance Ministers from 13 Asian and 25 European nations, as well as representatives of the European Commission, gather in north Chinas Tianjin Municipality for the Asia-Europe Finance Ministers Meeting to discuss various options for deepening economic and nancial ties between the two continents.

June 27, ASEAN/AUSTRALIA: Australian Foreign Minister Alexander Downer says Canberra would be willing to sign a nonaggression pact with Association of Southeast Asian Nations (ASEAN) to take part in ASEANs East Asia Summit, as long as the pact does not interfere with other Australian treaties.

June 27, CHINA: Chinas National Development and Reform Commission (NDRC) decides to raise the prices of gasoline and diesel oil by 5 percent and 4 percent per ton, respectively.

June 27, PHILIPPINES: An impeachment complaint is led in the Philippine House of Representatives against President Gloria Macapagal Arroyo, saying Arroyo should be ousted for a betrayal of public trust arising from the Gloriagate tapes that allegedly establish voter fraud during May 2004 Philippine elections. In a televised statement, Arroyo acknowledges the voice on the tape is hers, but denies having inuenced the election.


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June 29, SOUTH KOREA/U.S.: South Korean Unication Minister Chung Dong Young begins a visit to the United States scheduled to end July 3.

June 30, CHINA/KAZAKHSTAN/RUSSIA: Chinese President Hu Jintao be-gins a state visit to Russia and Kazakhstan scheduled to end July 7 that will include attending the summit meeting of the Shanghai Cooperation Organi-zation in the Kazakh capital, Astana.

J u l y a n d B e y o n d

July 1, VIETNAM: Vietnamese Prime Minister Phan Van Khai to meet Japanese Prime Minister Junichiro Koizumi in Japan.

July 1, SOUTH KOREA: South Korean Ministry of Finance and Economy to establish the state-run Korea Investment Corp.

July 1, ASEAN/CHINA: China and Association of Southeast Asian Nations to reduce duties on 7,445 products.

July 4, CHINA: Greater Mekong Subregion Summit to be held in Kunming, China, through July 5.

July 4, VIETNAM: Evaluation of Vietnams compliance with the World Trade Organizations Agreement on Trade-Related Aspects of Intellectual Property Rights compliance and of Vietnams draft of intellectual property law to be held through July 29.

July 5, KAZAKHSTAN/SCO: Shanghai Cooperation Organization summit to be held in Astana, Kazakhstan.

July 6, U.K.: G-8 Summit to be held through July 8 in Gleneagles, Scotland.

July 7, JAPAN/SOUTH KOREA: South Korea and Japan to hold consular affairs talks in Seoul, South Korea.

July 11, THAILAND/U.S.: The fourth round of Thailand-U.S. free trade agreement negotiations to be held in Montana through July 29.

July 12, SINGAPORE/U.S.: Singaporean Prime Minister Lee Hsien Loong to hold talks with U.S. President George W. Bush in Washington.


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July 18, CHINA/VIETNAM: Vietnamese President Tran Duc Luong to meet Chinese President Hu Jintao in China through July 22.

July 19, AUSTRALIA/TAIWAN: Bilateral economic consultations between Taiwan and Australia to be held in Canberra, Australia, through July 20.

July 24, ASEAN/LAOS: The 38th annual Ministerial Meeting of the Association of Southeast Asian Nations to be held in Laos through July 30.

July 28, APEC/U.S.: Asia-Pacic Economic Cooperation symposium on avian inuenza to be held in San Francisco through July 29.

July 29, JAPAN/TAIWAN: The 15th round of shery talks between Japan and Taiwan to begin in Tokyo.

July 31, APEC/MALAYSIA: Kuala Lumpur, 3rd Asia-Pacic Economic Cooperation Business Advisory Council meeting to be held through Aug. 2. TBD, CHINA/NORTH KOREA: Chinese President Hu Jintao likely to visit North Korea, probably in early July.

C h a n g e s

ChinaAfter 10 hours of negotiation, EU Trade Commissioner Peter Mandelson and Chinese Commerce Minister Bo Xilai reached an agreement early June 11 settling the current disputes between the parties over textile trade. The agreement, a memorandum of understanding, will limit the year-on-year growth of exports of Chinese textiles into the European Union to 8 percent to 12.5 percent through the end of 2007. Currently, the European Union is second only to the United States as a trading partner with China. The China Banking Regulatory Commission (CBRC) announced June 16 that the Chinese legislature seeks to dene fraudulent activities for bank loans and illegal disposal of nonperforming assets as crimes under Chinese law. Additionally, the CBRC said June 22 it will raise the maximum limit on foreign ownership of domestic banks. This move is intended to increase involvement of foreign investors in the management of Chinese banks and to hasten banking reform.


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Hong KongDonald Tsang, sworn in as the new chief executive of Hong Kong on June 24, is a Hong Kong native born in 1944. He attended Wah Yan College, graduating in 1964, after which he entered public service. Tsang worked in various government ofces until 1981, when he went to study in the United States, receiving a masters degree in public administration from Harvard University in 1982. He also has received honorary doctorates from the Chinese University of Hong Kong, the Hong Kong Polytechnic University and the University of Hong Kong. From 1985 to 1993, Tsang served as deputy secretary of the General Duties Branch and director general of trade before being promoted to secretary for the treasury. In September 1995, Tsang became the rst person of Chinese heritage to be appointed nancial secretary. In 2001, Tsang was promoted to chief secretary. After Tung Chee Hwa resigned, Tsang was appointed acting chief executive until the end of Tungs term on June 30, 2007. Tsang was knighted in 1997 for long-time service to Hong Kong, but does not use his title in public. He is also a devout Roman Catholic.

South KoreaSouth Korean Prime Minister Roh Moo Hyun appointed Chun Jung Bae to be his new justice minister. Chun, who graduated from Seoul National University in the 1970s with a law degree, focused his career on human rights law, representing unionists and dissidents. He was elected to Parliament in 1996, and became the Uri Party oor leader in May 2004.

Lee Jae Yong was appointed to be Minister of the Environment. Lee originally made his career as a dentist, but became involved in politics in the early 1990s through his involvement with environmentally minded nongovernmental organizations. He unsuccessfully ran for mayor of Daegu in 2002, and also unsuccessfully sought a seat in the National Assembly as a member of the Uri Party in 2004.

TaiwanTaiwans National Assembly adopted a packet of substantial constitutional reforms June 7, which included a provision for the assemblys abolishment. The legislature had approved reform packet in August 2004; the reforms enjoyed broad support from both the Democratic Progressive Party and the opposition Nationalist Party.


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Electoral reforms include an entire restructuring of the voting system, from a single-vote, multiple-seat constituency system to a single-seat constituency, two ballots system. Impeachment procedures for presidents and vice presidents are now relegated to the Council of Grand Justices. Reforms of the Legislative Yuan, Taiwans legislature, are also signicant. Beginning with the next election in 2007, the number of legislative seats will drop from 225 to 113, while legislators terms will increase from three years to four years. All constitutional matters, formerly addressed by the now-defunct National Assembly, will be decided by national referendums.


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he European Unions fortunes are shattering this month. French and Dutch voters rejected the draft EU constitution at the beginning of June, causing the process of political integration to grind to a halt. July begins the United Kingdoms six-month term as EU president, during which London will do its best to ensure that nothing happens to

resurrect the process.

T h i s M o n t h s H i g h l i g h t s : I n E v e r y I s s u e : The Constitution Crashes Trends, Stats and Indicators The Summit Stalemate Noteworthy Events The Weakening Euro Competing Visions of the EU

T


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urope is in the initial stages of political, and perhaps economic, disintegration. Triggered by the French and Dutch rejections of the EU constitution, and exacerbated by the collapse of the June 16-17 EU summit, June will go down in history as the period when the EUs fortunes shattered.

But, for now at least, the pieces remain close enough together that all hope has not yet been abandoned even if detached rational analysis indicates that it should be. The United Kingdom hijacked the June summit, shifting discussion of the failed EU constitution and in-limbo budget to the more fundamental question of what sort of Europe the European Union should aim for. British Prime Minister Tony Blair opined that the European Union should strive to be a nonpolitical grouping focused on preparing its economies for globalization, while spending its budget on infrastructure, research and development programs.

The counterproposal that Europe should continue to supply its farmers, particularly French farmers, with generous subsidies originated in Paris. Needless to say, the two views are utterly irreconcilable, ergo the summits collapse.

July will be a month of setting trajectories for the coming European slide. No major decisions will be made, much less come to fruition. No major developments will manifest, much less become crucial. Instead, over the coming month, the ssures opened in June will fester, resentments will build, and countries will become ossied in their approach to the European problem.

For France, this means digging in its heels against the waves of change sweeping over the Continent. For Germany, it means being distracted by the introspection of snap elections. For the United Kingdom, it requires plotting a way to force its agenda of a looser EU on its partners. A fundamental new Europe is taking shape. The direction in which Europe will go will not be apparent in July, but the environment in which the change will occur will take form.

No country will play a larger role in the development of this environment than the United Kingdom, which takes over the EU presidency from Luxembourg on the rst of the month. The United Kingdom has always preferred a weaker, broader, pro-market European Union than the traditional integrationist vision, and London will spend its presidency working toward that goal. In the end, however, London will only walk away with the rst of its three goals a weaker union in hand.

EE x e c u t i v e S u m m a r y


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J u n e : T h e M o n t h i n R e v i e w

T h e C o n s t i t u t i o n C r a s h e sJune began in the worst possible way for a European Union still reeling from French voters rejection of the proposed EU constitution on May 29: Dutch voters rejected it in a referendum June 1. Where the French rejection damaged forward movement on Europe, the Dutch rejection ended it. Where the French referendum forced Europeanists to take stock, the Dutch referendum scattered them in disarray. Where the French vote raised the possibility of European failure, the Dutch vote conrmed it. Taken together, the rejections killed the European political union and with it the idea that Europe might some day become a super-state. The Continent immediately buzzed with discussion over what would come next.

T h e S u m m i t S t a l e m a t eTwo weeks later at the EU summit, failure turned into a rout. The summit opened with a half dozen EU states announcing that they were indenitely suspending their own constitution ratication processes. It ended with the EUs 25 member governments squabbling over the budget.

At the summits end, the EU lacked more than just a budget for 2007 to 2013 It lacked, and sorely needed, a consensus on its present and future direction.

Instead of building that consensus, the June summit threw a spotlight on the divisions between two competing visions of Europes future. On one side stand French President Jacques Chirac, German Chancellor Gerhard Schroeder and Luxembourgian Prime Minister (and just-past EU President) Jean-Claude Juncker. These three want an EU that is not just an economic union, but a political and social union as well, and see the EU as destined to have a major role in world affairs.

Where the French vote

raised the possibility

of European failure, the

Dutch vote conrmed it.

The EU lacks and sorely

needs consensus on its

present and future

direction.

Its no surprise that

Britain has always been

nervous about the very

concept of Europe


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On the other side is U.K. Prime Minister Tony Blair. Britain has always been nervous about the very concept of Europe no surprise for a country that has suffered the threat of invasion any time continental Europe has been subjugated to a single power. London wants to see the Union big and wide and prosperous, but not politically united. In its view, pursuing social goals is all well and good so long as each state pays for itself, and Brussels does not become the capital of anything besides Belgium.

N o R o o m f o r C o m p r o m i s eBut rather than binding together and trudging on in search of a compromise, the various players descended into a t of backbiting and blame-inging worthy of a reality TV show. This split has even cut across traditional European block alliances. Notably there is now a ssure among the Netherlands, Belgium and Luxembourg founding EU states all where normally placid and cooperative relations have broken down to the point that ministers from the different countries are now hurling personal insults at each other. Belgian Foreign Minister Karel de Gucht, for example, criticized the Dutch masses for electing Jan Peter Balkenende, a mixture of Harry Potter and inoffensive small-mindedness, a man in whom I detect no trace of charisma. His subsequent apology was only marginally less insulting than his original comment.

I n t e r n a t i o n a l R i p p l e sMeanwhile, foreign powers, recognizing a political spasm when they see one, largely stayed away from Europe in June. Beyond Europe, most realize that the very existence of a European pole in international affairs is dying. Such players are already beginning to shift their positions to take the new power vacuum into account, but in Europe chaos reigns and will continue to do so. For example, China and Russia have begun (once again) to explore the possibility of alliance.

T h e U . K . P r e s i d e n c yComplicating matters for all is the fact that Blair, with his pared-down vi-sion of the Union, was about to take on the EU presidency himself on July 1 and take charge of all the issues Juncker had so thoroughly lost control of. The result was that Chirac, Schroeder, Juncker and,

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