Weekly
Geopolitical Report
By Bill O’Grady
February 24, 2014
The Return of Japan
Two weeks ago, we discussed Germany’s
apparent early steps to return to regional
power status (see WGR, The Return of
Germany, 2/10/2014). In this week’s report,
we will examine Japan’s steady evolution to
regional power status.
We will begin with a discussion of Japan’s
geopolitical situation, focusing on its
particular goals for maintaining power and
influence. We will cover how the U.S.
resolved Japan’s goals after WWII in such a
way that maintained regional stability.
However, as U.S. policy moves from
hegemonic domination to regional power
balancing, dislocations appear to be
developing in several parts of the world,
including Asia. Japan is reacting to
America’s changing policies by becoming
more assertive. We will discuss how
Japan’s policy is evolving and how these
changes could increase the odds of conflict
in the region. As always, we will conclude
with potential market ramifications.
The Geopolitics of Japan
Japan is an island nation, an archipelago of
four major islands along with 6,800 smaller
islands. Its land mass on the four large
islands is roughly the size of California.
However, 75% of its land is not really fit for
human habitation.
(Source: Wikipedia)
As this map shows, Japan is very
mountainous. Only 13% of these islands are
arable. The population of Japan is
concentrated on the coasts, especially in the
natural bays and harbors shown in green on
the above map. In addition to lacking arable
land, Japan has few natural resources.
Although this wasn’t a major issue prior to
industrialization, it became an important
factor when the country’s economy
developed. The mountainous nature of
Japan makes centralization difficult. Japan
has no interconnected river systems. In the
country’s history, there have been long
periods where regional warlords (shoguns)
held power and either a centralized
government didn’t exist or it was very weak.
Finally, the other major feature of Japan’s
geography that shapes its behavior is its
isolation. The nearest point between
Kyushu, the third largest island of Japan,
Weekly Geopolitical Report – February 24, 2014
and the southern tip of the Korean Peninsula
is 114 miles compared to 91 miles from Key
West, Florida to Cuba. The distance from
England to France is only 23 miles. China is
480 miles away from Japan. No nation has
successfully invaded and conquered Japan.
In the 13th century, the Mongols tried to
invade with a massive fleet which was hit by
a typhoon, subsequently dubbed the
“kamikaze,” or “divine wind.” A major
reason that President Truman opted to drop
two atomic bombs on Japan was due to
concerns that an invasion of Japan would be
extraordinarily costly. For the most part,
this separation has created a tendency
toward introversion.
This isn’t to say that Japan does not, at
times, seek contact with the broader world.
However, due to Japan’s geography, it
generally can pick and choose when it wants
to engage the world. Thus, throughout its
history, it has vacillated between
engagement and withdrawal.
Periods of introversion usually occurred
when Japan was trying to establish
centralized power. During these eras, the
country focused on internal matters. In
some cases, these periods of introspection
followed phases of extroversion where
people became worried about excessive
foreign influences. For example, after the
Portuguese came in the 16th century,
extroversion was dominant and Christianity
spread rapidly. This led to a sharp reaction
of introversion against the religion about
100 years later that led to a bloody
persecution of Christians.
During introversion periods, Japan tends to
fall behind the rest of the world
technologically. The history of human
societies shows that economies of insular
peoples tend to suffer from slow growth as a
steady stream of new ideas is hard to
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generate from a relatively smaller and
indigenous population. After periods of
introversion, Japan usually opens up to the
world and furiously tries to make up for lost
time.
Japan can engage the world during its
extroversion periods because it is so
isolated. Engagement does not mean that it
is risking invasion or incursion. Instead, it
can pick and choose what it wants from the
world.
In 1853, when U.S. Commodore Matthew
Perry steamed into Edo (Tokyo) Bay and
demanded Japan open itself to trade, the
country faced the possibility that it would be
colonized or it would need to modernize to
confront the threat from the West. The
Meiji Restoration of 1868, which ended the
Tokugawa shogun and a period of
introversion, restored the emperor and
brought centralization and modernization to
Japan. Most historians hold that the Meiji
Restoration marked the beginning of modern
Japan.
In the modern era, Japan has four
geopolitical goals:




Maintain central authority and unity of
the home islands.
Gain sovereignty over nearby seas.
Secure strategic approaches to the home
islands to secure supply chains.
Acquire necessary resources and labor
by expanding economic or military
power.
The fourth goal was especially necessary
due to Japan’s lack of natural resources.
Japan’s Policy of Expansion and WWII
From the 1860s into WWII, Japan
aggressively expanded its military and
began to attack its neighbors. In 1874, it
Weekly Geopolitical Report – February 24, 2014
captured Okinawa. Twenty years later, it
took control of Korea, wresting control from
China. In 1905, Japan routed Russia in a
war, a move that shocked the West. This
conflict prevented Russia from capturing
Manchuria’s mineral wealth; in addition,
Japan annexed the southern portion of the
Sakhalin Islands. In the 1930s, Japan
expanded into Manchuria to secure natural
resources and labor. The continued conflict
in China and worries about further Japanese
expansion led President Roosevelt to
threaten an oil embargo on Japan if it didn’t
abandon its territorial acquisitions. By the
early 1940s, the U.S. was supplying Japan
with nearly 80% of its oil. Roosevelt’s
ultimatum put Japan in a very difficult
position. Either Japan had to abandon its
fourth geopolitical goal or use its military to
acquire oil reserves that rested in Indonesia,
which were controlled by the Dutch and the
British. Attacking these colonies would
probably prompt a war with the U.S. at some
point. Thus, Japan made the momentous
decision to launch a surprise attack on the
U.S. Naval station at Pearl Harbor.
Although the attack was a tactical success, it
turned out to be a strategic disaster. World
War II ended badly for Japan. Although the
U.S. did not invade the country, it did force
Japan into an unconditional surrender by a
nuclear attack and established an occupation
government for a few years.
America’s Solution to the Japan Problem
As we discussed in the aforementioned
WGR on Germany, after WWII, the U.S.
directly addressed the German problem for
Europe by demilitarizing the country.
Germany is centrally located and difficult to
defend militarily; at the same time, the lack
of natural boundaries helped make the
country an economic powerhouse.
Essentially, the U.S. took over Germany’s
foreign policy, eliminating the need for the
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country to build a large military (at least
until now).
Japan’s situation was different. Japan is
similar to Great Britain; it is an island nation
that, as we noted above, can decide when it
wants to become externally focused or not.
At the same time, it is virtually impossible
to invade and difficult to contain in its
expansionary periods. As with Germany,
the U.S. eliminated the threat to Japan’s
neighbors by forcing Japan to adopt a
pacifist constitution that would not let the
country engage in offensive warfare.
Although Japan has “bent” this constitution
to allow it to build a formidable military, the
country has generally avoided any serious
military actions since WWII.
By “outsourcing” its foreign policy and
defense to the U.S., Japan could focus on
economic recovery and development. This
situation proved to be quite favorable for
Japan; from the devastation of WWII, Japan
built itself into one of the top economies in
the world. For most of the Cold War, the
U.S. allowed Japan to use export promotion
polices in its recovery, which included a
weak currency. The U.S. did press back
against this currency policy in the late
1980s, which was partially responsible for
the last three decades of economic
stagnation. Japan, thus far, has not been
able to transition from an export-driven
economy to a consumption-driven economy.
The American Policy Shift
Since the Cold War ended, U.S. foreign
policy has been adrift, swaying from
aggressive Wilsonian intervention to hints of
withdrawal. The current policy appears to
be evolving to one of offshore rebalancing.
Such a policy means the superpower refrains
from being directly involved in the world
beyond keeping the sea lanes secure and
keeping rival regional powers “balanced”
Weekly Geopolitical Report – February 24, 2014
(hence the name). As we noted in a
previous report (see WGR, 1/27/2014, The
TTIP and the TPP), the administration is
negotiating trade deals that would
effectively establish the global trading
regime going forward according to U.S.
dictates. The “pivot” to Asia and
negotiations with Iran could be considered
steps in establishing this new policy regime.
However, there are concerns the president
cannot deliver on these trade deals. The day
after his State of the Union address where
Obama asked for “fast track” authority
(critical legislation for trade agreements),
Senate Majority Leader Harry Reid (D-NV)
indicated that this legislation would not be
on the agenda this year. Adding to Japan’s
concern is the seemingly disjointed policy
toward Asia. When China recently
announced an Air Defense Identification
Zone (ADIZ) in an area that includes islands
claimed by both China and Japan, the U.S.
initially reacted strongly by flying B-52s
into the zone without warning China.
However, soon after, the administration
recommended that commercial airlines
notify China when their aircraft entered this
newly declared zone. The recommendation
that U.S. airlines comply with China’s ADIZ
was seen by Japan as a sign of weakness.
Japan’s current Prime Minister, Shinzo Abe,
is considered a right-wing politician that has
consistently called on Japan to throw off the
WWII constitution and take a more active
military role in the region. If the U.S. is
moving to offshore rebalancing, a balancing
power for China will be necessary; Japan, at
least for the next decade or two, is the
mostly likely candidate for this role. From
America’s perspective, Japan using its
military in a more active role relieves some
of the burden the U.S. has shouldered since
WWII. However, for Japan’s neighbors,
this is an unwelcome development; despite
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the passage of nearly seven decades, Japan’s
behavior during WWII is still a contentious
issue.
Ramifications
Every winter, Davos, Switzerland hosts the
World Economic Forum, which brings
leaders from government, business, the
media and academia to discuss various
topics. A number of news reports from that
event, which were conducted under
Chatham House Rule,1 suggested that a
number of participants are quite worried that
Japan and China may be nearing a “hot
war.” There are a number of reasons for
rising tensions. China fears Japan is an
active participant in a U.S.-led effort to
contain China. China has little influence
over Japan; most other nations in the region
house a Chinese diaspora that leads to some
degree of sympathy for China’s rise. No
such group exists in Japan. Given the antiJapan feelings in China, the CPC can use
opposition to Japan as a rallying cry. In
Japan, polls suggest that Japanese citizens
do not have a high regard for the Chinese
government either. Thus, using China as a
foil is a helpful strategy.
Japan’s return is due to the apparent U.S.
policy to reduce its global hegemony. This
decision, though defensible, increases the
risk of regional conflict. In a recent report
(see WGR, 1/13/2014, The Great Man or
the Great Wave), we examined one of the
great historical debates, namely whether
history is shaped by great movements
(waves) or great people. In general, we lean
toward the “Great Wave” side of the
argument which suggests that America’s
steady withdrawal from the world is really
part of a broader trend. American society
1
This rule means that participants are free to quote
any speaker at the event but cannot indicate who
made the comment. The rule is designed to foster
open discussions.
Weekly Geopolitical Report – February 24, 2014
saw the need to make sacrifices as the
superpower in the face of the Communist
threat, but now that Communism is no
longer relevant, Americans are simply less
inclined to continue those commitments. If
this is the next wave, it probably doesn’t
matter who occupies the White House in
2016.
If U.S. policy creates a power vacuum in the
Far East, it is reasonable to expect that Japan
and China will compete to fill the void. It is
also reasonable to see why China would
oppose Japan’s efforts to end its official
pacifist policy and fear its resurgence.
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For investors, it is important to note that
significant changes in the global
environment are underway. These changes
can also affect how markets relate to each
other, how currencies react, etc. Former
patterns may no longer hold. Although it is
too early to tell exactly how these changes
will affect markets, we feel confident that
relationships and correlations will likely
adjust and, as they do, investors will need to
adapt.
Bill O’Grady
February 24, 2014
This report was prepared by Bill O’Grady of Confluence Investment Management LLC and reflects the current opinion of the
author. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements
expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any
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