On his trip to Asia, President Obama will meet with President Hu Jintao on the sidelines of the G20 summit. In a Q&A, Douglas Paal challenges the assumption that the Obama administration has shifted to a harder stance on China, and instead explains that the media is misinterpreting many regional and bilateral issues—including China’s export of rare earth minerals and how China’s neighbors view Beijing.

Paal contends that despite growing nationalism and a host of issues where China and the United States disagree, there is unlikely to be any major incident before President Hu’s state visit to Washington in January. As the visit approaches, China’s leaders will take measures to contain rising public hostility, and Beijing has signaled it will respond to U.S. pressure to adjust its currency—although incrementally—to try to avoid a showdown on the issue.

What is the status of U.S.-China relations?

We’re in a period where people are opening newspapers every day and reading new superlatives about China, whether it’s the world’s fastest super computer, the second largest economy, the first to launch this, preparing for a moon mission—which will get a lot of people going. But the positive luster that had accompanied the Olympics in 2008 has been covered over with a bit of a tarnish because of China’s pushiness on a number of issues—whether its China’s maritime claims around its periphery, its position on human rights, or its pushback on the Western model of economic development where China is saying it doesn’t need the Western model and we’re going to go our own way.

And, obviously, there is also the currency issue, which is a big political issue for Washington. It’s probably not the right place for Washington to focus, but it is an important part of our trading and economic relationship and has become the political football in U.S.-China relations.

China, as far as I can tell, is responding to U.S. pressure to revalue its currency. But it will do so slowly, because when it does, China can lose jobs on production lines and they want to keep their jobs too. But more importantly, China is rebalancing investment and consumption in its domestic economy. We’re looking for evidence of that, and while the Chinese are talking a pretty good game right now, the question is whether they will follow through.

Is there an opportunity for the United States to counter China's rise?

The conventional, journalistic narrative is missing that this has been going on for years. But they don’t get noticed by the journalists until the secretary of state takes a trip and suddenly people write about it as if the administration has suddenly realized how to counter China.

If you put that childishness aside, there’s been a steady concern in the region about China. People are not rejecting China in East Asia or in Southeast Asia—Korea depends upon it as a major production platform; Japan would not be able to pay its citizens their high wages and retirement packages if they didn’t have a lot of factories producing very profitably in China; Taiwan is growing closer to China economically if not politically; and in Southeast Asia, there are very intense trade and tourism relationships.

So it’s not a simple preference for the United States or for China. It’s an effort on the part of the countries around China to be able to look over their shoulder and see a comforting Uncle Sam and his military presence providing a sense of stability.

Small countries like Singapore, or even a physically big but economically small country like Thailand, depend on global order being maintained. If global disorder reins, the cost of everything increases, and the opportunities for business and investment decline. The United States has been providing that global order since 1945.

China looks like it has half bought into that order but is not fully there, and so as China becomes a bigger factor in everyday life, people are concerned over how much China will respect the order or try and change it. This is a strong and understandable concern in the region that they want the United States around to preserve the existing international order. And they want the United States, if they are making changes, to make them by consensus and in small increments, so that people have predictability in their national and business lives.

Has the Obama administration shifted its policy toward China?

While newspapers are seeing shifts, I just don’t see them in Obama’s actual behavior. I had been one of the people telling the administration to speak up about the South China Sea. And I still think we ought to be very assertive in the Yellow Sea about our right to conduct military exercises there—either alone or with our South Korean or Japanese allies. And I think the administration is equally determined to do just that, and I don’t see them shifting lines to a tougher view of China. I think they’re pretty cold-eyed.

Should Washington take a tougher line on China's currency policy?

The United States told the Chinese it needed movement on the currency by the G20 in Toronto and the weekend before the G20, China announced it was going to move its currency. But they didn’t move it much, they’ve gone up about 1.5 percent over the last four months. So the United States told them again that they weren’t moving fast enough and they needed to get back to the pace that the currency revalued between 2005 and the middle of 2007, which was about 20 percent. And lo and behold, the Chinese have now revalued about that much.

China has a sort of sword of Damocles hanging over its head with pending congressional legislation on currency. The bill would allow the United States to declare China—or some other country—a currency manipulator and then the United States would take them to the World Trade Organization and impose tariffs on their products until the WTO ruled on the matter.

That legislation has been through the House, but it hasn’t been through the Senate. I think it would be very hard for China’s President Hu Jintao to come here for a state visit if that bill passes, so they’re watching very carefully. And the obvious logic to this problem is, well, if China wants to have a state visit and doesn’t want the currency bill to pass, they should revalue their currency faster—and they’ve been doing that. And I would anticipate that China would raise its currency by about 5 percent by about January.  

Is China flexing its muscles by reducing the exports of rare earth minerals?

One issue that’s really stirred people up has been that of rare earths and whether China has been using that as a political weapon in its relationship with Japan and the United States. I have to say there’s been a lot of really terrible journalism on the subject of rare earths. The stories aren’t informed by what has happened in U.S. history, or by what China has been saying loudly for the past couple years about its plans. China announced more than a year ago that it was going to start to cut back on its extraction and sales of rare earths.

Part of the concern is not just about availability and the long-term viability of the industry—some of it has to do with smuggling and people getting hold of assets in China and reselling them for a profit—so rent seeking by intermediaries in that trade—and China’s trying to clean some of that up.

China announced last year, and again this past summer, that they were going to reduce their exports to three-quarters of its former high and unsustainable levels. That three-quarters point was hit precisely at the same time the Japanese and Chinese were having a squabble over fishing boat frictions between the Japanese Coast Guard over the Senkaku, or Diaoyu-dao islands, which is disputed territory between China and Japan. A lot of Japanese noticed then that they were not getting their rare earth minerals, and decided that China’s decision was aimed at Japan. And there were probably a few people in China who said that it was aimed at Japan. And a few weeks later, Americans realized they weren’t getting their rare earths, and a few people in China said it was because the United States supported Japan.

But it all goes back to an underlying problem, and even further than that. The United States used to produce, subsidize and store rare earths for our own strategic industry purposes. And in the 1990s America stopped storing it and producing it, because one, the environmental costs were getting very high as it is a very intense process to pull rare earths out of a lot of soil. And second, because costs in the United States are much higher than they are in China and China was producing cheaply, why would the United States keep extracting it from the ground in the United States when it can just buy it from China. And thirdly, the United States was looking at a post-Cold War peace dividend, and since rare earth stockpiling was a Cold War measure, it decided to make a profit and sell it quickly by putting it on the U.S. Treasury and getting out of that business.

All of those decisions were made in the United States, and people in the rare earths industry know about them, but newspapers apparently do not. So journalists had been writing stories about how this is some kind of pointed Chinese gesture. Mrs. Clinton, when she launched her recent visit to Asia, said she was going to take this issue up and before she even spoke, the Chinese announced that they were trying to get this controversy off their backs.

What is Washington doing to help resolve disputes between China and its neighbors over islands in the South China Sea?

On the South China Sea, the United States has taken a position that there should be common negotiations over future access to the waters and territories there. The United States has taken no position on the outcome of the negotiations. This has been mischaracterized, in the media quite frequently as the United States siding with Vietnam, or on a particular outcome, and that’s an overstatement of the U.S position.

But there is no question that the South China Sea is vital to shipping in the world—something like 75 or 80 percent of Australian shipping goes through the South China Sea, Japanese energy supplies almost entirely pass through there—and so the United States has an important interest in maintaining the freedom of navigation that it has enjoyed up to now, which could be threatened if it were to accede to the Chinese territorial ambitions.

Is there a volatile situation between China and Japan over contested islands in the East China Sea?

There is the Senkaku Islands dispute, where the United States turned the islands over to Japan in 1972 after seizing them in 1945. It turned them over to the Japanese administration but not as a sovereign territory of Japan. And since then, the United States has maintained an alliance relationship which says it will protect Japan and those areas Japan administers, but the United States also says that it does not recognize Japan as the sovereign of those particular islands. It’s a bit of a complicated position to take, but it helps straddle the relative realities of China’s claims, Japan’s claims, and Taiwan’s claims on the islands, while at the same time providing the promise of the stability through the alliance protection of Japanese interest there.

How can the countries work together on North Korea?

The United States still has significant differences with China over North Korea’s sinking of a South Korean ship. China continues to deny it. Over the past weekend, Xi Jinping, the vice president the heir apparent in China made a blood-curdling speech about the sixtieth anniversary of the so-called Chinese People’s Volunteers entering into the conflict with the United States, and characterizing the war on the Korean Peninsula in terms unrecognizable to people familiar with the facts of history—that the United States somehow perpetrated the invasion and started the war—which is ridiculous. There are even Chinese history books that will refute this, but some continue to say that sort of thing.

This shows that we are still very far apart intellectually and strategically from China on what to do with North Korea. China is now supporting the unsupportable—the transition to the third generation of Kims in North Korea, Kim Jong Un, this new successor. China seems to feel that saying something now about how stupid the succession is would be more dangerous than waiting and watching the succession fail, and then dealing with the crisis then. Tomorrow’s crisis is always better than today’s.

The United States would like to get moving on this set of problems and get North Korea out of the nuclear weapons business, out of the provocation business. But I think the United States will be at loggerheads with the Chinese for some time to come on this, at least until the leadership changes in 2012 and after in China.   

Is nationalism rising in China?

It’s pretty clear that the mood in China is increasingly nationalistic. The Chinese government seems to be trying to contain the anti-Japanese sentiments that are emerging in street protests. Historically, these kinds of protests have taken down Chinese regimes in the past and so the government doesn’t want to stir them up—these protests are coming more from the people. But it’s also a product of the relentless propaganda against Japan over the year, and the unfortunate history of the war.

Now this anti-Japanese feeling is spreading, and anti-U.S. feelings are spreading as well, and even toward Southeast Asia, particularly the Vietnamese because of the disputes over the South China Sea. There’s a rising of a kind of Chinese xenophobia.

When looking at the country, it is growing so fast, and making huge and brave decisions—like closing steel factories as a stroke to reduce energy intensity. But when it comes to foreign affairs and domestic politics, its leaders are extremely conservative and cautious and they’re very reluctant to get in the way of this rising nationalism.

In fact, they’re kind of accommodating this feeling—keeping the street quiet and preventing the protests from merging but letting people express themselves on the Internet, and through the so-called free media that has now emerged in China—hundreds of new radio and TV stations and journals are publishing all sorts of opinions. And the politically correct opinion these days is pretty hostile to outside forces. So we’re seeing an iteration now between the rulers and the ruled, where the population is in a way pushing the rulers, and the rulers are giving back to the population, so they are creating a crescendo of hostility toward the outside world.

And then occasionally something comes up, like the summit meeting that’s going to take place here in the United States with President Hu Jintao. He intervenes to keep it cool until he gets through his summit meeting, but when that’s over, they’ll go back to venting again.

And this is going to continue to be a source of problems for the United States. The United States really needs the Chinese to loosen up their system, but responsibly. If they are going to allow people more freedom, they have to pull back on the propaganda. Or, if they keep the propaganda and the control apparatus, they will have to use it effectively. They have to make a choice. They aren’t making that choice right now and it’s adding an unhealthiness to the way China deals with the rest of the world and its part of why the region surrounding China is showing more nervousness.

China had “smile diplomacy” for a decade during the late 1990’s and that was very effective. Their diplomats did a terrific job, and their free trade agreements and investment and trade patterns really won a lot of friends. But this new angry nationalism in China is making people nervous.