Rapid Economic Growth at Home Adds to Heat on Hu to Adjust Yuan

By ANDREW BROWNE
April 20, 2006; Page A1

BEIJING -- Adding to U.S. pressure on President Hu Jintao to let the yuan appreciate, China's growth at home is surging so quickly it risks overheating.

Driven by exports and rapid development, China's economic growth raced ahead by 10.2% in the first three months of this year, even faster than the blistering 9.9% pace registered for all of 2005.

The speed appears to have taken Mr. Hu by surprise. "We do not want, nor are we pursuing, over-rapid economic growth," he said Sunday. But it is getting harder for Beijing to hold the line as its trade surplus hits record highs and sucks in vast amounts of cash.

China's trade surplus swelled to $12 billion for the first two months of the year, up from $10.8 billion a year earlier. Isaac Meng, an economist at BNP Paribas in Beijing, said he expects China's surplus to hit $130 billion this year, $28 billion more than last year's record.

China spurns arguments by U.S. politicians that its massive trade surplus with the U.S. -- $202 billion last year, by Washington's calculations -- is the result of a steeply undervalued yuan. Since it raised the value of the yuan by 2.1% against the U.S. dollar last July, China has allowed the currency to gain only 1% or so more.

Yesterday in Seattle, Mr. Hu reiterated a pledge to gradually liberalize China's currency policy, but reaffirmed his commitment to keep its exchange rate "basically stable at an adaptive and equilibrium level" -- underlining a reluctance to move too precipitously on currency policy. (See related article¹.)

Still, the exchange-rate issue is likely to be high on the agenda during Mr. Hu's meeting with President Bush today. While few expect Beijing to engineer another one-off currency revaluation, there are increasing expectations that Chinese policy makers -- seeking to cool the economy at home -- could allow a faster pace of appreciation for the rest of this year.

Many Western economists agree with Beijing that further appreciation of the yuan wouldn't itself do much to improve the U.S. trade deficit. But some also say a powerful argument may be building to allow for a stronger yuan given the growth of China's economy. A stronger yuan could help slow the influx of currency into the country, both by making Chinese assets more expensive for foreign investors and by making Chinese exports less desirable to foreign buyers.

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Signs of possible overheating are everywhere here. Investment in factories, highways and other fixed assets jumped 27.7% in the first three months of this year over the same period a year earlier, according to state media. The broadest measure of money supply grew 18.8% in March from a year earlier, higher than the official 16% target.

Easy bank credit is flowing again after more than a year of austerity. Commercial banks already have dished out more than half their targeted loan total for the full year. Funds are so plentiful that banks are cutting loan rates as they scramble for new business.

"Banks are chasing us to lend money," said Chen Tongkao, chairman of Zhejiang Dongfang Shipbuilding Co. Mr. Chen said that last month the company secured a 200 million yuan ($25 million) loan from state-owned Agricultural Bank of China at 5% interest, a discount over the official "guidance rate" of 5.58% for a one-year loan. The money will go toward building an 800 million yuan production line to make oil and chemical tanks for export.

Increasingly, the concern is that China is drawing in so much cash that it will spur inflation. Economists say the flood could feed an investment bubble, raising the risk of bad bank loans and wasteful investment. If such a bubble popped, it could mean massive overcapacity that leads to collapsing prices and industrial bankruptcies -- which has happened to China in the past, most notably in the mid-90s.

A downturn likely would ricochet throughout U.S. and other Western businesses because they are invested in China to an unprecedented degree. Also vulnerable: a slew of venture capital and private equity investors who could see their record-setting investments collapse if there were a sudden turn in the economy, similar to the popping of the U.S. Internet bubble early this decade.

The best gauge of the problem facing Mr. Hu may be the buildup of China's foreign-exchange reserves, the currency reserves held by the central bank. These grew by $21.4 billion in March to reach $875.1 billion, making them the largest in the world. Before long, the reserves are likely to exceed $1 trillion -- almost half the size of the Chinese economy.

The reserves are so bloated because of Chinese central bank intervention to prevent the yuan from strengthening too quickly. The bank buys dollars as they flood in from exports, investments and speculative "hot money," and sells yuan. The resulting glut of yuan suppresses its value but also floods the economy with liquidity. Authorities try to mop up the excess cash by issuing yuan-denominated bonds that are bought by banks.

Still, with cash-rich banks rushing to lend as the reserves swell, there's a danger of a new investment bubble, inflation and an increase in the amount of bad loans. Last week, Premier Wen Jiabao held a cabinet meeting and called for "comprehensive measures to solve the problem of fast growth in bank lending," according to a report posted on the Chinese central bank's Web site.

Elsewhere in the world, central banks might consider raising interest rates to deter borrowing. But in China, higher rates could add to the problem by sucking in more "hot money" betting that Beijing will have to relent and allow the yuan to rise faster. Such flows have picked up again this year after tailing off last year, economists say.

Economists say they believe Chinese leaders are anxious to avoid hitting the brakes on growth this time. China is still exporting excess production built up during the previous investment boom, and killing domestic demand would likely unleash yet another wave of exports, adding to the country's already bloated trade surpluses.

Instead, Beijing also has been hoping to ease the economy's dependence on exports and investment by refocusing growth toward domestic consumption. A few weeks ago, Premier Wen unveiled a domestic stimulus program, including measures to abolish an agricultural tax, boost infrastructure spending and increase government investment in the country's health and education systems.

The central bank also is trying to reverse the huge currency inflows. Last week, it announced measures to allow Chinese individuals and ordinary companies to invest in overseas shares and bonds for the first time. Also, the bank said individuals will be able to exchange Chinese yuan for as much as $20,000 each year, up from $8,000. Companies involved in trade will be given more freedom to buy foreign currency.

Up to now, China has imposed severe restrictions on the use of foreign exchange. It is miserly with the amounts it allows students to take overseas, and even getting dollars to pay for a visa can be a hassle. Smaller companies trying to get foreign currency to purchase imports often run into a tangle of bureaucracy.

In relaxing its foreign-exchange policies, economists say, the government wants to hold less foreign exchange, and have companies and individuals hold more. But over the longer run, they say, demand for dollars to invest overseas could depress the value of the yuan relative to the U.S. currency.

Even in the short term, the relaxation moves are not likely to substantially shrink China's reserves, which are growing at a pace of some $200 billion each year, says Calla Wiemer, a China expert at the National University of Singapore. "That means pressure to appreciate [the yuan] will continue," she said.

China plays the lobbying game

By Michael Forsythe Bloomberg News
WEDNESDAY, APRIL 19, 2006

WASHINGTON China, which up to now has relied on U.S. presidents to keep Congress from derailing bilateral relations, is turning to lobbyists to burnish its image with increasingly assertive lawmakers.

Employees of Patton Boggs, Washington's biggest lobbying firm by revenue, made at least 116 contacts with lawmakers or their aides on behalf of China in the last half of 2005, according to disclosures made to the Justice Department. China's lobbying rose 74 percent from the year-earlier period; it spent just under $500,000 in the second half on lobbying, paying Patton Boggs $22,000 a month.

China is "becoming more knowledgeable about how all countries need to play the game in Washington," said Kenneth Lieberthal, who oversaw China policy for the National Security Council under former President Bill Clinton. "The Chinese are simply starting to hedge by working harder with Capitol Hill because the Hill has become a more active player," said Lieberthal, who teaches political science at the University of Michigan in Ann Arbor.

As President Hu Jintao of China meets with President George W. Bush this week at the White House, U.S. lawmakers are challenging Bush on such issues as overseas investment in the United States, tariffs and currency policy. The United States is China's biggest export market, with two-way trade reaching $285 billion last year.

A Patton Boggs spokesman, Brian Hale, said the firm's China lobbyists declined to comment on their work.

In the past year, Congress scuttled a planned takeover of Unocal by China's Cnooc. Lawmakers including Senators Charles Schumer, a New York Democrat, and Lindsey Graham, a South Carolina Republican, have proposed legislation to put tariffs of 27.5 percent on Chinese goods unless China revalues its currency. The House last year passed legislation to let the president impose sanctions on European companies that sell arms to China.

Patton Boggs lobbyists have aimed most of their efforts at members of the Senate Foreign Affairs and Armed Services Committees, contacting offices of 13 of the 18 members of the Foreign Affairs panel from July to December 2005, according to the disclosures.

"In Congress, there has been an increase in interest in China," Zhou Wenzhong, China's ambassador to the United States, said in an interview. The lobbyists "know members and their staff better than we do, so they often help us to set up meetings. Sometimes they help us to follow what is going on in Congress."

In addition to Patton Boggs, the Chinese government retains other firms to influence Congress, including Jones Day.

Some of the contacts were for routine matters, such as the eight times Patton Boggs contacted aides to Senator Lincoln Chafee, a Rhode Island Republican. The calls were to set up and follow through on a Nov. 10 meeting between Chafee and Zhou, said a spokesman for Chafee, Stephen Hourahan.

Aides to the chairman of the Senate Armed Services Committee, John Warner, a Virginia Republican, were contacted at least seven times, with Warner himself conferring about U.S.- China relations with a Patton Boggs lobbyist on Aug. 4.

"We do not recall anything specific about the meetings and phone calls, if in fact they occurred," said John Ullyot, Warner's spokesman. "Senator Warner and his staff are contacted hundreds of times a week by individuals or companies" with business before the Senate.

Dan Adelstein, an aide to Geoff Davis, a Kentucky Republican who serves on the House Armed Services Committee, was contacted four times in December by Patton Boggs. The lobbyists were seeking information about a defense funding bill.

China's lobbying is still overshadowed by other nations. China and its provinces spent $483,325 on lobbying in the second half of 2005, employing three firms.

By contrast, just one of the 12 firms retained by Taiwan, Barbour Griffiths & Rogers, gets $1.5 million a year from the government of the island, which China considers a rebellious province. Patton Boggs's contract with Trinidad & Tobago, a Caribbean country with less than a thousandth of China's population, is bigger than its China contract.

Still, with Bush's job approval ratings in public opinion polls sliding to the lowest of his presidency, China must look elsewhere to block some more extreme congressional proposals, Lieberthal said.

China has been improving its understanding of how Congress works since the early 1990s, when lawmakers would engage in annual debates over whether to approve "most-favored-nation" trading privileges for it, said John Frisbie, president of the Washington-based U.S.-China Business Council.

"They've come a long way since then," Frisbie said. "There is a greater understanding in China about Congress's role." The congressional move last month to scuttle the purchase of U.S. port facilities by DP World, the state- owned Dubai firm, was another reminder of the lawmakers' power, he said.

"Certainly, the Chinese have become more sophisticated in how they approach matters here in Washington," said Myron Brilliant, vice president for Asian affairs at the U.S. Chamber of Commerce, the nation's largest business group, and a registered lobbyist. "They understand what's going on in the Congress."

White House Shifts Into Survival Mode

By Dan Balz
Washington Post Staff Writer
Thursday, April 20, 2006; A01

In a White House known for both defiance and optimism, yesterday's senior staff changes represent a frank acknowledgment of the trouble in which President Bush now finds himself. They are also a signal of how starkly Bush's second-term ambitions have shifted after a year of persistent problems at home and abroad.

Longtime Bush confidant Karl Rove -- who had hoped to use his position of deputy chief of staff to usher in an expansive conservative agenda -- was relieved of his policy portfolio to concentrate on long-term strategy and planning for a November midterm election that looks increasingly bleak for Republicans.

Rove probably will remain one of the most influential voices in the White House, but his shift in responsibilities suggests that new White House Chief of Staff Joshua B. Bolten intends to operate a different White House than his predecessor, Andrew H. Card Jr., who resigned after more than five years at the helm.

Bolten's White House, say former administration officials and Republican strategists, is likely to have clearer lines of authority and less free-lancing by powerful officials. They also expect Bolten to play a more active and influential role in shaping domestic policy than did Card.

More significantly, they said, unlike Card, who took as his principal responsibility the management of the president, Bolten probably will operate more in the mold of chiefs of staffs in previous administrations, who saw their role as managing the entire White House and sought to oversee the entire federal government, as well.

Whether the changes will bring fundamental change in a troubled administration is another question. One of Bolten's biggest challenges, administration allies say, will be to find ways to open up the Oval Office to new ideas and to the opinions of people who are not longtime Bush confidants.

On that score, many people who know the administration best are privately dubious. Presidents, more than chiefs of staff, determine how White Houses operate, they said, noting that Bush has shown that he prefers a tight circle of advisers and does not welcome the advice of outsiders. As Bush put it on Monday, in asserting that he would not fire Defense Secretary Donald H. Rumsfeld, "I'm the decider, and I decide what's best."

Rove's return to a role that closely mirrors that which he played in Bush's first term demonstrates how much this White House has now shifted to survival mode -- and how far events have pushed the president from the grand ambitions with which he opened his second term just 15 months ago.

Then, with Rove as the animating force, the president sought to engineer Republican political dominance by remaking government with such far-reaching initiatives as his plan to remake the Social Security program. Today, Social Security stands as Exhibit A of what went wrong domestically in 2005.

Public disillusionment over Bush's policies in Iraq have left the country in a sour mood and Bush's presidency at low ebb, threatening the entire Bush-Rove project to create a durable Republican majority. While that goal remains central to those closest to Bush, the focus at the White House for the foreseeable future will be trying to revitalize this presidency quickly enough to avoid crippling GOP losses in November that could thrust Bush into instant lame-duck status.

Realigning the White House staff and bringing in new faces appear central to that effort. This week's changes include yesterday's resignation of White House press secretary Scott McClellan and appointment of Joel D. Kaplan as White House deputy chief of staff for policy, as well as Monday's announcement that U.S. trade representative and former House member Rob Portman will succeed Bolten as director of the Office of Management and Budget (OMB).

The domestic policy process has been hampered since Bolten went to OMB, and one Republican strategist close to White House said the new chief of staff appears bent on trying to prevent Rove and others from interfering in every aspect of the governing process.

Rove will retain the "gravitational force" of his Bush relationship and could "overpower" Bolten in showdowns because he knows the president and the inside game better, this official predicted. But he added that Bolten believed that the strategy to overhaul Social Security was sloppy and hampered by Rove's becoming too involved in every aspect of the campaign -- policy, politics and communications.

Former administration officials said that Rove, though known for his ability to juggle many roles, was overwhelmed by the sheer volume of his responsibilities when he was promoted to deputy chief of staff after the 2004 election.

In addition, he was engulfed in the CIA leak case for his role, and remains under investigation by a special prosecutor.

Bolten and Rove forged a congenial working relationship during Bush's first presidential campaign, when Rove was chief strategist and Bolten chief policy adviser. That carried over into the White House during the first term, until Bolten departed as deputy chief of staff to take over as OMB director. Administration allies say they hope that the new assignments can restore an operating arrangement that they believe worked well.

One former administration official, who asked not to be identified in order to speak freely about his former colleagues, called yesterday's shift in Rove's responsibilities a "huge" development. "This is putting back things where they belong," he said. "It's given Josh back policy. Joel [Kaplan] is a total Josh disciple, and he is very good in the policy world. It focuses Karl back on politics, which is what he needs to do."

But former Bush spokesman Ari Fleischer said Rove's losing the policy portfolio also is significant, because the policy job "is where ideas comes from, where creativity comes from, and that is where presidents rise and fall."

"I think this is another building block in bringing in other voices to reenergize and reinvigorate the West Wing," said Kenneth Duberstein, White House chief of staff to former president Ronald Reagan, who predicted Rove will remain one of Bush's most trusted aides.

Despite his power, Rove has not been immune from criticism. Inside the White House, some aides were unhappy that he had sent McClellan out to say inaccurately that Rove had no involvement in the CIA leak case. Outside allies feared that Rove was so invested in the policies he had helped to shape and sell to Bush that he lost his ability to see where the administration had gotten off track.

Mindful that Rove's changed responsibilities might be seen as a demotion, administration officials and allies offered a counterview, saying that, given his personal relationship with the president, he will continue to exercise wide influence on policy and politics while having new freedom to think more strategically about the administration.

Other changes are expected at the White House and perhaps in Bush's Cabinet. One will be a replacement for McClellan; another is likely to be a new domestic policy adviser. Criticisms of the legislative affairs and communications operations as well as the national economic council suggest the potential scope of changes. But one of the most important steps came yesterday. As one strategist who has worked closely with the administration put it, "I don't know how you change the White House without changing Karl's role."

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Rove Gives Up Policy Post in Shake-UpMcClellan Resigns; New Chief of Staff Moves Quickly to Change West Wing

By Peter Baker and Jim VandeHei
Washington Post Staff Writers
Thursday, April 20, 2006; A01

President Bush's new chief of staff accelerated his election-year White House shake-up yesterday as Deputy Chief of Staff Karl Rove surrendered the policy management duties he assumed last year and press secretary Scott McClellan resigned as the public face of an administration under fire.

Rove, who steered Bush to two national election victories, will retain his title but focus on broad strategy and politics, while Joel D. Kaplan takes over as deputy White House chief of staff running the day-to-day policy process. To replace McClellan, Republican strategists said the White House is considering Fox News radio host Tony Snow and former Iraq occupation spokesman Dan Senor.

The moves effectively diminished or eliminated the roles of the two presidential aides most familiar to the general public, as newly installed White House Chief of Staff Joshua B. Bolten seeks to rescue the remainder of Bush's presidency. Coupled with other changes already announced and still in the works, Bolten hopes to demonstrate to the public and the Republican-led Congress that it will no longer be business as usual in a White House afflicted by political defeats, an overseas war and shrinking public support.

At the same time, the changes made public so far mainly have moved around figures who have been inside the Bush orbit for years, and White House officials made clear yesterday that no major shifts in policy are envisioned. With midterm congressional elections looming, strategists said the main goal was to make public gestures that would restore faith in Bush's ability to lead.
"The decision isn't one looking back at past performance or judgment," said White House counselor Dan Bartlett. "It was one looking forward. Josh is reenergizing and rebuilding his staff for the next thousand days."

The reshuffling, the most significant of Bush's second term, got underway when the president appointed Bolten to replace Andrew H. Card Jr. as his chief aide. Bolten, who took over Friday afternoon, has moved quickly to restructure the West Wing. On Monday, he invited aides already thinking of leaving to submit resignations. On Tuesday, he installed U.S. Trade Representative Rob Portman to take over his job as director of the Office of Management and Budget.

Aides said no further moves will be announced this week but anticipate more next week, hoping that stretching them out over time will provide momentum. "People have been watching this TV series for a long time, and it helps to plug in some new characters from time to time," said Bush political adviser Mark McKinnon. "Gets folks to tune back in and take a fresh look."

Bolten is still eyeing the White House legislative affairs office in hopes of improving relations with congressional Republicans. Bolten has privately expressed criticism to colleagues about the operation of chief White House lobbyist Candida Wolf, and it remained uncertain whether she would stay. The White House has also been interested in finding a replacement for Treasury Secretary John W. Snow.

A senior White House official said a lot of staff members remain uncertain. Bolten's call for resignations, the official said, has a lot of aides who had not been contemplating departing now planning to spend this weekend considering it. Bolten has said he will keep Card's schedule and structure until the middle of next week, and then put his own in place.

The biggest changes so far came with Rove's shift and McClellan's departure. Rove has been the driving force of the Bush presidency from its inception, and last year he added the title of deputy chief of staff for policy to his portfolio. But some Republicans saw it as a poor fit as the operation's vision man occupied himself with the trains-on-time responsibilities of the new job.

Among people close to the White House and in Republican circles around Washington, there remained debate whether the move should be regarded as a demotion or reassignment. The answer will remain unknown -- perhaps even to Rove himself -- until Bolten's operation has more time to prove itself. But there was agreement that the move was a negative verdict on the status quo.

"He's the best thinker in our party, and in the last year he's been doing all the staffing memos and making sure the paperwork is done on time and all that," a senior administration official said.

By turning over the daily policy management to Kaplan, Rove will free himself up to concentrate more on the midterm elections, which are crucial to Bush's fortunes, but he will remain an influential voice in broader policy discussions, as well. "That will leave Karl more time to focus on truly strategic policy at a critical time for the presidency," White House spokesman Ken Lisaius said.

Rove, 55, who has been Bush's most important adviser for many years, told people he knew his shift might be seen as a demotion but agreed with Bolten that he was bogged down by esoteric subjects distracting him from strategy. A Republican close to Rove said the change was unrelated to the CIA leak case, in which Rove remains under investigation, but was meant to calm Republicans who fretted that the White House mishandled issues such as the Dubai port deal and Hurricane Katrina.

"They needed to have the optics that there's going to be a change -- a message-delivery change and a different approach to policy, particularly domestic policy," the Republican said. "That's all it is. There's not going to be any change in policy. It gets Washington talking about different things."

Democrats dismissed the move. "President Bush doesn't seem to understand that you can't just change the window dressing, you have to make changes in the Bush administration's policies, which have undermined America's security," said Democratic National Committee Chairman Howard Dean.

While Rove's shift was disclosed on paper, Bush walked McClellan onto the South Lawn yesterday morning before a trip to Alabama. "The White House is going through a period of transition," McClellan said. "Change can be helpful, and this is a good time and good position to help bring about change. I am ready to move on."

McClellan, 38, who has been at Bush's side since Texas and served as chief spokesman for the past two years and nine months, choked up momentarily. Turning to the president, he said, "I have given it my all, sir, and I've given you my all."

Bush responded with praise: "He handled his assignment with class, integrity. He really represents the best of his family, our state and our country. It's going to be hard to replace Scott."

In a moment of unfortunate symbolism for a troubled White House, Bush and McClellan then boarded Marine One to fly to Andrews Air Force Base -- only to have to disembark when the helicopter would not work. Instead, the president departed by motorcade.

McClellan had told colleagues as recently as last month that he intended to stay but told reporters aboard Air Force One yesterday that he began reconsidering when Card stepped down and informed Bush of his decision in an Oval Office meeting on Monday. "I didn't need much encouragement to make this decision," he said.

With endless patience, McClellan has absorbed months of battering at daily briefings over the president's second-term problems. Although he never expressed it publicly, McClellan's colleagues said he was frustrated that his credibility had been questioned after he relayed Rove's assertion in 2003 that Bush's top adviser had nothing to do with the leak of a CIA operative's identity -- a claim later discredited by grand jury testimony.

McClellan said he would stay for two or three weeks as the White House brings in a replacement. Republicans close to the White House identified three main candidates: Tony Snow, Senor and former Pentagon spokeswoman Victoria Clarke. Snow confirmed he is considering it, while Clarke said she would not.

Replacing Rove in the job of deputy chief of staff for policy will be Kaplan, who worked for Bolten in the first Bush campaign, in the White House and then at OMB as deputy director. Bolten considers Kaplan, 36, his right hand and was the only one with a speaking role at Kaplan's wedding this month, aside from Judge J. Michael Luttig of the U.S. Court of Appeals for the 4th Circuit, who presided over the ceremony for his former clerk.

Kaplan, who rushed back to Washington from a Hawaii honeymoon Tuesday night, will be the third deputy along with Rove and Joseph W. Hagin, who plans to stay but will also give up policy duties, colleagues said. A Harvard Law graduate and former Marine, Kaplan also clerked for Supreme Court Justice Antonin Scalia.

WSJ: THE NUMBERS GUY

Fuzzy Math on Illegal Immigration

THE NUMBERS GUY

By CARL BIALIK

April 5, 2006

New York Democrat Charles Schumer said legislation is needed "to solve the problem of millions of foreigners who live here illegally and unprotected" as well as "to alleviate the problem of the millions more who enter illegally every year." He kept his estimate of the number of illegal immigrants vague because "no one knows for sure how many are really here," the National Journal reported. "Nor can anyone give a reliable estimate of how fast that unknown figure is growing each year."

A sound bite from last week? Nope. The year was 1985, Mr. Schumer was in the House of Representatives and debate was raging over how to address the growing number of illegal immigrants, then estimated at somewhere between 3 million and 12 million.

Twenty-one years later, several amnesties granted to undocumented immigrants have failed to keep the number of illegal immigrants from growing. And estimates of their numbers remain fuzzy and full of pitfalls, even as lawmakers toss them around in the latest round of debates over whether to offer guest-worker status to illegal immigrants.

At the core of the problem is the fact that undocumented immigrants don't generally come forward to be counted. The most widely quoted estimate of 11 million to 12 million is derived indirectly, using what's called a residual method: Researchers subtract the number of immigrants who were authorized to come to the U.S. from the number of foreign-born residents counted by the Census Bureau, then adjust the number using estimates of immigrants' deaths and migration, and of Census undercounting. Some critics say that estimate understates the degree of undercounting: Another estimate making the rounds holds that there are 20 million illegal immigrants.

That was the upper range Bear Stearns analysts Robert Justice and Betty Ng estimated last year, citing high growth rates in foreign remittances and in school enrollments in localities with high illegal-immigrant populations. The analysts added, "According to our discussions with illegal immigrants, they avoid responding to census questionnaires."

And there are still-higher estimates to be found online: The Web site of the "immigration crime-fighting" group American Resistance Foundation estimates there are more than 28 million illegal immigrants, based largely on border-patrol apprehension rates; however, there is little reliable data on how many border-crossers who are caught trying to enter a second time.

"No one really knows," says Bill Strassberger, a spokesman for the U.S. Citizenship and Immigration Services, a branch of the Department of Homeland Security.

Of those citing the 20 million figure, Mr. Strassberger says that "the number seems to be agenda-driven." But if so, it's not always the same agenda doing the driving.

On CNN last Sunday, anchor Lou Dobbs, who has argued for tighter border controls, spoke of "the toll that 20 million illegal aliens take on the infrastructure of the United States and on local, state, and federal taxpayer budgets." (At other times during his recent broadcasts, Mr. Dobbs has cited a range between 11 million and 20 million. A CNN spokeswoman says Mr. Dobbs is relying on the Bear Stearns report for the higher number.)

But talk-show host Tony Snow, arguing that immigrants are a boon to the economy, wrote Monday, "The United States somehow has managed to absorb 10 million to 20 million illegal immigrants not only without turning into Animal Farm, but while cranking up the most impressive economic recovery in two decades."

In 2000, before it was folded into DHS, the Immigration and Naturalization Service used the residual method to estimate there were seven million illegal immigrants and their numbers were growing by 250,000 to 300,000 per year. Mr. Strassberger says that remains the government's best estimate, though he concedes it's out of date.

Following largely the same procedure that INS used, the Washington, D.C., think tank Pew Hispanic Center counted 11 million illegal immigrants last year, and between 11.5 million and 12 million last month; the group is the source for most lawmakers and reporters citing a number. (The Wall Street Journal generally has printed estimates of 11 million, or a range of 11 million to 12 million.)

But the residual method is by necessity complicated, and each step in its formula introduces uncertainty. Jeffrey Passel, a Pew senior research associate, walked me through the procedure (also outlined in Pew's latest report). The starting point is the Census Bureau's annual Current Population Survey report, which bases a count of foreign-born residents on interviews conducted with about 80,000 households. The Census intentionally seeks out a disproportionately large number of Hispanic households to get richer data. Interviewers, either by telephone or in person, ask where every member of each household was born. These figures are then extrapolated to the nation, adjusting for the larger sample of Hispanics. The latest estimate of foreign-born Americans to emerge from such calculations was roughly 36 million, Dr. Passel says.

Next, Pew subtracts the number of foreign-born Americans authorized to be in the country. Dr. Passel's team compiles annual numbers of green-card recipients, refugees and people granted asylum, a count that stretches back decades. But merely adding these numbers would be misleading, because some authorized immigrants decide to leave the country and others die. Dr. Passel assumes that immigrants of a certain age die at the same rate as the country's residents overall, and uses estimates from various studies on "outmigration," something he concedes is "hard to measure." (The outmigration numbers are also much bigger -- perhaps seven times as large -- as the number of deaths, because immigrants tend to be young.) Then the calculated total is subtracted from the total number of foreign-born residents, and the result is adjusted upwards by 10% to account for census undercounting of illegal immigrants. (That adjustment is based on one post-Census 2000 survey of undercounting among Mexican immigrants in the Los Angeles-area; other studies have yielded different estimates of undercounting.)

Dr. Passel and Robert Warren pioneered the residual method while working together at the Census Bureau in the 1980s. Dr. Warren then helped develop INS's methods for its 2000 estimate, so it's no surprise that the government's methods are similar to Pew's. Michael Hoefer, director of the office of immigration statistics, a branch of DHS, told me that the government uses the Census Bureau's American Community Survey instead of the Current Population Survey, which is based on a larger sample of households but is published later than the CPS. (Mr. Hoefer's office is working on a 2004 estimate to update the 2000 official figure of seven million.)

Also, Pew's count of illegal immigrants includes those considered "quasi-legal," meaning they're on their way to legal status, and awaiting asylum or in temporary protected status; INS's count doesn't, though the next round of government estimates might. That could mean a difference of about one million in the total count, Mr. Hoefer says.

Back in 1985, Dr. Passel told the National Journal, "The fatal flaw in virtually every study was that there's some assumption that you have to make in your estimation model for which there is absolutely no data." But he says now that estimation methods have improved, thanks to refinements of the residual-method technique, more-regular Census counts of the foreign-born population, and comparison of the numbers with Mexico population figures to see if the estimate of illegal immigrants from Mexico squares with a gap between expected and actual population counts south of the border.

However, there is still large uncertainty in the current estimates, due largely to Census undercounting and limited data about immigrants leaving the country. It's impossible to say how uncertain the estimates are; neither Pew nor the government publishes a margin of error, which is a standard component of most statistical estimates.

The variable numbers have provided material for Comedy Central's Stephen Colbert, who noted that on a recent Sunday political talk-show, Sen. Arlen Specter, a Pennsylvania Republican, referred to "11 million undocumented aliens," and just 30 minutes later on a different network, Massachusetts Democrat Ted Kennedy used the "12 million figure." Mr. Colbert's comment: "One million illegals snuck into this country in half an hour! That is alarming. At that rate the entire population of Mexico would be here in three days. Congress, get to work on that fence." Mr. Kennedy's spokesman cited the Pew report; a representative for Mr. Specter didn't return my call seeking comment. (Numbers Guy readers Allen Cantrell, Shauna Laughna and Robert Tamiso also spotted inconsistent immigration numbers and suggested this column topic.)

Not everyone agrees that the numbers debate matters. "As long as people concede that the number is large to begin with and is increasing, the number itself is irrelevant," Vernon Briggs, a professor of labor economics at Cornell who favors enforcing sanctions against employers of illegal immigrants, told me.

But if that were so, the numbers wouldn't be continually cited by lawmakers and the press, who would serve their constituents and audience better by acknowledging the uncertainty of these estimates.

* * *

Several readers wrote in about my column last week on the different naming schemes world-wide for large numbers, and the efforts of Swedish scientist Anders Thor and others to standardize things. Here are excerpts from letters:

Mr. Thor has a unique window of opportunity to rally the U.S. into switching to the European methods of measuring large numbers -- it would immediately reduce the U.S. budget deficit.

--Judy Sterling

I've been waiting for someone to write this for some time. I've lived in Spain and it always fascinated me how people would say Mil Milones -- this was rather common as well when speaking of money prior to the Peseta/Euro change over.

--Patrick J. Sullivan, CFA

I enjoyed your column. It reminded me of a consulting project I worked on several years ago in Bangladesh. The Bangladeshis used their customary units of lakh (10,000) and crore (10 million) in budgets and other reports involving large numbers. At the time their currency, the Taka, was worth about two cents, so there were plenty of big numbers. To make matters more confusing (to us Americans anyway), lakh and crore numbers have digits grouped by twos, instead of threes. When looking at lakhs or crores, you'd have to suppress all your instincts to come up with the right value. Reports from most international agencies followed American number conventions, but the convention wasn't always clear in some European sources. It made for plenty of confusion. My suggestion for clearing up this mess: Let's all switch to using scientific notation.

--Charles Hartel

I second Charles's suggestion, and expect it to happen soon after we all switch to the metric system. Those unfamiliar with the lakh-crore system, and the two-digit groupings, can learn more at Wikipedia.

I have to ask how you came up with the "28.5 trillion brackets per second" in the 90 hours to achieve the perfect NCAA bracket. I trust you are correct, but could you explain the method?

--Jason Maus

Here's my method: There were 32 first-round games, each of which could have two possible outcomes, so the number of ways to fill out the first round of the bracket is 2 to the 32nd power, or 4.3 billion (following the U.S. definition for billion, as explained in last week's column). For each of those permutations, there are two possible winners in each of the 16 second-round games, so you'd have to multiply 4.3 billion by 2 to the 16th power, or 65,536. Follow that logic through to the championship, and you'll find there are 2 to the 63rd power -- or 9.22 million trillion -- possible brackets. There are 324,000 seconds in 90 hours, so divide that into 9.22 million trillion and you get 28.5 trillion brackets per second.

WSJ: THE NUMBERS GUY

Measuring the Child-Porn Trade

THE NUMBERS GUY

By CARL BIALIK

April 18, 2006

Unlike, say, the soft-drink or airline industries, the child-pornography industry doesn't report its annual sales to the Securities and Exchange Commission.

Yet in a press release¹ ahead of a recent House of Representatives hearing aimed at curbing the industry, Texas Republican Joe Barton said, "Child pornography is apparently a multibillion … my staff analysis says $20 billion-a-year business. Twenty billion dollars." Some press reports said the figure applied only to the industry's online segment. The New York Times reported², "the sexual exploitation of children on the Internet is a $20 billion industry that continues to expand in the United States and abroad," citing witnesses at the hearing. (The Online Journal's Real Time column³ also quoted the estimate from the hearing.)

My efforts this week to track down the number's source -- and free-lance journalist Daniel Radosh's similar quest⁴ on his blog -- yielded lots of dead ends. It turns out it can be easier to enter a big number into the Congressional record, and national press coverage, than to locate its origin. (Numbers Guy reader Brian Flanagan suggested I look into the estimate.)

What was Rep. Barton's staff analysis? A spokesman for the House Energy and Commerce Committee told me the source of the number was the National Center for Missing and Exploited Children, a group that advocates for the protection of children. When I first talked with that group's president, Ernie Allen, he told me that Standard Chartered bank, which has worked with the NCMEC to cut off funding to child-porn traffickers, wanted a quantitative analysis of the problem, so it asked for a measurement from consulting firm McKinsey & Co.

Mr. Allen faxed me an NCMEC paper that cites the McKinsey study in placing the child-porn industry at $6 billion in 1999, and $20 billion in 2004.

But a McKinsey spokesman painted a different picture for me: "The number was not calculated or generated by McKinsey," he wrote in an email. Instead, for a pro bono analysis for Standard Chartered, he said, McKinsey used a number that appeared in a report⁵ last year by End Child Prostitution, Child Pornography and Trafficking of Children for Sexual Purposes, an international advocacy group.

But the trail didn't end there: That report, in turn, attributed the number to the Federal Bureau of Investigation, as did a report⁶ last year from the Council of Europe, a Strasbourg, France-based human-rights watchdog. Both of those reports noted that estimates range widely, from $3 billion to $20 billion.

FBI spokesman Paul Bresson told me in an email, "The FBI has not stated the $20 billion figure... . I have asked many people who would know for sure if we have attached the $20 billion number to this problem. I have scoured our Web site, too. Nothing!"

I went back to the NCMEC Monday and shared what I found. In an email response, spokeswoman Joann Donnellan said, "If it is determined that this ends up not being a reliable statistic, NCMEC will stop citing McKinsey as the source and will also stop citing a specific number. Rather, NCMEC will revert to what it has said previously… that commercial child pornography is a multi-billion dollar industry."

This isn't the first number from the NCMEC that struck me as questionable. The group provided the estimate that one in five children is sexually solicited online, which appeared in public-service ads⁷ distributed by the Ad Council. The stat has received a fresh round of publicity thanks to donated air time⁸ from MySpace, a site popular with teens. As I wrote⁹ last year, the "one in five" estimate was based on research that was five years old which only covered children who spent time online. The survey also used a broad definition of sexual solicitation. Yet the stat persists. The NCMEC told me¹⁰ last July it hoped to have new research by the end of last year. Now, spokeswoman Tina Schwartz says the group expects new research to be released in the next couple of months.

* * *

As Congress debates whether to pass new laws specifically outlawing online gambling, a recent poll appears to show that the public is strongly against the legislative effort: Almost 80% of Americans oppose a ban, according to the survey.

The poll was conducted by well-known polling firm Zogby International on behalf of an online gambling trade group. As I've written¹¹ in the past, such sponsored research warrants extra scrutiny from readers, though the fact that the poll was commissioned by a special-interest group isn't by itself a reason to dismiss it.

Still, in this case, it appears that the sponsor of the poll influenced the way it was conducted, particularly in the way the questions were phrased. Here's one question: "Many gambling experts believe that Internet gambling will continue no matter what the government does to try to stop it. Do you agree or disagree that the federal government should allocate government resources and spend taxpayer money trying to stop adult Americans from gambling online?" Some 77% of respondents disagreed.

Here's another question: "More than 80% of Americans believe that gambling is a question of personal choice that should not be interfered with by the government. Do you agree or disagree that the federal government should stop adult Americans from gambling with licensed and regulated online sports books and casinos based in other countries?" You probably won't be surprised to learn that after being told that most Americans don't want the government to interfere, some 71% of the respondents to this question signaled they, too, were against a government ban.

The results of the poll were posted on the gambling trade group's Web site¹² and emailed to journalists.

The gambling questions "were fair and balanced, and gave the respondent appropriate choices," Fritz Wenzel, spokesman for Zogby International, told me in an email. (Zogby does many political polls separate from interest-group-backed research, including polling on the 2004 presidential race and 2006 gubernatorial and Senate races for the Online Journal.)

Polling experts disagreed when I showed them the poll. Cliff Zukin, president of the American Association for Public Opinion Research, a professional association of pollsters, told me the questions are "loaded and biased." Prof. Zukin added that if any of his students at Rutgers University wrote such questions, "I would fail them."

Robert Blumenfeld, an El Paso, Texas-based attorney for the Antiguan Offshore Gaming Association¹³, told me the trade group paid "less than $10,000" for the poll. The Antiguan group, which represents more than a dozen online casinos, drafted the questions with guidance from Zogby, Mr. Blumenfeld said. He disagreed with the suggestion that the phrasing of the questions might have influenced the results, but said the group would conduct further polling. "We're willing to put the question in a way that can't be subject to any kind of criticism," Mr. Blumenfeld said.

Mr. Blumenfeld said the group is using the results of the poll in its lobbying efforts to fight an online gambling ban.

It's not unusual for pollsters to conduct polls for hire. Many pollsters make their reputations with political polling, and make their money with sponsored polling. Still, Zogby's poll didn't meet certain standards¹⁴ set by the polling professional association headed by Prof. Zukin, which say, among other things, that pollsters should ask unbiased questions.

Zogby International and its chief executive, John Zogby, are well known in the polling world. Yet Mr. Zogby has at times lent his firm's credibility to polls conducted for sponsors and filled with leading questions, as a New Yorker profile¹⁵ in 2004 noted. One poll funded by People for the Ethical Treatment of Animals asked respondents if they would stop eating meat or dairy products "if you knew that within days of birth, chickens have their beaks seared off with a hot blade to keep them from pecking each other in their overly crowded cages?"

Other Zogby polls addressing gambling have had conflicting results. A poll¹⁶ conducted by Zogby on behalf of the New York Council on Problem Gambling, in 2004, found that 67% of respondents said that expanding gambling by the State of New York will definitely or probably increase the number of people with gambling problems.

The Zogby poll wasn't the only recent survey on online gambling to include what I'd consider leading questions. A Harris Interactive online poll¹⁷, conducted in February and mentioned in several news outlets (including the Online Journal) found -- among other things -- that 27% of respondents strongly agreed with the statement "since there is no effective way to regulate or control Internet gambling, it should remain illegal," and 27% of respondents somewhat agreed.

The phrasing of that question seems to make an assumption (the impossibility of regulation) that could have influenced responses. Humphrey Taylor, chairman of the Harris Poll, told me that the question was deliberately designed to "see how different arguments played." He said he wouldn't use the response to that particular question, which he called "projective," to determine whether people support legalizing online gambling. "In any release we do, we are fair and balanced, but any single projective question may not be," Mr. Taylor said, adding that the poll wasn't sponsored.

* * *

Several readers wrote in about my column¹⁸ last week on the number of illegal immigrants in the U.S. Here's an excerpt from one letter:

As a result of my own experience attempting to estimate the number of workers employed in California seasonal agricultural work during my Ph.D. research, I feel qualified to doubt the validity of any estimation method based on the U.S. census of population. While attempting to use census data from rural California counties to estimate the accuracy of two different state employment service reports on agricultural employment, I encountered discrepancies among the three sources of as much as 300%, with the census data always being the lowest. Conversations with friends in the urban Chicano community confirmed my suspicion that illegal residents were effectively avoiding enumeration. Perhaps the data collection has improved, but it's doubtful that people who want to avoid government scrutiny will make themselves available.

--Sue Hayes, professor of economics, Sonoma State University

Several readers also wrote in about my comment that scientific notation is likely to be adopted soon after the U.S. adopts the metric system:

We've lost enough dollars and lives because of continuing confusion between our systems of inches vs. millimeters and pints vs. liters, but the idea of mass re-education of the entire American public and mass retooling of manufacturing is frightening.

--Pearl Ladenheim

I would like to suggest a column on the status of metric conversion in the U.S. Is there hope or are we going to continue to bury our heads in a kiloton of sand (which is 20,000 pounds or 10,000 kilograms which, in turn, is 22,000 lbs)?

--Richard J. Behling

And finally, I got this letter about an Associated Press article¹⁹ on a Malaysian man who received a $218 trillion phone bill.

Of course it's amusing that the man received an absurdly high phone bill. But the really funny part, in my opinion, is the AP journalist's analysis: "It wasn't clear whether the bill was a mistake, or if [the] phone line was used illegally." $218 trillion?!? Hmm... I think it's pretty clear.

--Ray Weaver

日本資源戰略全面重新佈局，受中國需求遽增影響

　　日本經濟產業省資源能源廳將對金屬資源保障政策進行20年來的首次修正，並於22日透露新方針。經產省將以確保數位家電等日本尖端技術必須的鉑、銦等稀有金屬的穩定供應，作為政府的核心任務。新政策將寫入預定於5月完成的「國家能源新戰略」，擴大各種稀有金屬的儲備。　　受到中國經濟高速成長，造成對稀有金屬的需求量暴增，日本擔心這會導致全球性的供應短缺，影響其產業競爭力。鑑於產業界強烈要求將稀有金屬作為石油一樣的戰略物資加以確保，日本政府決定重新部署資源戰略。

　　被認為最有可能出現短缺的是鉑、銦及稀土類三種資源。鉑應用於汽車的廢氣排放淨化裝置、燃料電池；銦應用於液晶電視的液晶面板；稀土類則是混合動力車不可欠缺的材料。

在上述產品的國際競爭中，日本企業均處於優勢地位。一旦出現資源供給中斷，將導致產品停產，對日本經濟造成嚴重打擊。
（2006/3/23）

A Study in Diplomacy

Chinese, Japanese Friendship Offers Glimpse Into DifficultyNations Face Getting Along

By SEBASTIAN MOFFETT in Tokyo and JAMES T. AREDDY in Shanghai
March 21, 2006; Page B1

Growing up in Japan, Asayo Iizuka was fascinated by China. So the 22-year-old jumped at the opportunity to study at Shanghai's Fudan University, hoping to expand her knowledge and make Chinese friends.

There she met Chen Li, a 20-year-old economics student at Fudan, who hated Japan. When she was growing up, Ms. Chen's family had told her the Imperial Japanese Army had killed her great-grandfather.

So, at first, a friendship didn't seem possible. "I don't really like the Japanese," she informed Ms. Iizuka early on.

Yet the two women have stayed in touch and each continues to try to change the other's point of view. In the process, they confronted, on a personal level, some of the major issues threatening relations between Asia's two economic giants at a time when slow-growth Japan is finding opportunities in fast-expanding China.

"For 4,000 years China was the top country in Asia, but in the past 150 years, Japan has been more powerful," Ms. Iizuka says. "Now they are equal, but they don't know each other well enough to acknowledge each other."

Asayo Iizuka in Tokyo

Even as old wounds linger, China, including Hong Kong, has become Japan's biggest trading partner. About 99,000 Japanese live in China, more than any other country besides the U.S. Both governments are working to nurture better relations among the younger generation. Japan plans this year to set up a fund of 10 billion yen ($86 million) to pay for 1,100 Chinese high-school students to study in Japan annually for about 10 days and an additional 150 for several months to a year. A current government-affiliated study program enrolls 100 Chinese students in Japanese high schools each year.

"The economic relationship is robust and growing," said Jeff Kingston, director of Asian studies at Temple University Japan. "But I don't think that can continue indefinitely while government relations are in the deep freeze."

In China, memories are still strong of the Sino-Japanese war from 1937 to 1945, when the Imperial Army killed at least 10 million Chinese, according to standard estimates. The Chinese complain that Japanese school textbooks skim over the war and object to visits by Prime Minister Junichiro Koizumi to the controversial Yasukuni war shrine in central Tokyo that is dedicated to the 2.5 million people who died fighting for Japan, most of them during Japan's war with China and World War II.

In protest, Beijing has refused to schedule formal summit meetings with Mr. Koizumi and is opposing Japan's bid for a permanent seat on the United Nations Security Council. Thousands of Chinese participated in anti-Japanese demonstrations last spring.


Ms. Iizuka's fascination with China began when she studied the Chinese language in high school. She loved China's ethnic variety and thousands of years of history, and knew the language would help her career. While studying law and politics at a Tokyo university, she went in 2003 to spend a year at Fudan -- the top university in Shanghai.

That winter, a South Korean friend introduced the two women. The students exchanged phone numbers. But Ms. Chen talked little with Ms. Iizuka.

Ms. Chen had disliked Japan since she was a child growing up mostly near Shanghai. From age 7, schoolteachers took her class to see patriotic films; some were about heroic Chinese children risking their lives to resist evil Japanese soldiers during Japan's World War II occupation of China.


Chen Li in Shanghai

In high school, Ms. Chen took part in day-long hunger strikes against Japan. Now, she boycotts Japanese goods, and two years ago bought a digital camera made by a South Korean manufacturer. Buying Japanese products is "a bit like losing face," she said. "We were beaten by them, but now we have to accept their products?"

Ms. Chen bumped into Ms. Iizuka on campus after a winter break. Ms. Chen noticed that Ms. Iizuka seemed different from Japanese students who stuck together and dressed fashionably. Ms. Iizuka dressed down and wore floppy hats, a casual look Ms. Chen found approachable. "She was nice," Ms. Chen recalled. "I thought maybe I should be more open."

The two women found they had plenty in common. They both liked the late Hong Kong movie star Leslie Cheung. Ms. Iizuka treated Ms. Chen to her first Japanese meal, laughing when Ms. Chen flinched at the taste of miso -- bean paste -- soup.

Ms. Chen was beginning to have doubts about the accuracy of some of the information she had about Japan. Ms. Iizuka, meanwhile, felt a special mission to talk about China-Japan relations. In 2002, before her year at Fudan, she had taken a crowded evening train in Manchuria, a former Japanese colony in northeastern China. Fearing for her safety, she told fellow passengers she was Korean.

She later regretted telling a lie and vowed to be more open with the Chinese she met. She had heard about anti-Japanese feeling before she visited China and felt she needed to make a stronger effort to understand Japan's past wrongs. She also felt some Chinese anti-Japan sentiment came from skewed information. For instance, Japan is China's top foreign-aid donor, but China's state-controlled press rarely reports about the financial assistance.

Yet both women held on tightly to certain beliefs. Ms. Iizuka and Ms. Chen had fiery discussions, both in person and over email, over Mr. Koizumi's recent visits to the Yasukuni war shrine.

Though the prime minister has apologized for Japan's invasion of China and said his visits are to pray for the souls of regular soldiers, these apologies ring hollow in China because the shrine honors 14 Class A war criminals -- those tried for "crimes against peace," because they led Japan's war in Asia.

Ms. Chen said she was offended by Mr. Koizumi's annual visits. Ms. Iizuka responded that visitors honor relatives killed in action. "They're thinking of their own families," she recalled saying. Mr. Koizumi prays for peace, not for war criminals, she added. Ms. Chen argued that visits by a prime minister are different because "he stands for the country's opinion."

Ms. Chen retained her core feelings about Japan. When anti-Japanese sentiment bubbled up last spring, she joined one of the demonstrations in China. Ms. Iizuka said she was disappointed that her friend had participated, and she wished the Chinese wouldn't blame her generation for past problems. "It's natural for them to criticize Japan's past," she said. "But I can't accept it when they throw this at the Japanese of today. The Japanese of today have done nothing wrong."

Despite the differences in opinion, the two women have remained close. Last fall, Ms. Iizuka visited Shanghai, and they chatted like old friends over lunch in a rooftop restaurant, recalling their past arguments. Ms. Iizuka, who will soon start a job as a wire-service reporter, dreams of working in China one day. Ms. Chen said conversations with Ms. Iizuka have made her less radical. "If I dislike Japan," she said, "it doesn't mean I dislike all Japanese people."

Avon Calling, Again

MONDAY, MARCH 13, 2006
By JACQUELINE DOHERTY

AFTER A YEAR OF MISERY, AVON PRODUCTS is giving itself a makeover. The iconic marketer of make-up and skin-care products is slashing management layers, bolstering its overseas presence, spending more on advertising and focusing on lower-priced items. Success could reinvigorate its moribund revenue growth and send its shares, now 29, climbing 20% in the next year or so.

"It's not a stock for the faint of heart," says Diana Joseph, a portfolio manager with Chicago-based Dearborn Partners, who began nibbling at the shares for clients and her own account earlier this year. But "there is a reasonable probability the company will regroup, and it is a business with high margins and high cash flow," she adds.

If Avon's restructuring goes well, the shares (ticker: AVP) could rise to 35 in the next 12-to-14 months, Joseph figures. Along the way, investors will pocket a 2.4% dividend yield.

As the stock's 30% slide in the past 12 months suggests, Avon fans are few these days. Six analysts rate the shares Hold, while four are telling clients to sell. Growth investors largely have fled the name by now, and have been replaced by value funds such as Davis Selected American Shares (SLASX) and Oakmark Equity & Income (OAKBX), presumably drawn by the company's strong cash flow and historically low price/earnings ratio of 17 times expected earnings.

Attitudes toward Avon, which is based in New York, have changed notably since we penned a skeptical piece on the company more than two years ago ("A Thing of Beauty?" Jan. 19, 2004). At the time, much of Wall Street was bullish, although we thought investors were paying too much for a company whose U.S. growth was slowing. Our caution was premature -- Avon subsequently rallied to 46 from 33 -- but it wasn't misguided. By last fall, Avon had fallen to 24.
Citigroup analyst Wendy Nicholson, a growling bear in January 2004, upgraded her recommendation to Buy from Hold last fall, and currently has a $32 target on the shares. "Long-term, Avon will grow earnings twice as fast as the Standard & Poor's 500," she maintains.

To justify buying Avon shares today, you have to believe the company's restructuring will bear fruit. That's because last year's results were nothing short of ugly. After boosting revenues by 10% in 2003 and 13% in 2004, Avon suddenly posted a 5% increase, to $8.2 billion in 2005. Net income was flat, at $848 million, or $1.81 a share from operations. The year ended on a particularly poor note, with fourth-quarter net falling 37%, to $183 million. Restructuring charges dented results and will continue to depress earnings this year, although analysts are estimating operating earnings per share of $1.67 in 2007, which should mark the start of a rebound.

Avon's U.S. sales kick in roughly a quarter of total sales and a fifth of operating profit.

Consequently, the company has relied on robust growth overseas. Last year, however, even foreign markets were disappointing. Sales in Central and Eastern Europe rose by 15%, well below the 47% increase they clocked in 2002. In addition, Pacific-region sales contracted by 0.3% overall, and those in China fell 20%, compared with a 42% increase in 2004.

To some degree, Avon shot itself in the foot in '05, by slashing U.S. advertising spending 50%. But much of the drag came from events outside its control. Higher oil prices and rising interest rates squeezed spending by middle- and low-income consumers. And global competition has intensified, with industry giants such as Procter & Gamble (PG) and L'Or?al (LRLCF) putting lots of research and advertising dollars behind products in the $15-to-$25 retail price range. In the past few years, they have made it much easier to find high-quality skin-care items at the local drugstore, striking at the core of Avon's market. Avon's Anew skin-care line, meanwhile, fetches more than $30 a jar.

The solution: Introduce more products, bolster offerings at lower prices, such as the Solutions line of skin products, and boost advertising spending. This quarter, Avon is introducing Anew Clinical Eyelift, with a gel for the upper eyelid and a cream for below the eye, for $28. In the second quarter, the company will unveil Ageless Results, a skin cream based in part on Anew technology, that will sell for $12 to $15 per item. Also ahead: an instant-dry nail polish that will retail for $8. Avon hopes to bring new products to market faster than in the past, owing to a $100 million research facility it opened in Suffern, N.Y., last year.

IN A RECENT PRESENTATION, Avon CEO Andrea Jung, 47, said the company will reverse its ad-spending cuts in the U.S.; television viewers already have seen the results. U.S. TV advertising, which shrank to 10 weeks in 2005 from 21 weeks in 2004, will jump to an estimated 47 weeks this year. On a worldwide basis, ad spending will rise 50% this year, and double by 2008. Jung and other Avon executives declined to speak with Barron's.

With newer products and more advertising, Avon hopes to wean itself from price discounting. Last year, the company generated 80% of its sales from discounted products, up from 65% five years earlier.

Avon also hopes the buzz created by its redoubled efforts will energize its sales force of 4.8 million representatives, mostly women, around the world. Jung implied that she was studying compensation levels to ensure that the company offers competitive packages. As most "Avon ladies" are paid by commission, it's possible she'll have to alter compensation formulas, resulting in higher costs, if lower-priced products begin to comprise a larger percentage of sales.

The company also may need to appease some current and former Avon ladies, who are attempting to gain class-action status for a suit they filed several years ago in Superior Court in Los Angeles, contending that they received and were billed for products they never ordered. We detailed their allegations a year and a half ago ("It's Not Pretty," Oct. 11, 2004). The company contends these are individual customer-service issues.

NO REORGANIZATION IS WITHOUT RISK. William Pecoriello, a Morgan Stanley analyst, worries that instead of generating incremental sales, customers will buy the new, lower-priced products instead of higher-priced merchandise. Pecoriello, who has an Equal Weight rating on the stock and a $34 price target, also notes that Avon's 100% increase in U.S. ad spending this year will return only to 2004 levels.

The company's "share of voice," or the amount of spending it does relative to competitors, is likely to be down in 2006, compared with its level in 2004, as other personal-care companies have been boosting ad outlays.

To pay for new-product development and increased advertising outlays, Avon plans to cut 20% to 30% of its middle- and senior-management positions by this summer. Thursday, the company said that Susan J. Kropf, president and chief operating officer, will retire after 35 years with the company, and won't be replaced. While these cuts show Avon means business, they could disrupt the company's operations, says Morgan Stanley's Pecoriello.

Despite the cuts, Avon is establishing business units for China and Eastern Europe, to complement North America, Western Europe, Latin America and Asia Pacific. Theoretically, the result will be a flatter organization more in touch with representatives and customers.
In all, Avon forecasts savings of $300 million annually, half from management changes. Funds will be reinvested in the business, with half directed to advertising and half to research and development, sales-force enhancement and such.

"This is a multiyear plan that will touch every aspect of this company," Jung said in a recent presentation. Success could bring long-term revenue growth in the mid-single digits, as measured in local currencies, and operating margins should improve in 2007. Avon's operating margins peaked at 15.9% in 2004, and look headed to 11% this year.

Citigroup's Nicholson believes that the restructuring will allow Avon to generate 11%-to-12% earnings growth in 2007 and beyond. She's expecting flat-to-single-digit revenue gains in the U.S. and developed Europe, and 10% revenue growth in emerging markets, the source of more than half the company's sales.

In the past 10 years, Avon's price-earnings multiple has ranged from a 43% discount to a 53% premium to that of the S&P 500. If Jung & Co. deliver, Nicholson says, the stock's P/E could expand to a 35% premium, versus a 21% premium now.

Several developments could enhance the upside. Avon recently received permission to have a direct-sales operation in China, although approval came much later than expected. Until now, the company has had about 7,000 small shops in China. About 5,500 are franchised, and the remainder are company-owned.

AS AVON DEVELOPS A DIRECT-SALES FORCE in that country, it is likely that some of these shops will close, others will shift to the direct-sales model and still others will become salons, says Morgan Stanley's Pecoriello. In anticipation, the stores dramatically reduced their inventories last year, and sales declined 20%, from $220 million. China sales are expected to climb sharply in the future.

"China could be a $1 billion market for them," Pecoriello observes. "If you take a five-year view of China, there's a pretty big opportunity for them." Much depends, he adds, on the company's business model in China.

The Bottom Line

Avon Products hit a speed bump last year, and its shares fell to 24 from 46. They're now around 29, but could rally 20% as the company's makeover produces results.

Investors also tend to overlook the fact that Avon is a cash cow. Even with last year's disappointing results, the company generated $895.5 million of operating cash flow. Nicholson expects future cash flow to average more than $700 million a year.

The company's strong cash flow and balance sheet give it flexibility to pay a dividend and buy back shares while restructuring. Avon had $590 million of debt, net of cash, at year's end. It repurchased $728 million of stock in 2005 and increased its dividend 6%. In 2006, Nicholson believes that the cosmetic maker could repurchase up to $400 million of stock. That would contribute roughly 4% to growth in earnings per share for the year.

Avon's restructuring has been a long time coming, and like any makeover, could take longer than expected to complete. For shareholders, however, the result could be a beautiful thing.

Chinese IPOs Stick Close to Home

Not Many Firms Make DebutIn U.S. Amid Lawsuit Fears,Costs, Strict Regulations
By MICHELLE TSAI and LYNN COWANMarch 20, 2006; Page C4

The world's biggest initial public offering of stock and the U.S.'s best IPO debut last year came from two different companies with one thing in common: China.

But even as investors watch China's expanding economy with interest, they aren't seeing many new Chinese stocks listing on U.S. exchanges, and the ones that do are small fry compared with what trades in Hong Kong.

Since Beijing Internet-search engine Baidu.com Inc. went public on the Nasdaq Stock Market in August, gaining 354% on its first day, four Chinese companies have listed their stocks on American exchanges, according to market tracker Dealogic.

The largest global IPO last year was China Construction Bank Corp.'s $9.2 billion deal in October, listed in Hong Kong. The largest U.S. listing, for containership owner Seaspan Corp., raised $600 million.

Since 2004, when 10 U.S.-listed Chinese IPOs raised a total of $3.93 billion, both the number and size of listings have declined, according to Dealogic. The downturn comes despite solid trading gains for several Chinese companies that had their debuts in the U.S., including Suntech Power Holdings Co. Ltd. and Focus Media Holding Ltd., both of which have at least doubled from their offer prices.

A number of factors make Chinese companies favor Hong Kong over the U.S. The U.S. requirements are considered more onerous, and the threat of investor litigation higher. The cost of complying with Sarbanes-Oxley financial-reporting standards -- easily $1.5 million to $2 million a year -- also stands out, said David Liu, managing director at Jefferies Broadview.
Hong Kong presents an easier transition for Chinese founders who worry about communicating with investors and regulators in a foreign language. "They understand Hong Kong may not be the best market in terms of valuation, but at least it's a market they understand," said Vincent Chan, managing director of venture-capital firm Jafco Investment (Asia Pacific) Ltd.

Asia-based investors often can best appreciate investment theses for localized industries such as manufacturing, shipping and retail, according to Peter Tsou, vice chairman of Asia at Deutsche Bank AG.

Chinese companies listed on U.S. exchanges can struggle for research coverage because their market capitalizations are often less than $500 million. Investment banks usually cover companies whose offerings they underwrite, but foreign issuers tend to have greater difficulties.
"You're listing in a completely different country that has nothing to do with your business or your customers or your home market," said Vince Feng, managing director of private-equity firm General Atlantic LLC.

Elsewhere in the IPO market:

On deck for this week is the IPO of coffee-and-doughnut chain Tim Hortons Inc., which is as ubiquitous in Canada as Starbucks Corp. is in the U.S. Restaurant IPOs have performed well this year, and Tim Hortons has strong same-store sales and restaurant growth, so bankers are expecting a good debut on the New York Stock Exchange.

U.S. Policy Toward China

by Kenneth Lieberthal March 2001

Kenneth Lieberthal is professor of political science and William Davidson Professor of Business Administration at the University of Michigan. He was a special assistant to President Clinton and senior director for Asia on the National Security Council, and was a visiting fellow at the Brookings Institution from November to December 2000.

ABSTRACT

The Bush administration's China policy must be part of a larger Asian strategy that keeps America fully engaged, maintains the region's strength and dynamism in an era of globalization, and encourages China's own constructive engagement in the region. This would provide both the best prospect for encouraging China's internal reform and external cooperation and for creating the conditions to cope with the consequences should China ultimately seek to confront the United States across the region.


POLICY BRIEF #72

The new administration is making clear that it seeks to make China less central to America's Asia policy, shifting increasing attention to Japan. This approach will very likely prove to be more nuanced than fundamental. Both the Japanese and Chinese relationships have long required and will continue to demand a great deal of attention. No administration can downplay either without quickly producing problems that bring that country back centrally onto America's agenda.

Unfortunately, nearly a dozen years after the Tiananmen Square massacre, too much of the discussion in America about U.S.-China relations remains emotional, deeply enmeshed in domestic politics, and misleadingly simplistic. Many critics do not appreciate the fundamental reality that an effective approach to China vastly reduces the costs to the United States of pursuing its vital regional interests in Asia. Every country in that region looks at America's China policy as a key test of the American wisdom and staying power in Asia.

China's America policy is by no means wholly benign, and the United States should, therefore, adopt a hard-nosed view of its own interests. The key question is how best to pursue those interests. For nearly thirty years, Republican and Democratic administrations—despite disagreements on many particulars—have based their overall policy on six strategic judgements, or premises. The Bush administration should address those premises and, if it accepts them, develop its particular policy mix based on the imperatives of this underlying strategic framework.

America's China Policy: Six Premises

America has long sought a modernizing, reform-minded China that acts cooperatively with the United States and behaves constructively both in the region and globally. The following six core premises have undergirded the effort to advance this outcome:

Premise #1: The United States and Asia benefit from the type of stability that comes from China's meeting the needs and demands of its people. Major governmental breakdown in the People's Republic of China (PRC) would produce tragedy at home and severe problems for the region and the United States.

China has been one of the most rapidly changing societies in the world over the past two decades. Yet the country faces massive social, economic, and political challenges that genuinely threaten its overall stability. All of these problems will worsen during the next few years as China deals with the twin tasks of implementing accession to the World Trade Organization (WTO) and managing its political succession. The premise that avoiding massive Chinese political breakdown is in America's interest is not an endorsement of the status quo in China. In fact, China must rapidly reform its political system to make it more diverse, responsive, and efficient if it is to avoid major political instability in the coming period of extraordinarily rapid change. That is why it is important for America to work with Beijing and to constantly prod China's leaders to adopt the liberalizing reforms they have resisted and which are crucial to the future success of the country.

Premise #2: Market-based economic development?and the associated formation of a middle class and increased integration with the outside world?will, over the long run, produce liberalizing effects in China.

This has demonstrably been the case over the past two decades. Anyone who visited China at the start of its economic reforms in the late 1970s and returned today would marvel at the enormous changes in lifestyle, individual choice, access to information, and growth of a non-governmental public sphere. China's WTO entry will be the biggest influence on this ongoing process in the coming years. But the short-term effects of WTO implementation may instead be increased social unrest and political repression in order to maintain control. Premise #2, therefore, posits a long-term perspective that must be able to withstand short-term setbacks that periodically capture the headlines.

Premise #3: America has a fundamental interest in China's accepting international norms and rules. The United States makes the greatest progress when Beijing officially adopts these norms and rules and when it works with China to achieve rigorous implementation.

America has achieved considerable progress with this approach in areas such as nonproliferation. Less than full compliance on implementation should not negate this basic premise as long as the process moves substantially forward. Recent history in spheres such as human rights has provided evidence that public condemnation combined with sanctions alone too often enables Beijing to counter American criticism with complaints about foreign bullying and interference. Such patriotic rhetoric resonates among the Chinese population and transforms rejection of international norms and standards into an affirmation of national pride. The result sometimes inhibits real progress.

Premise #4: The United States has a strong national interest in having China believe that we are not inescapably hostile.

Beijing worries a great deal about sustaining its economic growth, maintaining domestic stability, and ensuring territorial integrity, and it fears America may want to undermine all three. In sharp contrast to the 1980s, non-governmental public opinion surveys in the PRC indicate that America is now widely viewed as the country least friendly to China. On both sides, words and actions affect each country's perceptions of the other's attitudes and intentions. Adopting rhetoric that regards China as an enemy can help to make it one.

Premise #5: Diplomatically, the United States must pursue a "one China" policy.

The diplomatic premise that there is one China and that Taiwan is a part of it is fundamental to the U.S. relationship with the PRC. This premise requires some well-known restraints on American diplomacy, but the United States has successfully pursued this approach in a way that is compatible with its interests and values. Ignoring these restraints would engender conflict that would severely harm Taiwan and undermine America's ability to successfully pursue policies that are built on the first four premises.

Premise #6: Maintaining peace and prosperity in Asia is in America's core economic and security interests, and active U.S. engagement in the region is vital to pursuing that goal.

China is already active both economically and diplomatically throughout Asia. The United States can benefit from and should encourage China's constructive engagement but must be fully prepared and firm if Chinese actions challenge Asian peace and prosperity or the American role in Asia.

Policy Recommendations for the New President

In its first months in office, the Bush administration will have to address such specific issues as how to handle a China-specific resolution at the United Nations Human Rights Commission meeting in Geneva. Even as it grapples with such issues, the administration should also consider fundamental initiatives that give operational substance to the above strategic policy premises. The most important of these are:

Introduce the possibility of a weaker, disorganized China into the policy debate.

To date, American public discussion of China policy has focused overwhelmingly on two alternatives resulting from the inevitable rise of China: a strong, antagonistic China (the "China threat"), and a successful, cooperative China (a "constructive strategic partner"). These alternatives are too narrow because a "rising China" is not the only possibility.

Current challenges may overwhelm the capacities of the Chinese system and produce fundamental instability. This possibility looms especially large over the next four years. Instability would reduce the government's ability to control proliferation, attack pollution, sustain economic growth, fight transnational crime, slow the spread of HIV/AIDS, and control the movement of people across the country's borders. There is, in sum, as great a "threat" to U.S. interests from a weak and unstable China as there is from a strong and antagonistic China. Indeed, an unstable China might even be more inclined to adopt an anti-American posture in order to mobilize domestic support.

The new administration's foreign policy officials should, therefore, explicitly address America's interest in China successfully coping with major domestic challenges, along with its interest in China not becoming a powerful antagonist to the United States throughout Asia. Grasping the potential for a failing as well as a rising China means that America's China policy should attempt to reduce the chances of China's failure as well as the possibility that China will view the United States in a belligerent fashion.

Provide assistance to increase China's capacities and willingness to manage those issues where Chinese success can have beneficial transnational consequences.

There are many areas in which the United States relies on effective Chinese efforts to help address transnational issues that have a Chinese component. These include such issues as promoting environmental protection, controlling proliferation of weapons of mass destruction and their means of delivery, implementing trade regime obligations, and countering transnational crimes such as terrorism, narcotics trafficking, and illegal smuggling of people. Currently, U.S. law and politics prohibit or constrain cooperation in many of these areas.

In those areas where China's success is fully compatible with America's interests, the Bush administration should seek the legal and political changes necessary for America to provide appropriate technical and related assistance. Past practice strongly suggests that the most effective way to deal with China on such issues is to:

* Initiate and support discussions among U.S. and Chinese specialists to develop Chinese counterparts who appreciate the problem and understand international experience and norms in dealing with it.
* Seek agreements that commit the Chinese government to specific goals and methods.
* Bolster those agreements with offers of technical and other assistance, as appropriate. Encourage the relevant American agencies to establish cooperative ties with their Chinese counterparts to handle the issues.
* Rigorously monitor Chinese performance and provide the Chinese government, where possible, with information on compliance failures while holding it to its obligations on implementation.
* Encourage, where practicable, Chinese participation in multilateral agreements in these spheres so as to achieve desired results while taking some of the burden off the U.S.-China relationship.

This approach requires patience, persistence, strength and sensitivity. It is far more difficult domestically than simply identifying Chinese failings and applying sanctions to compel better behavior. But its potential benefits are substantial. They include: 1) improved Chinese technical abilities to deal with problems where Chinese failures affect American and other interests, recognizing that some of the problems that concern us reflect weaknesses in the Chinese system rather than insidious efforts by the Chinese government; 2) creation of constituencies in China that favor compliance with international norms and standards; 3) ongoing American and international involvement in monitoring and improving implementation; 4) increased trust and reduced threat perceptions. American assistance in addressing serious Chinese problems weakens those in China who portray the United States as an implacable enemy bent on containing and undermining China. A broad approach can thus move China's capacities and perspectives in directions that meet American interests.

Regularize high-level consultations.

Beijing and Washington should regularize both annual summit meetings and a high-level strategic dialogue. Summit meetings provide opportunities to move issues forward, to have the top leaders better understand each other, and to set the tone for the relationship. Every summit creates incentives to break bureaucratic logjams in order to achieve agreements. Presidential meetings, for example, played key roles in achieving the WTO accession agreement in 1999 and the progress on missile proliferation controls made public in November 2000. President Bush should meet with President Jiang no later than the October 2001 Asia-Pacific Economic Cooperation (APEC) Leadership Meeting in Shanghai and should be in contact with him before that.

A strategic dialogue between senior officials from both countries should focus on global and regional developments and on the policy implications of those analyses. This dialogue should force key people on both sides to think through the place of U.S.-China relations in a broader context and to articulate underlying concerns. Held regularly, this dialogue will also vastly improve communication between key individuals at high levels, and can be crucial for crisis management as well as for broader mutual understanding. If discussion of trade motivated the U.S.-China dialogue during 1999-2000, strategic dialogue should motivate relations in the new administration. This strategic dialogue can make the very real differences between both nations over issues such as national and theater missile defense, Asian regional initiatives, and policies toward South and Central Asia more manageable.

Retain the "one China" policy and take steps to reduce the prospects for a cross-Strait missile/anti-missile arms race.

No issue holds greater potential danger for China, Taiwan, the United States, and East Asia than does the cross-Strait imbroglio. Yet there is little prospect of imminent political progress across the Taiwan Strait, largely because of the internal political dynamics in both Beijing and Taipei. American policy has long been based on three pillars: "one China," peaceful resolution, and cross-Strait dialogue. Although every American administration has sought to keep both sides from taking the fateful steps that could lead to conflict, developments over the past decade have nevertheless led to increased militarization and decreased trust in cross-Strait relations.

In view of the danger of the underlying situation, the new administration should try to reduce tensions and advance cross-Strait ties in a way that does not threaten Taiwan's freedom, prosperity, and security. Any cross-Strait resolution will require two steps: a China-Taiwan negotiation that cannot be coerced and will likely take decades, and a final agreement to form a loose formal association on terms that fully preserve the ability of the people of Taiwan to freely determine their domestic political and economic systems. The hard reality is that, given the Mainland's size and Taiwan's location, Taiwan will likely never attain long-lasting security without reaching a negotiated overall formal relationship with the Mainland.

The U.S. administration cannot tell either side what to do and should not become an active mediator across the Strait. But the Bush administration should pursue an active cross-Strait policy designed to reduce tensions, increase mutual trust, and encourage the resumption of cross-Strait dialogue. An important step is to continuously explain one side's views and concerns to the other, while always stressing America's insistence on peaceful resolution and a "one China" policy. This type of effort proved important during the tense aftermath of the March 2000 election in Taiwan and should be intensified. Because the cross-Strait issue arouses strong emotions on all sides and has become enmeshed in domestic political battles in each capital, the administration must also take special care to explain to Congress and the American public the rationale behind its strategy to nurture a peaceful resolution.

The Arms Issue

Militarily, the Bush administration faces a fast-approaching deadline on its biggest immediate issue with regard to arms sales to Taiwan. Each year, the administration uses a meeting in April to tell the Taiwan government the items that have been approved for possible purchase by Taiwan. This year, an April deadline means that the new administration will have to determine its position on this issue almost as quickly as Congress confirms its pertinent policymakers.

Taiwan wants some weapons systems—such as Aegis destroyers and PAC-3 anti-missile batteries—that Beijing has clearly indicated would cross red lines because in Beijing's view they are natural stepping stones to anti-missile defenses that are organically linked to U.S. systems. This would, Beijing argues, effectively reconstitute the U.S.-Taiwan defense treaty that the United States abrogated as part of the 1979 agreement to shift recognition from Taiwan to the PRC.

Should the administration sell these systems, Beijing would likely react very sharply so as to "teach" the Bush administration that it must take PRC concerns seriously. The resulting frictions could reduce the chances of cross-Strait dialogue and move U.S.-China relations onto a more confrontational path. But simple refusal to sell any of these systems might be perceived in Taiwan as a vote of no confidence.

China currently is able to launch several hundred ground-based missiles at Taiwan. This number is grossly inadequate (if armed with conventional weapons) to significantly degrade Taiwan's military capability, especially if Taiwan adopts prudent measures of passive defense. But the PRC's missiles can cause substantial disruption and produce political shock waves. Because such missiles are less expensive to field than are offsetting anti-missile defenses, China can, with some effort, effectively retain its current capacity to strike Taiwan with missiles.

Rather than blindly march down a path of escalating missile and anti-missile capabilities on both sides, the Bush administration should, by itself or through Taiwan, approach Beijing to seek an agreement in which China stops increasing its missile threat to Taiwan (via restraints in production and/or deployment) in exchange for Taiwan's eschewing additions to its current modest anti-missile capability. Appropriate mutual verifications would have to be built into any such agreement. Necessarily, any agreement on mutual restraint would take time to negotiate. In the interim, the administration should encourage each side to have its specialists begin studying the complex issue of potential confidence-building measures in the security realm, because both sides will eventually have to address this issue. It should also carefully evaluate the wisdom of declining to authorize sales of the controversial systems to Taiwan this year with a view to promoting a verifiable cross-Strait agreement on missile and theater missile defense restraint before the April 2002 round of Taiwan arms sales. This would require a strategy to assure that Taiwan sincerely seeks such an agreement and that the PRC knows that failure to reach one would likely end the restraint on sales shown in 2001.

Adopt Asian regional policies that contribute to the outcomes America seeks regarding China.

U.S. policies toward the region as a whole will have considerable bearing on relations with the PRC. It is in America's diplomatic, economic, and military interests to remain fully engaged in Asia, working with the countries in the region to confront the challenges that stem from a variety of sources, including globalization and China's activities. Moreover, America's overall posture in Asia will substantially affect China's perceptions and incentives. U.S. policies toward the region should, therefore:

* Maintain and strengthen America's existing alliances, even while making specific adjustments in the size and composition of forces to meet changing security needs.
* Increase regional capacities to address issues such as peacekeeping, disaster relief, counter-narcotics, and counter-terrorism. These capacities should be developed in a way that complements America's existing alliances, with China having appropriate opportunities to play a constructive role in the initiatives.
* Quickly renew and intensify trilateral consultation with both the Republic of Korea and Japan to address the dynamic changes occurring on the Korean peninsula. Strong U.S.-Korea-Japan coordination is critical for moving North Korea further along a path toward cooperation. As appropriate, consultations with Russia and China should intensify as a part of this effort.
* Strongly encourage structural economic reforms in pertinent countries to provide the basis for sustained regional economic growth in a globalized world.
* Support increased regional consultation and the development of regional institutions on the basis that these welcome full U.S. participation.

A Strategic Approach to China

Regardless of the balance the Bush administration seeks regarding the relative focus on China versus Japan, a strategic, active China policy will be necessary to the administration's overall success in Asia. The administration must seize the initiative early to frame the discussion of China policy if it wants to obtain the necessary political room to implement a nuanced, long-term approach. Early steps, both in articulating the policy framework and in dealing with cross-Strait issues such as arms sales, will significantly influence the record of the U.S.-China relationship throughout the Bush presidency.