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TOUGH TALK

The die was cast three weeks before President Clinton and Japanese Prime Minister Morihiro Hosokawa met for a fateful Feb. 11 White House showdown over U.S. access to Japanese markets. At an impromptu Cabinet meeting, Clinton's five trade negotiators had given him unanimous counsel on how to handle the encounter. If Hosokawa refused to agree to measurable standards for opening Japan's shuttered markets, they instructed, Clinton should just walk away from the table.

On Feb. 1, U.S. Trade Representative Mickey Kantor and W. Bowman Cutter, deputy director of the National Economic Council, were sent by Clinton to Tokyo to give Hosokawa advance word of the impending confrontation. Hosokowa shrugged off the warning, though, and the Japanese offered last-minute token concessions: They would agree to loosen the hospital-equipment and insurance markets eyed covetously by the U.S. The Clintonites' reply: "Not enough."

So when Hosokawa sat down in the Oval Office for what turned into an hour-long debate, both leaders got right to the point. Without raised voices or cross words, they admitted they were at an impasse. After Hosokawa complained at length that the U.S. approach violated free-market principles, an exasperated Clinton leaned forward and said: "We may be so far apart that there's not much more to discuss now. We might want to take a pause to reflect."

"WE WANT RESULTS." With those mild words, the U.S. and Japan embarked on their most serious trade dustup of the postwar era. Word that the "framework" talks had collapsed ignited fears of a trade war between the world's largest economy and the most aggressive exporter. If nothing else, the relationship between the two superpowers has changed fundamentally. "We're hoping for a clean break from the past here," Kantor told BUSINESS WEEK. "The Japanese insist their markets are open. They are not. No more business as usual. We want results."

While the Administration is talking tough and threatening retaliation, the real policy is more measured. The Clintonites are opting for a slowly escalating war of nerves that, they think, will lead Tokyo to back down before things get out of hand. The goal: to turn Japan away from endless accords that never improve market access and force it to commit to specific, measurable actions that will boost foreign imports.

Clinton believes that with the cold war over, economics can replace national security as the paramount issue defining Washington-Tokyo relations. Hosokawa, conversely, senses that in a less threatening world, Japan can finally say no. "It's two different philosophies of trade finally confronting each other," says Robert D. Hormats, vice-chairman of Goldman Sachs International. "There is no longer any compelling argument to reach agreement."

While U.S. exporters generally support the Administration's new line, they are nervous about the consequences. "I think it worries everybody," says Donald V. Fites, CEO of Caterpillar Inc. "Japan and the U.S. are major trading partners, and any disruption in two-way trade would be detrimental to both countries and to our companies."

The jitters quickly hit financial markets, with Japan taking most of the hit. The U.S. stock market seemed to shrug off the confrontation, but prices on the Tokyo Stock Exchange plunged. And on Feb. 14, the yen rose against the dollar in New York from 106.85 to 102.65. Although it recovered and now appears stable at around 104, many analysts believe the rate could now drop below 100 for the first time in modern history.

The Japanese are bracing for a good fight (page 29). Tokyo officials argue that Clinton is treating the bilateral relationship as a unique case for managed trade. Washington, they claim, wants an "affirmative action" program that uses quotas and timetables to reduce Japan's $60 billion trade imbalance. According to former Japanese Foreign Minister Michio Watanabe, the Clintonites "are sure to introduce retaliatory measures one after another."

In fact, such a path seems unlikely. Rather, the White House is launching a measured strategy that, as one Administration official says, "slowly ratchets up the psychological pressure on Japan until it makes the next move to get the talks going again. We're prepared to wait them out, but the next phone call is going to have to come from them."

NEW TARGETS. The first modest step in the U.S. pressure-point campaign was taken on Feb. 15, when Kantor formally declared the Japanese in violation of a 1989 agreement to give Motorola Inc. full access to the Japanese cellular-telephone market. That action, in itself, will have little practical impact. But the USTR, he said, is compiling a list of high-tech Japanese products, such as video camcorders and auto electronics, that could become the next targets for retaliatory tariffs.

Within the next few weeks, Administration officials say, the President will issue an executive order reviving the so-called Super 301 sanctions so feared by the Japanese. The law, which President Bush allowed to expire, requires the White House to publish a list of countries that use unfair trade practices. If the offenders don't change their ways, they become targets for mandatory retaliation. Officials say that when Clinton issues the executive order, he may cite Japan in a Super 301 action. But the initial effect would be to trigger an investigation that would last a year.

Similarly, the Administration may invoke the proceedings of the General Agreement on Tariffs & Trade. A charge that Japan has taken actions that "nullify and impair" previous trade agreements would trigger a GATT investigation. At upcoming meetings of trade ministers in Marrakech, Morocco, in April and at an Asia Pacific Economic Cooperation forum in the fall, the U.S. will try to persuade Asian and European nations to join it in demanding access to Japanese markets.

Trade hawks on Capitol Hill will be Clinton's allies in tightening the vise. House Majority Leader Richard A. Gephardt (D-Mo.) and Senator John D. Rockefeller IV (D-W.Va.) will soon introduce legislation that requires the President to set numerical measures of progress for a range of products if the Japanese don't agree to targets first. The get-tough approach has surprisingly strong bipartisan backing. "The Japanese better understand that this is not a partisan issue. This is an American issue," says Senate Minority Leader Robert Dole (R-Kan.), dropping the fierce partisanship that has characterized his recent stands on health-care policy and the budget.

The Administration's assault won't end there. Sources say Anne K. Bingaman, the Justice Dept.'s antitrust chief, plans to step up efforts to bring antitrust cases against companies in Japan for keiretsu-like agreements that U.S. exporters claim are blocking sales of their products. And the Commerce Dept. is reviewing Japanese companies' use of free-trade zones, which allow duty-free importation of parts to be used at assembly plants owned by the Japanese.

But the greatest peril to Japan may come from financial markets rather than policymakers. Even though Administration officials have studiously avoided pronouncements about the desired value of the yen, they've made it clear that they want to see it high. A rising yen could help redress the trade imbalance by making U.S. goods cheaper in Japan and Japanese products more expensive in the U.S.

FEW ALTERNATIVES. No doubt the Administration was pleased when the currency markets drove the yen up because of the chill the development sent through Tokyo's financial community. But the Clintonites want to avoid direct involvement in the markets, which can quickly lead to unpleasant consequences. If the dollar falls too fast, the Federal Reserve would have to prop it up, first by sopping up dollars on the market and eventually by raising interest rates and jeopardizing the economic expansion. "We won't use exchange rates as a weapon," insists a top Treasury Dept. official. "We believe in letting the markets be markets."

The markets, for their part, appear to think the Administration is getting what it really wants without having to ask: a dollar worth about 100 yen. "If the U.S. thinks the [trade] imbalance is at an unsustainable level and the negotiations are dead, the only way to deal with it is with a higher yen," says William P. Sterling, an international economist at Merrill Lynch & Co. Sterling predicts the dollar will fluctuate between 100 and 110 yen over the next 12 months, but he doesn't rule out its falling to 95 yen, if Japan's global trade surplus this year remains around $130 billion.

So far, U.S. business seems content to ride the whirlwind whipped up by the President's willingness to blow up the Hosokawa talks. "We don't need any of these little agreements anymore that don't accomplish anything," says Ford Motor Co. Vice-Chairman Allan D. Gilmour. "I'd rather have a big loss than another little victory." Adds Robert J. Saldich, CEO of Raychem Corp. in Menlo Park, Calif., and president of the American Electronics Assn.: "Frankly, we don't see a lot of alternatives."

Even so, the Administration's policy is fraught with risk. If Tokyo doesn't yield to a gradual escalation of pressure, Clinton could face a choice between retaliation or humiliation. Japan-bashing is considered election-year sport on Capitol Hill, and the President may find the unleashed trade hawks difficult to control.

SURGICAL STRIKES. But broad, hard-hitting sanctions could hurt American companies almost as much as Japanese: Nearly half the U.S.-Japan trade imbalance lies in components used by U.S. companies to make their own products. For that reason, Clinton likely would be limited to pursuing more surgical strikes against obscure Japanese products that aren't widely used--a relatively weak response after such initial bravado.

Clinton does not seem alarmed by the danger. Although he dithered on Bosnia, Somalia, and Haiti, the President seems eager to apply some economic jujitsu to Japan. Gazing into the future, the Clinton Administration sees Japanese-style mercantilism emerging as the leading threat to America's standard of living. Instead of an arms race, the Clintonites see an export race--rigged in Japan's favor. And they worry that such booming Asian nations as China, Indonesia, and Korea will model themselves on the Japanese export machine. "Don't think for a second these other countries aren't watching the outcome of this standoff closely," warns one senior Administration official.

Also watching are nervous multinationals on both sides of the Pacific, which are wondering whether the President's trade bluster could be the start of a more productive relationship with Japan--or perhaps the first salvo in an escalating, damaging trade war.Douglas Harbrecht and Owen Ullmann, with Richard S. Dunham and Thane Peterson, in Washington, and Robert D. Hof in San Francisco


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