China Could Be the Big Winner Amid Korean Tensions

The mysterious North Korean regime managed to rattle markets again this week. Markets sold off Tuesday after a volley of artillery fire killed two South Korean marines and set houses ablaze in the most flagrant act of provocation since Pyongyang had a South Korean naval vessel torpedoed last March.

Analysts are scrambling to decipher North Korea's motives. The most likely scenario is that the regime wants to get attention and draw world powers to the bargaining table where it can extract more concessions.

But for investors, a more consequential dynamic may be taking shape behind the scenes. The latest episode follows several hectic months in Asia where China's expanding economic might is quickly leading it to take center stage in regional politics. Ultimately, the showdown may boost Beijing's role as power broker in the region and could strengthen its hand when it comes to increasingly tense economic relations with the United States.

Geopolitical Issues

China has a complicated relationship with North Korea and the extent of Beijing's direct influence has been hotly debated. China provides plenty of symbolic support along with necessities like food and fuel.

But Pyongyang may ultimately have more leverage. A collapse in North Korea would eliminate an important buffer zone and could allow U.S. troops to easily reach its southern along with unleashing a refugee crisis.

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Analysts note that China seemed genuinely surprised by the recent barrage, and the North Korean move comes ahead of high-level meetings between China and the U.S.

"China is, no doubt, embarrassed by North Korean provocations in advance of President Hu Jintao's mid-January visit to Washington," analysts at political risk consultancy The Eurasia Group wrote in a note to clients. "Worse, the incident has again shown that Beijing is either unable or unwilling to restrain Pyongyang."

But as the U.S. and China compete for influence in the region, the development could give Beijing an advantage nonetheless. So far, China has remained supportive of North Korea, much as it was in March even as international outrage mounted over the sinking of the South Korean naval vessel.

The United States, after all, has limited means of influencing North Korean aggression and must use China as an intermediary. And along with South Korea, any exchange will serve as a litmus test for the ability of the U.S. to support the interests of other regional allies like Taiwan and Japan.

Tensions Rising

China, meanwhile, has plenty of concessions to seek in exchange for pressuring Pyongyang. Tensions have been escalating lately, with the U.S. becoming increasingly aggressive about the jobs that China's undervalued currency allows it to siphon off. At the same time, China complains that the U.S. is pursuing manipulative policies that could lead to inflation in the developing world.

Japan, another U.S. ally, has also seen rapidly escalating tensions with China. Earlier this month, Japan dispatched troops to disputed islands in the East China Sea that may be rich in natural resources. The move follows a bitter showdown after a Chinese fishing boat rammed a Japanese naval vessel and China informally clamped down on vital rare earth metal exports to Japan.

That, in turn, led to a new collaboration between Japan and India in the development and reuse of rare earth metals. This week, Japan's largest importer of rare earth metals turned to an Australian company to form a "strategic alliance" to secure future supply. Beijing's moves, in other words, are having a rippling effect across the region.

The rapid rise in the Chinese economy was accompanied by much wishful thinking. An ideal trading partner that was almost fused with America, China wished only to keep its factories humming as its wealth expanded, according to the popular view that emphasizes China's "peaceful rise."

But Beijing is proving itself shrewd rather than docile on the international stage time and again. And it will likely look to further its own agenda as tensions mount again on the Korean peninsula.