The Obama administration has protested against the Jerusalem Municipality's decision to license construction of 20 housing units for Jews on the site of the old Shepherd Hotel in the Sheikh Jarrah neighborhood of East Jerusalem. The US views construction of neighborhoods for Jews in the Arab areas of East Jerusalem the same way it views outpost construction in the West Bank, and opposes both. Prime Minister Binyamin Netanyahu has rejected the American protests very publicly, stating that Jerusalem is Israel's capital and not a settlement. By diverting the settlement construction issue to Jerusalem, Netanyahu, exploiting the American protest, hopes to rally Israeli and world Jewish opinion behind him and against Obama administration pressures concerning settlements in general. Nevertheless, and significantly, the prime minister and his advisers felt a need to anchor his protest in "facts." And the facts put them on shaky ground. For example, the Shepherd Hotel project is billed as having followed normal licensing procedures. But construction there had been held up by the municipality for the past 20 years in consideration of the site's sensitivity. Had Netanyahu picked up the phone to Jerusalem Mayor Nir Barkat he could have stopped the project. Instead, it looks more like the prime minister specifically asked Barkat to finally launch the project in order to engineer a crisis. Netanyahu argued loudly that it was inconceivable that Jews could live in Paris, New York and anywhere else in the world but not in Jerusalem. But Paris and New York are not Jerusalem, a de facto divided city. The annexation by Israel of Jerusalem's eastern half is not recognized by the international community, which almost unanimously designates it as the future Palestinian capital. Incidentally, few countries even recognize West Jerusalem as Israel's capital. Then, too, the prime minister claimed that anyone, Jew or Arab, could purchase a dwelling anywhere in Jerusalem, and pointed to a few dozen Arab residents in Jewish neighborhoods like French Hill and Pisgat Ze'ev. But these neighborhoods are in East Jerusalem, annexed by Israel in 1967. That's what the controversy over Jerusalem is all about. Arabs who moved there did so due to the housing shortage in Arab East Jerusalem. That housing shortage was brought on by two factors. One is construction of the Jerusalem security barrier, which separates East Jerusalem from the West Bank and makes it extremely difficult for Arabs to live outside the city and commute to work there. The second factor is the failure over the past 42 years of the government of Israel and the Jerusalem Municipality to issue all but a handful of housing construction licenses for Arab residents of the city. It is almost impossible for an East Jerusalem Arab (who is a resident of Israel but not a citizen) to buy a home in most of West Jerusalem or in many Jewish neighborhoods in East Jerusalem, where the land is leased only to full-fledged Israeli citizens by a state ownership institution. PERHAPS MOST significantly, this new controversy reflects three negative dynamics. First, Netanyahu evidently believes that Obama is pressuring Israel on a marginal issue and that he can be forced to retreat if Netanyahu plays it tough. But in Obama's view settlements are a major issue, one he has staked his prestige on region-wide. Second, even the kindest assessment of Netanyahu's actions finds him working at cross-purposes. He says Israel must be recognized as a Jewish state. Yet he makes strenuous efforts, in the course of which he sours American-Israeli relations, to ensure that Israel has a captive Arab population from East Jerusalem and the West Bank that reduces the country's Jewish majority and jeopardizes its Jewish character. Third, this incident reveals that there is apparently no discreet and highly trusted back channel through which Netanyahu and Obama can communicate. None of these dynamics bodes well for Israel's all-important relations with the US in the Netanyahu era. The only way Israel can remain a Jewish state is to seek a two-state solution based on withdrawal from the West Bank and Arab East Jerusalem - which is demographically, politically, culturally and commercially part of the West Bank. There is nothing sacred to Jews at the Shepherd Hotel; no one is asking Israel to yield Jewish holy places in Jerusalem to exclusive Arab sovereignty. But even an Israeli who doesn't agree with this determination, who doesn't want to yield "united Jerusalem" with its 250,000 angry and deprived Arabs to a Palestinian state, or believes the Shepherd Hotel area is strategically important to Israel's interests (e.g., as a land-link to Mount Scopus), should have the good sense to yield to the request of the president of the United States. Barack Obama is asking that we freeze settlement activity in East Jerusalem and the West Bank while the US, our security and political ally, pursues a new peace process and solicits Arab backing for its policies in Iraq and concerning Iran. Because this is in our interest, Obama deserves our support. Instead the prime minister of Israel escalates tensions. Yossi Alpher is coeditor of the bitterlemons.org family of Internet publications. He is former director of the Jaffee Center for Strategic Studies at Tel Aviv University. This article first appeared in bitterlemons.org and is reprinted with permission.