Partner Center Find a Broker

If you’re like some of my padawans who have been too busy trying to perfect the Gangnam Style, lemme give you a quick walkthrough of what’s been happening between China and Japan.

Last April, Tokyo Governor Shintaro Ishihara heated up the tension between China and Japan when he said that the government may use public funds to buy a set of islands from a private Japanese owner. The islands, known as Senkaku in Japan and Diaoyu in China, were sold at a value of 26 million USD last September 11.

This didn’t sit well with the Chinese, as many hit the streets this past weekend to protest Japan’s claims.

Furthermore, China has also declared the Japanese transaction as illegitimate, and sent six vessels last Friday to monitor the islands in an attempt to emphasize how serious it is about its claims of sovereignty.

The problem with this dispute, however, is that it has much bigger ramifications than the mere sovereignty over a small group of islands. Let me explain to you how this could affect each party.

For Japan, the consequences are huge.

Remember, China is Japan’s largest trading partner, with China accounting for 21% of total trade in 2011. To put this into perspective, the next largest trading partner is the U.S., who account for just 12%.

Biggest Loser

More specifically, there is a major concern that the dispute is negatively impacting Japan’s export automobile industry. Over the past month, Chinese sales of Japanese-branded vehicles dropped, while those of American, German, and South Korean vehicles all rose by more than 10%.

Meanwhile, Chinese citizens are boycotting Japanese goods and refusing to support anything Japanese. In fact, major Japanese companies like Toyota, Panasonic, and Canon have all been forced to shut down their plants in China due to damage to the plants or by union strikes by Chinese workers themselves.

If this continues, some analysts fear that the repercussions could be bigger than that of the earthquake and tsunami that rocked Japan last year.

China isn’t coming out without a scratch from this dispute though. If you recall, Japan was China’s fourth largest exports market as its shipments totaled $148.3 billion in 2011 while it imported a total of $194.6 billion worth of Japanese goods in the same year. I guess the Chinese still love their anime and Playstations!

Japanese companies are also flooding a lot of moolah into the Chinese economy. Their investments rocketed to $4.73 billion in the first seven months of this year, up 19.1% from last year’s numbers. That’s a lot bigger than the 1% uptick from U.S. investors and the 2.7% drop from European companies! To top it all off, China was also Japan’s top tourist destination in 2011 as more than 3.65 million Japanese visited its neighbor.

So who’s the biggest loser in this hullaballoo? If you ask me, it’s neither China nor Japan. It’s the global economy! For one thing, trade transactions between China and Japan reached a whopping $345 billion in 2011 alone.

And that’s just the tip of the iceberg! Remember that supply chains for products like the iPhone 5 and Toyota cars depend on smooth trade transactions between China and Japan. If they don’t resolve their conflict soon, even non-Japanese businesses will have reason to be worried.

Of course, it also doesn’t help that two of the world’s largest economies have bigger fish to fry. Japan is dealing with a sluggish domestic activity, while China is struggling to avoid a hard landing. If tensions between the two countries escalate, then we might see risk aversion in markets.