Anti-Japanese protests continue to spread throughout China, some of them turning violent, with stores vandalized and Japanese flags burned. Japanese companies that trade with China are considering their options in light of growing boycotts of Japanese goods. The continued friction between the two countries hurts both of them economically, and can make for delicate political positions due to the significant amount of trade between them.

Although Japan and China have had a contentious history for centuries, the roots of the current anti-Japanese sentiment in China stem from Japan's invasion of China and massacre in Nanking in 1937. The second Sino-Japanese war lasted from 1937 to 1945, as one theater in the Second World War. Among other atrocities, Japanese medical units allegedly tested chemical weapons on Chinese civilians, and used Chinese women as sex slaves. Although Japan eventually paid war reparations to China, it has yet to offer a full apology for war crimes. At one time, Japan's prime minister suggested that there was no proof that the military was involved in the prostitution of Chinese women. Since the war, significant anti-Japanese undertones have existed in China.

The match that ignited the current flare up of anti-Japanese protests across China was lit when Japan bought a small group of uninhabited islands from a private Japanese owner. The Senkaku Islands have been claimed by both Japan and China, and Japan's decision to nationalize them brought old tensions to a head.

Economic Consequences
The recent riots have started to affect economic trade between the two countries, especially for Japanese companies selling in or to China. According to Chinese sources, Sino-Japanese bilateral trade hit an all-time high of $345 billion in 2011, making China Japan's largest trading partner, and accounting for approximately 20% of Japan's export volume.

Widespread Chinese shunning of Japanese goods is expected to seriously affect the sales volumes of large companies, such as Sharp (OTC:SHCAY), Toyota (NYSE:TM) and Nissan (OTC:NSANY). Toyota and Nissan have already planned either plant shutdowns or shift reductions in their Chinese facilities to reflect the slowing of demand. If the slowdowns continue for more than a few weeks, the automakers could be in danger of not meeting production targets and having to revise earnings estimates. Shares of major Japanese retailer Fast Retailing (OTC:FRCOY) dropped by 7% almost immediately after the company announced that it was closing some of its locations in China. The company remains depressed in the face of continuing operating uncertainty.

Both the Nikkei and Shanghai indices remain down, the depression fueled by Japanese companies with exposure to China. Although the Nikkei is up 3.9% in 2012, it is still well behind the growth in the U.S. and European markets.

The Chinese National Tourism Administration issued a travel warning in September, urging tourists to Japan to be cautious in light of safety concerns. The resulting drop in tourism could significantly hurt Japan, since tourists spent almost $2.5 billion in Japan in 2011.

The economic impact to China of the rising tensions will be more muted. Japan is only China's third-largest trading partner and represents only approximately 10% of its exports. The danger for corporations in both countries with exposure to the other is how the instability will affect rating agencies' assessments of future operations. While this most recent skirmish may die down, the tension is likely to remain in the long term.

Political Consequences
The political fallout from the recent anti-Japanese protests depends substantially on how China reacts to Japan's nationalization of the Senkaku Islands. If China reacts militarily, it could throw the two countries into a war, similar to the short-lived 1982 war between Britain and Argentina over the Falkland Islands. Unlike that military action, however, both China and Japan have significant troops and weapons at their disposal and a war could drag on for months or years, with a resulting dent in both countries' business operations. The Chinese government will be pressured to respond in some fashion in order to calm the protests.

The Bottom Line
The long-term anti-Japanese sentiment in China affects the GDP of both countries, especially during flare-ups. While it is clearly in both countries' interests to settle the current matter diplomatically, if a military response occurs, the economic fallout could create a financial crisis in both Japan and China.

At the time of writing, Angie Mohr did not own shares in any company mentioned in this article.

Related Articles
  1. Stock Analysis

    Starbucks: Profiting One Cup at a Time (SBUX)

    Starbucks is everywhere. But is it a worthwhile business? Ask the shareholders who've made it one of the world's most successful companies.
  2. Stock Analysis

    How Medtronic Makes Money (MDT)

    Here's the story of an American medical device firm that covers almost every segment in medicine and recently moved to Ireland to pay less in taxes.
  3. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  4. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  5. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  6. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  7. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  8. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  9. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  10. Investing News

    The UAE: An Emerging Economy for Investors

    The learning from UAE on how it succeeded with timely diversification when the BRICS nations and the neighboring oil-rich economies faced challenges.
  1. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
  2. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
Trading Center