'Nuclear option' will do more damage to China than Japan

Given the huge surplus China could gain from its trade with Japan, it would have more to lose from a tit-for-tat imposition of sanctions

PUBLISHED : Thursday, 20 September, 2012, 12:00am
UPDATED : Friday, 21 September, 2012, 7:18am

Monday's edition of the China Daily carried an opinion article by one Jin Baisong calling on Beijing to impose trade sanctions against Japan in retaliation for the perceived slight of Tokyo's purchase of three of the Senkaku/Diaoyu islets from their former private owner.

What's more, Jin went on to suggest that Beijing should punish Tokyo for its presumption by dumping China's reserve holdings of Japanese government debt.

China Daily describes Jin as "deputy director of the department of Chinese trade studies at the Chinese Academy of International Trade and Economic Cooperation, affiliated to the Ministry of Commerce".

In other words, Jin is considered an expert on China's foreign trade. That's troubling because his article betrays a profound ignorance about how trade and financial flows between China and Japan actually work.

In his article, Jin argues that Japan is reliant on China and that "Japan's economy will suffer severely if China were to impose sanctions on it. China's loss would be relatively less".

However, a quick look at figures released last month by the Japan External Trade Organisation shows that over the first half of this year, China actually recorded a bilateral trade surplus with Japan of US$17.6 billion. This figure was no one-off. Last year, China ran a bilateral surplus of US$21.9 billion.

In other words, China gains significantly more from the trading relationship than Japan, and would have more to lose in absolute terms from a tit-for-tat imposition of sanctions.

Jin is untroubled by the arithmetic, however, arguing that "China basically exports low value-added products to Japan, which yield low profits in the manufacturing chain, while Japanese companies earn huge profits from their exports to China. That means China is in a lot better position to afford a loss in exports".

His reasoning is flawed. A lot of what Japan exports to China powers China's own export sector. Japan not only sells China much of the machinery for its factory production lines, but also ships to China many of the components that are assembled on those production lines before being shipped onwards for sale to the rest of the world.

For example, according to teardown analyses conducted over the past week, Apple's new iPhone 5 contains memory chips made by Japanese companies Elpida and Toshiba, a screen from Sharp, a Sony camera, Bluetooth gadgetry from Murata and a battery from Panasonic.

Granted, if China were to slap sanctions on imports from Japan, Apple could probably find alternative suppliers for these components. No doubt Samsung and LG Electronics would be delighted.

But the action would do untold harm to perceptions of China's role as a reliable link in the global supply chain.

It would severely damage China's already diminished competitiveness and accelerate the forecast migration of processing industries away from its shores, jeopardising the jobs of tens of millions of Chinese manufacturing workers.

But while a trade war would clearly hurt Japan's economy as well as China's, it is far from clear Jin's implied threat that China could ditch its holdings of Japanese government debt - known in financial diplomacy as the "nuclear option" - would do Japan any appreciable harm.

According to Jin, at the end of last year, China owned 18 trillion yen, or US$230 billion, of Japanese government bonds. "With Japan's national debt at stake, the proverbial straw that can save the Japanese economy seems to be in the hands of China," he wrote. "And China can use it to find ways to impose sanctions on Japan in the most effective manner."

Let's ignore that the proverbial straw actually broke the camel's back rather than saving anything and concentrate on the numbers.

Eighteen trillion yen sounds a lot. But when you consider that at the end of last year, the total stock of outstanding Japanese government debt stood at 991 trillion yen, and that yesterday the Bank of Japan pledged to increase its own purchases of government debt to 80 trillion yen, China's holdings are insignificant and Jin's threat is meaningless.

In fact, Jin's threat could actually benefit Japan's economy while harming China's finances.

Although dumping Japanese bonds would have little effect on the debt market, China's subsequent sales of its yen proceeds would drive the Japanese currency down from its near-record highs in the foreign-exchange market, which is just what Tokyo would like.

And then, of course, China would have to find somewhere else to park the money. That would mean lending it either to the US Treasury or European governments, neither of which looks like a compelling alternative right now.

In short, if acted upon, Jin's threats would hurt China far more than Japan. Beijing will just have to find another way to express its pique.