The bitter dispute between China and Japan over their rival claims to ownership of the Senkaku/Diaoyu islands in the East China Sea has severely strained bilateral political relations. Mishandling or mistakes by either side could trigger a clash between their paramilitary ships, draw in regular forces and lead to a wider war.
As if the prospect of a regional conflict between the world's second- and third-largest economies is not bad enough, China is extending the dispute into treacherous economic waters as well, potentially threatening Asia's growth and integration, as well as stability.
A recent report prepared for the United States Pacific Command (Pacom) in Hawaii, which oversees American forces and bases in the Asia-Pacific region, has called the Chinese strategy "guerilla economic warfare".
US officials have not gone that far. However, they have expressed concern over China's use of "economic coercion" in its territorial disputes with Japan and, earlier this year, with the Philippines over their conflicting claims to the Scarborough Shoal in the South China Sea.
Since the Japanese government tightened its hold last month on the uninhabited Senkaku islands, which it has administered since the 1970s, China has applied or encouraged economic reprisals designed to reduce imports of Japanese goods into China, cut sales of Japanese companies in the Chinese market and prevent Chinese tourists from visiting Japan.
The official Xinhua news agency said on Sept 24 that by nationalising the Senkakus, Japan "has challenged one of China's 'core interests', which brook no compromise".
In the latest economic reprisal, several big state-owned Chinese banks last week cancelled their participation in events connected to the annual meeting this week of the International Monetary Fund and the World Bank, which Japan is hosting in Tokyo.
The Pacom report said that China's strategy to inflict selective economic pain is being systematically deployed against countries that challenge its interests in territorial disputes and defy its settlement requests.
This has serious implications for China's Asia-Pacific neighbours. From Japan to Australia, they have become increasingly dependent on Chinese trade, investment and tourism for their economic health.
Japan has also flirted with economic reprisals over territorial issues with South Korea. In August, after South Korean President Lee Myung Bak visited the Liancourt Rocks in the sea between Japan and South Korea, Japan's Finance Minister Jun Azumi cancelled a planned meeting with his South Korean counterpart.
The mountaintops jutting from the sea have been occupied and fortified by South Korea, although they are claimed by Japan.
Tokyo also hinted it might reconsider a plan to buy South Korean sovereign debt, and let an expanded currency swap agreement with South Korea expire this month, rather than renew it.
However, Japan has territorial disputes with relatively few countries. China is an irredentist leader among major powers. It lays claim to land, sea, seabed and island territory that many of its neighbours also claim.
These claimants include not only Japan, but also South Korea, Taiwan, the Philippines, Vietnam, Malaysia, Brunei, Indonesia and India.
Three of them - Japan, South Korea and the Philippines - are US allies, and Washington is obliged by an act of Congress to provide self-defence assistance to Taiwan, which Beijing regards as a renegade province.
The Pacom report says China realises that US military and economic power still far exceeds its own. "Understanding this, China concluded that it would be foolhardy to engage in frontal military challenges with the US," the report states. "In addition, because the US might be called into action should China engage another nation militarily in the Asia-Pacific region or elsewhere, China found it beneficial to adopt a guerilla economic warfare strategy when it wanted to make known and impose its will."
The report added that this strategy "allows China to play the role of a puppeteer that administers pain surgically, but not beyond the point at which the puppet can recover and the economic relationship (be) resumed".
Still, there is debate even within China on how far it can apply economic leverage against other nations, particularly major economies like Japan, without inflicting unacceptable pain on itself.
Last year, Sino-Japanese trade accounted for nearly 21 per cent of Japan's total trade, but only 9.4 per cent of China's overall trade, prompting Mr Mei Xinyu, a researcher at a think-tank linked to the Commerce Ministry in Beijing, to conclude that China would "lose less than Japan if economic and trade wars have to be our choice ultimately".
However, an online analysis by the Chinese magazine Caixin on Sept 26 concluded that any major disruption to China-Japan trade, which was worth US$340 billion (S$418 billion) last year, would hurt both countries.
It said that China would suffer serious foreign investment, job and technology losses. "A consideration of our national interests demands that we separate politics from economics," Caixin said. "Economic sanctions remain a strategic tool of the Chinese government, but they must be wielded wisely."
Prolonged or worsening economic and political tensions between China and Japan could aggravate the growth slowdown across Asia.
In addition, it could disrupt moves towards closer regional integration and the building of an East Asian free trade zone linking Asean with the North-east Asian industrial powerhouses China, Japan and South Korea.
Negotiations among the three North-east Asian industrial powerhouses, each of which has a free trade agreement or comprehensive economic partnership with Asean, were to begin in Seoul late last month. But they were called off, apparently by China.
"We hope the suspension is temporary," said Professor Chen Yulu from China's Renmin University, who is an adviser to the Monetary Policy Committee of China's central bank. "It will be a big loss for Asia if the process is terminated."
The writer is a visiting senior research fellow at the Institute of Southeast Asian Studies.
