China vs Japan Boat Row: the Financial Side

There has a lot of attention on Japan holding Chinese fishermen and
Japan selling Yen to devalue it against USD, but everyone thought the
two news are completely unrelated to each other...until now. There
has been new reports (more like rumors) saying that the Chinese are
beginning to throw its massive 2.5 trillion USD foreign reserves into
buying Japanese government bonds, in such a scale that the CCP is
actually selling off many of its USD assets to make the purchases. If
the rumors can be proved correct, its potentially a huge financial
assault on Japan amid political confrontation.

The economics is this: when the Chinese sell off USD-denoted assets,
the demand of USD decreases, causing its value to decrease. At the
same time, buying Japanese government bonds requires the Chinese to
first buy huge amounts of cash in yen (using USD or RMB), causing the
demand and value of yen to increase (USD and RMB to devalue as they
are put in the market in place of Yen). Together, the two moves
causes USD to be able to buy less and less in yen, causing Japanese
exports to the USA to become more and more expensive.

When other countries launch such a financial offensive, the damage
would be limited. But considering the size of China's foreign
reserve, the effect on the exchange rate is huge. As Yen increase in
value and RMB decrease with respect to USD, Chinese exports become
more competitive compared to Japanese ones, reducing the economic
strength of export-dependent Japan. Also, when the Japanese are
printing Yen to buy in USD, it is hoping that the extra money supply
can flow into the market, dragging Japan out of its constant cycle of
deflation.

Logically, people would delay their purchases into the future when
they know prices are cheaper in the future, so deflation, obviously,
reduces domestic consumption. By putting more money in people's hands
(simply by printing them), Japan hopes that prices can grow again and
force people to make their long-awaited purchases. Unfortunately,
now, the extra printed cash is being recycled into the cash vaults of
the Japanese government in the form of money borrowed from China. (or
better yet, if possible, the CCP can just buy in Yen using RMB,
further devaluing RMB with respect to Yen to reduce Japan's export
competitiveness)

So, the extra yen either ends up in China's or Japan's government cash
vault. Government spending by the Japanese government is becoming
highly unpopular as debt is already twice the GDP and government
spending has not produced much positive effects in the past.
Basically, China is systematically killing Japanese exports while
Japan can only print more cash with no effect and sees its national
debt continue to rise. This, combined with China's threats to cancel
Chinese spending on Japanese goods and reduce tourists to Japan, are
sure to increase the already grim economic prospects in Japan.

And it is precisely the strong "domestic popular sentiment" against
Japan stemming from the fisherman row that gives Chinese government
the perfect excuse to set such an assault into motion. Without the
political tensions in the background, such a drastic financial move
may trigger opposition from a large domestic business community
working with Japan while getting further backlash from the USA for
financial manipulation. Now any opposition as such can be effectively
silenced as excessively "pro-Japanese" and "anti-nationalistic."

Brilliant may be the only word that can be used to describe CCP's
move. It is no wonder that China, despite having an increasingly
discontent constituency that hopes for increased pressure on Japan, is
standing firm on a verbal threats-only position. It is CCP's hope
that the continued financial assault used here, which not only weakens
Japan but also reduces the vulnerability of Chinese assets to
fluctuation of USD, can force both the Japanese and the Americans to
back down. Perhaps it is unsurprising that the US has repeatedly
issued statements stating that it would not like to see involvement in
the conflict over "some tiny island."

American neutrality puts further pressure on Japan. Japanese
population is generally wary of conflicts with China even if most
support Japanese government's position. If a political stalemate that
boosts national morale suddenly reveals itself to be a huge economic
loss over time, most people in Japan may not stick with the
government's heavy-handedness. In Japan's already vulnerable
political stability, if the incumbent Democratic Party of Japan were
to be seen as having miscalculated on such a grand scale, political
upheaval is sure to follow.