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There are reports that a flotilla of about 1,000 Chinese fishing boats is headed for the disputed islands at the heart of the dispute between China and Japan. A move toward the islands – known as Senkaku in Japan and Diaoyu in China – raise the question of whether Japan’s coast guard or navy would confront the ships.

The Associated Press

A dispute over a quintet of uninhabited islands is jeopardizing the political and trade relationship between the world's second and third-largest economies, as a number of Japan's flagship companies announced temporary closures of their China operations on Monday after being targeted by days of angry protests.

Automakers Nissan Motor Co., Honda Motor Co. and Mazda Motor Corp. – who collectively employ thousands of Chinese workers – each announced they were temporarily suspending production in China after a week of anti-Japanese protests around the country that saw Japanese-owned businesses looted and Japanese cars and restaurants attacked. Other industries, including electronics, food and retail, were also affected and the dispute put global supply chains for Japanese products produced in China under threat.

Protests are expected to crest Tuesday, the anniversary of the 1931 Mukden Incident, a staged attack on a Japanese railroad that was used to justify the Japanese Imperial Army's invasion and occupation of Manchuria at the outset of the Second World War. There were also reports that a flotilla of some 1,000 Chinese fishing boats was headed towards the disputed islands – which are known as Senkaku in Japan and Diaoyu in China – raising the question of whether Japan's coast guard and navy would try to confront the ships.

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Any kind of trade war – let alone a broader conflict – would be devastating. Commerce between the two Asian giants amounted to $345-billion (U.S.) last year, with many of Japan's globally known brands, including electronics firms, outsourcing much of their production to China. Already, there have been calls in China for a nationwide boycott of Japanese products. China is Japan's largest trading partner, while Japan is China's No. 2 partner after the United States and a major source of direct investment in the Chinese economy.

Joseph Caron, Canada's former ambassador to both Japan and China, said the situation will require delicate diplomacy from both sides to avoid escalation of the dispute. A heightened conflict would have implications for the global economy as Asia's manufacturing and supply chains are deeply integrated.

"It's important not to demonize one side or the other in all this. There is obviously going to be a painful but hopefully non-militarized adjustment to the fact that China's power is increasing," Mr. Caron said in an interview. "It is not only China that has legitimate interest in these waters and in the region.

"Unfortunately, we are seeing the manifestations of this adjustment in its worst and most dangerous form."

Neither country can afford a prolonged break in the trading relationship. The Japanese economy grew just 1.4 per cent in the second quarter of 2012, while China posted 7.6-per-cent growth in the same period, its slowest pace in three years.

"The reality is that while these adjustments are struggling to emerge, in so many other areas, levels of mutual dependence have never been higher," Mr. Caron said.

Japanese car manufacturers count China as a major market and a driver of future growth. Toyota, Nissan and Honda saw 11 per cent, 17 per cent and 20 per cent of their respective 2011 unit sales from China, according to Bill Russo, China auto analyst at Synergistics.

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Mr. Caron said targeted economic sanctions or large-scale boycotts imposed by both China and Japan are a distinct possibility if the dispute is not quickly resolved.

"It's worrisome. Our economic security depends so much on the success of those economies. So everyone is going to watch this very closely," he said.

Julian Dierkes, a professor at the Institute for Asian Research at the University of British Columbia, said he was optimistic that the deep economic ties between the two countries would keep the dispute from getting out of hand.

"The economic implications are huge but that is also the safeguard. ... It must be very clear to [Chinese] businesses and industry that there is no way to decouple from Japanese industry. Those inter-linkages are so clear and obvious," Mr. Dierkes said.

Some of the protesters in Beijing admitted they weren't sure how they could live without their Japanese electronics, fashions and snacks. "Japan is bullying China and I hope Japan does not take Chinese tolerance for granted," said Zhang Liguo, a 17-year-old student who joined the protests at the Japanese embassy.

"But we cannot deny the advantages of Japanese products."

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The temporary closure of Japanese manufacturing facilities and other businesses came as the United States announced a new trade action against China. Speaking in Ohio, a hub of American auto parts manufacturing, president Barack Obama accused China of illegally providing $1-billion worth of subsidies to its auto parts industry.

"These are subsidies that directly harm working men and women on the assembly line in Ohio and Michigan and across the Midwest... . It's not right, it's against the rules and we will not let it stand," Mr. Obama said.

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