China/Japan: The Australia Playbook or Grey Warfare
China will likely escalate pressure on Japan to back down over it less pacifist stance on self-defense, as it wants to drive a wedge between Japan and the U.S. One option is to repeat the 2020 copybook when China banned coal imports from Australia for 3 years. A 2nd alternative is grey warfare around Japan’s Senkaku islands like China has done in the South China sea close to the Philippines. Both are likely, though we do not see this as a precursor to a China invasion of Taiwan.
Figure 1: Japan 2024 Exports to China (% of Total)
Source: Comtrade/Continuum Economics
China pressure on Japan has included President Xi reportedly discussing the matter with President Trump who in turn is reported to had a conversation with Japan PM Takaichi. China will likely be upset that Takaichi has not pulled back from her comments that a China blockade on Taiwan would likely trigger a self-defense clause in Japan’s protection. Given the close proximity of the Okinawa island chain to Taiwan and the disputed Japanese islands of Senkaku, Takaichi is unlikely soften the position in the near-term. Japan is also planning to base missiles in Younguni island (Okinawa chain) that is 110km from Taiwan, which has prompted wolf warrior comments from some China officials.
China wants Japan to back down, as it regards Taiwan as an internal political issue that other countries do not get involved in. Secondly, in the scenario of an invasion or full blockade of Taiwan, China would prefer that Japan does not give the U.S. permission to use the huge military bases in Naha in Okinawa. Though we see only a 10% probability of this occurring in 2026 or 2027 (here), China wants Japanese public opinion to block U.S. base usage in this worst case scenario. This could mean that China escalates current tensions with Japan to try to meet these objectives.
One option is the Australia playbook, where China blocked coal imports in 2020. Australia had in early 2020 launched an enquiry into the origins of COVID, which had prompted a furious reaction from China’s authorities. Coal imports were banned for 3 years. China also significantly restricted Australia imports of barley, timber and wine. Though Australia largely found alternative markets it was disruptive. Thus it would not be surprising to see more Japanese exports to China facing an outright ban or being significantly restricted. Japan exports USD124bln to China in 2024 across a variety of sectors (Figure 1). This would not materially hurt Japan’s economy as they would likely redirect most exports, but it would cause political pressure in Japan to soften the stance over China and Taiwan.
China 2nd option is grey warfare against Japan around the Senkaku islands. Grey warfare is significant around Taiwan, with frequent large scale navel and aircraft military exercises. The South China sea grey warfare is a more subtle scale carried out by China fishing boats and coastguard vessels (here). A China coastguard vessel is reported to have challenge a Japanese fishing vessel near the Senkaku islands on Dec 2, showing that China is already using some of these tactics. However, China tends to be careful in this agitation with the Philippines for fear that it could escalate too far and get the U.S. involved on Philippine’s part. This will likely be the same with any grey warfare with Japan into 2026. China taking coastguard action just outside the Okinawa islands (Figure 2) would be too high risk and provocative, that would see U.S. China hawks coming to Japan support. However, China could repeat its naval exercises to the east of the Okinawa islands into the Western pacific as occurred in May (here), which involved sailing warships through the Okinawa chain.
Whether Takaichi changes position is difficult to see in the near-term, as she always wants to increase defense spending and have more freedom for self-defense. This stops short of U.S. defense secretary call on Japan to spend 5% of GDP on defense, but medium-term the real issue is whether Japanese voters are comfortable with Takaichi change of stance or whether a push back is seen as events escalate.
Figure 2: Senkaku and Okinawa Islands
Source: Continuum Economics