Jin Baisong from the Chinese Academy of International Trade – a branch of the commerce ministry – said China should use its power as Japan’s biggest creditor with $230bn (£141bn) of bonds to “impose sanctions on Japan in the most effective manner” and bring Tokyo’s festering fiscal crisis to a head.
Writing in the Communist Party newspaper China Daily, Mr Jin called on China to invoke the “security exception” rule under the World Trade Organisation to punish Japan, rejecting arguments that a trade war between the two Pacific giants would be mutually destructive.
Separately, the Hong Kong Economic Journal reported that China is drawing up plans to cut off Japan’s supplies of rare earth metals needed for hi-tech industry.
The warnings came as anti-Japanese protests spread to 85 cities across China, forcing Japanese companies to shutter factories and suspend operations.
Fitch Ratings threatened to downgrade a clutch of Japanese exporters if the clash drags on. It warned that Nissan is heavily at risk with 26pc of its global car sales in China, followed by Honda with 20pc. Sharp and Panasonic both have major exposure. Japan’s exports to China were $74bn in the first half of this year. Bilateral trade reached $345bn last year.
Mr Jin said China can afford to sacrifice its “low-value-added” exports to Japan at a small cost. By contrast, Japan relies on Chinese demand to keep its economy afloat and stave off “irreversible” decline.
“It’s clear that China can deal a heavy blow to the Japanese economy without hurting itself too much,” he said. It is unclear whether he was speaking with the full backing of the Politburo or whether sales of Japanese debt would do much damage. The Bank of Japan could counter the move with bond purchases. Any weakening of the yen would be welcome.
A recent study by the US Defence Department concluded that a Chinese firesale of US debt was not a serious threat.
The US defence secretary, Leon Panetta, was in Beijing on Tuesday to try to stem the political crisis, calling for restraint on both sides.
He warned earlier that “provocations” over the islands could spiral out of control and lead to conflict.
Mr Panetta said the US is neutral but this is a hard balancing act, given the US nuclear umbrella for Japan and its use of military bases on Japanese soil as an “unsinkable aircraft carrier”. The ambiguity of the US role was glaring after a deal with Tokyo on Monday to build a new anti-missile radar shield – ostensibly against North Korea.
Diplomats say China is calibrating the crisis to probe the strength of US ties with Japan, knowing that alliance fatigue in Washington and the clumsy handling of the dispute by Tokyo has created a rare opportunity.
The Obama administration must navigate a delicate course. A tough line against China risks putting the world’s two superpowers on a collision course: a soft line risks setting off alarm bells in Japan and pushing the country towards rearmament.
Christian Le Miere from the International Institute for Strategic Studies said the crisis had become dangerous, citing Mao Zedong’s aphorism from 1930 that “a single spark can start a prairie fire”.
He said the region is “rife with historical enmity and chauvinism”, encouraged by Tokyo’s “seeming lack of contrition for wartime atrocities” and China’s own well-nurtured narrative of humiliation by foreigners.
China’s post-Maoist regime derives its legitimacy from nationalism, especially now that the boom is fading and China is losing some of its competitive edge.
The anti-Japanese fervour was systematically stoked by the “Patriotic Education Campaign” of Jiang Zemin in the 1990s to divert attention from party corruption and the growing gap between rich and poor.
But it is a double-edged sword for China’s leaders. “Given its potency, it is difficult to control. Nationalism can turn against the government, if it is perceived as doing too little,” he said.
Markets are already starting to price in an arms race in Asia. Shares of China’s North Navigation Control Technology, which makes missile systems, have jumped 30pc in recent days.
China is becoming self-sufficient in defence. It was the world’s biggest net importer of weapons six years ago. It fell to fourth place last year.
Japan is at the other extreme. An official report this year – “A Strategy for Survival” – said Japan’s spending on its “Self-Defence Force” had shrunk by 4pc in 10 years. It called for “urgent” action to rebuild the country’s military.
If there is any silver lining in an Asian arms race, it may at least soak up the region’s excess savings and pull the world out of semi-slump. But be careful what you wish for.