TOKYO (AP) -- The craggy island specks in the East China Sea aren't even an economic backwater. They have no factories, no highways, no shops, no people -- only goats. But the high-pitched row between Beijing and Tokyo over their ownership is exacting a growing toll on Japan, threatening to send its recovery from last year's disasters into reverse.
Sales of Japanese cars in China are in a free-fall. At the China Open last weekend, a representative of Sony Corp. (NYSE:SNE), which is a sponsor of the tennis tournament, was loudly booed at the title presentation for the women's final. Chinese tourists are cancelling trips to Japan in droves. And some analysts say Japan's economy will shrink in the last three months of the year.
The business and economic shockwaves come after Japan last month nationalized the tiny islands, called Senkaku in Japan and Diaoyu in China, which were already under Tokyo's control but are also claimed by Beijing. The move set off violent protests in China, and a widespread call to boycott Japanese goods. Toyota Motor Corp. (NYSE:TM) and Honda Motor Co. (NYSE:HMC) dealerships were burned down in one city.
Seeing footage of Toyota cars getting smashed by angry rioters, Toyota President Akio Toyoda had looked almost tearful, confiding in reporters: "I couldn't bear to watch. It hurt as though I was getting beaten."
A report by J.P. Morgan, released Tuesday, projected Japanese auto exports to China will crash 70% during the October-December period. The export of auto parts will slip by 40% -- about the same drop estimated for exports of other consumer products, such as electronics, it said.
The aftermath of the latest phase of the sizzling territorial spat with China will cause Japan's economy, the world's third-biggest, to shrink 0.8% in the fourth quarter, according to J.P. Morgan. It had previously forecast no growth in the quarter.
J.P. Morgan chief economist Masaaki Kanno fears the fallout could get worse in the months ahead, as the September sales numbers for Japanese automakers only account for damage that started the middle of the month.
Toyota said Tuesday that sales of new vehicles in China dropped 49% in September from a year earlier to 44,100 vehicles. Honda said September sales plunged 41% to 33,931 vehicles. China sales for Nissan Motor Co. slid 35% last month to 76,100 vehicles.
Even the most optimistic scenario does not foresee a recovery in Japan's economy until the second quarter of next year, Kanno said.
"What we have ahead of us is going to be terrible," he said. "It's like last year's disaster all over again."
The quake and tsunami in northeastern Japan last year hobbled the economy for months. Auto production was particularly hard hit because parts suppliers had been located in disaster area. Flooding in Thailand that followed added to the automakers' woes. They had only bounced back toward the end of last year, after months of rebuilding.
Kanno's report said the number of Chinese tourists would decline by 70% while Japanese tourists to China would fall by 30%.
Ayumi Kunimatu, spokeswoman for Japanese carrier All Nippon Airways, said 43,000 seats had been cancelled for flights from September through the end of November -- 28,000 of them from China to Japan, and 15,000 from Japan to China. Up to now, China flights had made up a quarter of ANA's international passengers.
A person who answered at China International Travel Service in Beijing confirmed group tours to Japan had been called off. The Chinese state-run news agency Xinhua reported that more than a hundred thousand Chinese cancelled Japan trips, and the number of tour groups to Japan had plunged by 40%.
The tourism fallout to hot springs and ski resorts is likely to deal a serious blow to Japan's regional economies, which are already more vulnerable to such slowdowns.
China, with its growing middle class, had been one of the emerging markets that Japanese companies were counting on to boost sales amid a long stagnation in their domestic market.
Japan's trade with China reached record levels over the last 12 months, totaling more than $340 billion. China is Japan's biggest export market.
Although the immediate damage is being felt in Japan, the souring relations and the realization of the so-called "China risks" are likely to crimp investments from Japan, hurting the Chinese economy as well, in the long run. Japan not only exports to China but also has significant manufacturing investments there in areas such as autos.
The unfolding dispute between the two Asian neighbors underlines how easily historical animosities can be revived -- and so emotionally -- no matter how closely intertwined the economies have grown. Enmity between the two nations started with military Japan's victory against China's dying Qing empire in 1895 and then exploded as Japan invaded swathes of China in the 1930s and 1940s and enforced a brutal occupation. China's communist government has nurtured anti-Japanese sentiment in successive generations through its control of education and the media.
Carl Weinberg, chief economist at High Frequency Economics, based in Valhalla, N.Y., said the territorial dispute is not going to set off a shootout.
"However, economic conflict has already begun. This can and will cost the woebegone Japanese economy dearly in the form of exports," Weinberg wrote in his weekly report, estimating that the loss of 40,000 vehicles for Toyota is worth about half a billion dollars.
Increasingly, Japanese have been looking to other nations such as Vietnam, Thailand and Indonesia as destinations for investment, and a hostile China could speed up that trend.
Japanese supermarket chain Aeon Co. said damage at one of its stores had totaled 700 million yen ($8.8 million) as looters smashed windows, broke in and ran amok, toppling shelves and kicking merchandise. That doesn't account for the loss of sales from the store's closure or boycotting consumers.
But spokesman Toshiyuki Mukohara was calm, noting the company remained committed to China, and its 34 other outlets were doing business as usual.
Although the flare-ups have calmed in recent weeks, it would still require courage to be seen in a Japanese car in some Chinese cities.
Japanese automakers temporarily closed some of their China factories. Production is back up this week but reduced to lower levels as demand has collapsed.
Toyota, which makes the Prius hybrid, Camry sedan and Lexus luxury models, had planned to sell 1 million vehicles in China this calendar year.
"But that may be very difficult to achieve," company spokesman Dion Corbett said.
The Motley Fool is short Sony (ADR) and has the following options: long JAN 2013 $22.00 calls on Sony (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.