The Asian paradox: brisk business despite hostilities

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Nearly one-third of Japan's foreign goods purchases in the first four months of this year came from China. During the same period, the two countries' bilateral merchandise trade rose 17 percent from the year earlier. And China holds the advantage. These trade flows generated China's trade surplus with Japan that is nearly double Tokyo's total shortfall on overseas trade transactions.

This is a remarkable development for countries experiencing an increasingly dangerous military standoff over apparently irreconcilable differences about their maritime borders.

There is a similar, although less acute, situation in Japanese-South Korean relations. Japan's sales to South Korea in the four months of this year have increased 2.4 percent from the year earlier, and the bilateral trade is now running at an annual rate slightly above its last year's level.

This trading business is going on while the Japanese and South Korean leaders are locked into long-running disputes about their wartime history and contested territorial claims. They cannot even agree on how to call the body of water that separates them: the Japanese call it the Sea of Japan, but the Koreans call it East Sea. Incidentally, an 82,000-strong Korean lobby in the State of Virginia pushed through the law last year that requires textbooks to use East Sea instead of the Sea of Japan, the name which presumably became "official" during Japan's occupation of Korea from 1910 to 1945.

A model of Oriental wisdom?

I am intentionally ignoring the usual price and income effects influencing these bilateral and regional trade flows to focus on positive business developments in a manifestly hostile environment, bordering on outright warfare.

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And these are not trivial trade numbers. They are among the key activity drivers in the three largest East Asian economies representing a quarter of global demand and output – a share of the world economy well in excess of EU's 20 percent and America's 18.3 percent.

The question is, can this precarious 'Asian paradox' continue?

We may get an important part of the answer during the state visit to Washington June 14-19, 2015 by the South Korean President Park Geun-hye. In fact, President Park coined the phrase 'Asian paradox'. In her speech to a joint session of U.S. Congress in May of 2013, she said: "Asia suffers from what I call 'Asia's paradox', the disconnect between growing economic interdependence on the one hand, and backward political, security cooperation on the other."

Most observers seem to expect that intense diplomacy could lead to some sort of political 'reconnect 'between Japan and South Korea, America's strategic allies in Asia, after President Park's visit to the U.S. The essential condition for such an event would be Japan's public statement about its military occupation that South Korea could accept.

That seems very difficult. Such an important historical concession – sufficiently explicit in form and substance – would appear to be contrary to the political platform and the world view of the current Japanese administration.

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Status quo, until …

In addition to intractable territorial claims, Japan's wartime behavior is a fundamental issue in South Korean and Chinese relations with their eastern neighbor.

China is the elephant in the room. I, therefore, believe that it is unrealistic to expect a breakthrough in South Korean and Japanese relations in the absence of an acceptable modus vivendi between Beijing and Tokyo.

South Korea has no open questions with China. The two countries signed last week their free trade agreement, hailed by President Park as a "historic milestone in the countries' efforts to deepen their strategic cooperative partnership". China's President Xi Jinping responded by calling the agreement a "monumental event" that will "not only lead to a new leap in trade relations between the two countries but also bring practical benefits to the people of both countries" .

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Trade experts in Beijing and Seoul expect that the agreement will rapidly boost the bilateral trade to $300 billion (from an estimated $235.4 billion last year), with further benefits coming on stream when they free up their service trade by 2017.

But there is no such amity between Beijing and Tokyo. There is no agreement anywhere in sight on their competing territorial claims, and Beijing's forthcoming celebrations of 70 years since the end of WWII will probably create additional irritants in bilateral relations.

China's continuing large-scale land reclamations in the South China Sea, and the attendant sovereign territory claims on sea and in the air, are also creating new challenges for Japan, Southeast Asian neighbors and the United States.

That is very serious and very dangerous. Any unauthorized, let alone hostile, encroachment on what China considers part of its sovereign territory is a casus belli with a nuclear armed country. And China has warned all comers: it will defend its territorial integrity with all the means available.

How is the world going to deal with this? Nobody seems to have a clue. Yes, there are some analysts who see an American military confrontation with China as an inevitable outcome of Beijing's rising economic and political clout. But such an "end of the world" scenario is hardly an operational advice for any sane political leader. Most other sinologists offer mushy, naive and utterly useless 'muddling through' views of a relationship with a rapidly growing second-largest world economy.

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Maybe we shall know more about this after President Xi's state visit to Washington next September. He seems to have ideas about what he calls the "great power relations." He sees that as a "win-win situation" for everybody involved. But Washington will probably stick to its pragmatic view of a "competitive" (adversarial?) and "cooperative" relationship.

Investment thoughts

The 'Asian paradox' will live on – until changing power relationships bring a new regional and/or world order. The countries in the region are adjusting to new realities. China and Japan are apparently working to avoid 'accidents' around their disputed maritime border.

East Asia will remain the fastest growing segment of the world economy. Its huge excess savings, currently standing at a staggering $865.5 billion, are covering more than 80 percent of the world's balance-of-payments deficits. The region will remain by far the largest global capital exporter.

Strong fundamentals – relatively sound public finances (with the exception of Japan), large trade surpluses, low inflation and a prodigious growth potential – make East Asia an attractive investment destination. The Apex 50's current annual return is 11.6 percent in dollar terms.

With these fundamentals, the region has nothing to fear from likely interest rate tensions in the U.S. And the chit-chat about Asian 'currency wars' is just that.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.