If you drop 'hot money' in Asia – keep it there

Getty Images

Before rushing to blame destabilizing capital flows for playing havoc with Asian economies and asset markets, please consider this.

Japan is about to come to blows with its neighbors about border problems and age-old enmities.

India and China have been struggling to come to terms with issues along their near-4000-kilometer border ever since they fought a brief war 50 years ago.

(Read more: Bank of Japan ups growth outlook; inflation goal intact)

Meanwhile, Vietnam and the Philippines are laying claims to territories China says are pieces of its ancient real estate.

The list of historical grievances goes on and on, depending on the scope and severity of conflicts that are being discussed.

Huge development opportunities lost

The economic damage caused by these political and military tensions go much beyond the numbers one sees in relatively small intra-Asian trade and investment flows. Indeed, these losses of output and employment are dwarfed by squandered opportunities for Asia's prodigious economic development to improve the lives of two-thirds of humanity.

Just think of last year's puny Sino-Indian trade of $66 billion. Surely, these two countries – home to more than half of the Asian population – could do much better than that. That is certainly what the Indian business community thinks and wants, and it seems that the same thought is shared by its Chinese counterparts.

So, what is in the way of better and more productive Sino-Indian relations – a phenomenon many observers consider as being "this century's most important trade partnership?"

Border issues and their inability to solve them despite a long, ongoing technical dialog. These issues will linger on despite the recent agreement on a more predictable security environment along the countries' frontiers.

There is also China's close relationship with Pakistan – India's presumed arch-enemy – and Delhi's safe haven for Dalai Lama of Tibet, whom Beijing accuses of leading a separatist movement.

(Read more: The verdict on Abenomics, one year on)

None of these problems are likely to be solved anytime soon. Frictions and unease could even worsen in the coming months because relations with China loom large in India's campaign for general elections which must be held before next May. Opposition is blaming the government for being "too soft" on China. If elected, they are promising to take a much tougher stance toward their big neighbor to the north.

What that tougher stance toward Beijing means is unclear. But whatever it might be, this sort of political discourse is sure to set back trade and investment ties of the kind India needs to narrow its $30 billion trade deficit with China, and to restore the growth momentum necessary to alleviate poverty and modernize the economy.

Statesmanship needed

While there still may be a chance that at some point India and China could set the border issue aside and forge ahead with improving economic ties, one can only hope, as Washington apparently does, that "cool heads will prevail" to avoid a Sino-Japanese military conflict over territorial problems in the South and East China Seas.

Intensive diplomacy and relentless business lobbying don't seem to be getting Beijing and Tokyo any closer to a peaceful compromise. In fact, the dangers of an intended or accidental wave of violence – which would draw in the United States through its military alliance with Japan – are very much present as the two countries' air and naval assets continue to operate in close proximity around the contested territories.

The bellicose rhetoric is not cooling either. The Japanese prime minister is threatening a military response to any Chinese incursions into the territory over which Japan currently exercises its sovereign rights. Beijing, for its part, vows to defend its territorial integrity and warns that Tokyo would be held responsible for any attempt to interfere with that.

How, under these circumstances, could one expect trade and investments to flourish between neighbors who also happen to be the world's second- and third-largest economies, accounting for more than one-fifth of global demand and output?

(Read more: China's manufacturing activity picks up pace)

Japan's lackluster exports to China are reflecting the political difficulties these two countries are going through. After slightly negative growth figures for the first half of this year, Japanese sales to China recovered during the third quarter to eke out a 3.7 percent annual gain in the first nine months – a far cry from double-digit growth at times when the two governments were still seeking peaceful solutions to their long-standing disagreements about borders and history.

Investments have also been declining. Japanese companies are increasingly taking their business to their small Asian neighbors as they keep complaining about administrative difficulties affecting their operations in China. Clearly, the extraordinary synergy and complementarities of these two economies at different stages of economic development have been lost.

Asian Century needs unity

Asia and the world economy are the worse for it because Sino-Japanese tensions are now spilling over into the rest of the region where Japan apparently seeks to contain China's growing economic and political influence. That is further exacerbating divisions and animosities in an area that was supposed to benefit from closer economic integration by strengthening intra-regional trade and investments, and decreasing Asia's excessive dependence on exports to the rest of the world.

As might have been expected, portfolio investments and asset prices are reflecting these problems.

The disappointing performance of Asian stock markets (with the exception of Japan) since the beginning of the year is a signal that investors are not impressed by the growth dynamics of intra-Asian trade. The region is still seen as being too dependent on the sluggish U.S. economy, and on the euro area barely emerging from a long recession with a double-digit unemployment rate. As a result, Asian economies and financial markets are buffeted by destabilizing capital flows stemming from excessive monetary creation in the U.S. and Japan.

(Read more: China HSBC flash PMI hits seven-month high)

That is a great pity and an enormous waste for Asia and the rest of the world. By committing to peaceful and negotiated settlements of their long-running border disputes, Asian leaders could unlock the huge potential of lasting economic growth and usher in the true Asian Century

Will they do it? I believe they will – and most probably faster than it now appears likely. Formidable and unstoppable forces are driving Asia's change. So, if you drop some of that "hot money" in Asia – keep it there.

Follow the author on Twitter @msiglobal9

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.