by William Pesek, Bloomberg.com

Naoto Kan isn’t alone in his “sense of sadness.” He shares it with 126 million Japanese.

Japan’s finance minister is blue over how quickly China is gaining on Asia’s biggest economy. Two years ago, anyone who said China would overtake Japan in 2010 was laughed into submission. Fantasy may soon become reality and the Japanese media can’t churn out enough dire stories about it.

“Generally speaking, it’s a good thing that China and Asia are growing and Japan needs to make efforts to ensure it can benefit from that,” Kan, 63, told reporters in Tokyo last month. “Coming from a generation that experienced high growth, my honest feeling is a sense of sadness.”

Far from being sad, Kan should see this moment for what it really is: one that shakes Japan out of its 20-year slumber.

PricewaterhouseCoopers LLP’s recent prediction that China will overtake the U.S. as the largest economy by 2020 is the talk of Tokyo. It’s shock enough for Japan to fathom playing second fiddle in Asia, never mind China being the globally dominant power 10 years from now. Expect a corresponding surge in sake and whiskey sales around Japan.

Adding insult to injury, the great Toyota Motor Corp. is recalling cars in China, and Japan Airlines Corp. is bankrupt. Add in deflation and the threat of a Standard & Poor’s downgrade and it’s hard not to conclude 2010 is getting off to a dreadful start for Japan.

Silver Lining

The silver lining is the China effect. On the face of it, China’s economy should be larger than Japan’s -- its population is almost 11 times bigger. If China’s currency weren’t 40 percent or so undervalued, it would already be No. 2. As many in Japan say, though, size will matter more when China matches Japan on a per-capita income basis. Japan’s is 13 times China’s.

That’s many a year off, of course. As the process unfolds, Japan could be well-positioned to benefit. What’s so bad about having a massive economy growing 10 percent in your neighborhood? With the U.S. consumer limping along, Japan needs all the demand for exports it can find.

Policy makers in Tokyo are officially out of reasons to delay the radical change Japan needs. To date, they have had more than their share of warnings: the collapse of the 1980s bubble economy, the “Lost Decade” of the 1990s, the Asian crisis in 1997, the U.S. credit meltdown, you name it. They just haven’t answered them, opting to add more debt and yen to punt big reforms forward.

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