In 1923, when a strong earthquake destroyed most of Tokyo, Japan
suffered a crippling economic downturn that may have hastened the
onset of military rule. Yet financial markets around the world
barely shrugged.
Ninety years on, Japanese cash plays a crucial role in global bond
and stock markets. Despite two decades of stagnant growth on home
turf, Japan is the second-largest foreign owner of United States
government securities, with nearly US$900 billion (S$1.15 trillion)
of America's public debt. This time it could be the rest of the
world that takes a financial hit, while the Japanese economy
booms.
To understand how this could happen it is necessary to follow the
Japanese money. Savings by individuals and money held by Japanese
insurers and financial institutions amount to trillions of dollars
in cash, much of which makes its way on to world securities
markets. When natural disasters happen in Japan, individuals and
companies need this cash to rebuild, and insurance companies need
it for payouts.
Earthquake insurance is hard to get for most households in Japan,
so much of the cost- estimated at US$100 billion- will have to come
from a mountain of ordinary savings held in Japanese financial
institutions, much of it invested overseas.
For anything that is insured, possibly amounting to between US$10
billion and US$15 billion - the situation is complicated. Japanese
insurers will also have to sell overseas assets but they will be
spared the full cost because they have reinsured a lot of their
risk with overseas insurance firms, who in turn have reinsured it
with other insurers.
This insurance trail is a global labyrinth. Japan's risk, it turns
out, is the world's risk.
Sure enough, as US markets opened last Friday, the sell-off of
Japanese-held treasuries began. Bond prices fell and yields rose,
although analysts say the selling was offset by buying from
investors fleeing debt problems in the euro zone and unrest in the
Middle East. The yen was also sold off immediately after the
earthquake - before investors realised that billions of dollars
held by Japanese insurers and investors would have to be
repatriated. Within a few hours the selling reversed itself and the
yen strengthened sharply.
Japan's central bank said it would inject ¥15 trillion into the
economy to stabilise markets but that did not stop the Nikkei index
slumping 16 per cent earlier this week - the biggest two-day fall
since the 1987 global stock market crash.
All of this was predictable. In 1991 I wrote a book, Sixty Seconds
That Will Change the World, about the consequences of a major
earthquake in the Tokyo area, and discovered that the rest of the
world would come off far worse than Japan.
US treasuries would have to be sold to meet insurance claims and
pay for rebuilding, resulting in falling bond prices and rising
interest rates. The yen would then rise as these overseas savings
were repatriated.
A model produced by the Tokai Bank in 1989 found that Japan, after
experiencing severe short-term negative growth, would bounce back
as the cash flowed home and the rebuilding began. It was the rest
of the world, starved of this investment and hit with rising
interest rates, that went into recession.
Qualitatively, the financial markets are already reacting exactly
as predicted. But there are differences in quantitative
terms.
The Tokai model was based on a major earthquake much closer to
Japan's industrial heartland and a rebuilding cost of about US$1
trillion at 1990 values. And Japan was then a much more significant
global creditor than it is today. Twenty years ago, it was the
world's largest creditor nation and the top buyer of US bonds. Now
it has lost that position to China.
Perhaps the biggest difference is the Tokyo government's fiscal
position, awash in debt that amounts to two years' worth of GDP. It
can ill-afford the generous injections it is making to stabilise
markets and the spending that will be needed to restore
infrastructure. If the model plays out as predicted, the sell-off
in bonds will continue, and the yen could rise further. The
immediate effect on the Japanese economy will likely be to turn an
expected 0.3 per cent growth this quarter into negative growth,
perhaps sending Japan back into recession.
But within a year the rebuilding effort will deliver strong GDP
growth. Production of everything from cars to concrete will have to
be ramped up to satisfy the expected demand.
Peter Hadfield is the author of Sixty Seconds That Will Change the
World.
Source:
http://www.todayonline.com/Commentary/EDC110318-0000336/In-a-year,-Japan-may-be-booming-while-world-pays-for-quake