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