The painfully arduous history of one of the world’s most ancient archipelagos, Japan, stands in congruity with the troika of disasters that hit the nation in the week following March 11. Being hit by a magnitude-9 earthquake (equivalent 30,000 Hiroshimas), a Tsunami that wiped out whole towns, and the nuclear crisis unfolding at the Fukushima nuclear plant, has put even the famous Japanese resilience to test.
The economic impact of the earthquake & tsunami, estimated to be in trillions of dollars with repair costs of approximately $600 billion will trouble a nation already reeling under record debt levels and a deflationary economy.
However, there is an unseen benefit amidst the ruins. The Japanese economy that has been in a state of prolonged stagnancy for the past two decades may get a kick-start in the aftermath of the earthquake. However, this revival may come at a price of a global meltdown.
To understand this phenomenon, it is imperative to understand the Japanese money trail. Investments, savings and money held by Japanese companies, financial institutions and insurers run into trillions of dollars. During its days of record growth, Japan pumped in cash by the truckloads into the world securities and treasuries market. Now, whenever a catastrophe struck Japan, the domestic companies and financial institutions needed money for rebuilding activities while insurers needed it for payouts. This money, for the most of it, came from investments made by these organizations overseas.
So how does this lead to a global meltdown? Japanese insurers over the years have reinsured their risks with other insurers. The insurance trail that has puffed up into a global labyrinth of reinsured risks has made Japan’s risk, the world’s risk. As Japanese organizations now start selling their overseas assets to pump money into the domestic markets, two likely outcomes will take place.
The first being, the Japanese domestic markets, awash with fresh cash will finally see an increased level of economic activity with heavy investments primarily in infrastructure, realty and energy.
This repatriation will lead to the strengthening of the yen and may possibly lead to inflation making a come back in the Japanese economic cycle that has suffered deflation for a long time. The second effect will be a global scarcity of capital. With most of the funds being diverted to Japan, the global markets will bear the brunt of the paucity.
Another effect could be the frequently overlooked fact about Japan’s huge trade surpluses with manufacturing powerhouses of China, South Korea and Taiwan who source huge volumes of components from Japan. Thus, even with a strengthening yen, these countries will still have to purchase components from Japan. With the earthquake striking at major electronic industry clusters and ancillary industries, major supply disruptions will surely affect production all over the world and the rising yen will shrink profit margins.
The impending debate and public outcry over nuclear power in the face of the Fukushima nuclear plant episode may force Japan to look at other sources like oil and natural gas to fulfil its energy needs. This will in turn send oil prices skyrocketing and lead to higher inflation and food prices all over the world.
In its efforts to ease the pressure in the markets, the Bank of Japan is resorting to quantitative easing by pumping in more money into the economy. The effect of these measures coupled with Japan’s rebuilding exercises will take time to unravel. In the meanwhile, even with a moribund economy, Japanese cash is still a major player in the global money markets. So, while Japan rebuilds itself, the world that was just about emerging from the subprime crisis could well be thrust back into another one.