Japan Will Recover

  • Japan’s immediate focus is on the enormous human suffering, and rightly so. Attention also turns towards the extent of the damage to the economy and its reconstruction and rehabilitation plans.
  • The good health of Japan is central to a robust global economy that generates lots of jobs and enhances productivity.

Mohamed El-Erian, CEO of PIMCO, 14 Mar 2011

Our hearts go out to the Japanese because of the human tragedy that resulted from a devastating earthquake and tidal wave. I want to echo Dr. El-Erian’s sentiments here. It will difficult and it will have globe-spanning consequences, but Japan will recover.

This is a monumental event not just for Japan, its people and its economy, but also for the global economy.  As we speak, huge swathes of the Japanese economy sit idle as the country struggles to find survivors and restore its infrastructure. That necessarily means that Japanese capital will be repatriated from abroad, creating as yet unknown consequences for global markets.

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In the video below from a Friday appearance on RT America, I make a few comments about what this could mean for the global economy. The bottom line for me is that the Japanese, as huge exporters of capital today, have a significant impact on a number of markets globally. It’s early days yet, so it’s not clear to me  at least what impact all of this will have. However, at a minimum, as the Japanese invest to rebuild at home, this is going to present an opportunity cost for the alternative uses of capital, both in Japan and externally.

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I have caught a few other good evaluations of the broader economic implications of the Japanese earthquake and tsunami. Here are a few below.

Gonzalo Lira has a good write-up on some potential themes emerging. He writes:

Over the next few weeks, Japanese companies will liquidate foreign holdings, in order to repatriate capital so as to pay for reconstruction. That is, they’ll be selling foreign assets and buying yens. So the yen—if left unchecked—could conceivably rise over the next month or two, a rise that could potentially be substantial, and severely disruptive.

So the BOJ won’t leave it unchecked: To combat the effects of capital repatriation on the yen—and to provide short term liquidity to the Japanese government—the Bank of Japan has already announced a liquidity window for Japanese banks. There’s no question that this “massive liquidity” they are looking to inject will be expanded to Japanese companies looking to dump foreign assets and spend money on reconstruction. The BOJ invented Quantitative Easing, after all.

Therefore, yen appreciation is a non-issue at this time, and for the immediate short-term. The BOJ will make sure to keep the currency in check.

Insurance, however, will be an issue. The experience with the Chilean earthquake was, the big insurance companies—especially the big international ones—didn’t lay off enough of their liability; that is, they didn’t fully reinsure themselves. In Chile, the last major earthquake had been in 1985: Obviously, international insurance companies calculated that they could maximize profits by minimizing the cost of reinsurance, gambling that this year, The Big One wouldn’t hit. The strategy worked like a charm—until February 2010, when The Big One finally did hit.

John Hempton also makes the insurance connection. However, he believes that uninsured losses are the big problem and points to 77 Bank based in Sendai as a big loser from the economic impacts of this disaster. John writes:

The second substantive post on this blog was about 77 Bank – a bank in Sendai – the capital of Miyagi Prefecture.  This is the epicenter of the Tsunami/Earthquake damage.

The original post – like this blog at the time – probably had less than 20 readers.

I have repeat the post below.

Warren Buffett once said that Fannie Mae had more supercatastrophe risk in it than Berkshire Hathaway.  He figured the really really big hurricane or earthquake could do more damage to Fannie than Berkshire even though Berkshire is the largest supercat insurer in the world.

Buffett was – I suspect – right.

We now unfortunately have a gruesome test of Buffett statement on finance and supercatastrophe.  There is probably more uninsured damage in the destruction of North East Japan than in any other event in history – and uninsured damage falls sharply on banks.

77 Bank – deeply concentrated in the disaster zone – is the test.  It is not a test I would want to repeat.  But I think we will – at the end of this – be able to confirm Buffett’s observation that banks don’t like supercats.

Banking and supercatastrophe

Also, Reuters explains:

Japanese insurers will probably sell some of their most liquid foreign assets such as U.S. Treasuries so they can respond to the worst disaster since World War Two.

The crisis could lead to insured losses of nearly $35 billion, risk modeling company AIR Worldwide said, making it one of the most expensive disasters in history and nearly as much as the entire worldwide catastrophe loss for the global insurance industry.

Traders braced for just such an outcome on Friday, when the yen surged and Treasuries fell. The Bank of Japan probably will add money to the system to limit the liquidation of assets. But the big question remains of how much follow-through selling is yet to come.

Dan Fuss, the vice chairman of $150 billion Loomis Sayles, told Reuters on Sunday that his best guess is that Treasuries will continue to see losses.

Because Japan is the second-biggest holder of U.S. government debt and they have nearly $900 billion in dollar reserves, Fuss said Japan will likely use reserves for rebuilding.

"A big buyer of bonds is taken out of the market," Fuss said, adding that Japan "will be less able to add to their reserves and less able to buy Treasuries."

I will write more as reports unfold. To my friends in Japan, be safe. Our thoughts are with you. Satoshi, that means you!

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