How should an economist react to a catastrophe such as Japan? Even thinking about the financial and commercial impact of the country’s most serious earthquake since seismological records began can appear callous – given the scale of the human suffering.
The official death toll, as it climbs up grimly, is now above 7,000. The eventual total is likely to be three times bigger. The impact on those left behind – families, work colleagues – is unthinkable. And words can’t describe the courage of the engineers at the Fukushima nuclear power station, as they battle to prevent more fall-out, exposing themselves to surely fatal doses of radiation.
These human tragedies aside, though, Japan is a place of cardinal economic importance. Last year, total GDP was $5,300bn, according to the International Monetary Fund. So we’re talking about the world’s third largest economy, after America and China – some 60pc bigger than Germany, Europe’s commercial power house.
Japan is also among the world’s most important creditors – not least to the governments of some ailing Western nations. So while the tsunamis didn’t reach Europe, and the West should mercifully be spared any radiation, there could be a world-wide financial aftershock from Japan’s worst ever peace-time disaster.
Not so long ago, the Japanese economy, while not yet fully escaped from its long-term malaise, was in relatively good shape. During the third quarter of 2010, GDP grew by a buoyant annualized 3.9pc, with consumption leading the charge. This was unusual for Japan, given the population’s neurotic savings habit – a reluctance to spend which has contributed mightily in recent years to keeping this once-dynamic economy locked in a deflationary spiral.
During the middle of last year, though, consumption temporarily boomed, in turn boosting investment. One reason was that many Japanese punters bought fuel-efficient cars ahead of the expiration of a popular government subsidy programme.
Then, towards the end of 2010, growth collapsed. During the fourth quarter, in fact, the economy shrank 0.3pc, as consumption dipped once more. So this earthquake, and related tsunamis, have hit Japan at a time when it’s already down.
The destruction of Japanese homes, commercial buildings and infrastructure is, of course, an enormous blow to the country. While shocking, though, such damage has no direct impact on GDP – because this measures economic activity, rather than the capital stock.
Having said that, the disruption to commercial life caused by this disaster will have a major, and immediate GDP impact. That’s why, unfortunately, it seems to me that Japan is likely to endure a further economic contraction between April and June, tipping it back officially into recession.
The four parts of Japan most affected – Fukushima, Iwate, Miyagi and Ibaraki – together account for around 6.5pc of GDP, according to official statements. Across these regions, factories have been closed, as inspectors check for damage. Much of the local workforce, as well as being traumatized, are now homeless – effectively, economic refugees. Normal commercial life in these areas has largely ground to a halt and won’t return to normal for months and possibly years.
In addition, Japan is at the start of what is likely to be a prolonged power shortage. The country has more than 50 nuclear reactors, which produce 30pc of its electricity. While the numbers aren’t clear, informed sources say around a third of these facilities, right across the country, have now been shut for inspection. So, Japan has a gaping electricity deficit – which will also undermine economic activity, even in areas well away from the blighted North Eastern regions.
These are the negatives – and although they will take time to put right, they are temporary. The positive point for Japan, if anything positive can be taken from the cataclysmic events of March 11th, is that the reconstruction effort, while adding to recorded GDP, could also serve to get the economy moving in a more profound sense, countering the country’s long-entrenched deflationary mind-set. There is a good chance, in my view, that this could happen.
Having spent some time in Japan, I am not surprised to see the current stoicism with which the country is enduring its ghastly predicament, and the extent to which communities appear to be pulling together. The reconstruction effort, when it engages, as it will, is likely to be executed with the requisite skill and determination which propelled Japan, in just a few short post-War decades, from a relatively small Pacific economy into a world-beating commercial powerhouse.
So, after dipping for a few quarters, Japanese GDP could, eventually surge. Only time will tell – but, in my view, medium-term investors bet against Japan at their peril. In the here and now, though, the forthcoming slowdown could be sizeable. If the regions directly affected lose, say, a third of their economic activity in 2011, that amounts to an annual GDP drop of 2pc or more.
Beyond Japan, there is much talk of the country’s importance in the global supply chain. Westerners have now also noticed that Japan’s biggest trading partner is no longer the US, but China. The People’s Republic has lately been making a big contribution to the nascent global recovery. So there are fears that a recession-bound Japan could impact an already slowing Chinese economy, casting a pall over broader global growth.
The real economic danger, though, isn’t the impact of this catastrophe on world-wide commercial activity, but on global investor sentiment. Japanese stocks fell over 10pc last week. The Nikkei 225 share index suffered its biggest two-day fall since the game-changing 1987 crash.
It was the 1995 Kobe earthquake which led indirectly to the collapse of Barings, as “rogue trader” Nick Leeson upped his bets on Japan to avoid discovery of his growing losses. Some investors will no doubt see this disaster, and the “unknown unknowns” which may result, hard on the heels of Arab unrest and rocketing oil prices, as one uncertainty too many.
That’s why some big economies, including the US and the UK, are now jointly intervening to weaken the yen. Just as in 1995, this latest Japanese earthquake has caused its currency to surge. That may sound strange, given that the country’s productive capacity has been hit. But the yen has just climbed to post-war high against the dollar, as markets foresee cash repatriation following big sales of Japanese assets overseas, not least by insurers, to pay for reconstruction.
Japan has sovereign debts equal to 200pc of GDP. But 95pc of those IOUs are held by Japanese institutions and households. In terms of its balance sheet with the rest of the world, Japan is a huge creditor.
And therein lies the rub. During the immediate aftermath of this earthquake, global financial markets followed their well-rehearsed “emergency drill”, which led to the usual net buying of “safe haven” assets like US Treasuries. A realization is now dawning, though, that if Japan starts cashing in some of its vast $980bn stock of American government debt, the market for Treasuries could take a serious hit, causing the US government’s borrowing costs to escalate, together with those of other Western nations.
Traders estimate that more than $25bn has been spent in recent days by the G7 economies, reportedly to bring down the yen, and help Japan’s recovery effort. The Japanese people are no doubt grateful.
The fact that this is G7 currency initiative, though, a body that doesn’t include China and the world’s other large net creditors, won’t be lost on the Japanese authorities. They will be well aware, as should we be, that this currency intervention is driven almost entirely by Western financial self-interest.
Liam Halligan is Chief Economist at Prosperity Capital Management
This article first appeared in The Sunday Telegraph: