Japanese contagion risk threatens tipping point for global financial markets
Posted on 13 March 2011 with 4 comments from readers
The Japanese economy, along with the UK, was already contracting in the fourth quarter of last year, but the devastation of the 9.0 earthquake on Friday will probably turn this into a recession with at least two quarters of negative growth.
Factories, oil refineries and power stations were shut down, with a fifth of nuclear plants out of action, quite apart from the widespread devastation to the north eastern region and human tragedy.
But the contagion risk to the global economy is more complex. If history is any guide then there will be a sustained sell-off in global assets by Japanese institutions over coming weeks and a repatriation of money to pay for the recovery operation. This risks an overvaluation of the yen for an already very weak and indebted economy, and pulling down global financial markets that only last week celebrated a record bull run.
Tipping point
A more obvious tipping point is hard to imagine and yet US stocks still managed to inch higher last Friday in a fit of stupidity. Economists immediately pointed to the Kobe earthquake of 1995 as a precedent for a sudden dip in GDP followed by a sustained recovery over several quarters. Will it really be the same this time?
The Japanese bond market is already overstretched this year with public debt more than twice the US level. Will it now tip over and interest rates soar? It is a nightmare possibility that some economists think inevitable and a natural disaster that will make huge demands on the public purse is just what is needed to make it happen.
More optimistic commentators have taken the view that Japanese equities might well benefit if the bond market falls. But the crashing of a bond market of this size is the market equivalent of a nuclear reactor meltdown and there is a threat of that happening too. Stocks would also sink at least initially.
Red flag
For US stock market analysts who have just produced long lists of reasons to sell or be cautious about US equities this adds another major factor. Japanese institutions are big investors in US stocks and bonds.
Certainly waiting around to see if things are being exaggerated by media coverage does not look wise. Indeed a move to US dollars, yen and short positions is advisable.
Arabian investors temporarily enthused by the failure of the day of protest in Saudi Arabia last week might want to pause for thought. The financial tsunami that follows the Japanese earthquake could be equally devastating to local stock market values. Oil prices fell in reaction as refineries that are shut down do not need crude oil. That ought to be a warning.
4 Comments posted by readers:
Very interesting commentary, Peter!
A Possible Red Flag # 2:
You raised the first “red flag” in your commentary above. But there’s a possible “second red flag” that I see. Japan has invested heavily in European government bonds, especially those of the PIIGS nations; a big part of this investment was born by the Japanese insurance firms.
No doubt, there are tremendous insurance losses, I’m not familiar with Japanese law or the limitations on insurance losses . . . but it seems to me that Japan may be forced to sell off a chunk of the European government bonds that they’ve been purchasing over the past year or so.
So if the Japanese butterfly flaps its wings just a little, it may cause an eventual windstorm in Europe.
Peter , good post. We as A ‘PEOPLE’ Need to pray for Japan .
You won’t be seeing any extra Japanese Yen going overseas to US markets in the near term so I reckon that the market will correct now in the US. In the past the Japanese spent a lot of money investing the US markets but now that the Japanese have local problems to worry about and huge local financial issues I doubt anyone will be allowing any local government funds to go overseas into US markets.
The butterfly has flapped its wings in one corner of the world, and the world has noticed; now, all people in the world are feeling the effects, and will continue to do so for a long time.
It is during unfortunate and catastrophic times like this that we realize deep within ourselves that all people, regardless of national origin, are inter-connected. Our thoughts and prayers extend to the people of Japan.