Japanese aftershocks to rock the world economy

Posted on 16 March 2011 with 3 comments from readers

Just as observers initially underestimated the impact of the 9.0 earthquake that struck Japan last week, they are probably also now underestimating the aftershocks of this event for the global economy, and wrongly see this as solely a domestic matter for Japan.

Indeed, while Japanese stocks rebounded from their third worst crash in history yesterday, it is still far from certain what the fall-out from the earthquake will be. Chinese and French nationals have been the first to evacuate from Tokyo.

Mass panic

What will the panic be like if a city of 20 million decides to runaway from radiation clouds? And the probability of that happening is now very high. Radiation levels in Tokyo are rising and the wisest folk got on a plane yesterday. Workers have just abandoned the failed nuclear reactors ‘temporarily’.

Goldman Sachs admitted it got the earthquake wrong last week, and said that if the blackouts last to the end of June, GDP will shrink at an annual two per cent rate in the second quarter and if this continues for the year the economy will carry on shrinking. And who can build a replacement for this power station capacity in that timeframe?

However, it is hard to believe there will not be unexpected aftershocks for the global economy too. You do not see the destruction of capital on the scale of the past couple of days without consequences. $500 billion in equity vanished.

That has to leave a big hole on somebody’s balance sheet somewhere. Who was highly leveraged just at the wrong time? Who is hemorrhaging badly now? And in this globally connected world that institution or individual does not have to be in Japan.

Or will the cross border transmission mechanism be in derivatives? These highly complex financial structures often contain considerable leverage with risk margins rather finely set.

China crisis

Could China be in trouble if the Japanese market flounders? Hedge fund managers like Jim Chanos are shorting China as an investment bubble. Is the Japanese earthquake the black swan event to pop this bubble?

Then again bond markets have benefited in a flight to quality. But Japan is the second largest foreign holder of US treasuries and may become a net seller soon, or at the very least buy far fewer bonds this year than last because the money is needed at home. That would push up interest rates.

HSBC analysts said that on the precedent of past Japanese financial market implosions it takes about a week before the real selling in overseas markets by Japanese investors starts, and Japan is the world’s largest overseas investor. So we have not seen anything yet.

ArabianMoney would certainly be very weary of those US analysts who see the current emergency in Japan as a reason to buy slightly cheaper financial assets in other markets.

It maybe that the fear of contagion risk is overdone but from the precedent of the initial underestimate of the domestic impact of this disaster that seems a very foolish proposition.