There has been a lot of ink spilled this week over how Japan's crisis might affect financial markets and investments on our side of the Pacific. While it's near impossible to predict how the crisis will play out in global economic activity, commodity prices and corporate earnings, one way to address the question is pretty straightforward: Follow the money.
The logic is simple. Japan needs a lot of money, to rebuild its earthquake-and-tsunami-devastated infrastructure. Japan has a lot of money invested outside its own borders. It's probably going to want a lot of that money back.
Lessons from Kobe
Stéfane Marion, chief economist and chief strategist at National Bank Financial, pointed out that Japan is the second-biggest foreign owner of U.S. government debt - $886-billion (U.S.) as of January, fully 20 per cent of the total U.S. government paper in foreign hands. Most of Japan's foreign assets are in the U.S. market, making it by far the biggest target for the Japanese to liquidate their holdings to raise funds for the massive reconstruction.
And indeed, there's a precedent for just such a Japanese reconstruction-fuelled liquidation. In the month following the Kobe earthquake of 1995, Japan swung from a net buyer of U.S. long-term securities (both bonds and stocks) to a massive net seller of a record $30-billion in a single month, equal to 13 per cent of its total holdings.
Since the damage from the current disaster has dwarfed the Kobe quake, it's reasonable to think Japan's selloff of U.S. securities could be even bigger this time.
"We estimate that the swing in Japanese purchases could be as large as 2 per cent of U.S. GDP," Mr. Marion said.
That size of a hit could have a profound effect on U.S. government bonds - flooding the market with supply, and driving up interest rates.
"This could add around 50 basis points to the 10-year Treasury yield," he said.
Canada less exposed
Is the Canadian debt market facing similar pressures from Japan? Probably not.
Douglas Porter, deputy chief economist at BMO Nesbitt Burns, noted that Japan's total Canadian bond holdings at the end of 2010 were $44.8-billion (Canadian), representing 7.8 per cent of all foreign holdings of Canadian bonds, down from more than 14 per cent at the time of the Kobe quake.
After Kobe, Japan reduced its Canadian bond holdings by $1.4-billion (Canadian) over the next quarter - about 3 per cent of its Canadian bond holdings and just 0.4 per cent of total foreign holdings at the time.
Total foreign holdings of Canadian bonds stood at $574-billion at the end of 2010. Even if the Japanese were to cash in 10 per cent of their holdings, it would still represent less than 1 per cent of the total foreign market for Canadian bonds.
"Even large-scale repatriation by Japan of Canadian bonds would likely be readily absorbed by other buyers," Mr. Porter concluded.