These are difficult days for market economists. Like the rest of us, they stare in awe at the video of a raging river where none should be, consuming Japanese coastal communities and sweeping over the countryside. They know the death toll will climb into the thousands.
But they can’t really get into that. They have to assess how the earthquake and tsunami will affect the Japanese economy, the yen and global financial markets.
Sometimes they -- and those of us who seek their counsel -- try too hard.
“Some idiot told a reporter the percentage of Japan’s GDP that was generated by Sendai’s economy, and the teen-aged scribbler then published that number as an indicator of the economic risk,” Carl Weinberg, chief economist at High Frequency Economics, said in his morning note to clients on Friday. “We do not know what we do not know about the damage that has been done. Experience tells us that the economic shock can be, and likely will be, much bigger than anyone can imagine.”
The Bank of Japan said it settled all transactions on Friday, so the financial system appears intact. That will be tested Monday when survivors seek funds to stabilize their lives. For many, their local bank branches no longer exist. The central bank already was scheduled to meet Monday and Tuesday for regular rethink of policy. The benchmark interest rate is already zero and central bankers are running a quantitative easing program, creating hundreds of billions of dollars to fight off deflation. They will do more early next week if the situation warrants, including intervening in foreign-exchange markets to support the yen if private investors turned against the currency.
There was no immediate sign of that. The yen reversed losses, probably because investors reasoned Japanese insurance companies will be repatriating assets from abroad to help them meet disaster claims. For example, about 16 per cent of Tokyo’s buildings are insured for earthquakes, according to economists at UBS AG. Those economists doubt yen strength will continue. Investors already are long yen, so there’s little reason to expect significant buying, they reasoned in a research note Friday. And just as authorities would attempt to put a floor under the yen, under the circumstances, they also likely would attempt to put in place a ceiling. “We expect the Japanese authorities to react to the disaster with both fiscal and monetary policy easing,” the UBS report said. “Hence, we believe the Ministry of Finance would intervene – with the Bank of Japan acting as its agent – to prevent any decline is USDGJPY below the 80 level. They might even reconsider currency intervention to support Japanese exporters.”
Japan isn’t in the best position to deal with reconstruction effort. “The timing of the disaster could not have been much worse,” observed Julian Jessop at London-based Capital Economics. The country’s economy is weak, its debt load is heavy and its political system is sclerotic.
The reconstruction effort will boost economic growth. Japan’s economy expanded 0.8 per cent on a quarterly basis in the immediate aftermath of the Kobe earthquake in 1995, which, at this stage, appears to have been the bigger disaster, according to Mr. Jessop. Japanese quarterly economic growth averaged 0.9 per cent over the six months that followed.
Japan likely will finance the rebuild on its own. World Bank President Robert Zoellick said Friday that his institution stands ready to help Japan, but the world’s aid institutions are in place to help poorer countries. Japan is the world’s third-biggest economy. Like New Zealand, which is dealing with the devastation from the Christchurch earthquake, Japan’s government will finance it’s reconstruction at home or on international financial markets.
That might seem a challenge for a country that is running a fiscal deficit of more than 9 per cent of GDP. The IMF last month called on Japan, along with the United States, to “strengthen their adjustment credentials by specifying the measures they intend to adopt to honour their commitments to reduce deficits and debt.”
The earthquake and tsunami will keep Japan from doing that immediately. “It will be that much harder to deliver a credible long-term fiscal plan in the summer if the economy is stuck in recession, the public finances are in an even worse state and many people are still suffering the after-effects of this disaster,” Mr. Jessop said.
But Japan has trillions in its postal savings system that it can use to back further bond issuance. That’s one of the reason the yen remains a safe haven currency despite the weakness of the Japanese economy. “They have the resources and the work ethic to deal with this,” Douglas Paal, vice president for studies at the Carnegie Endowment for International Peace, said in an interview.
As for the political system, which is paralyzed by infighting, Mr. Paal is unsure what to expect of Japan’s leaders. UBS economists wondered if Prime Minister Naoto Kan might emerge stronger from the disaster, reversing his decline in popularity polls, leaving him in a better position to get the economy in order. Of course, for that to happen, Mr. Kan will have to deliver. “A superstar may arrive, or they may trip and stumble,” Mr. Paal said. “I’d say it is 60-40 they trip and stumble.”