As the aftermath of the enormous earthquake and tsunami that hit Japan on Friday starts to filter throughout the world, it is useful to put some thoughts together to help you understand the potential consequences.
If history is anything to go by (as with the US authorities in the initial days of the GFC), Japan’s authorities will play down the potential consequences and try to appear like it knows exactly what it is doing and all will be well.
You need to know that all WILL NOT be well!
Whilst it is impossible to predict exactly how this will play out, it is possible to give you some potential consequences, but first some economic facts may be useful.
The above chart shows the total net debt of the Japanese government from 1981 to March 2011. Net debt is all the money the government owes minus any financial assets corresponding to debt instruments. It is the true debt position net of any liquid financial assets like Gold or foreign currency reserves.
You can see that the debt level of the Japanese government has been rising alarmingly since 1995 and the IMF is predicting that this debt level will continue to grow.
Now here is a chart of the total GDP of Japan from 1981 to today.
The GDP of Japan from 1995 through to today has remained roughly constant at 500 Trillion Yen (about $US6.5 Trillion at the current exchange rate of 0.0125 Yen/USD) since 1995 whereas other western nations like US and Australia have been advancing at the rate of 3-5% per annum on average. So their economy has been stagnant for some time.
So why has the GDP been stagnant while debt levels are rising rapidly?
Here are 2 reasons:
1. The wealth of Japanese people has been rapidly deteriorating since 1995. Below is a chart of the Japanese Nikkei 225 Index from 1997 to today.
The Japanese share market has been a Secular Bear Market since 1997 with the vast majority of the time spent under the downward trend line.
Please do not forget that the Japanese economy is the second largest in the world, and its citizens have been losing wealth for a long time.
2. The Japanese population is rapidly ageing and declining in number.
The pyramids in the chart shows Japanese demographic spreads in 1950, 2008 and the projected in 2050, with Age on the vertical axis and Millions of People on the horizontal. You can see the huge increase in the Over 65’s over the three charts and the huge decline in the under 14’s. Japan’s population is shrinking and ageing rapidly.
What are the implications of this?
As the population ages, the greater the reliance will be on government welfare and aged services. This means that there will be even greater strains on government debt as less and less people are contributing to wealth through income tax and more and more people rely on government hand-outs.
In a nutshell, the Japanese economy has been in systematic decline since its peak in 1990, and the government has tried everything in the Keynesian book of economics with little or no effect except the racking up of massive debt for 20 years now.
Now onto where we are today!
The earthquake and resultant tsunami have shattered the north eastern coastline of Japan, with whole towns containing thousands of people washed away. It will be months before the Japanese people know the extent of the loss of life and cataclysmic damage to property and industry in the immediate regions affected, and then the ongoing economic impact to the nation as a whole. I am really struggling as I write this to even begin to understand what it is like for the survivors.
The massive tsunami has caused major structural damage to one of Japan’s primary nuclear power generation plants at Fukushima. As I write, this plant is closer and ever closer to a total meltdown that will cause nuclear radiation contamination for hundreds of kilometres around the plant. We can rely on the government to give us misinformation and play down the significance of this event. The truth is we are perilously close to massive radioactive contamination, and if that happens, the world will become a different place.
We are also now on the edge of a total global economic meltdown.
How?
Japan is a net lender to the world. They have had years of Balance of Trade surpluses fed by a manufacturing and finished goods sector that are world class, producing a range of products that the world has been eager to consume. To keep the exporters competitive with the nations that consume their goods, the Yen has needed to be as low as possible.
To make the value of the Yen relatively low, the Bank of Japan (BoJ) has for years purchased debt instruments from the rest of the world, primarily the USA. As its major trading partner, the lower Yen makes Japanese imports cheaper in the US. When the BoJ needs to keep the Yen down, it sells Yen and buys USD, then purchases US Treasuries with the USD. This reduces the value of the Yen compared to the USD.
The Japanese government now holds around $US900 BILLION in US Treasuries, and has been a consistent and reliable buyer of US Debt for years. In fact, the only way that the US has been able to fund its massive expansion of services to the US people over the last 25 years is by selling its debt to foreign governments like China and Japan (China holds over $1 TRILLION of US Treasuries).
Post earthquake and tsunami and nuclear incident, Japan needs cash.
Why?
In tumultuous times like this, demands on the government from its people for help, as well as a fall in tax receipts means that the immediate cash flow position will become more and more critical over the ensuing weeks and months.
So Japan is in the process of calling in much of its liquid assets it holds outside of the Yen. The chart below shows the recent movements of the Yen over the last month and pay particular note of the rapid increase in value of the Yen/USD post the earthquake on Friday.
So the race to repatriate overseas foreign reserves is on in earnest and will continue into the future.
If you think we are immune, take a look at the Yen/AUD chart over the same period.
So the Japanese Yen is appreciating rapidly as BoJ brings home all the booty it has been storing up overseas so it can help its own.
So what does all this mean?
As Japan calls in all its storehouse of foreign reserves, these massive flows of capital throughout the world will start to have the following effects:
- Japanese exporters will be increasingly marginalised as the Yen appreciates in every foreign currency making it more difficult for Japanese manufacturers to compete;
- Japanese imports will become cheaper as the Yen appreciates quickly, making overseas companies, particularly Chinese manufacturers, with a whole new competitive edge that the Chinese particularly will not miss;
- Japanese manufacturers could start to buckle under the pressure, with closures and more unemployment, adding further to the government malaise;
- Japanese GDP will shrink resulting in lower tax revenues for the government;
- Interest rates will rise rapidly as the government has to borrow more and more to pay the bills;
- Inflation could rise rapidly under the weight of higher interest rates and wage demands;
- The Japanese economy could fall into a debt-driven deflation for an extended period, or the Japanese Yen could eventually collapse leading to Hyper-inflation and asset devaluation. Either way, all roads look like leading to an economic storm in Japan that WILL affect the rest of the world.
I have not taken into consideration above if the nuclear meltdown scenario reaches its ultimate conclusion. That will force a complete re-think of how Japan will energise itself in the future. This scenario is would be catastrophic for an energy intensive Japan.
How Can This Affect The World Economy?
Japan is either the second or third largest economy in the world, depending on how you measure it.
The economic shock to the rest of the world of an impotent Japanese economy will be devastating. The immediate risk is that posed to the US economy particularly.
Please click here to see for yourself the current debt position of the US economy, the largest in the world by a long way. These numbers are just plain staggering.
So if the Japanese decide to sell their US Treasuries, the following could be the result:
- US Bond Yields could rapidly escalate, driving up interest rates and inflation in the US and vastly increasing the interest expenditure of the US government;
- The resultant rapid fall in US Treasury values could force other foreign US Treasury holders to reassess their position in US Treasuries as an asset class, and commence to sell off their holdings;
- This could start a run on US Treasuries as both foreign debt holders and local banks panic and dump US Treasuries;
- The US government could default on its debt obligations and cause huge losses to Treasury holders;
- This will cause panic on the stock market and start a run on US stocks;
- If the above plays out, the USD will collapse, causing Hyper-inflation and the collapse of the US economy.
- After this, the rest of the world is in it up to its arm pits as the debt-ridden global financial system melts down as banks collapse across the globe.
So before you is the Black Swan! The one little act of nature that could trigger a whole set of events that eventually leads to an overall decline in world markets.
If all this transpires, are you ready for it?
What do you need to do?
These are terrifying times for those adopting a buy and hold unprotected share market based strategy.
Do you have a strategy that can deal with what is happening and the times ahead?
Make an appointment and come and see us.