Eye on Japan's Recovery Within a Recovery

Just days before the Great Tohoku Earthquake, Japan’s central bank was expressing optimism that the nation’s economy was returning to a moderate growth path after a bout with chronic deflation that has dragged on for two decades.1

Now the Japanese government is estimating that the damage caused by the 9.0 temblor and the resulting tsunami and nuclear accident that devastated Japan’s northeast coast on March 11, 2011, may surpass $309 billion. That price tag — more than double the damage from Hurricane Katrina, which ravaged the U.S. Gulf Coast in 2005 — would make this the costliest natural disaster on record.2

Image via Wikipedia

Although Japan has been in the economic doldrums since the early 1990s, suffering from an aging population (it was the only major nation not to experience a baby boom after World War II), the country plays a critical role in global commerce. Its nearly $6 trillion economy is the third largest, behind China and the United States, and accounts for nearly 9% of global economic output.3–4

The human toll of the disaster is heartbreaking, with perhaps 10,000 confirmed dead, nearly twice that number still missing, and hundreds of thousands displaced.5 Yet this event could serve as a turning point for Japan’s economy. Rebuilding could create investment opportunities, help break the cycle of deflation, and provide a paradigm-shifting jolt that may help a new Japan emerge from the rubble.

But in the near and medium term, Japan will face many challenges that could send ripples through the global economy.

Stabilizing the Yen

In the days after the quake, the Japanese yen surged in chaotic trading, hitting an all-time high on March 16. Two days later, the G-7 nations staged an unusual intervention to help bring the yen’s value down against other currencies.6

A similar currency spike occurred after the 1995 Kobe earthquake, when insurance companies had to buy yen to pay claims, driving up the value. This recent surge may have been driven by speculators who anticipated the yen would rise in the aftermath.7

A strong yen is seen as harmful to Japan’s export-driven economy. Prices for Japanese goods are expected to rise because they have been made more scarce by the country’s lost productivity. The combination of a strong yen and higher prices could cause Japan’s exports to lose market share to lower-priced competitors.
Supply-Chain Interruptions

Japan is a key supplier of equipment, mainly related to transportation and machinery. It supplies 14% of the world’s automotive exports and is an important source of parts for U.S. car makers.8 A shortage of just a few parts can bring an assembly line to a halt. This could lead to temporary plant closings while new supply chains are established. If Japan can’t restart production on key exports, it could create openings for its competitors.

Japan is the world’s biggest steel exporter. A drop in production is anticipated but unlikely to affect the world steel market because there is still slack capacity from the Great Recession. Major mills in 64 nations are operating at 82% capacity.9 Again, this could create an opening for Japan’s steel-making competitors.

Japan is the source of 60% of the world’s silicon wafers, a building block for computer chips. Two factories wiped out in the disaster accounted for 25% of world supply.10 Japan also supplies 90% of a special resin used to make printed circuit boards.

The risks associated with investing on a worldwide basis include differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. These risks may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

High Saving Rate

Japan may be in prime shape to pay for rebuilding. It has an abundance of yen-denominated assets, as evidenced by its high personal saving rate, which has averaged almost 17% since 1980.12 The high saving rate may be due to the nation’s persistent economic woes, which have wrought low wages and deflation. (Deflation in particular creates an incentive to save because goods become cheaper over time.) This means that reconstruction may commence regardless of the near-term prospects for Japan’s economy, which is likely to slump.

Tragedies like the one unfolding in Japan may be unpredictable, but they are inevitable. It’s important not to overreact to such events, but to position your portfolio to withstand — and perhaps benefit — when they strike.

1, 4, 6–11) The Wall Street Journal, February 28, 2011; March 25, 2011; March 19, 2011
2) Associated Press, March 23, 2011
3, 12) Haver Analytics, 2011
5) NHK World, March 24, 2011

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from a Naperville Accountant or Naperville Investment Services advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2011 Emerald Connect, Inc.

Friday, May 6, 2011