From Tsunamis To Typhoons

The damage to the world economy from Japan's disaster, Europe's debt crisis and war in Libya is uncertain. That in itself is damaging.

FOLLOWING the earthquake and tsunami that struck Japan on March 11th, survivors scrambled for shelter and sustenance. Investors, meanwhile, scrambled for knowledge. Speaking at a London seminar hosted by GaveKal Research, a consultancy, Jonathan Allum of Mizuho International noted how many of his fellow analysts suddenly purported to be experts on seismology, oceanography and nuclear physics. He was more honest about the limits of his own wisdom. "I know quite a lot about economics and finance and I'm pretty good on German progressive rock," he said, but that was about it.

The list of esoteric worries troubling the world's investors is growing. As Western aircraft enforce a no-fly zone over Libya, some of Mr Allum's peers are no doubt waxing lyrical about the payload of the Eurofighter Typhoon. Across the Mediterranean, Europe's debt crisis is still in full swing. Markets fretted about the prospect of a long-expected bail-out for Portugal, after the parliament in Lisbon rejected the minority government's latest austerity measures on March 23rd and the prime minister promptly submitted his resignation. Possible write-downs on Irish bank debt by the new government in Dublin are another concern; so too is the threat that losses will be imposed on private creditors when a permanent European rescue fund starts operating in 2013.

Everyone knows that the disaster in Japan, the violence in the Middle East and the euro zone's fiscal strains are bad for the global economy. But no one knows quite how bad. This lack of clarity can be as harmful as the disruption itself.

An increase in stockmarket volatility is one gauge of uncertainty. The expected volatility of the Japanese stockmarket increased by 224% in the days following the quake, according to the VXJ index (see chart 1), before falling back somewhat. This index, which serves as Japan's fear gauge, surpassed the spike after the September 11th attacks, although it did not match the worst days of the global financial crisis. The equivalent index in America briefly surged, by 46%.

Despite their strong handshakes and leadership training, businessmen are skittish creatures, easily demoralised and deterred. This is quite understandable, given the uncertainties that haunt any commercial venture. In a recent report, Goldman Sachs cite the work of Nicholas Bloom of Stanford University, who has examined the behaviour of firms in the face of 17 "uncertainty shocks", from the Cuban missile crisis to the credit crunch. The spike in uncertainty alone was enough to make businessmen defer decisions about investment and hiring. Industrial production typically drops by about 1% in the first months after an uncertainty shock, Mr Bloom finds, an effect akin to a seven percentage-point hike in interest rates, before rebounding strongly later (see chart 2).

The wobbliness of investor confidence may be one reason for the paradoxical strengthening of the yen (from ¥83.30 to the dollar to ¥76.25) in the wake of Japan's disaster. In stressful times people retreat to safer currencies, even if those currencies belong to the country in distress. In any other country a stronger currency might have contributed to the recovery, by directing the economy's energies inward and allowing it to import more resources from abroad. But in Japan, which suffers from a chronic shortfall of domestic spending, a strong yen threatened to erode one welcome source of demand—foreigners—adding to the difficulties Japan's exporters already face in getting their wares to market.

So on March 18th Japan combined with other members of the G7 to push the yen past ¥80 to the dollar. They probably sold about ¥2 trillion ($24.7 billion) between them, according to Masafumi Yamamoto, a currency analyst for Barclays Capital. The other members of the G7 may well have no more than ¥5 trillion left in their foreign-exchange reserves, of which only a third is in cash. Any further intervention may therefore be a solo effort by the Japanese. It could still succeed: a government in control of a printing press should be able to debauch its own currency without needing outside help.

The yen may weaken of its own accord, given Japan's increased need for imports and diminished ability to export. The damage to Japan's buildings and infrastructure could amount to anything from ¥16 trillion to ¥25 trillion, according to Japan's government, equivalent to about 3-5% of Japan's GDP. But that figure does not include a variety of wider, fuzzier costs.

The disaster has reduced Tokyo Electric Power Company's capacity to about 34 gigawatts, 20-30% short of peak demand at this time of year, forcing the utility to schedule power cuts. If the cuts last for three months, it could depress manufacturing output by almost 14%, or ¥5 trillion, says Kyohei Morita of Barclays.

The loss of power is compounded by a loss of consumer confidence, both at home and abroad. "The most troublesome thing is harmful rumours and the psychological effect [on consumers] as a result of radiation concerns," says Kaoru Yosano, the economy minister. Shangri-La Asia, which runs 71 luxury hotels around the world, has temporarily stopped importing fresh food from Japan, according to Bloomberg News. The chances that any customer would eat radioactive fish or vegetables from Japan are negligible. But the chance that they would think about radiation when eating Japanese produce is almost 100%. That in itself may be enough to spoil their enjoyment of the food.

Even as they rebuff some products, Japan's foreign customers are scrambling to get hold of others. The price of memory chips has jumped. General Motors has suspended production at a factory in Louisiana due to a shortage of Japanese parts. Many of the cars people buy and electronics people use have a bit of Japan inside them, even if they are sold under other countries' brands, says Mr Allum. Judged by their imports of electrical machinery and transport equipment, Thailand, Singapore and Taiwan are most exposed to disruptions in this supply chain.

As the Japanese economy recovers, some of its trading partners will hope to benefit from its rebuilding boom. Exports from Malaysia, which include plywood and veneers, surged in the year after the 1995 Kobe earthquake. In the long run Japan will also replace its shortfall of nuclear power with larger imports of gas, boosting the fortunes of countries like Brunei and Qatar. But in the short run it will have to burn more oil: at least 300,000 barrels per day (bpd) more, according to the Centre for Global Energy Studies in London.

That will add to the upward pressure on oil prices, which have risen to $115 for a barrel of Brent crude for delivery in a month's time, up by 25% since the start of the year. Oil-price shocks are at least wearily familiar. Libya's fate is hard to predict but the economic uncertainties boil down to a hoary question: how much is Saudi Arabia, the linchpin of OPEC, the oil-exporters' cartel, able and willing to pump?

When Iraq invaded Kuwait in 1990, the Saudis pumped more oil, and when the Venezuelans downed tools in 2002, the Saudis did the same (see chart 2). They seem to be trying to repeat the trick now: according to Oil Movements, a consultancy, westbound shipments from the Middle East have increased by 200,000 bpd since January. But Saudi spare capacity is not what it was: enough to make up for the loss of Libya, but not the loss of Libya and Algeria combined. If unrest in Bahrain spread to eastern Saudi Arabia, some think the oil price could reach $200 a barrel.

Faced with the uncertainties of life, John Maynard Keynes argued that businessmen rely on the convention that the "existing state of affairs will continue indefinitely". The events of recent weeks have shaken that cosy assumption.

Thanks to The Economist - Finance And Economics