Focusing on the Japanese Crisis

March, 2011

We are all saddened by the horrific crisis in Japan.  The financial question on everyone’s mind is what impact will this have on my investment portfolio.  The simple answer is, that there are still too many potential scenarios to make any confident projections.  We have been researching the situation and will summarize what we know.

The Japanese economy represents about 8 ½% of global gross domestic product (GDP).  Their economy was projected to grow at 1.5% prior to the Tsunami.  If that growth rate is reduced to 0%, the impact on global growth will be a little more than 1/10th of 1%.  The area where most of the devastation occurred represents only 4% of Japan’s total GDP and about 2% of Japan’s total population.  The industrial heartland of Japan has not been affected and Tokyo was not damaged.

The1995 Kobe earthquake in Japan knocked $100 billion off of Japan’s GDP.  From a damage standpoint, this disaster should be lower except for the unknown impact of electrical shortages and a possible nuclear disaster.  30% of Japan’s power generation is from nuclear and 20% of that is now offline (6% total reduction).  It is likely that Japan will have rolling blackouts through the county until at least April.  The only historic perspective we have on a nuclear disaster is Chernobyl and Three Mile Island.  We hope the Japanese can prevent a nuclear disaster.

Besides the negative perspective regarding nuclear energy, the largest impact from the Japanese disaster will likely be on global supply chains, interest rates and commodities (especially natural gas). Japan is a key cog in the global supply chain of tier 1 manufacturing processes (autos, chemicals, semi-conductors).  Companies in these industries may not be able to satisfy global demand.  Yen repatriation is a possibility, which would cause the yen to strengthen and have a negative impact on Japanese exporters.

Japan is also a key consumer of high end machine tools and technology systems.  Sales of corporations serving Japanese manufacturers in these capacities may be impacted.  Japanese citizens are also consumers of high end retail goods and are avid tourists.  These industries may see some decline in marginal demand.

Because Japan will have to either borrow money or its citizen’s will save less money to rebuild, it likely that interest rates will go up (at least in Japan). Also due to the rebuilding, commodity prices,  which had already been heading higher due to global demand growth will likely continue to go higher (perhaps not immediately but when the rebuilding begins in earnest).  Last but not least, Japan is the largest importer of liquid natural gas and it is likely that this will be the energy source used to replace the lost nuclear electrical capacity.  In conclusion, listening to JP Morgan’s, Japanese economist, the silver lining of the catastrophe is that deflation in Japan may finally come to an end.