Japan 2011: 'The Impact Will Be Global'

Expert outlines worldwide consequences from Japan's tragedy

A man cycles past upturned cars and other tsunami-wrought devastation in Natori City, Miyagi prefecture, on March 14, 2011. (Mike Clarke /AFP/Getty Images)

NEW YORK, March 15, 2011 - In the wake of Japan's tragic Great Tohuku Earthquake and Tsunami disaster, Asia Society Global Council Member Kenneth S. Courtis outlined some of the bigger economic questions posed by the catastrophe for AsiaSociety.org. Courtis is Consultant and Former Vice Chairman-Asia for Goldman Sachs (Japan), Ltd.

What might be the political and economic impacts [of the March 11 earthquake and tsunami] on Japan?

Of course, there are not just economic implications, as an event like this is also profoundly political in its implications. The Japanese government had been very weak going into this vast catastrophe. So, will the nation's rival political parties be able to overcome their deep differences? It was expected that a general election would be held soon. That is now seems less likely. Yet the government cannot pass new spending plans without the support of the opposition. Indeed, the government has not yet even managed to pass the regular, annual budget for FY2011, let alone a new, and major supplementary budget to finance the rebuilding of the vast devastation along the Tohoku coast.

At best, there will be a hiatus in political infighting. And, Japan has seldom produced the best in the last few decades. The current government has been trying to reduce public works and pubic investment as part of an initial effort to reverse the debilitating trend in public finances. If it were to keep to that objective, that would mean big cuts in other parts of the budget (for example, social entitlements)  in order to release funds for the rebuilding. But in such a precarious political situation, such cuts seem very unlikely.

So the result is very likely to be still substantially larger deficits for the next three to four years. This would surely drive total government debt to close to 250% of GDP by 2015. In this context, a more likely scenario is that vast pressure builds on the BOJ to sharply increase monetary expansion. That pressure will be further justified due to the "deflationary" impact of the crisis as for the next couple of quarters overall output will be lower.

What about Japan's energy needs?

About 5% of Japan's electricity generation capacity could be lost for good. They are filling some of these reactors with sea water (i.e., salt water), which means that they have basically given up on saving them as electricity production units. The salt will corrode them to such an extent that they cannot be of further use. The main object is to stop a meltdown from happening, at any cost. About a third of Japan's electricity comes from nuclear power. So far they have shut five reactors. These five produce about 20 percent of the country's nuclear energy.

So that means about six to seven percent of the national electricity supply is now offline. Two refineries have also been shut, and ports in some areas are disrupted, so that will also have an impact. So let's guesstimate that eight to nine percent of total electricity is now offline. And it is likely to be off line for some time. Additionally, about two to four percent of other energy—oil, gas, coal—is also offline. So in total about 10 percent of capacity is currently offline. There will also have to be safety checks at all of the nuclear plants and work done to increase their resistance to future quakes. That will also make it difficult to increase supply any time soon.

Of course, the economy will not require as much energy immediately, as activity will be down. For the next few days, everyone will be checking for damage—car assembly lines, chemical plants, electronics plants, et cetera. But as production comes back on stream, there will be constraints on production for a period until new electricity supply can be brought back on stream.

Next: "The impact will be global."

How might energy prices be affected?

Japan currently imports about 4.25 million barrels a day of oil. I estimate it would need to import an additional 400,000 barrels a day for the next two quarters, at least, to offset this lost nuclear power capacity. With some Libyan supply now out, Saudi Arabia has increased production to make up the shortfall. The Japanese drama only adds to this complicated supply situation. The world economy is still highly fragile, so we will now have to watch energy prices very, very closely. Japan buys about 115 to 125 tons of thermal coal annually, mostly from Australia. That would have to increase by approximately 25 million tons. April 1 is the date for completing the annual supply contracts with Australian producers.

So this new situation—and additional demand—will now become part of the negotiations. And that will mean higher prices for thermal coal. As for LNG, there's lots of excess supply in the world market from Russia's Sakhalin and Qatar. Japan is one of the few countries which has the infrastructure to take new supply easily. China, South Korea, Taiwan, and India will all be making the same calculations. They will want to get in the market ahead of Japan, so I would expect them to become aggressive buyers right now, which will also push prices higher. Also, this means, in my book, more upward pressure on the currencies of suppliers like Canada, Australia, Indonesia and Columbia.

What about things like production and global supply as well as logistics?

All of this means that transportation will be disrupted for a period. Let's say two quarters. The government has announced an energy rationing program for the next two months. The earthquake and tsunami have led to a closing of some electronics production and some steel production, and so on. Taiwan, South Korea, China, and Japan form a very tightly integrated production and supply network of just-in-time-delivery.

For example, in these four countries, with regard to the iPhone, some 110 different companies are involved in making the final product. The same goes for many other products. So any disruption in supply and logistics will impact the entire region of Northeast. Asia, and as this region largely dominates much of world manufacturing, the impact will be global for, say again, two quarters. For example, think flash memory chips, high-end electronic components, key components for flat screens, etcetera ... and cars as well, along with top-end car parts. 

For example, one fifth of Taiwan's total imports are electronic parts from Japan. For Korea it is about one-sixth of total imports, and for China it is about an eighth of total imports. Who can fill the slack? There is no one obvious. The US? Probably not, as they do not even produce most of this stuff anymore. The EU? Maybe. But only some on the margins. As these industries all run the leanest of lean production systems, there will be inevitably disruptions of supply, and so there will be upward pressure on prices for consumers around the world.

How might currency rates react?

Basically, what we could see is a period of capital repatriation back to Japan. Companies will need cash to rebuild, to cover losses and increased working capital requirements. Households will also be requiring cash. This is exactly the same process that happened after the Kobe quake in 1995. The Japanese yen went from about 100 (to the US dollar) at the time of the quake to the historic record high of 79.80 by mid-April, as Japan firms and institutions repatriated capital.

A similar development occurred following after the collapse of Lehman and the decision to destroy AIG. In the following three months, the yen went from 105 to the high 80s. Most of the repatriation at that time was by Japanese banks and insurance companies. The dynamics of this period were different, but it is another reference point. I would guesstimate that two to three trillion yen will be repatriated during the coming three months, unless this is entirely offset by currency-money supply intervention, the result, given everything else will be in itself a higher yen.

How might that affect Japan's economy?

A higher yen in the current context would be extremely negative for Japan's economy. So I expect to see the Bank of Japan operating aggressively in providing liquidity to offset any upward pressure on the currency as a result of quake-induced repatriation. But if this process is not carried out smoothly, the result will be short-term pressure from Japan on the dollar and on US T-bill yields.