Japan’s Financial Aftershock
Japan’s high debt burden threatens to create a second catastrophe.


Jim Lacey

Still none of this is good news for an already struggling Japanese economy. If I owned any Japanese equities, I would be a seller. The Nikkei was already down nearly 8 percent by the weekend, and Nikkei futures are showing a continued fall for Monday. Continuing to use the market’s reaction to the Kobe earthquake as a guide indicates that the Nikkei is set on a glide path lower for at least the next several months. Furthermore, the shutting down of several oil refineries has temporarily reversed the rising price of oil on global markets. Unfortunately, this effect is going to be short-lived, as Japan’s oil demand will increase as damage is repaired and other refineries pick up the slack. Moreover, any price reductions caused by demand destruction in Japan will be overwhelmed by the ongoing crises in the Middle East.

One can also expect Japanese investors, particularly insurance companies, to start bringing home a lot of yen to help pay for repairs and to add liquidity to the nation’s financial system. This was already evident on Friday, when the long depressed yen gained 1.5 percent against the dollar and 1 percent against the Swiss franc. Further yen repatriation can easily impact the U.S. bond market. Japan is the third-largest purchaser of U.S. government debt and may exit the market for awhile in order to conserve funds to pay for recovery. When a market player the size of Japan exits, even for a short period, it will have an effect. Expect the U.S. government to have to pay somewhat higher interest on new debt for an unspecified period.

The yen’s rise may be arrested by investors looking to unload it as worries about Japan’s prospects grow and some begin to doubt its safe-haven status. Moreover, if the yen does begin a precipitous rise, one can expect the Bank of Japan (BOJ) to intervene. The BOJ, for the first time in 15 years, entered the currency markets in September in a failed effort to halt the yen’s appreciation. It did so again Monday morning, with an $86 billion intervention, probably the first of several it will take to stabilize the market. It has already announced that it is cutting next week’s two-day meeting to one day. It is a fair assumption that, as it has no room to lower interest rates, the BOJ will flood the market with a multi-trillion yen intervention.

In the end, Japan will likely see its way through this crisis without melting down, although that is not a certainty. It would have been easier and considerably less risky if Japan’s leaders had not been so financially irresponsible for so long. If the irresponsibility continues, it is near certainty that some future crisis will leave a wrecked economy in its wake.

There are a lot of lessons here for Washington.

— Jim Lacey is the professor of strategic studies at the Marine War College and author of the forthcoming The First Clash.