2011 Japan Earthquake, Nuclear Accident and Economic Implications

The sixth largest earthquake ever recorded at 9.0 on 11 March in northern Japan and the ensuing tsunami plus nuclear accident at the Fukushima Daicchi is a potential game-changer to the current fragile global economic stability.

With facts still foggy a week after the event, it is not inconceivable fear starts to take over. After all, in the nuclear industry "perceptions" are everything (aka Three Mile Island 1979, Chernobyl 1986). Already some multinational companies have chartered private jets to evacuate their overseas staff from Japan.

This radiation threat can zigzag but I see the economic picture taking shape in the following direction:

1. The world watches rivetted by this destruction in an advanced economy. One reactor may be so catastrophically damaged it contaminates the whole site so rendering the permanent complete shutdown of the entire electricity generating complex. Immediate energy shortages cascade to a grinding slowdown for industries served in the local area. It will take weeks to play out.

2. Japan is a major world player. The smooth cash flows in the global economic system to this financial centre will be disrupted as Japan rethinks the rebuilding programmes for this region which will probably take several years. Initial estimates are this area generates 3% of the national output. Just-in-time manufacturing and logistics patterns can screech to a halt if there are no alternative networks available and the implications can be heavy for domestic exporters and multinational companies. For the financial players, global money movements can be disrupted as their interest rate sensitive strategies and carry trades in the country start to morph into something completely unexpected in an uprooted Japanese landscape. Already we saw drastic and unexpected G7 intervention in the yen this week.

3. Should Japanese exports plunge and imports rise for the reconstruction efforts, Japanese money flows will tend to stay onshore within Japan. They may find they cannot participate in the US Treasury auctions of which they are the world's second biggest holder. US Treasury yields will therefore start to notch up and this can have ominous implications for bondholders and governments in their debt-servicing interest payments.

4. With money ebbing away from the US Treasury auctions, already magnified by fiscal crises in Western Europe PIGS countries, questions will be raised whether another round of quantitative easing be required after the end of June. The current rising oil price due to north African tensions (another potential game-changer in Middle-East oil dynamics) does not help. Is the groundwork being "justifiably" prepared for QE3 based on this Japan crisis?

5. There could be spill-over effects into the enormous derivatives arena. This is a fast-changing financial landscape for the international big boys and any changes in the economic assumptions that underpin these assets can quickly turn them toxic.

6. Everything changes. Faster than you can believe.

The baseline is starting to shift this week. We cannot foretell whether the resulting market turbulence (Nikkei down 16.5% in two days, worst performance since 1987 crash) was just a temporary hiccup or the harbinger of bigger moves to come over the the next two months, as the economic consequences of the guargantuan task ahead for the world's leading creditor nation are digested. Japan recovered relatively quickly from the 1995 Kobe 6.9 earthquake.

After the stunning market rebounds over the last two years, it may be time to hit the sidelines by paring down the non-core holdings and move to cash.