Monday, March 14, 2011

Japan Earthquake

We are becoming far too experienced in having to think about the economic consequences of tragic natural disasters.

If you have read your latest QSO, we are thinking about the impact of the Christchurch earthquake on the New Zealand economy in three phases - the short, medium and long-term impacts. At this early stage, this is also the best way to think about the impact of the earthquake in Japan.

The first phase is the initial negative impact of the immediate disruption to the economy, including consumption and production in the Tohoku region. It is too early to predict the quantum at this time. This immediate impact will also include loss of distibution channels and the disruption from the loss of power.

Offsetting this will be the fact that Japan, along with other parts of the developed world, is operating at a low level of capacity utilisation. That means other parts of the Japanese economy may be able to lift production to compenate for the loss of productive capacity in the earthquake zone. While that may be the case, it will take time to organise.

The medium-term impact will be the rebuild phase. But as with the Christchurch earthquake, the growth impact from this phase should be interpreted carefully. This is not building new productive capacity for the economy. Its better described as getting the economy back to where it already was in terms of housing, infrastructure and productive capacity.

The long-term impact for Christchurch was about the decisions still yet to made by families and businesses about their long-term commitment to the city and the possibility they may relocate elsewhere in New Zealand Similar issues may impact the quake-hit regions of northern Japan. In both cases it will remain to be seen whether that becomes a country exodus as well.

The impact on New Zealand of the Japan earthquake is also difficult to ascertain at this point. In terms of exports of inputs into production such as aluminium, the answer will come back to how badly damaged productive capacity is and how readily production can be shifted elsewhere. In terms of exports of primary products, the answer lies in the extent to which distribution channels have been impacted.

In the wake of the Christchurch earthquake, the Reserve Bank of New Zealand eased monetary policy by cutting interest rates by 50bps. With interest rates in Japan at 0.1%, that option was not availabe to the Bank of Japan. The BoJ is largely limited to the provision of short-term liquidity. Indeed the Bank has pumped 15 trillion Yen into money markets. They have also announced a further round of asset purchases.

Economic growth had already dropped significantly at the end of last year on the back of the end of a number of stimulus programs. Forecasts for growth this year were around 1.5% pre-quake. With the short-term impact of the disaster likely to be GDP negative, the BoJ action was appropriate for an economy prone to deflation.

The fiscal implications of this disaster will prove to be significant. Most developed countries are facing significant structural budget challenges. Those challenges in Japan are largely demographic, making them harder to solve. Nevertheless, they just got more difficult.

More later.....