Another Shock to the World Economy

by Dr. Lynn Reaser

Fears over the Middle East, oil prices, European sovereign debt, and China’s efforts to slow its economy were already weighing on the global economy.  Japan’s 8.9 earthquake has delivered another potential blow.

The devastation to lives and property has been alarming from Japan’s worst earthquake on record.  The destruction of productive capacity and infrastructure together with the disruption of economic activity will hit the economy’s real gross domestic product (GDP) hard in the short-run.  However, a process of massive rebuilding should shortly ensue that will be highly stimulative.  These efforts should arrest some of the deflation threat that the country has been trying to reverse.

The experience of the 1995 Kobe 7.2 earthquake, which killed 6,400 people, is instructive.  Industrial production fell sharply in January, the month of the earthquake, but then bounced back in February and March.  Significantly more industrial activity was concentrated in Kobe, than in the epicenter of the recent earthquake that is largely rural along the northern Pacific coast.

The 2011 earthquake has disrupted supply chains of such industries as autos and semiconductors.  The biggest economic risk at this juncture involves the extent of damage to the area’s nuclear facilities.  Energy supply dislocations could cause power brown-outs in Tokyo.

Re-insurance firms will incur significant obligations and losses.  At the same time, they are likely to boost rates, implementing a strategy already contemplated following the recent earthquake in New Zealand.

Japan’s central bank has moved to inject large amounts of liquidity to the economy to insure that firms have access to credit.  The federal government will also pass a supplemental budget to include rebuilding funds that are expected to be actively deployed in the second half of the year.

World economic growth is likely to see minimal impact over two to three quarters of time.  Interest rates could be slightly higher in the second half of 2011 as economic activity accelerates and Japan’s debt burden rises from the 200% of GDP already existing.

The Japanese yen will move higher in the short-run, as insurance firms sell assets to pay claims and foreign assistance money flows into the country.  The shut-off of some of Japan’s nuclear generating capacity will increase the country’s demand and importation of diesel fuel and liquefied natural gas (LNG).  Overall commodity prices are likely to see little impact as the solid trend of global growth continues.

Japan’s tragedy should remind us of the unexpected risks we continually face.  It also should help us appreciate the resilience of a nation’s individuals and the generosity of people around the world to help those in need.


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