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PrintMarch 13, 2011
Japan's Disaster and US Finances
The catastrophic events in Japan so overwhelming in their visual impact, will also have an influence on the economy of the United States.
The still to be determined cost of rebuilding the devastated area and its infrastructure may well exceed $250+ billion. While some buildings were insured, much of cost of reconstruction will fall on the Japanese government and the taxpayers. It is expected that Japan, as the second largest holder of US Treasuries, will cease their purchase of these instruments and will begin instead to sell a portion to help fund a massive rebuilding effort.
Further Japan will, in all likelihood, have to issue new bonds in order to accumulate the funds needed. They then will be in competition with the United States for international bondholders.
What does this mean for the US? In order to sell its bonds interest rates will have to be increased to appeal to the marketplace. Additionally, the Federal Reserve, which is about to end its latest quantitative easing program (QE2), has been buying 70% of all recently issued Treasuries. The US government is still operating at a level of $200+ Billion dollar deficit per month; when the Fed will no longer buy that debt, then the Treasury Department must turn to private investors who will demand a higher yield.
Further, inflation will at some point have to be taken into account by the Federal Reserve. That action too will require the raising of the interest rate in order to make the bonds attractive.
Normally a natural disaster as occurred in Japan of this magnitude would be reflected in a massive drop in the value of a nation's currency and long-term financial outlook; however that has not been the case so far with Japan. The yen fell quickly after the earthquake struck but has since surged higher in the belief that domestic investors will repatriate the yen.
Per the Financial Times:
"The last major earthquake to hit Japan was the Great Hanshin Earthquake, which hit Kobe on January 17, 1995" notes Geoffrey Yu, UBS currency analyst. "It caused over $100 billion in damage, but the [yen rose versus the dollar] over 20 per cent in the following 3 months. There is no reason to believe this time the reaction would be different."
The day after the earthquake the yen increased by 1.0% against the dollar as compared to the value on the day of the earthquake. There is a great deal of confidence in the economy and respect for the resilience of the Japanese people among those in the international financial markets.
With the United States pursuing unsustainable fiscal and monetary policies, any worldwide dislocation of resources (such as oil or food staples), war or major natural disasters will impact the economy of the country more so than ever before. That impact may soon be reflected in higher interest costs.
