The Global Economic Effects Of The Japanese Crisis
March 21, 2011
By Tom Barrett
As is normal with any huge news story, there has been 24/7 coverage of the Japanese earthquake, the human disaster, and the potential for a meltdown in the nuclear power plants. I would like to focus this week’s column on the economic effects of these events, both those that we can already perceive and those that history tells us will likely develop. These effects could well be massive and devastating, not just to Japan, but to the global economy and particularly to the United States.
For those who have not been glued to their TV’s and need perspective, here are the Numbers: 8.9 – the magnitude of the worst earthquake in Japanese history. 10 meters (30 feet, as tall as a three storey office building) – the height of the tsunami that rolled over coastal Japan. 10,000 – the number of people feared dead.
I will limit my remarks to what we know at this time. In other words, I will not speculate on the potential effects of a meltdown of one or more nuclear reactors. I will simply discuss the economic effects of what has already occurred – the earthquake itself and the fear of a meltdown or meltdowns.
First, the big picture for Japan itself. This is a nation that has not been heavy on preparedness. I am not qualified to comment on actual nuclear power plant safety procedures and protocols. But one rather obvious fact has emerged in all the obligatory comparisons between the Japanese nuclear power plants and Three Mile Island. The Three Mile Island plant in Pennsylvania was built twenty feet above the ground. That doesn’t sound like much, but it provides a huge safety factor in case of a water surge. The Japanese plants in question were built at or near sea level. Pennsylvania is not tsunami-prone. Japan is.
Japan was just as ill-prepared financially for such a disaster. In fact, their lack of preparedness is going to lead to a financial earthquake that may ultimately cause as much damage to the nation as the physical one. Following the Kobe earthquake the Japanese stock market was back to normal in about a year. This will not be a quick fix like that was, partly because it was not as destructive, but mainly because the Japanese economy was in better shape prior to that earthquake.
I teach workshops in churches, colleges and other venues on personal finance, at which I talk about common sense principles like reducing debt and maintaining cash reserves in case of an emergency. I can tell you that most individuals in those workshops are not very well prepared when they first start learning the principles. But they are a lot better prepared than Japan – or our own nation, for that matter.
In the case of Japan, they went into this emergency with a monstrous National Debt which was 225% of their GDP (Gross Domestic Product). In simple terms, that means that the government owed 2.25 times more than ALL the goods and services produced by all the very industrious Japanese people in an entire year. Friends, as gargantuan as the US debt is, Japan’s tops it.
In the short time since the earthquake the Bank of Japan has pumped Billions of Yen into the system, which of course has caused the Yen to drop in value. (The Bank of Japan is their central bank, like the US Federal Reserve System.) Their currency, like the US Dollar, is a “fiat currency,” like all other currencies in the world today. That means it is backed by nothing except empty promises from the government that it will make sure the currency maintains some value.
This was not always the case. Most governments used to back their currency with gold, and some with silver (or a combination of the two). When that was the case their currency was money, because it was backed with real money – precious metals. But every nation that has abandoned a precious metals standard has found that their currency becomes nothing more than a commodity, like wheat or pork bellies.
For example, US money was backed by precious metals for the first 2/3 of nation’s existence, until 1933. We had little or no inflation, the nation had very little debt, and the US Dollar was the most respected currency in the world. In that year FDR took the US off the Gold Standard by Executive Order, without Congressional authorization. Since then we have suffered massive inflation and the Dollar has lost 96% of its value. Now, in times of crisis (such as the recent events in the Middle East) people have begun buying Gold instead of Dollars, which had always been considered a “safe haven.” In fact, the so-called “BRIC Nations” (Brazil, Russia, India and China, a block of emerging nations whose economies are on a positive path) recently held a meeting to discuss what currency should be the World Reserve Currency. The US Dollar has held that position since 1944, when it took the place of the British Pound Sterling. Not surprisingly, the United States was not invited to participate in the meeting.
Japan, the world’s third leading economic power, is heading down the same road as the United States. The Yen is nothing more than a commodity. It, like the US Dollar, the Euro and the British Pound, is not money; it is an IOU from the government. And we all know how valuable an IOU becomes when the ability of the signer to pay its debts comes into question. When currency was backed by precious metals it was not a commodity, because the paper money could not be printed unless there was gold or silver to back it. Once currency is disconnected from precious metals, it becomes fiat currency, just another commodity. And the laws of supply and demand apply to it, just as they apply to all other commodities.
The law of supply and demand says that when massive quantities of a commodity hit the system (as happened when the BOJ printed Billions of Yen), the price of that commodity will drop. And, as we saw, the price of the Yen did drop, and will continue to do so as the government prints more paper. What will this mean for the Japanese people? Well, of course what I have just described is inflation caused by the government. Inflation means that the currency will buy less because it is worth less. So at a time when they are already financially devastated, they will have to pay more for everything. And of course, with the Yen devalued, it will buy less foreign goods. This is particularly bad because, with their factories and supply infrastructure in rubble, much of their essential needs will have to be imported.
Before we leave this subject, please allow me to philosophize for a moment. I recently produced a DVD about God’s Money that I spent six months researching. In it I reviewed six thousand years of the economic history of the world in 90 minutes. (I had to talk fast!) I reached several conclusions. One was that God doesn’t make junk, so He never made fiat money. We all know that He made the Gold and the Silver. As I examined the Bible regarding this subject it became clear that He intended for precious metals to be the foundation for the economic systems of nations. And that the nations who heeded this counsel would be blessed with economic stability – no inflation, deflation or monetary crises.
And in fact, history has shown this to be true. In the DVD I relate the experience of many nations of thousands of years which had sound economies when they were on a precious metals standard, and which experienced hyper-inflation when they foolishly abandoned such a standard. History shows that there has never been a paper (fiat) currency in any nation of the world that has survived.
Our Founding Fathers were students of and believers in the Bible. They knew that the Gold Standard was God’s standard. And so they made it clear in our Constitution that only Gold and Silver would ever be Constitutional money. They spoke of “coining” money, never of “printing” money. (And no, that was not because printed money was not known at the time.) They also said that only Congress (the people) had the power to coin money. So when in 1913 we gave the Federal Reserve (which is not Federal, and is in fact a group of private banks) the power to issue paper money backed by nothing, the act was un-Constitutional on several levels.
The other effect of this massive printing of Yen is that it will necessitate a massive “Stimulus Package,” ala Barrack Obama. Think about it. Japan’s production is down, so it will have to import more. The people have less money because business have cut back or been destroyed altogether. And the government recklessly devalues the currency, increasing an already unpayable National Debt.
The next step will be Stimulus with a capital “S.” The government hasn’t started talking about it yet, but mark my words, they will. I don’t claim to be a prophet, but I see the handwriting on the wall on this one. And I guarantee they will hand out the money in the way they have learned from Obama. Just as he gave the stimulus money to political supporters and buddies of his close friends, the Japanese powers-that-be will reward past supporters and incentivize those who can help them in the future.
And the money will not flow to those who can do the most to help the economy, such as job creators, any more than it did under Obama’s “stimulus.” (The average cost of a job created under Obama’s “jobs creation” package was 11 times that of the cost of a job created in the private sector. And most of the government-created jobs are gone within a year. Don’t expect Japanese politicians to be any more efficient – or less corrupt – than US politicians.)
Do I sound cynical? I’m not. I’m actually very hopeful that if we tell people what is actually happening they will get mad enough to force governments all over the world to start doing what is right for the people, rather than for the politicians and the bankers. The Bible says, “My people perish for lack of knowledge.” Maybe if we get the word out God’s people will spend less time vegging out in front of the TV and more time getting involved in things that effect their lives. Ya think?
So how will the Japanese crisis affect the rest of the world? Let me count the ways. Trade. Parts. Investments. Debt Instruments. Nuclear Power Generation.
As I mentioned, Japan is (at least for now) the world’s third largest economy. That means that they do a lot of trade with other nations. The US is their largest trading partner, with the European Union right behind us. Even though there has been great enmity between the nations for thousands of years, economic proximity has dictated that China has become their third partner. Most of their other large partners are Asian, with Canada, Mexico and Panama the only ones in this hemisphere besides the US making the Top 15 list.
Trade goes both ways. Nations (and individuals, for that matter) don’t engage in trade unless there are benefits for both parties. So although Japan will be hurt most in the aggregate by whatever drop in their ability to trade results from the earthquake and the tsunami, their trading partners will be hurt as well.
One area where their trading partners will be hurt worse than Japan by Japan’s inability to meet its contractual trade obligations is in the area of spare parts. I haven’t heard much commentary on this from the talking heads on TV, but a huge percentage of the parts for a variety of industries, both for manufacturing and repairs, come from Japan. Many industries will be affected, but the worst hit will be the electronics and automobile industries.
There are two problems. One is that for some parts, Japan is the only source. Unfortunately, there are reports that the spare parts for some equipment vital to US national security are manufactured only in Japan. We don’t know that this is factual, and if it is, I am sure that if the factories that produce such parts in Japan have been shut down, we will quickly start producing them here (provided we have access to the patents and designs).
But what about the millions of Japanese cars in the US and other countries? Parts for these cars can only be obtained from Japan. And what about the millions and millions of so-called “American-made” cars? They may be assembled here, but as much as 70% of what goes into them is imported. Many of the imported parts that used to be bought from Japan now come from countries where they can be bought more cheaply, like South Korea. But Japan still provides much of our automobile electronics.
The other problem is a practice called quick response manufacturing (QRM). Part of this involves buying the parts needed for manufacturing an item “just in time” to use them. The benefits of this strategy are obvious. Less money is tied up in parts inventory, so less interest is paid. Less storage space is needed. There is a lowered likelihood of parts becoming obsolete (especially in electronics manufacturing) while they are “on the shelf” waiting to be soldered into the final product.
The negatives become just as obvious when an event like the Japanese crisis happens. Factories come to a screeching halt. A product that is 98% complete, but which cannot be shipped without a $1 part that is unavailable, sits in the factory. Manufacturers that have deposits on large orders that they can’t fill can go out of business waiting for the parts they need.
The reports coming out of Japan are still very sketchy. Naturally their first focus is on trying to save lives and relocating and feeding their displaced citizens. But initial aerial photographs indicate that there has been destruction in some key industrial areas. We should pray that essential manufacturing plants have not been damaged (or that if damaged, they can be quickly repaired) for the sake of the economies of both Japan and her trading partners. In addition, even those plants that have not been damaged will have to deal with power shortages for some time to come - perhaps for years - which will hamper their ability to produce goods.
As far as investments, think of it this way. Japan has invested heavily all over the world, including buying real estate and business in the United States and Europe. If you experienced a personal tragedy – say, a close relative with no health insurance was involved in a life-threatening accident – you wouldn’t hesitate to liquidate investments to secure funds to save that relative’s life, would you? Japan will be no different. They will start to pull in investment dollars from all over the world to save their nation from this crisis. When I say “they,” I don’t just mean the government; I mean businesses, trusts and individuals, as well. This will cause real estate values to drop as the real estate is dumped on the market; and it will cause interest rates to go up, as business scramble to find capital to replace the capital withdrawn by the Japanese.
Finally, Japan’s investments in debt instruments will impact the United States more than any other nation (although Japan does own debt from other nations as well). Japan is the second largest holder of foreign-owned US debt, after China. China owns 24%; Japan owns 21%.
Here’s the problem for the US: Nobody wants our debt.
For months now China and other foreign nations have been conspicuously absent from the US Treasury auctions. Why is that important? For decades the United States has owed more than it owned. If the nation were a person, a business, or even a state, it would have had to declare bankruptcy long ago. The only thing that has prevented this is the “power of the press.” Of course, here we’re talking about the printing presses that print the US Dollars that are backed by nothing.
The problem with printing worthless money is that it can’t go on forever. “Why not?” you say. “The US has gotten away with it for 78 years.” Imagine a factory that makes blue jeans. Suddenly people stop buying blue jeans. How long can the factory keep making jeans? Only until the factory gets so filled with boxes of jeans that the workers have no room to move around in to make more jeans.
All around the world nations, businesses and individuals that have been traditional buyers of US debt (Treasury instruments) have been backing away as they have lost confidence in the dollar. The latest to dump Treasuries has been Pimco, the huge fund that until two weeks ago was the largest private holder of US debt in the world. They announced that they had liquidated not some, but every last one of their Treasuries. John Paulson, the manager of the largest (and arguably the most successful) hedge fund in the United States went even further a few months ago. He started shorting US Treasuries.
(Shorting is when you bet against a security. It is more aggressive than just passively selling a security that you already own in order to cut your losses. You short when you believe strongly that a security will go down, so that you can make a profit on its downfall.)
The strongest proof that the US government – the Dollar – are in trouble is the QE2 you have been hearing about in the news. QE2 sounds like a luxury ocean liner, but it would be more aptly named The Titanic. QE2 stands for the second round of “Quantitative Easing,” a move in which the Federal Reserve is buying $75 million dollars worth of debt per month from the US Treasury for eight months – a total of $600 Billion. Why are they doing this? Because no one else wants the debt. It’s a shell game. It would be like you taking $100 out of your right pocket and putting it in your left one, and saying you “lent” yourself $100. The Fed “buying” debt from the Treasury, when they’re the ones who print the dollars that create the debt? Come on. Who do they think they’re fooling?
Finally, it is almost impossible to calculate the potential financial losses worldwide due to the fears generated by the problems created by the earthquake at Japan’s nuclear power generation facilities. As we all know, Japan has had looming over it the possibility of not just one, but multiple meltdowns. As of this writing there has been no meltdown, and it seems unlikely there will be one. We certainly pray that there will not be, as the effects would be horrible, not just for Japan, but, as the radiation spread, for the world.
But consider this. If just the fear of a meltdown could cause the problems discussed below, imagine how they would be magnified if an actual nuclear event occurred.
Following the Three Mile Island incident there were no nuclear power plant licenses issued in the United States for over 30 years. The anti-nuclear power activists milked this minor incident for 30 years, even though there was no radiation leakage and the containment vessel worked. Imagine what they will do with this fresh treasure trove of propaganda from Japan. We could see a halt to new licenses (and re-licensing) for 50 to 100 years, not just in the US, but also in other countries where the environmental inmates run the asylum.
Now think of what this will do to energy costs in a nation like the US where 20% of our electricity is produced with nuclear power. No new nuclear plants. License renewals denied to existing plants. (Some renewals have already been held up for years prior to the Japanese crisis; what will happen to those now?) And a president and Senate that refuse to allow US oil companies to drill proven oil reserves that would make us energy independent within a generation.
For the last few weeks people have been calling me to say that they have heard that the Japanese crisis will have little impact on our economy and the economies of the rest of the world. “It will be just a blip,” the pundits are saying. If you have been hearing the same, I hope this column has opened your eyes.
Many of the problems brought about by this tragedy cannot be averted. They will occur, and the world will have to deal with them. But there are others that our government can and should prepare for and deal with. The problem will be finding politicians who don’t have their heads in the sand, and who have the guts to tell their constituents that we have to start living within our means.
TIME: Will Japan’s Quake Be the Costliest Ever?
Last Nuclear Power Plant License Issued in the 1970’s
Interesting & Comprehensive Account of the Three Mile Island Incident
What is the Fed’s QE2?
The Non-Federal “Fed”
End the Fed by Ron Paul
The Best Defense Against a Worthless Dollar