–Well a lot has changed since we left the Markets and Money offices here in St Kilda on Friday afternoon for the long Labour Day weekend. The task of today’s letter is to tell you what little we know about what’s going on in Japan. And as this is fundamentally a financial letter, we’ll discuss the financial and investment aspects of the story.
–It goes without saying that talking about Japan’s long-term fiscal position or the direction of oil prices can seem a little inhumane at times like this. There are thousands of people dead and missing and a serious nuclear emergency playing out that could affect millions more. But you can’t simply get caught up in the emotion of an event and let it overwhelm you. That is not a good survival strategy. So let’s begin dealing with it piece by piece.
–First, as you no doubt know by now, on Friday afternoon an earthquake measuring 9.0 on the Richter scale struck off the coast of northern Japan, about 370 kilometres from Tokyo. The U.S. Geological Survey reports that it was the fourth largest earthquake recorded since 1900 and the largest ever to strike Japan. Unfortunately, because of the size of the initial quake, there is a good chance of aftershocks as large as 7 or 8 on the Richter scale.
–If there are more earthquakes, there may also be more tsunamis. The tsunami that hit Japan’s north-east coast after Friday’s quake was worse than anything Hollywood could have imagined. The death toll will likely rise into the tens of thousands. More earthquakes and possible tsunamis will complicate search-and-rescue and recovery operations.
–The most urgent problem today is the failure of the cooling systems at three separate nuclear reactors at the Fukushima Daiichi facility 240 kilometres northeast of Tokyo. The earthquake knocked out the back-up cooling systems in at least one of the reactors. Then, the tsunami swamped back-up diesel generators used in the cooling system.
–There have been three separate explosions at the facility since Friday. Nuclear fuel in at least one of the reactor cores is melting. Plant operators are trying to cool the reactors by pumping in sea water. All of the reactors are still contained in their containment structures. No major radiation leaks have been measured.
–It’s important to know that the explosions have not released huge quantities of radioactive material into the atmosphere. The explosions thus far have come from the build-up of hydrogen gas, which is apparently a by-product of over-heating nuclear fuel rods. All of the reactors are still contained.
–Of course the massive worry is that any or all of the three reactors at the plant could heat up out of control and melt through their containment buildings. An explosion would be likely, releasing radioactive gas and material into the environment. This is what happened at Chernobyl in 1986, although it is important to point out that the there was no containment building at the Chernobyl plant and Russian scientists have told the ABC there is no comparison between the two disasters.
–That’s as much as we can say about the state of things because that’s as much as anyone appears to know. We will know a lot more in the next 24 hours. But it is fruitless to speculate here. Instead, let’s shift our attention to the reaction in financial markets and what you can expect next.
–Japanese stocks fell by 6.2% on Monday; although it was a wonder the markets were even open given the disaster. The Bank of Japan turned on the money spigots and injected $183 billion in liquidity in order to keep asset markets functioning normally. But the Japanese stock market is off another 7% this morning as we write.
–To be blunt, a worst-case scenario is that a massive radiation leak from the Fukushima facility blows down to Tokyo and makes the city a very dangerous place to live and breathe for a long time. That seems highly unlikely. But it’s certainly something people will be thinking about until the reactor problems are resolved.
–Credit ratings agency Moody’s is looking at the problem in terms of Japan’s massive public debt. In a statement released over the weekend, Moody’s said Japan could, “at some point” reach a fiscal “tipping point”. What kind? The kind where investors demand much higher bond yields because they are sceptical of the long-term soundness of government finances.
–You have to wonder about this. Any early estimates about how much it will cost to clean up and rebuild are almost certainly made up, or just loosely based on the Kobe earthquake in 1995, although there was no tsunami or nuclear crisis then. But even so, for a country that’s already running a public-debt-to-GDP ratio of 200%, what is a few hundred billion more in borrowing?
–In the short term, it won’t be a problem. The Japanese have been able to maintain a high sovereign credit rating (minus the occasional warning) because the borrowing was funded by Japanese savers and not foreign creditors. Will that change now? We’ll see.
–The U.S. stock market was barely bothered. This probably tells you how incredibly rigged the American investment game is at the moment. With the Fed acting behind the scenes, not a Great Arab Revolt, not an earthquake, not a tsunami, and not a potential nuclear disaster can damage the spirits of the armies of the Bernank.
–Aside from Japan’s long-term fiscal crisis, the obvious issue here is energy. Japan doesn’t have a lot of oil and gas. But you don’t get to be the world’s third-largest economy and one of the largest exporters of manufactured and high-tech goods without having a reliable source of power for industry. Japan gets about 30% of its electricity from its fleet of nuclear plants.
–Judging by the $1.5 billion hammering taken by Aussie-listed uranium stocks yesterday, the conventional wisdom (knee-jerk reaction) seems to be that regardless of what happens in the next few days, Japan’s nuclear accident is a death blow for nuclear power. Already governments in Europe have put nuclear expansions under review.
–But Japan’s energy situation is telling. Its lack of access to natural resources as it industrialised (and militarised) is arguably what got it into World War Two. It seems especially cruel, given that Japan is the only country to ever have nuclear weapons used on it, would now suffer from a major nuclear accident.
–Yet the energy problem remains. And don’t forget that this is all taking place in the midst of a fundamental change in the power structure of global energy markets. The Middle East and North Africa, as we explained in our recent issue of Australian Wealth Gameplan, are in the midst of a long revolution. This will destabilise the secure supply of crude oil from that region for many years.
–With higher oil prices (and declining global production) energy for the world still has to come from somewhere. Do you think the Chinese will summarily dismiss nuclear power because of what has happened in Japan? And more importantly, is that a rational response to what’s happened? More on that tomorrow.
For Markets and Money Australia