Where Have the World’s Savings Gone?

Global markets have fallen heavily overnight with the Australian market also in the red today. No one seems to really know what is going on at the Fukushima Daiichi nuclear power plant. John Price, an Australian-based nuclear safety expert, told the UK Telegraph:

‘”We don’t know even the fundamentals of what’s happening, what’s wrong, what isn’t working. We’re all guessing,” he said. “I would have thought they would put on a panel of experts every two hours.”’

It’s fair to say there’s an information vacuum at the moment and people are not entirely sure the Japanese Government’s briefings are as in-depth as they can. We’re not here to criticise anyone today but it wouldn’t be the first time a government has withheld information ‘in the national interest’.

NHK World reports this morning that the old gang, the G7 industrial countries, are due to get together very soon and discuss the impact of the crisis on financial markets. Who wants to bet this one-trick pony group will make a statement about orderly currency movements (good luck with that, see below) ‘standing by ready to provide liquidity’ and blah blah?

The sooner these meddlers get off the stage the better. Most of the world’s economic problems stem from too much debt and the implicit promise of ‘liquidity’ every time something goes wrong.

As tragic and devastating as it is, the global economy should easily be able to withstand a disaster of this magnitude. Instead, we are in a situation were the global ‘recovery’ looks like being snuffed out.

There will be plenty of people who will point to Japan’s earthquake and tsunami as the reason for the recent share market collapse. And superficially, they’d be right. But the collapse came because the recovery was built on a house of cards.

A rally built on liquidity and the false promise of a free lunch will disappear at the first sign on an ‘exogenous’ shock. And this is one major exogenous shock. We’re thinking it will change the financial landscape for a very long time.

So, why is it such a big deal?

Well, according to the latest figures from Japan’s Ministry of Finance (2009) Japan has a positive net international investment position of US$2.9 trillion. That means it owns more in foreign assets than foreigners own in Japanese assets.

Japan has accumulated this massive savings pool by living within its means for decades. Put simply, it has produced more than it consumed. Japan’s private sector savings have funded a succession of brain-dead Keynesian government for years, as well as providing a huge amount of global liquidity via the famed yen ‘carry trade’.

Now, the Japanese are bringing these funds home…and the currency markets are reeling. Check out the charts below. Yesterday, Dan showed you the correlation between the AUD/Yen exchange rate and the ASX200. Today, we just want to focus on the currencies.

The first chart shows the AUD/Yen rate. As you can see, Japanese money is flying out of the country.

The US dollar is faring no better, as you can see in the chart below.

The US dollar is in freefall against the yen. Japanese exporters (one of the only globally competitive industries in Japan) will not be able to compete with such a strong yen. This virtually ensures Japan will head back into recession.

There are a few implications for you to think about here.

Most obviously this capital flight is impacting risk assets – shares and commodities. Because the selling is indiscriminate there will no doubt be opportunities that arise from such selling. Keep in mind that it’s prices that are moving around wildly, not actual values.

Companies that do not rely on foreign capital to finance themselves should do ok. The big miners come to mind, although the impact on commodity prices will have an effect on their revenues and earnings. This is where valuations (long forgotten in liquidity booms) will come back into vogue.

Financial institutions on the other hand will do it tougher. Banks borrow and lend. That’s their business. Unlike Japan, Australian has a negative net international investment position of around $780bn. We rely on foreign money to fund our standard of living.

Most of this funding occurs via the banking system. Now, Japan doesn’t fund 100 per cent of Australia’s capital needs so we don’t need to put our cap in our hand just yet. According to this report it could be around the 7.5 per cent mark, which doesn’t seem much but it is a decent chunk.

The point is that the cost of debt and equity capital should begin to rise in Australia and around the world…slowly but surely. A rising cost of capital translates into lower asset prices.

Since WWII Japan has been the world’s pre-eminent creditor nation – the world’s saver. With the rebuilding effort, an economy that will probably plunge back into recession, and an ageing population, Japan will begin to consume those savings at an ever-faster rate.

In response, global interest rates SHOULD rise to encourage savings. Savings are needed to provide capital for global economic recovery. But our idiot central bankers will do more to ‘ease financial conditions’ and deplete the world of more much needed capital.

The dislocation of the world’s tectonic plates last Friday has set of an equally massive dislocation in global capital markets. The changes will likely be profound.

Tomorrow, we’ll look at gold’s response, and whether you should prepare for inflation or deflation.

Greg Canavan
For Markets and Money Australia

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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