BLOOMBERG BUSINESSWEEK
The Japan Earthquake: The Cataclysm This Time
By William Pesek
March 17, 2011, 1:47 PM GMT+9
At his first press conference, Prime Minister Naoto Kan called it a crisis, and for an hour or so that felt right. No nation is immune from tragedy, and the expectation is that slowly, with the help of friends, people of character dust themselves off and rebuild.
Then the videos began—of waters rising with horrible speed to swallow entire towns. Of shipping containers rolled like toys. Of roads turned to tofu and nuclear plants wheezing radiation. As a sense of proportion settled in, crisis rapidly proved inadequate. What Japan suffered on Mar. 11—a 9.0 earthquake, followed by a 20-foot tsunami, followed by a nuclear threat that stirred excruciating historic echoes—was three crises. A cataclysm unlike any Japan has faced before.
The death toll is expected to top 10,000, and nearly 400,000 Japanese have been left homeless. The emotional impact of all that loss and dislocation is incalculable. Markets, though, have their own calculus, and Japan’s Topix index of 1,669 companies was brutal in its precision. On the first two business days after the quake, the Topix tumbled to its worst two-day plunge since 1987. In a country already wracked by nearly 20 years of stagnation, a decade of deflation, anemic employment, and competition from an ascendant China, the market’s verdict was clear: It will be a challenge for the world’s third-largest economy to remain so.
Perhaps the market overreacted. Analysts at Goldman Sachs (GS) and Morgan Stanley (MS) suggested there might be a buying opportunity in the chaos. Yet manufacturers from Sony (SNE) to Toyota Motor (TM) temporarily closed plants at a time when Japan can least afford to be idle. The Gucci and Hermès outlets that decorate Tokyo’s glitzy Ginza are empty. Without the nuclear facilities that provide 30 percent of the country’s power, rolling blackouts shuttered restaurants, bars, theaters, and mom-and-pop shops. “Continued stock turmoil and disruptions to production will drive the economy into an extremely severe state,” says Masaaki Kanno, chief Japan economist at JPMorgan (JPM) in Tokyo.
Before Mar. 11, Japan was gasping for economic life. Gross domestic product shrank at an annualized 1.3 percent rate in the three months ended Dec. 31, forcing the Bank of Japan to pump 28 trillion yen ($346 billion) into the financial system. Since the cataclysm, BOJ Governor Masaaki Shirakawa has doubled planned purchases of exchange-traded funds, real estate investment trusts, corporate debt, and Japanese government bonds to 10 trillion yen and launched a program to supply financial institutions with 30 trillion yen in three- and six-month loans at 0.1 percent interest. The intent is to support asset prices while the panic abates, yet the Nikkei 225 index tumbled almost 11 percent on Mar. 15, before bargain hunters led a 5.7 percent recovery the next day.
As difficult as the short term will be, it pales compared with the very worst-case economic scenario: a debt crisis the likes of which the world has never seen. Investors fretting over Greece and Ireland will find their fiscal travails quaint if the nation with the world’s largest public debt hits a wall. Japan’s debt is about double the size of its $5 trillion economy. It’s not a question of whether Japan is too big to fail; it’s whether it’s too big to save.
This is the darkest view at the darkest moment. It could get significantly worse if the Japanese can’t cool the spent fuel rods at the Fukushima Daiichi Nuclear Power Station. Gregory Jaczko, chairman of the U.S. Nuclear Regulatory Commission, testified before Congress on Mar. 16 that the rods are bleeding radiation into the atmosphere, and the threat of exposure is far greater than his Japanese peers have admitted. If true, the present picture will be enviable.
Still, Japan is not helpless in dealing with whatever aftermath may come. It is the world’s largest creditor as well as its largest debtor and has $886 billion worth of dollar reserves, for example, to help fund a rebuilding effort without adding to the national debt. The private sector has a financial surplus that exceeds the government deficit. Japan prints one of the three genuinely international currencies, boasts one of the biggest equity markets, and its bond market is the second-largest to the U.S. in outstanding debt in circulation. An economic meltdown there will reverberate far and wide, shoulder-checking markets from Germany to Singapore. But a market catastrophe, unlike a natural one, can be avoided with shrewd management.
Neither the bad-loan problems of the 1990s and early 2000s nor mushrooming budget deficits over the past 15-odd years triggered the bond crash that many short-sellers predicted. Japan’s secret? About 95 percent of public debt is held domestically, virtually eliminating the risk of capital flight. Yet the hundreds of billions of dollars needed to rebuild northeastern Japan could nudge it from stability and into debt market turmoil. Mar. 11 “may have shifted such a potential tipping point a bit forward, unless Japan’s political parties are galvanized by the crisis to also address the country’s long-term fiscal challenges,” says Thomas J. Byrne, a senior vice-president at Moody’s Investors Service (MCO) in Singapore.
If the days since the quake are any guide, little galvanizing is under way. A quick chat with the man on the Tokyo street is all it takes to understand just how disenchanted many Japanese are with their elected officials. “There is so much conflicting information, and everything is said with ‘maybe’ and ‘possibly’—nothing specific,” complains Natsu Hasegawa, a 37-year-old Tokyo hairstylist. Adds Eri Inutake, a 39-year-old florist in Tokyo: “We have a feeling that they are hiding something from us. It’s not a great feeling to lack trust like this.”
If politicians have failed to inspire the confidence of their constituents, they’ve been even less successful at addressing the primary concern of investors: how much borrowing they plan to do to fund rebuilding efforts. It’s a question no one can yet answer credibly, given the vastness of the devastation. Goldman Sachs analysts estimate the total cost of the catastrophe will reach 16 trillion yen, 1.6 times the cost of the earthquake that hit Kobe in 1995. Rebuilding the Tohoku region, which accounts for about 8 percent of Japan’s GDP, is one thing. Accounting for output losses related to power outages is quite another. Then there’s the radiation factor, which impacts not just the health of the affected populace and the habitability of land, but also the national psyche. Other than makers of surgical masks, duct tape, and bottled water, it’s hard to discern many economic winners from the threat of irradiation. And even the manufacturers of emergency supplies are unprepared.
The scene on Mar. 15 at the 24-hour Don Quijote store in Tokyo’s Roppongi district provides a case in point. The multistory general store was mobbed by several hundred Tokyoites clamoring for flashlights, candles, cooking-fuel cans, and radios—all of which were already sold out. The Japanese are as stoic as their reputation; the near-total absence of looting and crime in a landscape where houses have been cracked open and possessions lie on the streets is a testament to the virtues of the world’s most orderly society. Still, desperation was in the air as staffers bowed and apologized for the sudden mismatch between supply and demand. Shoppers pushed and shoved and insisted they be told which of the store’s other locations had their sought-after items (to no avail). In hyperpolite Japan, it was a scene of rare aggression.
Japan historians often note that major earthquakes in 1855, 1923, and 1995 coincided with, and perhaps caused, significant national turning points. This is the hope of those who think Japan must set itself on a new trajectory to compete in the 21st century, that disaster might be transformative. “It’s terrible for the Japanese people in the short run, but the long-term implications are positive,” says Curtis Freeze, Tokyo-based founder of Prospect Asset Management, which manages $280 million and has been investing in Japan for more than two decades. “Think of New Orleans on a much bigger scale.”
Japan in 2011 is not the Japan of 1855, 1923, or even 1995, yet history provides at least some precedent for measured optimism. The 1855 quake that destroyed much of what is now Tokyo came at the twilight of the Tokugawa period, during which Japan was isolated for two centuries. The aftermath brought on a headlong drive to import the latest technology and culture and launch Japan into modernity. The devastation of 1923 left about 130,000 people dead, set Tokyo ablaze, and destroyed about 37.5 percent of Japan’s GDP. It also catalyzed the construction of the sophisticated networks of trains, roads, parks, and public services that helped Japan become an economic superpower.
The most famous example of Japanese resilience is the recovery from the bombings of Hiroshima and Nagasaki. From the ashes of history’s only two nuclear attacks came a new democratic constitution and a zeal for creating a vibrant trading economy. The industrialists of the day created such names as Sony and Honda Motor (HMC), paving the way for what Japanese call the “Golden Sixties,” a period of rapid growth and internationalism highlighted by the 1964 Tokyo Olympics. It also gave birth to Japan’s focus on disaster preparedness. Even as the Fukushima Daiichi reactors smoke, it’s worth noting they were protected by the highest sea walls in the world. And while the scale of the tragedy prevents us from celebrating the achievements of Japan’s engineering corps, no skyscrapers tumbled during the strongest earthquake in a century. No trains traveling 150 miles per hour derailed. All the drills and preparations of civil servants, families, and companies reaped the most precious of all harvests: lives saved.
The psyche and character that built modern Japan aren’t what they used to be. Emperor worship once provided a focus for society, but Akihito is not Hirohito. (The Emperor Showa may have had a role in war crimes, but his surrender speech—”The war situation has developed not necessarily to Japan’s advantage”—was all it took for the Japanese to accept occupation.) The emperor’s subjects are also not as innovative, or as young, as they once were. The median age in Japan is 44. China’s is 35. And Japan’s population is set to shrink from 127 million to 125 million by 2014. The country’s leadership is aging, too. It controls the budget and coddles the elderly to such a degree that pundits call Japan a “silver democracy.” It’s no mystery why young Japanese lack optimism. In an October 2010 survey, Brian Salsberg of McKinsey in Tokyo concluded: “Youth is wasted on young, goes the old saying, but in Japan the young seem weary and resigned long before their time.”
Japan’s political establishment and corporate leadership have been reluctant to tap its female workforce. Too many educated women are relegated to the role of tea girl. Goldman Sachs strategist Kathy Matsui in Tokyo says if Japan’s female employment rate matched that of males—one of the highest anywhere at about 80 percent, according to Matsui—GDP would get a boost of as much as 15 percent. Given that labor shortages could be Japan’s biggest problem as it strives for recovery, it’s crucial that women and immigrants, still poorly integrated into Japan’s culture and workforce, be given a chance to compete. That goes for new companies, too. Incentives protect national champions at the top of the corporate food chain at the expense of startups that would create wealth and jobs at the other end of the economy. “Japan would gain from a friendlier business environment for startups, but policy makers remain disinclined to put their faith in market fundamentalism,” says Jeff Kingston, a Temple University professor in Tokyo.
When Kan became Prime Minister in June 2010, he talked about shaking up the economy. He also set his sights on the phlegmatic bureaucracy standing in his way. Paradoxically, to succeed he’ll need to stick around for a while. There have been five Prime Ministers since Junichiro Koizumi ended a five-year term in 2006. None has had the time to pursue a comprehensive agenda for the future, and none deserved it.
Sadly, Kan will have the benefit of a nation in shock. While many Japanese are still searching for loved ones and contemplating an unknowable future, politics and economics will be far from top of mind. When the country stirs, though, Kan must be ready to lead. It’s possible that China’s rapid offer of help and condolences set the stage for a softening of relations between Tokyo and Beijing. Asia’s two biggest economies putting aside disagreements over trade, territory, defense, and history would benefit both populations. A change in the physical and mental landscape of Japan could also be a spur to urgency. If it is, the world may discover that cataclysm can be an opportunity, too.
