Think The Japanese Disaster Is Just What The Keynesian Doctor Ordered? Mo Says No

Tyler Durden's picture

That would be Mohamed El-Erian from Pimco, by the way, who first among the lunatic fringe (here's looking at you Goldman and Kudlow), admits that contrary to what all the Koolaid guzzlers claim, the Japanese quake may not be what the Keynesian doctor ordered after all. We urge readers to read this piece as a counterpoint to Goldman's stern defense that the Japanese quake is but a scratch, and one that will lead to world peace, prosperity and a doubling (give or take) of global GDP. In fact, El-Erian tells all the pundits who in addition to permabulls are also suddenly nuclear physicists and geologists, to shut the hell up, "as tempting as they may be, analytical shortcuts are best avoided
at this early stage.
It will take time and thorough analysis to specify
the true consequences of Japan’s triple calamity, including the
longer-term impact on its economy and that of the rest of the world. The Japanese have shown admirable courage in the face of unthinkable
tragedy. I have no doubt that a successful reconstruction program will
lead their country to recovery. In the meantime, however, the urgency of
restoring a sense of normalcy and hope to a dramatically wounded
society warrants thoughtful and deep analyses
." On this matter, we couldn't agree more.

From PIMCO:

Understanding Japan’s Disasters, by Mohamed El-Erian

  • Japan’s reconstruction challenge will likely be more difficult than after the Kobe earthquake.
  • Negative wealth and income effects this time around will be more severe, and the recovery process will probably take longer and be more complex.
  • Japan's disasters will add to the global economy’s headwinds.

As we all struggle to comprehend the economic and financial impact of
Japan’s calamity, it is tempting to seek historical analogies for
guidance. Indeed, many have been quick to cite the aftermath of the
terrible 1995 Kobe earthquake. But, while that example provides some
insights, it is too limited to understand what lies ahead for Japan, and
excessive reliance on it could undermine appropriate policy responses,
both in Japan and abroad.

First, let us consider the similarities between Japan’s current
tragedy and that of 1995. Both involved terrible earthquakes that
resulted in tremendous human suffering and large-scale physical damage.
Both required the Japanese government to display considerable agility in
its rescue efforts. Both triggered multiple offers of help from friends
and allies around the world. In both cases, wealth destruction was
accompanied by disruptions to daily economic life.

There are also important forward-looking similarities. As with the
aftermath of Kobe, the current focus on rescuing survivors will be
followed by a huge reconstruction program. Massive budgetary allocations
will be made (2% of GDP in the case of Kobe). Affected households will
receive financial assistance to help them restore some normalcy to their
lives. Roads, housing, and much other infrastructure will be repaired
and upgraded.

These similarities have led several economists to provide early
predictions of the national and global economic consequences, including a
sharp V-like recovery in Japan’s growth rate in 2011, as the initial
downturn is followed by a surge in economic activity, implying a rapid
recovery in Japan’s tax base and level of GDP. Such predictions counsel
caution against over-reaction by policymakers outside Japan. Rather than
immediately incorporating Japanese developments into their thinking,
policymakers should treat the effects on the global economy as
“transitory” – that is, temporary and reversible – and thus “look
through” them in designing their responses.

But there is a risk that this approach could understate the Japanese
disaster’s domestic and international consequences. As such, it could
contribute to insufficient responses in Japan itself – from the
government to individual companies and households – as well as in other
countries. Indeed, such a mal-diagnosis could delay what I believe will
be an eventual solid recovery in Japan.

Five factors suggest that Japan faces a uniquely difficult and
uncertain set of challenges. First, the economic damage from Japan’s
three calamities (a horrifying earthquake, a devastating tsunami, and a
nuclear crisis) may well be double that of Kobe. And, unlike Kobe, these
calamities did affect Tokyo – indirectly, fortunately – where some 40%
of Japan’s industrial production is located.

Second, Japan’s public finances are weaker than in 1995, and
demographic factors are less favorable. Domestic public debt today
stands at roughly 205% of GDP, compared to around 85% in 1995. The
country’s sovereign rating is AA-, not AAA, as it was 16 years ago. This
erodes the flexibility and ultimate effectiveness of fiscal responses.

Third, benchmark interest rates are already near zero, and have been
for a while. This undermines the potency of monetary policy
notwithstanding bold and imaginative efforts by the Bank of Japan to
inject liquidity into the economy.

Fourth, the addition of destabilizing nuclear uncertainty to the
terrible impact of the natural disasters amplifies the reconstruction
challenges. Given the damage and dangers, it will take time for Japan to
restore fully its power-generation capabilities, affecting the
potential GDP growth rate. Food safety is also a concern, as is the
economic impact of nuclear uncertainties on the Japanese psyche.

Finally, Japan’s external environment today is more challenging.
During the post-Kobe reconstruction period, world demand was buoyant and
global productivity surged, owing to China’s gathering boom, America’s
information-technology and communications revolution, and political and
economic convergence in Europe.

Today, aggregate demand in advanced economies is still recovering
from the global financial crisis, while systemically important emerging
economies like Brazil and China are tapping their policy brakes in order
to counter economic overheating. Meanwhile, on the supply side,
countries are dealing with high and volatile commodity prices, including
an oil-price spike as a result of the Middle East uprisings.

If this analysis proves correct, it implies that Japan’s
reconstruction challenge will be more difficult than after the Kobe
earthquake. Negative wealth and income effects this time around will be
more severe, and the recovery process will probably take longer and be
more complex.

At the national level, this calls urgently for a degree of unity and
decisiveness that has been absent from Japanese politics for years.
Without it, the authorities will find it difficult to communicate and
implement a medium-term economic vision that puts rapid sustained
growth, and not just reconstruction, at the core of the policy response.

Japan's disasters will add to the global economy’s headwinds – be
they the impact of the initial fall in consumption in the world’s
third-largest economy, or disruptions to global supply chains
(particularly in technology and autos). And Japan’s nuclear crisis will
mean greater uncertainty about nuclear power in other countries.

There is also a financial angle, the importance of which depends on
the mix of new government borrowing, debt monetization, and repatriation
of Japanese savings that is used to fund Japan's reconstruction
program. The greater the repatriation component, the larger the negative
impact on some financial markets.

So, as tempting as they may be, analytical shortcuts are best avoided
at this early stage. It will take time and thorough analysis to specify
the true consequences of Japan’s triple calamity, including the
longer-term impact on its economy and that of the rest of the world.

The Japanese have shown admirable courage in the face of unthinkable
tragedy. I have no doubt that a successful reconstruction program will
lead their country to recovery. In the meantime, however, the urgency of
restoring a sense of normalcy and hope to a dramatically wounded
society warrants thoughtful and deep analyses.