I’ve been thinking all week about the disaster unfolding in Japan. The level of human suffering is mind-boggling. In fact, I’ve wanted to write about it all week, but, frankly, I needed some time to compose my thoughts and allow the disaster to play out. Too many unknowns. A common and useful crutch is to use history as a guide, to frame and structure the questions and likely outcomes. A few of the questions I’ve been pondering this week include:
Questions
What does it mean for our portfolios? How far might equities decline? How likely is it that significant amounts of radiation will leak at Fukushima? Is Japan’s disaster comparable to other recent disasters (Katrina, Kobe earthquake in ’95, 9/11 and Chernobyl)? Will this disaster derail the global economic recovery? Is the bond market susceptible? How might Fukushima affect energy policy? Is Fukushima or Egypt/Libya/Bahrain the bigger factor right now? What about inflation? Will Quantitative Easing III (QEIII) be realized? QEIV? It’s been dizzying.
What History Says about the Economic Effects of Natural Disasters
Looking at scads of research and speaking with a few smart and knowledgeable people I learned a few things about the economic effects of natural disasters. Historically, neither Katrina nor Kobe nor Chernobyl affected global growth rates to any meaningful extent. All of those disasters resulted in slower quarterly followed by increased demand in the following quarter (i.e. netting out the economic effect). The highest estimate for the economic cost of the Japan disasters is $300 billion. This is 5% of Japan’s $5.4 trillion dollar economy, but only .5% of the global GDP.
The Federal Reserve met early this week and was silent on the implications of the tragic disasters in Japan for the U.S. Perhaps the Fed lacked information to take even a preliminary position because events are still unfolding. Further, the Japanese as a culture are deeply imbued with Confucius’ sense of dignity, which above all is to “Save Face” and “Avoid Shame.” Undoubtedly, the Japanese feel shame for their tragedy at the nuclear reactors in Fukushima. Policymakers can be certain that the full extent of the damage and the intermediate consequences will not be known by us for some time to come.
This Last Week
As individuals, I think many of us have had a difficult week. Clients have been uncertain and afraid. Investment managers don’t know what is happening and don’t know what to say to clients because we don’t yet know the outcome at Fukushima.
I believe that there will be solutions to the tragedy at Fukushima in the coming weeks; even it means that they need to desert the plant and fill it in with sand. My fear all week has been that the uncertainty and enormity of the situation in Japan could potentially douse the animal spirits of the current global economic recovery.
Animal Spirits & Investment Ramifications
At the moment, it seems animal spirits are alive and well. Here is the evidence: The global stock markets managed to get through this week, despite the continuing uncertainty of the nuclear containment, with less than a 2% decline for the week. The flight to the safety of treasury bonds and gold was substantial but contained.
So the big question, do we panic and make a change? In the last 30 years, the only time selling into a panic has been the right thing to do was when Lehman Brothers was allowed to fail in 2008. But that disaster imposed systematic risk to the financial system. The disaster of Japan, as horrifying as it is and as uncertain as it is, does not seem to be an event that threatens the financial system. In homage to John Maynard Keynes, if my assessment of the facts change, then I will change my position. But for the moment, I believe that while the human suffering and enormity of Japan’s triple disaster (earthquake, tsunami, Fukushima) is self evident, I don’t believe that Japan will significantly impact the global economic recovery.
This week, in our clients’ investment portfolios, we essentially held tight. The stocks that we own are among the strongest companies in the world. Most pay dividends of three to four percent. We have a large allocation to fixed income. Since most of our clients’ liabilities, including their monthly expenses, are denominated in dollars, we are very content to produce solid tax-free yields of four to seven percent using general obligation municipal bonds. We sleep well at night knowing that our bonds reduce the volatility of our client’s account values. We also hold Gold and Silver in most client portfolios. Gold and Silver maintained their value this week.
Energy Policy
The bigger question that Japan’s nuclear calamity poses is its effect on energy policy in this country and around the world. As big as the events in Japan are the revolutionary events in Libya, Egypt and the Middle East are probably an even bigger factor contributing the the present uncertainty. The disaster in Japan calls into question the prudence of nuclear power as well as provides a potential turning point in our approach to energy policy.
But nothing is going to change right away. Nuclear power is the cheapest way to produce energy. Further, safe nuclear power seems possible. But that is an open debate. And its not anything that is going to be decided quickly, because nuclear energy is a huge part of the energy grids in the U.S., France, Japan, Russia, Germany, Canada and South Korea. The following are the primary nuclear energy producers:
Nuclear Power production Worldwide*
U.S. 105 Gigawatts 10 Gw under planning/construction
France 66 Gigawatts, 2 Gw under planning/construction
Japan 47 Gigawatts 20 Gw under planning/construction
Russia 23 Gigawatts 17 Gw under planning/construction
Germany 21 Gigawatts,
South Korea 18 Gigawatts 8 Gw under planning/construction
Canada 15 Gigawatts
UK 13 Gigawatts
China 9 Gigawatts 37 Gw under planning/construction
India 4 Gigawatts 10 Gw under planning/construction
Brazil 2 Gigawatts. 2 Gw under planning/construction
*Source: The Federation of Electric Power Companies of Japan & JP Morgan Research from 3/17/2011
Further, no matter what the debate elicits, it’s pretty unlikely to affect the energy policy in Sao Paolo, New Dehli or Beijing.
Infrastructure Investments
The infrastructure building and building codes of the 20th century reduced the fatalities from natural disasters, particularly earthquakes from the hundreds of thousands to the thousands. The US policy of refusing to invest in infrastructure, including renovating buildings, traffic and city design, and repairing our bridges is crazy. I believe that if the human tragedy of Japan and Africa is to serve any purpose it is to be a catalyst to renewed thinking about our energy policy as well as infrastructure investments.
Today
Today, March 18, the minister of Japan declared “We will rebuild.” I believe him. The dedication of the Japanese people is likely to bring much good tomorrow and in the years to come. If anything, the disaster in Japan reinforces the investment themes of the Bernanke printing press flooding the world with dollars to solve our ills. That’s why this week’s calamity reinforced our investment philosophy. My conviction in this regard is subject to change, but that’s my best estimation today.
Tomorrow
Tune in Tomorrow morning (Saturday morning) for the Rising Paycheck Money Show on KDIA AM 1640 at 11am-noon. I’ll be talking about Japan, energy policy and what it all might mean for your savings and retirement accounts. And I’d love to get your email with your questions to radio @ barnescapital.com
