The turmoil of the Japanese earthquake and tsunami and unrest in North Africa has failed to derail the bright progress of the global economy, says Guy Monson
THE G7’S CO-ORDINATED foreign exchange intervention in the yen is its first in over a decade, and is only the latest in a string of extraordinary policy decisions following the tragic set of crises unfolding in Japan. In comparison with the turmoil unfolding on the ground, though, the economic reaction to both this and the turbulence in North Africa is thankfully rather limited.
The year began with accelerating global growth, sky-high food and commodity prices, and overheating in the emerging world, but we are now seeing a modest (though likely welcome) reversal. Startlingly, the strong industrial growth that led the recovery in the US and Europe last year is continuing, despite production lost in Japan and a rekindled spike in the oil price (following events in the Middle East). Some surveys of US manufacturing have reported record levels of activity in industry, with similar findings in Europe and even the UK.
Similarly surprising is the fact that financial markets in the West have hardly reacted to the crises in Japan and the Gulf (when considered for the year so far). As yet, for 2011, the S&P500 is discreetly up, as well as European equities, and even the Nikkei Index has so far only witnessed a decline of just over 5 per cent. On the whole, world bond markets also remained composed; so far this year, US ten-year yields have barely dropped, while Japanese bonds (in spite of future funding costs of a minimum of $100 billion) are mostly unchanged once the brunt of the early days of yen intervention are included. Even the gold price has scarcely responded.
In comparison to the 2008 credit crisis, which began in world markets and then swelled to encompass the real economy, the current real-world crisis has been mostly disregarded by financial markets. This composure is in part attributable to highly accommodative central banks: the continuing quantitative easing programme in the US (which will probably run until June) has witnessed the weekly purchase of $10-15 billion of US Treasury bonds by the US Federal Reserve, while the European Central Bank remains energetic in its support of the continent’s peripheral banks. And the Bank of Japan is providing huge liquidity to its banking system, as well as an extension of its QE programme.
But the economic response to the crisis has also supported markets — a certain amount of correction in commodity prices, reduced Asian and Chinese growth expectations and globally lower interest-rate expectations are all seen as market-positive. Reports from global corporates suggest minimal significant impact — for the most part, global earnings momentum continues to appear healthy. Daimler Trucks, to give an example, announced a ‘significant’ 2011 sales increase.
It seems unavoidable that Japanese activity will decline for the moment, but, beyond the immediate power issues, rebuilding the country should prove growth-positive. The area directly affected by the earthquake represents around 4 per cent of Japan’s GDP, but the impact could theoretically be greater, as the region acts as a channel for broader production via its network of roads, ports and airports. The most material economic damage is likely to come from the loss in power-generation capabilities. Early estimates suggest an impact of minus 1 per cent on GDP growth in the first half of this year, which will probably be offset in the latter half.
Supposing that this power loss can be resolved smoothly, the effect of the crisis on growth in the medium term is potentially positive. Rebuilding and reconstructing the $150-250 billion of ruined assets should push up investment spending and economic growth in the years ahead. After the 1995 Kobe earthquake in Japan, capital spending surged; in the following two years, GDP growth was boosted to 2 per cent above its trend. The scale of the necessary reconstruction effort may be greater this time around, and therefore the medium-term impact on growth could also prove greater.
Japan’s central bank has reacted rapidly to the crisis, providing liquidity, increasing its QE programme and heading the G7’s only foreign-exchange intervention programme since 2000. By mid-March, the Bank of Japan had pumped around ¥34 trillion (£260 billion) into the system, securing sufficient liquidity for banking operations. A ¥5 trillion increase in the bank’s asset purchase programme (taking the programme up to ¥40 trillion) is perhaps of greater long-term significance. With a committed Bank of Japan supporting markets, the credit market has proven extremely well behaved, with minor impact as yet. Once these temporary measures are over, there will no doubt be a considerable programme of public spending, targeting infrastructure rebuilding in the worst-affected areas.
Adding to these stimulus measures, the aggressive spending programme announced in the Gulf in response to the large demonstrations in the region will be a boost to growth and global earnings, though it may also fuel further inflationary pressures.