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So Now Earthquakes are Bullish on a Country and its Currency

The devastation and loss of life from a massive 8.9 earthquake are yet to be quantified.  The quake, among the biggest ever recorded in the world was 8,000 times stronger than the one which devastated Christchurch New Zealand last month.  This offshore quake caused a tsunami that flooded north east Japan, and hundreds, perhaps thousands of boats were washed ashore.  An untold number  of buildings were damaged, broken gas mains resulted in fires, train service north of Tokyo has been halted, oil refineries caught fire, and there is concern for the safety of exiting nuclear power plants.

It seems inappropriate that pundits comment on the economic impact when the tragedy is still unfolding, but markets move first and the mourning come later.  The suggestion that the rebuilding after the destruction will give a boost to the lethargic Japanese economy  seems erroneous.  Replacing functional infrastructure destroyed by an act of nature does not seem like a recipe for economic stimulation or growth, unless you are a Keynesian.  Merely replacing what was lost does not get you ahead. 

Initially the yen lost ground to the USD,  with the greenback strengthening to 83,30 yen before turning around and quickly selling off to a low of 81.65.  Market observers then recalled what happened after the tragic Kobe earthquake in 1995.  Although the Nikkei average was under great pressure, and the economy had massive damage, the yen gained 20% against the USD.  So it seems they concluded earthquakes are bullish on the yen, and earthquakes cause instant repatriation of monies from abroad.

There may be some factors that will work against this conclusion.  Yes tremendous sums of money will be need for the damage clean up, and the reconstruction.  Insurance stocks, hard hit today because they will have massive claims to settle in Japan, will not be the only source of rebuilding funds.  Public sector funding will also be needed.  With the Japanese government currently dependent on the issuance of new government borrowings to pay for their massive deficit, a deficit which amounts to about 200% of the GDP, rates could climb.  Currently tax receipts cover only about 55% of annual spending with new government loans required to finance the rest.

The Japanese are able to carry this massive debt because rates  are very low, .22% for two year notes and 1.25% for ten year paper.  What happens if the need to borrow more money results in higher rates?  Will the Bank of Japan then increase the money supply following the Bernanke QE II example?  This action was bearish the USD and we suspect it would have a similar result on the yen.  With the US QE II winding down, and Japan's potential program in the wings, which currency do you prefer to buy?

Recently yen strength has been a concern for the Japanese Finance Minister and the Japanese exporters, and they both think a strong yen is injurious to the economic recovery.  Do they want a stronger yen now?

Another concern about the Japanese economic strength going forward is the data coming out of China, Japans largest trading partner.  Yesterday the Chinese PPI was released, a y/y increase of 7.2%, higher than the 6.6% in the previous period.   This illustrates the Chinese inflation problem continues, and this is before higher oil prices are included.  Chinese efforts to slow their economy may provide the Japanese with a headwind, slowing the Japanese economy.

Today's sell off in the USD/JPY had taken us down to the bottom of the recent trading range, and we think this is in a buying range.  The theory that Japan is a safe haven, a good place to park your scared money seem like an incorrect fable passed down from another generation.  It looks to us like the risk is 100 points, and a return to the 84 handle might be possible.