Friday, March 18, 2011

Japan Earthquake and Its Possible Implications

Dear Readers,

I haven't posted here for long owing to my personal busy schedule which kept me away from stock markets and related events. Last week there was a magnitude 9 earthquake in Japan and Nikkei, Japan's stock market index, plummeted heavily after there were reports of possible meltdown and even possible 'criticality' of Japanese nuclear reactors. What it means is if the crisis goes out of control, there are chances of extreme radioactive pollution whose effect will not be limited to Japan and even Hawaii islands of US may feel the heat. I hope the situation does not go that far away  and all becomes well for Japanese people sooner.

On the developments in Japan almost all Asian markets reacted, some mildly down to some even positive (Indian markets). Most analysts talked about Japan's economy in real trouble with GDP falling etc etc. I agree with the loss of economy and its impact on GDP of Japan but I think this probably is the end of Japan's two decades long problem, economically.

Japan was struggling with deflation despite zero interest policy of Japanese Central Bank. Even Japan's Debt to GDP ratio had gone high up owing to the soft monetary policy. Whatever analysts think, I have this belief that some kind of destruction (Shumpeter's Creative Destruction) was necessary for Japan and that was being denied by BOJ and Japanese govt for two decades. Although a natural disaster like this one is not totally comparable nor even wanted, the reality is that this destruction of infrastructure caused by the earthquake and resulting tsunami may result into a positive start for Japanese economy.

Before I talk more about Japanese economy and the impact of this destruction on it, let me talk about some historical events. There have been so many natural and man-made disasters in the last century but I pick only the biggest ones. Let us start with WWII, certainly not a natural disaster but a man made horror. The last secular bull market started with the WWII. Then, what happened after 9/11? We all know the US markets posted big gains after the unfortunate event of 9/11. Although this can not be an event that could be compared in magnitude with WWII, but once again it showed how destruction did not lead to sustained stock market downside, instead it was the turning point! Then, let us revisit the 2004 South Asian tsunami, what happened? Indian and other affected Asian markets rallied sooner and even economies of these countries grew. Also, the Mumbai terrorist attacks in Oct 2008 coincided with a bottom for Indian markets! There are many other examples but the question is what's the logic?

Its actually simple. When there is a crisis in a place, there is in fact an opportunity for growth! Yes, the destructed place has to be rebuilt and so there is a flow of money towards the opportunity. It happened during and after WWI, WWII, and it must happen now, in Japan. How long it should take? I think answer depends on the actual situation of nuclear reactors and the radiation threat. If that stabilizes, then we may see Japan regrowing sooner and faster.

The initial reaction of Indian markets on the Japanese earthquake news was positive. Most probably this happened as investors felt foreign money would now flee from Japan and enter India. I think this is myopic vision and I see the possibility of exactly opposite happening in coming days.

I feel really sorry for the people of Japan who were affected by this disaster, and I have the deepest sympathy for them but this is the reality. The destruction, although very upsetting for many Japanese, may actually bring forward a new age of growth and economic prosperity in Japan. Ironic, but that's how things are sometimes!

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