Global economy to take a beating after tsunami

TOKYO, Japan — The scale of the disaster caused by the massive earthquake and tsunami in Japan, damage to the world’s third-largest economy and the threat of nuclear meltdowns, are likely to shake the fragile confidence of global financial markets already on edge due to events across the oil-producing Arab world.

“There's set to be a flight from risk across global financial markets,” said a Tokyo-based trader at a U.S. financial firm who had not been authorized to talk publicly.

With the threat from potential shortages of oil and other resources already weighing on the minds of investors across the globe, the horrific events in Japan look set to further worsen sentiment in the financial markets.

Japan itself has been experiencing a stuttering recovery from the global financial crisis, by which it was struck the hardest of any of the major economies. Japan’s auto giants shut down production over the weekend, along with many other large industrial sectors.

Tokyo Electric Power Company (TEPCO), operator of the three nuclear power reactors currently battling overheating problems, has announced rolling power outages from Monday across many of the regions outside the capital that are home to major manufacturers. Tokyo itself is to be spared, for now anyway.

Japanese national debt — at around 200 percent of GDP — is already higher than any country except Zimbabwe, and the recovery and rebuilding required after the quake can only exacerbate this. A quarter of tax revenue in Japan is already taken up by servicing the debt mountain and this is only sustainable because the interest paid on it is so low. If the rates on Japanese Government Bonds (JGB) rose considerably then default could be a real possibility.

“The way this could affect JGBs is a hard one to call: uncertain times usually see people gravitating toward the safety of bonds,” said the Tokyo trader, “but the amount of money that will be needed for reconstruction is going to be huge, and this will inevitably make the Japanese national deficit even worse.”

The yen lost strength just after the quake, as might be expected after such a major disaster, but has since actually gone back up to higher than it had been trading prior to Friday. The same phenomenon occurred after the massive Kobe earthquake in 1995, caused by Japanese government, companies and investors selling overseas assets and bringing money back home.

If the Japanese government does have to repatriate money to pay for rebuilding, a likely source will be U.S. Treasury bonds — of which it is a major holder — putting more pressure on the straining U.S. public finances.

For one foreign worker from Tokyo's financial sector, who was at Narita International Airport on Sunday, concerns of rising or falling indices were the last thing on his mind, “I’m on the next flight to the U.S. and not coming back until the situation with the nuclear plants is under control. I don’t care what’s happening on the markets.”