Uphill battle for Japan. How can they fight it?

While the situation is extremely tense in Japan at the moment with all eyes set on the Fukushima Daiichi Nuclear Plant, the Japanese markets are open and the obvious, not ethic at all but expected nonetheless, has happened. The Nikkei plummeted more than 11% in the earthquake's aftermath just to regain more than 5% today. Japan is now officially the playground for avid speculators and this can do no good to the forthcoming Japan recovery. 

It is quite difficult to ask for stability in the markets when the country itself is still (literally) shaking, but investors and speculators should leave Japan some room to breath, for the greater good. Japan is still one of the biggest economies worldwide; playing against it just to make some easy money now is quite a stupid, short-sighted and naive thing to do and could have heavy consequences in the future. But we know human stupidity is second only to human greed, and that you cannot expect nothing good from the same people that invented subprime-mortgage-backed securities and thus brought the world economy to its knees... So let us analyze what Japan can do from here on.

Credit: Yahoo! Finance

Japan's instruments for recovery
Japan's economy is one of a kind, after booming heavily during the eighties, it entered a phase the Japanese call "The lost decade", stagflation after their asset bubble burst has plagued the economy since then. The global crisis we have been suffering since 2008 has not helped Japan totally get out of their slump at all, even though before said crisis Japan showed promising signs of recovery with GDP growths better than Europe or the US. Still, Japan is the world's third biggest economy after USA and China so it will not be bare-handed through its long, hard, recovery.

Japan's earthquake biggest replica: the economic one

First of all, my thoughts are with the Japanese people in these difficult moments. I am sure being such a hard-working, disciplined and respectful country they will have no (unmanageable) problems getting over it very soon. 

Earthquakes as big as the one that hit Japan last night are always followed by numerous replicas of different strength. These replicas can last for several days until the tectonic plates 'settle down' again. Well, we have begun to see what can be the biggest and more widespread replicas of said earthquake: the economic one. Few hours have passed since the disaster and we can already see the effects on the markets: oil prices, gold and stocks go steeply down and the german bond and the US dollar go up. Pure textbook reaction.

ECB raising interest rates. Damage control?

Take a quick look at the news an see how many times the expression 'raising tensions' appears on articles lately when talking about the situation in the Middle East. I am sure you do not have enough fingers to count them... Now take this same expression but exchange the word 'tensions' by 'interest rates' and see everybody panic and run for their lives. Although we have lived (and we are still living) one of history's longest period of low interest rates, people keep asking for more. Governments and enterprises around the world have grown so accustomed to debt issuing and uncontrolled spending thanks to cheap money that mentioning the slightest interest rate hike makes them shiver.

The key factors to justify a (slight) interest rates raise are all there though: we have growing core inflation, uncontrolled energy prices, excessive debt and severely depreciated currencies. On the other side we have a weak, mostly artificial recovery (already mentioned), that depends heavily on the availability of cheap money. Which side has a more important impact on the future status of the economy? It is clearly the first one, no hesitation. The Middle East turmoil is not coming to an end soon, and until it does the oil barrel price will keep rising, putting even more pressure on inflation control measures.

More inflation in the actual scenario we are facing would kill all recovery aspirations on the medium and long-term, even if it now seems detrimental for the short-term.

Do not get me wrong, as of now, a raise in interest rates will be hard to handle, specially for debt-burdened countries like Greece, Ireland or Portugal. It would be bad for Spain too even if its debt situation is marginally better, because all the semi-public savings banks (called 'Cajas de Ahorros') are now undergoing reforms to transform themselves into normal banks. A process that needs, and will need, a lot of funding and bond issuing on their part. For these troubled countries higher interest rates mean only one thing: more expensive financing, that is all they can think of when they hear these words.

The US Dollar not-so-free fall

When talking about international trading and investing everybody has grown accustomed to the same face, the US Dollar. It was at the core of any transaction, it denominated almost all the financial instruments you could think of and it was the shelter everybody looked for when things got ugly (this last one was shared with gold obviously). But this familiar face seems to be aging quickly for a number of reasons and, most importantly, it does not seem to care about it.

This omnipresence of the USD has always been key for the US economy, as it has allowed for the US to issue more and more debt at quite low prices independently of the markets situation. The perceived-risk of the US debt had always been very low (notice the past tense here). The US government of course knew this, and used it on its favor but they have been using the strategy for too long and too hard. As it happens with everything, if you overuse and stress something for long enough, it breaks...

EUR-USD exchange rate. Credit: Yahoo!

 

Tuning down inflation

Falling into deflation or stagflation has always been one of the greatest fear for politicians, economists and enterprises. A negative inflation rate theoretically means less money is available, in turn that means less credit and everybody knows what that means in a debt-dependent world like ours. Also deflation is correlated with lower prices, which people tend to associate with depressed economic growth. Whether one agrees with this affirmation or not, during last year's credit crunch it made some sense to be fearing deflation and its consequences,  thus no one worried about currency devaluation and general credit easiness to avoid it all costs.

Now, after the crunch is mostly forgotten and credit channels work again as normal, it begins to look like a flagrant excuse to keep interest rates at all-time lows and to support the worrying commodities rally. 

Strangely, some economists are still asking for a moderately higher inflation as a way to increase competitivity and as a way to cut salaries inadvertently (you cannot lower them without complaints, but you can make them effectively lower by increasing inflation) to boost employment. Everybody knows how to raise inflation, what is difficult is controlling its raise. Raising inflation when official levels are well under 4% would no be a problem by itself, the issue here is that official inflation levels are all wrong.

Davos tells the world to be optimistic, the world does not care.

The one-word conclusion one could take from the Davos' World Economic Forum (WEF) 2011 meeting from last week would be "Optimism" because that was what every big corporation CEO and every government leader were continuously saying, but everybody knows saying something a lot of times does not make it more real than saying it for the first time. 

For sure this optimism cannot be based on the Global Risks 2011 report that the World Economic Forum published because the data shown there is quite worrying. Let us have a quick look at this data.