Cembalest and JP Morgan on Japan

Michael Cembalest is Chief Investment Officer for JP Morgan Chase Private Bank, and I always enjoy reading his global investment research bulletins. His current piece has some great insights about Japan from the geopolitical and historical sides. He shows that after the WWII, when Japanese industrial production hit its nadir in 1946, it took just six years to recover to the normalized prior high, and Japan was not advantaged like Europe by the Marshall Plan.

As economic writers have talked about "Lost Decades," and we read consistent gloom about the demographics, high savings rates, and interest on government debt being fifty percent of revenues, here is an excerpt from the recent JP Morgan Chase bulletin:

"Japan faces a lot of challenges, such as poor demographics, ongoing deflationary pressures and the worst debt dynamics in the world. However, as we wrote last August, Japan’s domestic debt market is held 93% domestically, rather than relying on the kindness of strangers (like the U.S. or parts of Europe). Japan also has the ability to mobilize the investment accounts of nationalized banks and insurance companies (Yucho, Kampo), which have accumulated over 300 trillion yen of JGBs in the last decade."

Not relying on the kindness of strangers or on their currency being a global reserve currency is a big deal. Cembalest also puts together their Middle East research to say that Japan, and the world, should not feel a secular sting from rising energy prices:

"Japan is the world’s third largest oil importer, the largest importer of thermal coal, and the largest importer of liquid natural gas (2). One would think that with 6%-7% of the electrical grid permanently offline (3) and another 7% of the non-nuclear grid temporarily affected, that energy prices would be surging across the board. But there are 3 caveats contributing to lower crude oil prices:

** First, to replace lost electricity, Japan needs ~300 thousand barrels per day of oil equivalents (mostly for diesel generators). In the context of the global oil supplies and 3.5-5.0 mm bpd of spare capacity, this should be manageable, particularly since much of Japan’s incremental energy imports will take the form of liquid natural gas
** Second, the decline in economic output associated with a disaster like this tends to depress energy demand
** Third, the Saudi Day of Rage passed without much incident, and Qaddafi has retaken most of the oil facilities. On our conference call today, Vali Nasr highlighted that this calm should not be interpreted as a broad sanction for the status quo. Saudi Arabia is still caught between what he described as 3 pincer movements of Shi’a populations (in Yemen, Bahrain and Saudi Arabia’s own Eastern Province; see chart on last page) looking for some combination of wealth, political freedoms and religious autonomy. But for now, the stability of oil exports in the Gulf region looks secure. As we discussed on the conference call today, the history of supply interruptions based on weather or geopolitical events mostly points toward a recovery in exports once the immediate event has passed. Only in the case of the double-barreled 1979 Iranian Revolution followed by the war with Iraq, did we see a country experience a sudden and unrecoverable decline in oil exports." Source: "Matter over Mind," JP Morgan Chase, Inc. ,2011.

On the philosophical side of things, there's often nothing like a crisis to bring people together. After 9/11, I always felt that one of the terrorists' misjudgements was to have planned their heinous strike on New York, which they felt to be the center of global capitalism. It is also the singular, global metropolis with a virtually unlimited well of resourcefulness, grit, fortitude, compassion and openness to working together for a common cause. When the disaster struck, petty squabbles and power grabs were forgotten; for the rest of the country, the old "let Manhattan drift out to sea" sentiments were replaced by the feeling that "we're all New Yorkers now." The images of President Bush throwing a baseball from the mound at Yankee Stadium vividly showed everyone that we had taken the blow and that, as a nation we wouldn't be overcome, even by a well conceived strike at the heart of our greatest city.

If the political leaders are up to it in Japan, a similar, great national unity and drive to rebuild can come out of the current crisis. Even as Japanese society has become secularized in the press, there are deep spiritual traditions among the populace that can provide a firm foundation for the months and years ahead. All the people will be looking for is leadership from the major parties. Emperor Akihito's remarks were of more than symbolic importance, as he is a revered figure to the Japanese; his urge to "live strong for tomorrow" is an aphorism straight out of Japanese martial arts traditions.

It certainly is in the tradition of U.S. international engagement to help a major trading partner, and Western European leaders should also follow suit. Hopefully, GE is sending their best teams of reactor engineers and scientists to learn from what went wrong with the containment vessel design and safeguards, and to also help their customers right things without looking at their lawyers for approval. There will have to be much grieving, since no one knows what the death tolls are; there's also a lot of uncertainty about the levels of continuing radiation exposure and their spread, but let's hope that this crisis and its aftermath can be a catalyst for Japan coming out of its economic desert experience, which would benefit the entire global economy.