Tohuko vs. Kobe

Tohuko vs. Kobe
Bill Witherell, Chief Global Economist
www.cumber.com
March 13, 2011

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It is too soon to develop good estimates of the likely economic and financial effects of last Friday’s massive earthquake and subsequent devastating tsunami, particularly with the situation in the damaged nuclear plants still unresolved. However, a comparison with the effects of the major earthquake that struck Kobe, Japan on January 17, 1995, may provide some useful reference points.

That earthquake, known in the US as the “Kobe Earthquake” and officially in Japan as “The Great Hanshin-Awaji Earthquake Disaster,” measured 6.8 in magnitude, compared with 8.9 for the Tohoku earthquake. The magnitude scale used by the US Geological Service is not linear. Friends in Japan have indicated that the energy released by last Friday’s quake was some 200 times that released by the Kobe quake. Unlike the Kobe quake, the Tohoku quake was centered offshore, generating the tsunami.

The Kobe quake struck at Japan’s industrial heartland. The affected regions accounted for 12.4% of Japan’s GDP in 1995. The five prefectures most affected by the Tohoku quake are not as industrialized as the Kobe quake region. They account for about 7.8% of GDP.

Following the Kobe quake, industrial production dropped in the month of January but then advanced by 2.2% in February and 1% in March. The effect on Japan’s GDP was imperceptible. That was despite the estimated $120 billion in damages (at today’s exchange rate), which then equaled 2.5% of Japan’s GDP.

It has often been the case that the effect of a natural disaster on a nation’s economic growth turns out to be less than initially expected. In 1995, the Japanese economy had considerable spare capacity that could be used to offset the reduced production from the area affected by the quake. That situation is also present today in Japan. While the Japanese economy expanded at a 3.9% clip last year, better than many other advanced economies, it remains well below full-capacity production levels.

Another positive factor is the announcement by Governor Masaski Shirakawa of the Bank of Japan that he is ready to unleash “massive” liquidity to assure the stability of Japan’s financial system and to meet the credit needs of the affected region. Monday morning, the Bank of Japan followed through with an $85-billion injection into the markets. Also, Prime Minister Kan has indicated the government is preparing a major fiscal package. While increased government outlays will add to the country’s excessive debt, this longer-term consideration will not deter the government from taking action needed to meet this crisis.

In view of the above considerations and the Kobe precedent, some analysts are already predicting that the effects of the Tohoku earthquake on Japan’s economy will be minor and mostly transitory. We hope this will prove to be the case, but based on the limited information we have to date, we think there is a certain risk the Japanese economy will be hit harder and take longer to adjust than was the case in 1995.

The Japanese equity market was hit immediately in 1995 by the Kobe quake, with the Nikkei 225 benchmark index plunging 8% in the following week. The market continued to trend downward through June, with the decline reaching 24.4% by the end of June. Of course, other factors were at play, including heightened US-Japan trade tensions, but it is interesting to note that the apparent effect on equity investor attitudes was considerably more adverse than the macroeconomic developments would imply. The Nikkei 225 regained its pre-quake level by mid-December 1995.

The Tohoku quake, tsunami, and still unfolding nuclear crisis are clearly having a traumatic effect on Japan, the worst crisis Japan has suffered since World War II. We do not expect investor and consumer confidence to recover rapidly. The Nikkei 225 dropped 1.7% in the 14 minutes the market remained open after the quake last Friday. Monday morning the market opened down an additional 5%. Eventually this market will likely offer a buying opportunity, but it is far too soon to judge when that will be the case.

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This commentary was written by Bill Witherell, Cumberland’s Chief Global Economist. He joined Cumberland after years of experience at the OECD in Paris.

His bio is found on Cumberland’s home page, www.cumber.com. He can be reached at Bill.Witherell-at-cumber.com.