Tuesday, 15 March 2011 07:01

Can Contagion Be Avoided Considering The Magnitude Of Japan's Woes?

My condolences truly go out to the people of Japan. A massive earthquake, a horrifyingly destructive tsunami, and then multiple nuclear emergencies and radiation poisoning is more distress than any nation had had to endure in such a short period of time in recent history. I am reticent to discuss the ramifications of such, alas that is the crux of the analysis of BoomBustBlog. I have noticed that many professional investors are detached from the real world causes and consequences of volatility and large swings in the markets. In a way, I can sort of understand. It's like playing a video game. All you are doing is pushing buttons in reactions to changing pixels on a glowing screen. Unfortunately, the reality of the matter is sometimes much more than that. Thus, as we go on to illustrate what I see will probably come out of this situation, let’s keep in mind that real people are getting hurt to very significant extent. Real children, real families, real grandparents...

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From CNBC: Japan Braces for Potential Radiation Catastrophe

Prime Minister Naoto Kan urged people within 30 km (18 miles) of the facility north of Tokyo to remain indoors and conserve power amid the world's most serious nuclear disaster since the Chernobyl disaster in Ukraine in 1986.

As concern about the crippling economic impact of the nuclear and earthquake disasters mounted, Japanese stocks fell as much as 14 percent before ending down 9.5 percent, compounding a slide of 7.6 percent the day before. The two-day fall has wiped some $620 billion off the market.


The French Embassy in Tokyo warned in an 1 am London time advisory that a low level of radioactive wind could reach the capital -- 240 km (150 miles) south of the plant -- in about 10 hours.

Also in the news, Nikkei Plummets as Panic Spreads, Futures Tumble Worldwide on Japan Nuclear Crisis and BoJ Pumps More Funds.

BOJ Fails to Contain Investor Panic as Nuclear Danger Rises

The Bank of Japan’s step to provide short-term liquidity and expand an asset-purchase program failed to contain investor panic today as the risk of nuclear radiation leaks north of Tokyo escalated.

Stocks Slide as Japan Plummets on Nuclear Concern; Oil Falls

Stocks dropped, with the Topix index posting its worst two-day plunge since 1987, and Japan’s default risk jumped as Prime Minister Naoto Kan said the danger of further leaks from a nuclear power plant damaged by the nation’s biggest earthquake was increasing. Commodities fell.

While at the same time, those countries on the other side of the world are wish-washing on how to climb out of the hole -  Euro-Area Nations Divided Over Method for Boosting Aid Facility

European governments remained divided over how to boost the rescue fund for debt-strapped countries, taking the gloss off a weekend pledge to step up the fight against the fiscal crisis.

As I type this at 5:34 am EST, S&P futures are down 35.70 points. Here's a snapshot of the rest of the world a couple of hours earlier.

STOXX 50 2793.95 -58.16 -2.04%
FTSE 100 5690.55 -84.69 -1.47%
CAC 40 3804.14 -73.90 -1.91%
DAX 6686.18 -180.45 -2.63%
FTSE MIB 21484.20 -320.15 -1.47%
Nikkei 8605.15 -1015.34 -10.55%
TOPIX 766.73 -80.23 -9.47%
Hang Seng 22678.20 -667.63 -2.86%
S&P/ASX 200 4528.70 -97.70 -2.11%
Shanghai 2896.26 -41.37 -1.41%

In January, I posted In said missive I illustrated that Japan's 200%+ debt to GDP ration, although not the same threat as Europe's lower but more immediate issues, simply cannot be ignored, as excerpted:

The Potential for Spillover Effects Simply Cannot Be Ignored If You Look At This From An Empirical Perspective

A key risk in sovereign default is the spillover effect due to interlinkages in the financial system, reference"Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?" Sovereign defaults transmit risks ACROSS asset classes, and a crisis in one country can easily engulf others due to cross border exposures. Empirical data points out that sovereign default are usually clustered. The Asian financial crisis of 1997–98, when sovereign debt problems hopscotched from economy to economy, is a testimony to what could happen to Europe this time around. In addition, the spillover effect also affects corporate bond yields as company’s ability to borrow money not only depends upon its own creditworthiness, but also on the financial health of its home-country. When investors lose confidence in the government's ability to use public finances they demand a premium to access capital to corporates, raising the financing costs. A downgrade in sovereign ratings/default also has negative affect on the stock markets.

The charts below show bond volatility and equity volatility across major markets - US, UK, Germany and Japan. Both equity markets and bond markets across geographies are strongly correlated thus demonstrating cross border intervention. In addition, we have also shown interlinks between equity and bond market demonstrating cross-asset correlation.

Last year, we introducing the “BoomBustBlog Sovereign Contagion Model“, wherein we spent many analyst man/months to create a realistic model to capture the potential for social unrest, financial and economic contagion as they could skip across sovereign borders, continents, asset classes and hemispheres. We are in the final stages of a significant update to this model, which still stands as what we consider a tour de force in realistic risk modeling.

The equity markets quoted towards the beginning of this post, and the debt markets clearly show the high correlation that I spoke of above. A country with a 200% debt/GDP ratio is simply not in the condition to handle near simultaneous earthquakes of historical magnitude, Tsunamis and multiple nuclear disasters without transmitting contagion to the world's already highly indebted countries who are on the margin as it is. Three clear potential calamities stand out.

First, In A Scramble For Liquidity, Lower Quality Debt (We All Know Who That Is) Will Get Thrown Out The Window

One is the claim from many insurance companies that they don't stand to lose much from claims. The property and life insurer's who did not explicitly cover earthquakes and tsunamis may be off the hook claim-wise, but radiation poisoning is not an act of God and can potentially (and unfortunately) send claims and reserves through the roof. No matter which way you look at it, insurer's are going to need liquidity - be it for business continuity, casualty, property, life and/or health. They are going to need it now, and for the the longer tail stuff as well. Where do you think they will get this liquidity from? Well, the BoJ is Pumping More Funds into the Japanese Economy, but they have been doing that for 21 years. The need now is greater than ever. The Japanese insurers (a large industry in Japan), are probably going to start selling off bond inventory, and that is going to pressure yields. The will sell off the most liquid stuff immediately (but hat will be ameliorated in part by the BOJ pumping cash in to support prices) and look to dump speculative experiments that will be difficult to move if spreads widen farther (if they are smart). That means any Eurozone periphery debt will be thrown out. Subscribers can download the current production contagion models below which clearly illustrate who said countries will be:

I'm sure you can all guess what may happen next, with the high volatility, correlation, and added selling pressures.

Second, Real Estate Is All About Location 3, or Location, Location, Location. There's Very Little That Is Worse For Your Real Estate Location Qualities Than Lethal Doses Of Radiation Poisoning

As you can see, Japan has had a very rough time of it real estate-wise over the last two decades. This situation will significantly exacerbate it, particularly with radioactive winds approaching Tokyo and the possibility of an evacuation existing.

From Reuters: Radiation fears spark panic buying, evacuations in Tokyo

Panic swept Tokyo on Tuesday after a rise in radioactive levels around an earthquake-hit nuclear power plant north of the city, causing some to leave the capital or stock up on food and supplies.


Embassies advised staff to leave affected areas, tourists cut short vacations and some multinational companies told staff to move from Tokyo out after low levels of radiation were detected in one of the world's biggest and most densely populated cities.


In one sign of the panic, Don Quixote, a multistory, 24-hour general store in Tokyo's Roppongi district, was sold out of radios, flashlights, candles, fuel cans and sleeping bags on Tuesday as a Reuters reported visited the shop.


... Winds over the troubled Fukushima Daiichi nuclear-power complex, about 240 km (150 miles) north of Tokyo, are blowing slowly southwesterly toward Tokyo but will shift westerly later on Tuesday, a weather official said.


Some scientists, however, urged Tokyo to stay calm.


"Radioactive material will reach Tokyo but it is not harmful to human bodies because it will be dissipated by the time it gets to Tokyo," said Koji Yamazaki, professor at Hokkaido University graduate school of environmental science.


"If the wind gets stronger, it means the material flies faster but it will be even more dispersed in the air."


University of Tokyo professor of bioengineering Hiroyuki Takahashi added: "If the nuclear fuel remains contained, there will be very little health risk."

Could you imagine trying to sell your apartment and having to explain that to the prospective buyers? Imagine if the buyers came back with the retort: "But the news reports from this morning read:  "The level seems very high, and there is still a very high risk of more radiation coming out," Prime Minsiter Naoto Kan said. Kan said most people have left the 20-kilometer evacuation zone around the plant, and he advised people within a 30-kilometer (19-mile) radius to stay indoors to avoid possible radiation poisoning. "It is likely that the level of radiation increased sharply due to a fire at Unit 4," Chief Cabinet Secretary Yukio Edano said. "Now we are talking about levels that can damage human health. These are readings taken near the area where we believe the releases are happening. Far away, the levels should be lower." UPDATE - Third Reactor Core Exposed to Air in Japan ... and Nuclear fuel rods fully exposed at Japan reactor - Jiji - Mar 14, 2011 · ... Nuclear fuel rods at aquake-stricken Japanese nuclear reactor are now fully exposed,Jiji ...


FLEEING TOKYO... The Czech Symphony Orchestra left Tokyo by bus for Ishikawa prefecture on the west coast.


"Some of them wanted to go home after the earthquake but it's pretty much impossible to get tickets for a hundred people now," said Hitomi Sakuma, a friend of the orchestra who was seeing them off at a Tokyo hotel. About 350 Japan-based expatriates at Infosys Technologies Ltd, India's second-largest software services exporter, are returning to India, its chief executive said.

As reported by the Star: 

Though Kan and other officials urged calm, Tuesday's developments fueled a growing panic in Japan and around the world amid widespread uncertainty over what would happen next. In the worst case scenario, one or more of the reactor cores would completely melt down, a disaster that could spew large amounts of radioactivity into the atmosphere.


“I worry a lot about fallout,” said Yuta Tadano, a 20-year-old pump technician at the Fukushima plant, who said he was in the complex when quake hit.


“If we could see it we could escape, but we can't,” he said, cradling his 4-month-old baby, Shoma, at an evacuation centre.


The radiation fears added to the catastrophe that has been unfolding in Japan, where at least 10,000 people are believed to have been killed and millions of people have spent four nights with little food, water or heating in near-freezing temperatures as they dealt with the loss of homes and loved ones. Up to 450,000 people are in temporary shelters.


Asia's richest country hasn't seen such hardship since World War II. The stock market plunged for a second day and a spate of panic buying saw stores running out of necessities, raising government fears that hoarding may hurt the delivery of emergency food aid to those who really need it.

...  Afterward, officials just south of the area reported up to 100 times the normal levels of radiation, Kyodo News agency reported. While those figures are worrying if there is prolonged exposure, they are far from fatal.


Tokyo reported slightly elevated radiation levels, but officials said the increase was too small to threaten the 39 million people in and around the capital, about 270 kilometres away. Closer to the stricken nuclear complex, the streets in the coastal city of Soma were empty as the few residents who remained there heeded the government's warning to stay indoors.


Kan and other officials warned there is danger of more leaks and told people living within 19 miles (30 kilometres) of the Fukushima Dai-ichi complex to stay indoors to avoid exposure that could make people sick.

... In Tokyo, slightly higher-than-normal radiation levels were detected Tuesday but officials insisted there are no health dangers. “The amount is extremely small, and it does not raise health concerns. It will not affect us,” Takayuki Fujiki, a Tokyo government official said. Kyodo reported that radiation levels nine times higher than normal were briefly detected in Kanagawa prefecture near Tokyo and that the Tokyo metropolitan government said it had detected a small amount of radioactive materials in the air. Edano said the radiation readings had fallen significantly by the evening.

Honestly, it is these "The situation is contained" comforts issued by government officials that should give the populace pause. Just ask the US citizens about the subprime crisis.

Third, At 200% Debt to GDP, Can Japan Afford This Without A Resustucturing?

This is the question of the day. I will go though the subscriber contagion models and trace the potential linkages of Japanese contagion in my next post on the topic. In the meantime, Why Japan at 200%+ Debt to GDP Is In Much Better Shape Than Much Of Indebted Europe.I have also made an FX trend model available for all to download. Its 10 mb, containing a lot of data, but you'll definitely get your money's worth. The model is available here: BoomBustBlog Complimentary FX Index model

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Related inflationary reading:

Inflation Cartoons From The BoomBustBog Constituency

The Spectre of Stagflation is STILL Raising Its Ugly Head!

Continuing the Deflation/Inflation/Stagflation/Depression/Recession Rant…

All Throughout Last Year and During the Inflation/Deflation Camp Debates, I Warned of the Risks of Stagflation. Did I Have a Point? Let’s Look at the Numbers Behind the Numbers…

BoomBustBlog China Focus: Inflation?

BoomBustBlog China Focus: Interest Rates

Chubble (The Unmistakeable, Yet Thoroughly Argued Chinese Bubble), Unemployed/Deleveraging Shopaholics Pushing Retail Stocks & Other News

Last modified on Thursday, 14 July 2011 05:01


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  • Comment Link Jim Wednesday, 16 March 2011 22:17 posted by Jim

    The Wall Street Journal today reported that many Japanese companies are repatriating assets into yen to hedge against domestic losses. Double-entry bookkeeping was invented in the 13th century as a way for Italian merchants to reconcile their real-time positions with the final debts of small private partnerships at the end of voyage. Unless you're in the habit of regularly drilling down on multi-national corporations, the reconciliation of currencies may not be immediately apparent from the news media.

  • Comment Link Jerry Wednesday, 16 March 2011 16:17 posted by Jerry

    I must be tooo negative....everytime I see our market go up under exteme situations, I think the Fed is again involved because so many seem to think it's psychological so you can fool all the (little) people....I've even wondered it the Fed isn't collaborating any increase in Japan's market and the Asia markets now again playing the same let's fool the (little) people..

  • Comment Link Reggie Middleton Wednesday, 16 March 2011 04:40 posted by Reggie Middleton

    It will have some effect on Apple's launch although I can't quantify the amount. It will also have an effect on the sourcing of other consumer electronic devices.

  • Comment Link Reggie Middleton Wednesday, 16 March 2011 04:39 posted by Reggie Middleton

    Outside of direct central bank manipulation I do not know the cause.

  • Comment Link Justin Wednesday, 16 March 2011 03:16 posted by Justin

    Any thoughts on the strength in the Yen as this nuclear thing has evolved?

    I know the "selling assets for Yen" explanation but this doesn't make sense to me. In selling their Yen or otherwise denominated assets they are concurrently buying Yen denominated assets, as in government bonds, bank deposits or in the case of physical cash, whatever garbage the BoJ has on its balance sheet.

    Or does nobody in finance understand the double entry bookkeeping system?

  • Comment Link weej Wednesday, 16 March 2011 00:28 posted by weej

    Hey Reggie- how do you think the Japan situation will affect Apple? IIR Apple has done a huge chunk of business over the past few years with all their new high margin products (iphone 3 & 4, ipad, etc). I'm sure they were planning to sell a whole lot of ipad2's in Japan over the next few months. Yet today they announced that they were cancelling the Japanese release of ipad2. Also sales of ipad2 in the US have been tracking below expectations. Will the Japanese nuclear meltdown be the pin that pops the AAPL bubble?

  • Comment Link Jim Tuesday, 15 March 2011 13:37 posted by Jim

    Japan has far more stringent building codes than elsewhere. They drill regularly, several thousands of people may die. It certainly is no Chernobyl, although it may be worse than Hurrican Katrina. I find it hard to believe that the markets are reacting simply to this event then. It is more likely that it reflects the lack of progress in restructuring Japan's labor market and financial system over the past two decades. The question is whether the world will lose patience in yen, despite the perennially low interest rates. China is slowly decreasing its dependence on the US, but its move upscale industrially and nationalism threaten to decouple it from Japan. If that triangle fall apart, then the US and Japan could find themselves dancing alone in the markets (which certainly would send rates upwards). The European Union's upcoming trade area with South Korea (remember who is attached to that peninsula) will have interesting ramifications that still aren't clear.

  • Comment Link Reggie Middleton Tuesday, 15 March 2011 13:14 posted by Reggie Middleton

    "The questions anyone needs to ask themselves are first, is what happened in Japan not orders of magnitude worse than anyone’s worst-case scenario."

    Strangely enough, this is a question that nobody seems to ask in the media. I was net short when it occurred, not because I saw it happening, but because there are just too many balls up in the air in order for at least one not to fall. Actually, it really seems as if quite a few will be falling.

  • Comment Link Reggie Middleton Tuesday, 15 March 2011 12:55 posted by Reggie Middleton

    Very interesting. So, if the chlorine corrodes the steel does this mean the containers will release (or are releasing) radioactive material?

  • Comment Link Frank Shoemaker Tuesday, 15 March 2011 11:58 posted by Frank Shoemaker

    How a reactor works is this. E=MC^2 mass can get turned into a lot of energy. U 235 when you hit it with a low speed neutron it tends to split in half. The two halves weigh less than the original U235 atom. The difference is a lot of energy. One of the A-bombs that was dropped on Japan has a mass converted to energy of one gram. Why they use U235 is that when it splits in half it releases 2 neutrons. This allows for you to lose one of them and still have a sustaining reaction this is what is called a chain reaction. If it is self sustaining but self limiting it is called critical. If it grows on an exponential curve, that is if more than one neutron is reused per fission (that is what it is called when you split U235 in half) then you have a super critical mass. The unit of measure for criticality and supper criticality is dollars and cents. Reactors are painstakingly designed so that they are very hard to run supercritical.

    Melt down is what happens when the cooling fails. The heat released by the continued decay of fission products (they are mostly unstable themselves and give off radiation for quite some time, but the short half life ones are the ones that are most trouble after a shut down the heat drops quickly over several days after shutdown so the longer they can keep things under control the better for everyone if they lose it later.) is about 7% of the reactor power just after shutdown.

    Japan has some boiling water N reactors. They need more water after shutdown that non boiling water reactors do. And the diesels didn’t work. They are pumping sea water in the reactors. This is the death of the reactors. They will never be reused after this. The problem is corrosion. Chlorine isn’t nice on stainless steel.

    I hope this is some help to you. Google the terms I wrote and spend some time reading.

  • Comment Link Mark Hankins Tuesday, 15 March 2011 11:14 posted by Mark Hankins

    The questions anyone needs to ask themselves are first, is what happened in Japan not orders of magnitude worse than anyone's worst-case scenario. So any business with a direct exposure to Japanese is basically toast to the extent of that direct exposure, and will be damaged to the extent it is exposed to Japanese manufacturing inputs from a country that has lost a significant fraction of its generating capacity while it copes with the human tragedy and cleanup.

    Second, who is not exposed to the knock-on effects of Japan's woes. I would argue that that would a few tribesmen in Africa for whom a Coke bottle would represent a significant technological incursion.

    You can print funny money, but you can't make crucial electronic parts out of ones and zeroes. The latter can be a bottleneck in any economy if Japan cannot sustain volume production.

  • Comment Link Jim Tuesday, 15 March 2011 10:58 posted by Jim

    Perhaps, the most sobering figure today is that China was a net seller of US Treasuries in January and Japan a net buyer. Amidst all the hubub in "Der Spiegel" today about their nuclear plants, the little article on the state-owned banks is particularly sobering. As the US sorts out the junk in all those swaps, the losses will spread not so much to Germany's international banks as to the banks tied to its Laender, or states. The article notes that it will hit Hamburg and the industrialized Rhineland particularly hard. This western belt of Germany also happens to be where Germany's nuclear plants are concentrated, its ports are located, and its factories are focused. The southern belt from Stuttgart to Munich and into Austria looks better off, but state resources for unemployment and education will bring painful changes in 2013 to European politics.

    The curious fact is that China is decoupling from US trade toward European and Middle Eastern trade, while the US is coupling to Japan and Latin America. Just as the Trans-Atlantic trade involved African slavery and European finished goods, we seem to be seeing a triangle form between Europe, Africa and Asia on one side AND Anglo-America, Latin America and Asia on the other. It could prove very disruptive for the Northeastern US and the structures evolved over the past five-hundred years. In the meanwhile, Reggie's warnings about Japan are timely. It sounds like the old anecdote about the racoon and dog that are chained together in the stream. The dog may be bigger, but the stream is stronger than either the number one and number three economies.

  • Comment Link Jcaunter Tuesday, 15 March 2011 10:45 posted by Jcaunter

    I myself would love to know how nuclear pants work. In other news, Buy The eFfing Dip.

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