Tuesday, 15 March 2011 11:01

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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Last modified on Thursday, 14 July 2011 09:01