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How Japan's Earthquake Will Impact the Global Economy

As the crisis in Japan moved from natural disaster to potential nuclear meltdown, investors around the world weighed the mounting economic and financial uncertainty.

As the crisis in Japan moved from natural disaster to potential nuclear meltdown, investors around the world weighed the mounting economic and financial uncertainty.

Japanese authorities removed emergency workers from the third reactor at Fukushima Daiichi Nuclear Power Station following an explosion there on Tuesday morning, which damaged a containment structure and raised the odds of greater radioactive emissions. Without workers on hand, the odds of a meltdown appeared to be higher. However, water levels in the reactor began to rise later in the day, and radiation levelsbegan to fall.

Equity markets around the world declined amid fears that the earthquake and tsunami that hit the country on March 11, damaging nuclear power facilities, will slow economic growth and hurt asset prices. On Tuesday, Japan’s Nikkei 225 index fell 10.6 percent, extending a 6.2 percent loss on Monday. It was the deepest two-day drop since 1987. Stocks in many other markets around the world declined too. S&P 500 futures fell 2.8 percent in New York on Tuesday morning. The S&P 500 fell 0.6 percent on Monday. Treasury prices rose.

Japanese stocks are high, relative to global markets. And many experts believe that U.S. equities may be due for a correction as well. The crisis in Japan, compounding geopolitical risks in the Middle East, could affect equity values for an indeterminate amount of time.

“Since Japanese equities have been out-performing global equities year to date, we believe recent events will prompt profit taking and expect investors to remain on the sidelines near term until there is greater clarity on the repercussions of the disaster on prices and on the outlook for oil prices,” Goldman Sachs analyst Kathy Matsui said in a note to investors.

“It’s a negative for equity markets,” says Eric Lascelles, chief economist at RBC Global Asset Management.

Manufacturers from autos, to semiconductors and steel have temporarily shut down operations in parts of Japan. That has disrupted the flow of goods around the world. Japan’s semiconductors are used in Apple Computer products and South Korean consumer electronics. Shipbuilders in South Korea count on steel from Japan. Consumers and auto dealers around the world will be feel the brunt of auto plant shutdowns in Korea. And luxury goods makers are expected to lose business as exports to Japan slow down. Shares of Burberry Group fell 4.3 percent.

The implications for the nuclear energy industry will be negative for the short term, and possibly for the long term, according to Lascelles.

The cost to insurers well may rival the record $62 billion that followed Hurricane Katrina. “One question is whether this will turn out to be the largest insurance loss of all time,” Lascelles said. Shares of Hartford Financial Group, which derives about 15 percent of its revenue from Japan, fell about 2.8 percent.

He doubts that the crisis will bring down an insurance company. But the losses could lead to higher insurance rates for customers around the world. And as insurance company raise cash to pay off claims, but may be forced to sell assets, thereby hurting the values of seemingly unrelated equities around the world. While the scale of such forced selling relative to the size of global markets won’t be huge, it could still be a factor for investors to consider.

As recovery and rebuilding efforts get underway, companies in the construction sector could benefit, though.

It could be sometime before the implications for various sectors, from insurance, to technology, manufacturing and construction, are fully priced into the market, according to Lascelles. “These trends still have some legs. They have some way to go,” he said.

It remains to be seen how the crisis will affect the Japanese economy itself. The optimistic view, Lascelles said, is that it will provide the growth catalyst that Japan has needed for decades.

But the rebuilding efforts will create more fiscal strain on Japan, where the ratio of debt to GDP already is 200 percent, compared to 90 percent in the U.S. Japan is “chronically under insured,” according to Lascelles. That means that the government will pick up the tab for a particularly large part of the recovery effort, pushing the level of public debt perhaps even higher.

Japan’s high debt level has been manageable because of extremely low interest rates, and the fact that it is funded domestically. The country isn’t overly dependent on foreign reserves. But if the debt level goes much higher, that balance could be thrown off.

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