Global Crisis

U.S. Economic Policy Not Changing In Response To Japan As Officials See Little Risk

Posted on Sunday, March 20, 2011

American policy makers are expressing assurance that the ongoing crisis in Japan will not affect the tenuous economic recovery underway in the United States, and anticipate no additional measures to spur growth.
Friday's 9.0-magnitude earthquake off the northeastern coast of Japan has sent financial markets into a tailspin. Since last Thursday's close, the Standard & Poor's 500 Index is down 2.9 percent through Tuesday, hitting a six-week low. Japan's Nikkei 225 slid 17.5 percent over the same period. The MSCI All-Country World Index, which tracks large stock exchanges, dropped nearly three percent.
Officials don't share investors' concerns, though.
"Our focus and attention is going to be on trying to help them make sure they can help meet the humanitarian challenge and the reconstruction challenge," Treasury Secretary Timothy Geithner told a Senate committee Tuesday in response to a question about possible risks to the U.S. The disaster in Japan does not pose a significant risk to the U.S. economy and Japan is wealthy enough to pay for its own reconstruction, he added.
The Federal Reserve's main policy-making body, which sets interest rates affecting economies across the globe, similarly declined to address possible concerns about Japan in a Tuesday statement after its latest meeting. In fact, the Federal Open Market Committee upgraded its view of the economy, saying the recovery is on a "firmer footing."
Federal officials have not publicly pledged any economic policy measures to shield the American economy from risks tied to Japan. And given the current outlook, they're not likely to, expert observers say.
"Probably nothing of real substance in response to the earthquake will be done domestically," said Jon Haveman, who served as a senior economist on President Bill Clinton's Council of Economic Advisers, and who now owns the San Francisco-based consulting firm Compass Economics. "If they do anything in the next month or so, it will have to rely on indicators that are not traditional. It will have to rely on evidence that certain activities in either or both economies have been materially affected, in an obvious way."
The devastation from last week's earthquake and tsunami has stalled Japanese exports and compromised the country's power supply, inciting trade disruptions that could affect economies around the globe. With infrastructure and factories destroyed, major companies, such as Toyota and Sony, have shut down part of their operations. The automotive and technology sectors, which economists have hailed as key sources of global growth, now face stalls.
But policy makers in Washington have not publicly taken steps to shield the American economy, and leading economists say such measures likely won't be needed. A trade disruption is the principal economic risk emerging from last week's disaster, economists say. Japan exports certain components that are necessary to produce cars and high-tech gadgets. About 40 percent of the world's flash memory chips, and a fifth of the world's semiconductors, come from Japan. Crucial auto parts, which are used worldwide to make cars, also come from that country.
But, according to many accounts, a shortage will have only temporary and modest effects on the U.S. Any disruption in Japan's car part supply will be corrected by reserves in this country, and will probably not cause any lasting stall to production, according a Wednesday note from Goldman Sachs.
"There are often alternative sources of supply," said Robert Feldman, chief economist for Morgan Stanley in Japan, who spoke by phone from Tokyo. Feldman warned that the disaster could cripple Japan's economy for months to come, but added, "The impact on the U.S. will not be huge."
Roughly 5 percent of U.S. exports are sold in Japan, totalling less than 1 percent of U.S. economic output, according to Goldman Sachs. That trade channel won't face any significant strain, economists say. Exports to Japan might even increase, as that country buys materials and equipment from abroad to rebuild.
Other potential threats will be similarly minimal, economists say. Japan, already the world's most indebted country, will likely have to borrow more money to pay for the reconstruction process. In theory, that could prompt the country with the second-largest holdings of U.S. debt to slow its purchases of Treasuries as it attempts to increase its cash. If demand for U.S. government bonds weakens, that could raise interest rates, potentially threatening the U.S. economic recovery.
But economists don't see that scenario playing out.
"That could put some upward pressure on U.S. interest rates," said Mark Zandi, chief economist of Moody's Analytics. "But again, the numbers here are quite small. We may be talking basis points, not tens of basis points."
The White House declined to discuss how the events in Japan may affect the American economy. At a briefing with reporters in Washington, White House press secretary Jay Carney said the government is keeping a close eye on the economic impact of the disaster.
"We're monitoring, as we do always, the global economic environment, but we stand ready to assist the Japanese who are our friends and allies in any way that we can," Carney said Monday. "It's important to remember that the Japanese have demonstrated a great resiliency and ability to pull together during times of adversity, and we are confident that they will overcome this challenge and recover from this tragedy."
Publicly, the U.S. government has not outlined any explicitly economic policy in response to Japan. But behind the scenes, officials may be preparing specific measures to stave off a financial crisis, said Edwin Truman, who served from 1998 to 2001 as assistant secretary of the U.S. Treasury for International Affairs.
A common caveat among economists' forecasts is that the economic situation is still developing, and unforeseen risks could emerge. The U.S. government, Truman said, may be preparing for at least one of those risks.
"If you have a 16 percent drop in the [Japanese] stock market, that could raise questions about certain Japanese financial institutions," said Truman, currently a senior fellow at the Peterson Institute for International Economics, in Washington. "You can be confident that the Treasury and the Federal Reserve have said, 'We stand ready to help.'"
If Japanese banks were to face a crisis, U.S. banks would be exposed to losses. As of the end of September, U.S. banks held about $305 billion worth of claims against Japanese banks, according to the most recent data from the Bank for International Settlements. The figures are measured on an "immediate borrower" basis, which assigns claims to the immediate counter-parties in deals.
Truman compared the current situation to the aftermath of the terrorist attacks of September 2001, saying that Federal officials are likely preparing to bolster defenses against financial trouble. Part of that defense could be a pledge to support Japanese banks, Truman said. When the U.S. government lends money to foreign financial institutions, it does so indirectly, through those countries' central banks.
The stimulative policy in the U.S. is scheduled to change this summer, when the Federal Reserve's asset-purchase program ends in June. Since the beginning of the so-called quantitative easing policy, 70 percent of annualized U.S. debt issuance has been bought by the Fed, according to Bill Gross of PIMCO, who runs the world's biggest bond fund. The Fed is trying to increase the flow of cash and keep the country's interest rates low.
But when the Fed stops buying Treasuries, it's unclear who will fill the gap, Gross said.
If, at that point, Japan has eased its own purchases of U.S. debt, the American economy could face a new risk, economists note.
"One important buyer is now out of the market, probably," said Bernard Baumohl, chief economist of the Economic Outlook Group, who until recently stood out for his relatively optimistic forecasts.
If demand for Treasuries slackens, that could raise interest rates, making borrowing more expensive, and threatening the recovery that in recent months has seemed to be building momentum.
"It all depends on whether the private sector will find greater interest in buying Treasuries at a higher rate," Baumohl said. "If they do, that solves that problem. If they don't, the Federal Reserve has a whole different set of circumstances to consider."
William Alden, THE HUFFINGTON POST, Shahien Nasiripour contributed to this report.


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