Posted on Sunday, March 20, 2011
Four years ago, there were fears of a financial meltdown — a term borrowed from the nuclear power industry. Now there are fears of a real meltdown.
Comparing the two events may risk seeming insensitive to the rising human toll in northern Japan, but there are similarities in causation. In each case, overconfidence born of experience led to increased risks once a disaster unfolded.
Fortunately, there is reason to hope that the worst fears will not be realized. When — let us hope it is not “if” — the radiation releases are controlled, Japan can begin to rebuild and the worst economic fears could prove to be as exaggerated as the depression fears that paralyzed financial markets two years ago.
In the years preceding each meltdown, the very act of reducing apparent risks may have increased actual risks. In the world of finance, there was a general acceptance of the idea that banks and their regulators had developed sophisticated risk models to prevent a disaster. As lending grew more reckless, there was confidence that no real risks were being taken.
In Japan, the risks of earthquake and tsunami were well known, and believed to have been dealt with. An earthquake could damage a nuclear plant and its vital cooling process if power to the reactor were cut off. So backup generators were built and batteries installed to provide power even if the generator did not immediately kick in. A tsunami could cause flooding. So huge sea walls were built to prevent floods.
All the precautions had worked in previous earthquakes, and that history was reassuring.
Unfortunately, it appears that those building the nuclear plants assumed that the risk from tsunamis had been eliminated by the precautions that others took. The backup generators were behind the flood walls, but they were not on high ground, as would have seemed necessary without faith in the walls. So the generators flooded and the cooling systems broke down. That led to radiation releases. Whether it will lead to something much worse is still unknown.
In the world of finance, the assumption that safeguards would prevent disaster led people to believe it was safe to borrow heavily. There had, after all, been a prolonged period in which markets were not turbulent and there were only profits, not losses, to be realized from taking on the additional risk of leverage. As the economist Hyman Minsky wrote years earlier, “stability is destabilizing” because it encourages confidence that benign circumstances will endure.
We learned from the financial crisis that the comfortable assurances that authorities knew what to do were misplaced. Central bankers had insisted that it was futile and unnecessary for them to look out for bubbles, since they knew how to deal with the results if one did burst. The 2001 recession after the collapse of the technology stock bubble was both short and mild. The Federal Reserve emerged triumphant, its wisdom and capabilities widely admired.
But this time it turned out that easing monetary policy was not nearly enough, and the United States will be dealing for years with problems caused by homeowners who are — to use another term that seems newly inappropriate — underwater. Many, but not all, of those once-confident central bankers now say they were wrong.
It has become clear that the Japanese nuclear industry was ill equipped to deal with the current disaster. Otherwise the cooling systems would have continued functioning even if the earthquake had disabled plants. The cost — in lives and yen — is as yet unknown.
Each case — a collapse of house prices and a cascade of problems threatening a large release of radiation — was viewed as so improbable that it could be virtually ignored in considering risks. Those who counseled otherwise were viewed as alarmists.
What was not considered sufficiently, perhaps, is just how serious an unlikely risk may be. If it is bad enough, the risk may not be worth taking, no matter how good the odds. There is a reason people do not play Russian roulette, even if the odds are highly favorable. It is a game you lose only once.
At a time when brave workers are risking death from radiation, when whole communities have been destroyed by the tsunami and survivors are suffering in makeshift shelters, it seems inhuman to even suggest that of the two meltdowns, the financial one was worse. Bank failures do not kill people.
In economic terms, however, the financial crisis was extraordinary. It caused world gross domestic product to fall 1.5 percent in 2009, according to World Bank calculations. Nothing like that happened during the severe downturns of the 1970s and 1980s. The early estimates of the impact of the disaster in Japan suggest that economic damages will be far less, even though Japan accounts for almost 9 percent of world G.D.P.
But those damages will be significant, and that significance is only increased by the fact the financial crisis weakened developed economies and left governments with vastly increased debts. Even assuming that the radiation damage does not permanently scar a significant part of Japan, that country’s output will fall sharply for a time, and that time could be extended if rolling blackouts remain necessary. Some of that slack could be made up by non-Japanese companies, but in some industries they will be hampered by a shortage of needed components from Japan.
We owe the concept of “just-in-time” inventories to Japan. Now that practice could make the temporary damage to world growth all the more severe. Shortages of some products could drive up prices, making inflation numbers around the world that much worse.
It is, in other words, a recipe for 1970s style stagflation, at least briefly.
Japan’s plight could be worsened by the fact that many Japanese did not buy earthquake insurance, and most such policies that do exist pay half or less of the damage if a home is destroyed. Through a complicated arrangement, the Japanese government is responsible for much of the insurance liability, and if the affected areas are to be rebuilt much of the cost will fall to the government, whether or not the properties had insurance.
Fortunately, there are few countries as well equipped as Japan for the task.
That statement may seem surprising given the attention paid to the large Japanese government debt, which has led to almost hysterical warnings in some circles about an eventual default. How can this overextended government borrow more money?
As it happens, Japan owes the money almost entirely to itself. The private sector has ample resources. Moreover, Japan borrows in yen, the same currency the government can print. Default worries are absurd.
On March 10, the day before the earthquake and tsunami struck, Japanese five-year bonds yielded 0.57 percent. A week later, the yield had fallen to 0.51 percent. That is hardly the sign of fearful investors. Instead, it reflects a flight to safety.
In addition, Japan has the industrial base to undertake rebuilding. It will not need to import workers or expertise.
Finally, the Japanese economy is anything but overheated. There is plenty of spare capacity. Michael T. Darda, the chief economist of MKM Partners, a Connecticut-based research firm, points out that Japan’s G.D.P. is now lower than it was in the early 1990s, when expressed in nominal yen. Adjusted for deflation, there has been some growth, but not much.
If ever there was an economy that needed some stimulus, this is the one. The Bank of Japan now has a good reason to print money.
“Considering Japan’s limited capacity to take on more debt due to its already high debt/G.D.P. ratio, and impending pressures on domestic savings from an aging population,” Mr. Darda wrote, “reflation and debt monetization seem like the most likely path forward.”
For now, it seems reasonable to think that ordinary Japanese may cut back on spending for nonessentials, much as Americans did after Sept. 11, causing further weakness in the economy. Hoarding of some goods — among them milk and gasoline — appears to be happening in areas far removed from the crisis.
The economy is unlikely to stabilize until the nuclear situation is clearly under control, essential goods readily available and survivors living in conditions worthy of a wealthy nation. Only then will the country be in a position to assess how badly it has been hurt and begin the recovery process.
This tragedy has destroyed many lives and much wealth. There is a risk that the government’s response will anger rather than unify the Japanese people, and that a crisis careering out of control will only worsen a reputation of incompetence and indecision that has grown as the country’s economy stumbled through the last two decades.
But there is a chance that the crisis could encourage a national unity of purpose, as Sept. 11 did for a time in the United States. If the Japanese government can maintain that sense of unity and show a new ability to act decisively and effectively, an economic disaster need not be part of the horrible legacy of the March 11 earthquake.
By FLOYD NORRIS, THE NEW YORK TIMES