Japan adds to volatile mix of global growth threats

Private economists have been largely sanguine about the global repercussions of the devastating earthquake and tsunami that hit Japan''s northeast coast a week ago, killing thousands and sparking the worst nuclear accident in a quarter century.
                                            
In a research note published on Friday, Deutsche Bank said the impact of Japan's triple-disaster on global growth was likely to be so negligible as to be "caught in rounding error." But top policymakers from the world's richest nations are sounding a very different note, even if they have largely steered clear of voicing their concerns about systemic risks in public until now.                          

One senior official from a G7 country who requested anonymity dismissed the benign forecasts of many banks on Friday with an air of disgust, pointing to the nuclear threat in Japan, the acute market volatility it has produced and risks associated with bloody conflicts in the Middle East.   

   
A top G7 central banker told Reuters earlier this week that he feared the world economy was headed "right down" at a time when financial markets are still fragile in the face of an unresolved European debt crisis and high oil prices.      

Spooked by events in Libya and Bahrain, traders have pushed oil up to levels not seen since shortly before the collapse of Lehman Brothers in 2008.    

   
The United Nations approved military action to contain Libyan leader Muammar Gaddafi on Thursday and OPEC's largest oil producer Saudi Arabia has sent troops into the Gulf Arab island state of Bahrain to quell unrest. 

Indeed, it is the still-fresh memory of Lehman''s bankruptcy, and the speed with which it sent markets and economies spiralling downwards, that has many officials on edge now even if the world economy has rebounded and is projected to grow by 4.4% this year and 4.5% in 2012, according to the latest IMF projections.                      

The "known unknowns" - in the words of former US defense secretary Donald Rumsfeld - have multiplied exponentially in recent weeks, unsettling the sense of comfort that had returned to G7 capitals over the past year.     

That may have ramifications for the speed at which central banks tighten monetary policy this year. While China moved again on Friday, there are growing suspicions the European Central Bank could hold off on an interest rate hike expected for April.  

Perhaps the clearest concrete consequence of Japan's disaster for the broader world economy has been disruption to the global supply chain.

Manufacturing plants across the world's third largest economy have been forced to shut down or work well below capacity either because of physical damage from last Friday's 9.0 magnitude earthquake or due to power outages, shortages of raw materials, or logistics problems.

Japan's grip on the global electronics supply chain - it exported nearly a $100billion worth of electronic parts last year - is causing particular concern.

"When a wrench is thrown into a global supply chain which is as globally integrated and run as tight as ours currently is, it is very hard to predict what the consequences will be," strategists at Gavekal said in a note to clients on Friday.

"For example, who would have immediately thought that the Lehman bust would trigger a freeze in trade finance, which, in turn, led to a prompt collapse in global trade of a magnitude not seen since the 1930s Great Depression?" The senior G7 official said fears that financial markets might get out of control and spark a real-economy backlash were a key factor behind the overnight decision to pursue joint intervention for the first time since central banks came to the aid of the newly-launched euro in 2000.  
   
Global stocks surged and the yen, which hit a record high against the dollar earlier in the week, fell sharply as central banks in Tokyo, Washington, Frankfurt and London joined forces to push down the Japanese currency. A strong yen would prevent Japan's heavily export-reliant economy from bouncing back rapidly, as a broad spectrum of private economists are now predicting.    
       
Drawing on the lessons of the Kobe earthquake in 1995, most are calling for a sharp slowdown in output over the coming months, followed by a robust rebound in the second half of 2011, with only marginal consequences for global growth.                                                                                                                             The wild card in those projections is Japan's nuclear crisis. On Friday Japanese engineers acknowledged for the first time that burying the crippled Fukushima plant in sand and concrete - the method used to seal Chernobyl leakages in 1986 - might be a last-resort option to prevent a catastrophic radiation release.   

"We are still hoping for an only temporary slump in output, which will be followed by a later recovery triggered by reconstruction," economists at Unicredit said on Friday.

"If, however, the nuclear catastrophe were to spin completely out of control, recession and deflation fears would also resurface around the globe - transmitted via the international growth and sentiment correlation, the global capital nexus, and rapidly rising risk aversion. Even in the absence of a worst-case scenario, Unicredit said, the downside risks for financial markets and growth had "increased enormously."