Wednesday, March 16, 2011

Watching Japan

Japan puts us all in an interesting situation, even if you don't live in Japan. While everyone is focused on the nuclear accident, the true global forces at work here are economic. Once the nuclear situation is stabilized, and it will be eventually though the damage in the interim may be horrific, Japan is going to have to rebuild. And depending on the extent of that rebuilding, the entire world may undergo a seismic shift in trade patterns.

The problem that everyone is ignoring is that Japan will need more yen for the rebuilding effort at home. Thus they will have to repatriate yen from overseas in order to achieve this goal. But in order to repatriate (buy) yen, they are going to have to sell something else. And given the scope of this disaster, the most likely candidate becomes US Treasuries.

Now many of us are already aware that the Federal Reserve and US Treasury are flooding the existing market with US Treasuries. In fact, the Federal Reserve is having to buy more and more US Treasuries in order to keep interest rates low. If the Fed were not buying, interest rates would already have spiked upward, forcing the US to pay even more interest on its debt.

Into this market Japan is also going to be forced to sell. You can't assume they'll sell someone else's bonds. No, they don't have enough of anyone else's bonds to raise the money they need to rebuild. That number is already estimated at over $300 billion with higher end estimates as large as $1 trillion US dollars for rebuilding costs.

The only pool they can tap large enough to fund this rebuilding is their holdings of US Treasuries. Yet with the Obama administration's record deficits coupled with Japanese selling, we will begin to see upward pressure on US interest rates. As those interest rates rise, the money available to the US government for non-interest expenses will drop even further, forcing more borrowing and even higher interest rates. Eventually interest expenses can get so high that they bring this entire house of cards down.

Thus, Japan's disaster may become a trigger event leading to the eventual collapse of the US dollar and of the US government. It won't occur immediately, and indeed, in the short term the dollar may manage to make another good stand as a "flight to safety" investment. But it cannot last so long as the twin burdens of US deficit spending and Japanese rebuilding loom in front of the US dollar.

Keep an eye on this one. We may be on the verge of taking another significant step down the staircase of catabolic collapse.