Japan Can Draw From $3 Trillion Hoard If It Must Repatriate Funds
-- Rough estimates put total Japanese external investment at $3 trillion
-- If Japanese investors need money to cover rebuilding costs after the quake, they could draw on those funds
-- To gauge the extent, the 1995 Kobe earthquake experience is instructive but less-than-perfect
By Deborah Lynn Blumberg
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--Around $3 trillion in Japanese foreign portfolio investments are at stake in the aftermath of the Sendai earthquake, as the country faces years of repair from the worst crisis to hit it since World War II.
The vast bulk of that pool of cash is likely to stay where it is, but the risk of a chunk of it doing so is significant as a recovery in the country gets underway--and, at the margins, that unwind could have a marked impact on the prices of the assets and currencies in which it is invested.
Thousands of homes, businesses and infrastructure must be rebuilt in Northern Japan after the devastating quake and subsequent tsunami that struck the country last week. Insurance companies must also pay claims.
"The risk [of repatriation] is severe," said David Ader, head of government bond strategy at CRT Capital.
Japan, which historically has been one of the largest providers of net savings in the world, had a total of around $2.86 trillion in external financial assets and liabilities outstanding at the end of 2009, according to data from Japan's Ministry of Finance. While no other worldwide report has since been released, published information showing gains in Japanese holdings of U.S. securities--the prime destination for Japanese portfolio investment--suggest the figure likely moved closer to $3 trillion by the end of 2010. In terms of U.S. assets, Japan had about $884 billion in dollar-denominated stocks, bonds and other securities as of the end of December, according to data from the U.S. Treasury Department, showing a gain of $118.3 billion since the end of 2009.
Japan's last massive quake, which centered on Kobe on Jan. 17, 1995, prompted significant outflows of funds from Japanese foreign holdings as insurers and other Japanese companies and institutions repatriated money to cover costs at home, though that didn't happen until later in the year. Speculation over the same happening again has prompted a marked decline in long-dated Treasury bonds over the past two trading days.
At this stage, it is very unclear how costly the reconstruction effort will be and therefore how much repatriation may be needed. However, Boston-based AIR Worldwide has estimated that the quake caused insured property losses of $15 billion to $35 billion. That number doesn't include costs to be borne by many more Japanese individuals and firms that didn't have catastrophic insurance and also doesn't contemplate the costs of lost energy during the blackouts caused by a meltdown at one nuclear plant nor the higher costs that would arise if that situation turned more dire.
CRT Capital's Ader, for one, said he will be keeping an especially close eye on auctions of U.S. Treasurys to gauge whether there will be any diminished demand for U.S. debt as Japan starts to rebuild. Japan is the second-largest holder of U.S. Treasury securities after China.
Weekly flows data from Japan's Ministry of Finance on purchases and sales of foreign securities will also be crucial. Those data are released each Thursday. However, typically in March, the end of Japan's fiscal year, Japanese companies move money home to a certain extent degree anyway, so investors should be careful to draw any grand conclusions from that data over the next few weeks.
For the U.S., a significant risk is that Japanese insurance companies and other investors will sell or buy fewer longer-maturity securities, especially Treasurys, to help fund domestic quake-related costs.
Selling Treasurys would push up yields on these securities and lead to higher borrowing costs for the U.S. government as well as consumers and businesses, at a time when the U.S. economy is still healing.
Ader said he believes the Treasurys benchmark yield curve--the gap between the two- and 10-year notes' yields--could steepen as longer-maturity issues weaken and short-term debt performs better. Shorter-maturity Treasurys could benefit if Japan were to intervene to support the yen because the Bank of Japan would reinvest proceeds from those intervention in two- to three-year notes.
"You have the makings of a very steep yield curve," Ader said.
However, Ward McCarthy, chief financial economist and managing director of the fixed-income division at Jefferies & Co., said that, based on the 1995 Kobe experience, the risk of selling by Japanese insurance companies would appear to be limited, at least in the near term.
In 1995, more than 400,000 buildings in Japan were destroyed or badly damaged, including an estimated 200,000 homes. Roughly 6,500 people were killed and as many as 15,000 injured. Estimates of insurance losses to domestic insurance carriers vary, but appeared to be in a range of $3 billion to $5 billion, he said. However, based on U.S. Treasury data, overall net Japanese investor activity in the U.S. fixed-income markets was little changed in the immediate aftermath of the quake.
Japanese investors purchased a net $3.1 billion Treasurys in January 1995 and a total of $3.4 billion in the U.S. fixed-income markets. Net Treasury purchases by Japanese investors slipped to $2.5 billion in February, but rebounded to $4.7 billion in March.
Japanese investors did, eventually, become net sellers of Treasurys in 1995, but not until autumn, and it is impossible to tell from the data if that was a delayed response to the losses from the earthquake in January 1995, or an unrelated market event, McCarthy said.
The BOJ has also doubled the size of its ongoing asset-purchase program to 10 trillion yen by increasing purchases of government debt by 500 billion yen, which will help to funnel money into the economy.
"There will be a variety of outlets for raising cash in Japan besides selling Treasurys," McCarthy said.
-By Deborah Lynn Blumberg, Dow Jones Newswires; 212-416-2206; deborah.blumberg@dowjones.com
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