The US Dollar’s Dependence On Quantitative Easing

Since every central bank of major economies has been inflating, it’s a question of which central bank has been inflating the most. The obvious answer is the US. The US has not only been inflating her economy, she has basically been inflating the rest of the world.

A US Dollar rally can occur and can be sustained once the US withholds inflationism. But $64 trillion question is: Can they afford the consequences?

Like in early 2010, experts and officials babbled about “exit strategies” as the US economy’s recovery advanced, something which we debunked as a Poker Bluff[1]. Yet 10 months later, the Fed re-engaged in Quantitative Easing 2[2] citing “low consumer spending” and “unemployment” as an excuse even as the US moved out of the recession in June of 2009^th[3].

The mainstream doesn’t get it or has stubbornly been denying this.

Quantitative Easing or euphemistically called Credit Easing isn’t about the economy but about buttressing politically the US government and the banking system.

As Mises Institute Lew Rockwell writes[4],

Another truth is that the Fed doesn’t really care about inflation as much as it cares about the solvency of the banking and financial systems. Bernanke would drive us right into hyperinflation to save his industries. Savers living on pensions just don’t have the political clout to stop the money machine.

US housing has still been struggling. Since a substantial segment of the banking system’s balance sheets have been stuffed with US mortgages, then QE 1.0 and 2.0 has managed to keep these afloat but has, so far, failed to strongly revive the US housing market[5].

Under enfeebled housing conditions, a failure to continue with the QE amplifies the risks of falling housing prices thereby jeopardizing the fragile state of the US banking system.

Most importantly, the US Federal Reserve has been buying US Treasuries which means the US central bank has been funding the profligacy of US government.

Yet much of US treasury has also been substantially held by the foreign governments.

However, there are signs that the interest to hold US debt has been waning.

According to Economic Times India[6]

China, the biggest foreign holder of US debt has trimmed its portfolio to $1.15 trillion to diversify its foreign reserve portfolio to avoid risks.

China reduced its US Treasuries portfolio by $5.4 billion to $1.15 trillion in January, according to the data released by the US Treasury Department on Wednesday.

It is the third straight month of net selling after China's holdings of US debt reached a peak of nearly $1.18 trillion in October 2010.

If the Japan repatriation trade proves to be a real event risk, then this could even further dampen interest to support US debt.

With substantial foreign held US debt maturing over the next 36 months[7], if foreign governments withhold from buying, will the US accept higher interest rates?

Given the ideological background and the path dependency by the incumbent monetary authorities, the answer is a likely NO!

The US government can’t simply put her fragile banking system at risks, and thus, we can bet that QE 3, 4, 5 to the nth, will likely occur until the market recoils from these.

The above doesn’t even include the financial conditions of wobbly states and municipalities.

Financial conditions of US states have been plodding[8] while Municipal bonds, following a huge meltdown, has also been floundering. The rally in the Muni bonds have not erased the losses.

Controversial analyst Meredith Whitney, who recently presaged “50 to 100 sizable defaults to the tune of “hundreds of billions of dollars worth of defaults”[9], has been constantly under fire by the mainstream, for such prognosis. She has even been summoned by a US Congressional Panel. Anyone who goes against the government appears to be subject to censorship or political harassment.

The point is: given all these fragile conditions, will the Ben Bernanke led US Federal Reserve bear the onus of withdrawing, what has given Bernanke and the Fed an artificial aura of success?

---

[1] See Poker Bluff: The Exit Strategy Theme For 2010, January 11, 2011

[2] CNN Money.com QE2: Fed pulls the trigger, November 3, 2010

[3] Reuters.com Recession ended in June 2009: NBER, September 20, 2010

[4] Rockwell, Llewellyn H. Is QE3 Ahead?, Mises.org, March 18, 2011

[5] Northern Trust, Sales of Existing Homes Moved Up, But Median Price Establishes New Low, February 23, 2011 and

Food and Energy Prices Lift Wholesales Prices, But Pass through to Retail Prices is Key, March 16, 2011

[6] Economic Times India, China continues to trim its US debt to avoid risks, March 18, 2011

[7] Osborne, Kieran U.S. Government: Evermore Reliant on Foreign Investors Merk Investments, March 15, 2011

[8] Center on Budget Policies and Policy Priorities, States Continue to Feel Recession’s Impact, March 9, 2011

[9] New York Times, A Seer on Banks Raises a Furor on Bonds, February 7, 2011

Where To Invest Your P100,000 Spare Cash?

The Philippine Daily Inquirer recently conducted a poll on where to place a surplus of P100,000 among experts.

The Inquirer writes,

WE ALL know this is true: One reason why the rich get richer, so to speak, is because they have access to better investment advice—the kind that is often unavailable to regular investors whose bank account balances don’t go beyond six digits...

Surprisingly, the results of our discussions with these financial experts showed that investment success was not achieved through secrets known only to the affluent, but on decisions that are mainly ... common sense.

If beauty is in the eye of the beholder, so does investing.

That’s because everyone’s risk-reward profile is different or unique. They can be aggressive, conservative, or a mix of it.

So as with the diversity in time preference of expectations, e.g. long term, medium or short term.

This also applies to one’s comfort zone (e.g. biases such as preferred industry, “home bias”, or etc...).

The objectives can also be different, e.g. hedge against a currency, tacit influence of social pressures or etc...

The level of knowledge and the scale of knowledge acquisition, as well as, degree of exposure (e.g. passive or active) are also distinct, and matters significantly.

Thus, it would signify a folly to reduce an advice to a "one-size-fits-all" frame.

While common sense is indeed the answer, common sense, while available to all, seems to be unwittingly the least of the desired path. That’s mainly because common sense is boring stuff.

At the end of the day, P100,000 in spare cash should be allocated, perhaps based on the world’s most successful equity investor, Warren Buffett advice, “Risk comes from not knowing what you are doing.”

(hat tip: Jodie Espino)

Wind Farms Are Environmental Friendly...Not!

We are made to believe that wind farms, as an alternative energy source, are environmental friendly.

Telegraph’s James Delingpole says otherwise... (bold highlights mine)

So wind farms don’t just despoil countryside, frighten horses, chop up birds, spontaneously combust, drive down property prices, madden those who live nearby with their subsonic humming, drive up electricity prices, promote rentseeking, make rich landowners richer (and everyone else poorer), ruin views, buy more electric sports cars for that dreadful Dale Vince character, require rare earth minerals which cause enormous environmental damage, destroy 3.7 real jobs for every fake “green” job they “create”, blight neighbourhoods, kill off tourism and ruin lives, but they also

KILL WHALES!

According to researchers at the University of St Andrews, the sound of offshore wind farms is likely to mess with the whales’ sensitive sonar systems and drive them ashore, where they get stuck on beaches and die.

Has anyone else noticed the gentle irony here? Well, let me explain with the help of my magic sledgehammer: save possibly the polar bear and the mighty snail darter there is no creature on the planet more totemic of green values than the whale. Saving whales is what greens do. Or rather what they used to do in the days when greens were actually interested in caring for the environment instead of, say, trying to destroy the capitalist system. But now, here they are actively promoting a form of renewable energy which in the process of producing next to no energy very expensively also does the most stupendous damage to the environment and the eco-system.

Hat tip and photos from Matt Ridley

Post script: Telegraph’s James Delingpole says that following the publishing of the whale study, the man who led the research team, dissociated himself from the article. (This only reveals how politically powerful the environmental movement is)

Nonetheless, Mr. Delingpole concludes,

What this means is that, though at this stage we know for absolute certain that wind farms despoil countryside, frighten horses, chop up birds, spontaneously combust, drive down property prices, madden those who live nearby with their subsonic humming, drive up electricity prices, promote rentseeking, make rich landowners richer (and everyone else poorer), ruin views, buy more electric sports cars for that dreadful Dale Vince character, require rare earth minerals which cause enormous environmental damage, destroy 3.7 real jobs for every fake “green” job they “create”, blight neighbourhoods, kill off tourism and ruin lives, the possibility that they also lure whales to their doom remains at this stage an unproven hypothesis. (Just like Anthropogenic Global Warming theory, then.)

Has Brazil Successfully Inflated Their Debt Away?

So claims popular analyst John Mauldin in his latest newsletter.

You don’t even have to go that far back to see hyperinflation and how brilliantly it works at eliminating debt. Let’s look at the example of Brazil, which is one of the world’s most recent examples of hyperinflation. This happened within our lifetimes. In the late 1980s and 1990s, it very successfully got rid of most of its debt.

Today, Brazil has very little debt, as it has all been inflated away. Its economy is booming, people trust the central bank, and the country is a success story. Much like the United States had high inflation in the 1970s and then got a diligent central banker like Paul Volcker, in Brazil a new government came in, beat inflation, produced strong real GDP growth, and set the stage for one of the greatest economic success stories of the past two decades. Indeed, the same could be said of other countries like Turkey that had hyperinflation, devaluation, and then found monetary and fiscal rectitude.

In 1993, Brazilian inflation was roughly 2,000 percent. Only four years later, in 1997 it was 7 percent. Almost as if by magic, the debt disappeared. Imagine if the United States increased its money supply, which is currently $900 billion, by a factor of 10,000 times, as Brazil did between 1991 and 1996. We would have 9 quadrillion U.S. dollars on the Fed’s balance sheet. That is a lot of zeros. It would also mean that our current debt of 13 trillion would be chump change. A critic of this strategy for getting rid of our debt could point out that no one would lend to us again if we did that. Hardly. Investors, sadly, have very short memories. Markets always forgive default and inflation. Just look at Brazil, Bolivia, and Russia today. Foreigners are delighted to invest in these countries.

Sometimes I feel like dispensing the role of snopes.com a popular website which serves as “the definitive Internet reference source for urban legends, folklore, myths, rumors, and misinformation.”

Well, here is the account of Brazil’s inflation-debt dynamics according to the Wikipedia.org, (bold highlights mine)

The stabilization program, called Plano Real had three stages: the introduction of an equilibrium budget mandated by the National Congress a process of general indexation (prices, wages, taxes, contracts, and financial assets); and the introduction of a new currency, the Brazilian real, pegged to the dollar. The legally enforced balanced budget would remove expectations regarding inflationary behavior by the public sector. By allowing a realignment of relative prices, general indexation would pave the way for monetary reform. Once this realignment was achieved, the new currency would be introduced, accompanied by appropriate policies (especially the control of expenditures through high interest rates and the liberalization of trade to increase competition and thus prevent speculative behavior).

By the end of the first quarter of 1994, the second stage of the stabilization plan was being implemented. Economists of different schools of thought considered the plan sound and technically consistent.

1994-present (Post "Real Plan" economy)

The Plano Real ("Real Plan"), instituted in the spring 1994, sought to break inflationary expectations by pegging the real to the U.S. dollar. Inflation was brought down to single digit annual figures, but not fast enough to avoid substantial real exchange rate appreciation during the transition phase of the Plano Real. This appreciation meant that Brazilian goods were now more expensive relative to goods from other countries, which contributed to large current account deficits. However, no shortage of foreign currency ensued because of the financial community's renewed interest in Brazilian markets as inflation rates stabilized and memories of the debt crisis of the 1980s faded.

The Real Plan successfully eliminated inflation, after many failed attempts to control it. Almost 25 million people turned into consumers.

The maintenance of large current account deficits via capital account surpluses became problematic as investors became more risk averse to emerging market exposure as a consequence of the Asian financial crisis in 1997 and the Russian bond default in August 1998. After crafting a fiscal adjustment program and pledging progress on structural reform, Brazil received a $41.5 billion IMF-led international support program in November 1998. In January 1999, the Brazilian Central Bank announced that the real would no longer be pegged to the U.S. dollar. This devaluation helped moderate the downturn in economic growth in 1999 that investors had expressed concerns about over the summer of 1998. Brazil's debt to GDP ratio of 48% for 1999 beat the IMF target and helped reassure investors that Brazil will maintain tight fiscal and monetary policy even with a floating currency.

In short, monetary reform via the dollar peg (first), fiscal austerity and the move towards greater economic freedom resulted to the reduction of Brazil’s debt.

Here is the account of the World Bank... (bold emphasis mine)

Brazil’s debt decomposition indicates that primary fiscal balances and real GDP growth have been the most significant debt-reducing factors between 1993 and 2003. Brazil’s primary fiscal balance, which has improved significantly in the recent past, has provided the largest debt-reducing contribution, in particular since 1999. Real GDP growth was responsible for a debt decline of 9.0 percent of GDP over the decade.

Apparently the World Bank says the same-fiscal side reforms functioned as the critical factor in Brazil’s debt reduction.

And here is a paper from the Inter-American Development Bank entitled The Structure of Public Sector Debt in Brazil

Afonso Sant’anna Bevilaqua, Dionísio Dias Carneiro, Márcio Gomes Pinto Garcia, Rogério Furquim Ladeira Werneck, Fernando Blanco, Patricia Pierotti, Marcelo Rezende, Tatiana Didier writes, (bold highlights mine, italics theirs)

Given Brazilian inflationary history, the domestic bonded debt market was recreated in the mid-1960s with the introduction of indexed bonds (ORTNs), which were then conceived as an antiinflationary tool. The idea was that only the money financing of the fiscal deficits was inflationary. In the period of more than thirty years since its creation, the Brazilian open market has evolved into a very sophisticated one. The gross bond debt held by the private sector is currently around one fourth of a trillion US dollars; the megainflation of the 1980s and early 1990s did not inflate away the Brazilian debt.

During the megainflation, most of the debt was placed with banks (and later, with mutual funds managed by the banks) which used the bonds as the asset counterpart of inflation protected deposits (the indexed money, or domestic currency substitute). With the Real Plan this situation is gradually changing. The debt maturity has been lengthened (with a few setbacks, as the recent Asian and Russian crises), and more agents interested in becoming final holders of long debt—as insurance companies and pension funds—are becoming more important in the financial arena.

A radical change in Brazil debt maturity profile and similarly a change in the classification of debt holders had also been a part of Brazil’s debt reduction dynamics. This paper even highlights: “the megainflation…did not inflate away the Brazilian debt”.

Bottom line: Beware of oversimplified misleading analysis.

Fearing A Slap On The Face, UN Sanctions A No-Fly Zone

Faced with the prospects of a victorious comeback by Libya’s 42 year dictatorship under Muammar Gaddafi, the UN approves a No-Fly zone over Libya.

The Marketwatch reports,

The United Nations Security Council voted 10 to 0 supporting the use of "all necessary measures" including the use of a no-fly zone to protect civilians and rebel forces in Libya from forces loyal to Col. Moammar Gadhafi. Russia and China, which held veto powers, abstained from the vote, along with three other council members. The passing of the measure is expected to lead to U.N.-backed military strikes in Libya within hours, according to media reports.

UN’s action represents a response to a potential slap on the face if Gaddafi forces wins.

Writes Lew Rockwell's Eric Margolis,

In a huge embarrassment for President Barack Obama, who has been demanding Gadaffi resign, the gutsy new US national intelligence director, Gen. James Clapper, told Congress that Gadaffi’s forces were winning. Fortunately, US Defense Secretary Robert Gates put the brakes, at least for now, on Republican hawks and the-only-good-Arab-is-a-dead-Arab neocons who were urging the US impose a no-fly zone over Libya.

There will also be many red faces in Europe. Libya is a major oil supplier. If Gadaffi survives and reconsolidates his rule, Europe will have to continue buying oil from him. Germany’s Angela Merkel and her pal Sarko will look very foolish.

That means the leaders of France, Germany, and Britain, who have been calling for the overthrow of Gadaffi, may have to make nice to him again, and even, horror of horrors, go to Tripoli and be filmed holding hands with the smirking Libyan dictator, decked out in one of his Marx Brothers military outfits. Revenge, Libyan-style, will be oh so sweet.

To save face means to intervene militarily which is what the No-fly zone is all about. Libya’s civil war will now evolve into an international war.

So the UN’s foreign policy appears designed to boost the self esteem needs of political authorities by getting their soldier’s hands bloodied and also by shifting away of resources from productive activities. In short, the self interest of politicians matter more than the public.

Also, reputational needs of political heads translates to benefits for the military industrial complex. So if it isn’t the banking elites, it is the military industrial elites that mostly benefits from government interventionism. Of course the banking elite is also tied to the military industrial complex indirectly since the banking elites has been the chief financers of government expenditures.

Currency Intervention: Japan And The G-7 Aims To Boost Stock Markets

Japan’s fundamental problem today is the risk of nuclear contamination and disaster recovery reconstruction. In dealing with latter, since Japan is a nation largely without resources, it will have to import them. In other words, her economic pattern will likely shift from export oriented to import dependent reconstruction.

So how do Japan and the G-7 address this predicament? Inflate the system!

This from Bloomberg, (bold highlights mine)

The Group of Seven will jointly intervene in the foreign exchange market for the first time in more than a decade after Japan’s currency soared, threatening its recovery from the March 11 earthquake.

Japan began the effort, sending the currency down 3.1 percent against the dollar at 9:34 a.m. in Tokyo. Each of the G-7 members will sell yen as their markets open, Japan’s Finance Minister Yoshihiko Noda told reporters in Tokyo today. The G-7 said in a joint statement after a conference call of its finance ministers and central bank chiefs that it will “provide any needed cooperation” with Japan.

Japan’s central bank also said in a statement that it will pursue “powerful monetary easing” as policy makers sought to reduce the threat the world’s third-largest economy sinks into a recession. The Nikkei 225 Stock Average gained after the announcements, paring losses to 12 percent since the quake and ensuing tsunami killed thousands and led to rolling blackouts and radiation leaks at a nuclear plant.

More from the same article...

The Bank of Japan has been pouring cash into the financial system to stabilize money markets and on March 14 doubled an asset-purchase fund to 10 trillion yen, pledging to step up purchases of securities including government debt, exchange-traded funds and real-estate investment trusts.

Noda and Economic and Fiscal Policy Minister Kaoru Yosano sought to quell speculation driving the yen higher yesterday. Noda said markets were nervous and Yosano said there was no basis for an argument that the nation’s insurance companies were repatriating foreign assets to pay for earthquake damage.

“The speculation was that Japanese life and casualty insurers will repatriate dollar-denominated assets to secure funds in the wake of the earthquake,” Yosano told reporters in Tokyo yesterday. “But they have ample cash, deposits and other liquid assets,” he said, adding that the Financial Services Agency and Bank of Japan have confirmed insurers aren’t selling their dollar assets.

Weakening the Yen would make imports more expensive at the time when the Japanese would need alot of resources.

Moreover a weak yen hardly deals with the risk of nuclear contamination.

So you see, Japan isn’t trying to deal with her fundamental problems. Instead Japan and the G-7 is trying to goose up the stock markets and other financial markets in order to save the banking elite. As well as, approach the economic recovery angle from the wealth effect-aggregate spending point of view.

See how predictable they are!

A Wall Street axiom says, “Don’t fight the Fed”. I’d paraphrase this and say ‘don’t fight central banks and governments determined to destroy the purchasing power of your money, be it the US dollar or the Yen or the Peso’.

And this is why increasing cash balances represents fighting the major trend.

Video: Understanding The Risk of Radiation From Spent Fuel Pools

MSNBC's Rachel Maddow lucidly explains the problem of spent fuel pools which has been the source of the risk of radiation from the damaged Fukishima nuclear power plants. (HT Bob Wenzel)

Earthquake Map of the US and the Philippines

The Daily Mail says

But 39 out of the 50 states – including New York and Tennessee – have moderate to high seismic hazard risk.

That still a lot better compared to the Philippines...

...where except for a few spots, the entire archipelago seems in a high risk zone. Map from USGS

The Philippines is part of the Pacific Ring of Fire belt, where “About 90% of the world's earthquakes and 80% of the world's largest earthquakes occur”

Have a nice day.

CNN: The Federal Reserve's biggest bloopers

It’s a pleasant surprise to see one of mainstream media join in the bashing of the US Federal Reserve.

The CNN Writes,

Since it was created in 1913, the Federal Reserve hasn't exactly had the best track record of predicting booms and busts.

Not to mention, its leaders have had some embarrassing sound bites along the way, whether they're referencing punch bowls or helicopters.

Here are some of the Fed's biggest bloopers over the years.

Go to the slideshow here

This just goes to show how Fed critics, led by Ron Paul and the Austrian School, have been gradually moving from the fringes and into the mainstream.

Chart Of The Day: The Historical Short Term Impact of Natural Disasters On Stock Markets

I earlier wrote about the impact of natural disasters on stock markets as mostly short-term in duration.

Eventually, markets write them off or discounts or reappraises ‘uncertainty’ into ‘risk’.

The Economist has a good depiction of such discounting process on the stock markets as seen in several major disasters via the graph below...

From the Economist

UNCERTAINTY over the extent of the damage caused by the earthquake in north-east Japan on March 11th, and the associated radiation leak at the Fukushima Daichi power station 140 miles (225km) north of Toyko, has made trading on Japan’s stockmarket an eventful affair. The Nikkei 225 index fell 17.5% in the three trading days following the catastrophe, wiping some ¥37 trillion ($458 billion) off equities. This compares unfavourably with market reactions to other disasters. Once the New York Stock Exchange had reopened six days after the September 11th terrorist attacks, the S&P 500 fell by 11.6% over five trading days, but after a further 14 days it had recovered to its pre-disaster level. After Japan’s last severe earthquake in the city of Kobe in 1995 the Nikkei 225 fell by 7.6% over the next four trading days, but it did not recover to its pre-earthquake level for another 11 months. The Nikkei 225 regained some lost ground today, closing up 5.7%. The Japanese will be hoping for the same bounce back in their own fortunes.

As I earlier said, while the earthquake-tsunami event had been predictable or was expected to happen (except for the exactitudes), the uncertainty over the scale of damage from the unfolding nuclear accident has been the black swan event.

Since this has yet to be resolved, the escalating risks of radiation leakages continue to linger or haunt the markets, hence the prolonged selling pressure.

The question remains if there are other hidden but more powerful forces at work which operates on the cover of the unfortunate Japan’s nuclear episode.

A Tally of The Impact of Japan’s Disaster On Global Stock Markets

Japan’s triple whammy of nuclear-earthquake-tsunami has likewise slammed on the world’s stock markets.

Developed economy stock markets which earlier this year had outperformed the world have been the hardest hit, and are now laggards

Here is an update of the performances of the world’s bourses since Japan’s disaster struck.

According to Bespoke Invest,

The average year to date stock market performance of the 79 countries listed has now turned negative (-2.20%). The average performance of the countries since 2/18 is -4.38%. As shown, Japan is down the most since 2/18 with a decline of 16.13%. Germany and France rank 2nd and 3rd worst with declines of 12.29% and 11.08% respectively.

Most of the world’s market has turned red. Although some like the BRICs (except Brazil) and ASEAN has been little scathed so far.

However, with the way the markets have been performing overall (I mean, currencies, bonds, commodities, stocks), I suspect that Japan’s calamity has only instigated and could be masking the unseen driving force behind the series of downdraft.

And it’s called the TIGHTENING of the monetary environment—as many EM central banks have been raising interest rates while authorities of developed economies seem to be conditioning the markets of the same prospective actions despite the calamity. I’d like to see more evidence on this.

The World’s Largest Nuclear Energy Producers

Speaking of du jour anxieties, the Economist gives us a roster of the world’s largest nuclear energy producers.

Writes The Economist,

THE explosions and meltdown fears at Fukushima Daiichi nuclear-power plant that followed Friday’s earthquake have increased concerns in Japan about the safety of nuclear power. The country is not well placed to move away from it though, with only America and France producing more electricity from nuclear sources. Germany, which yesterday suspended a deal to delay closing its ageing nuclear plants, is the world’s sixth-largest producer. In percentage terms the story is rather different. Nuclear power in Japan accounts for just 29% of total domestic power production, putting Japan 15th on the list of the most nuclear-reliant countries. It ranks far below France, where nuclear power makes up three-quarters of electricity production.

This should give nuclear phobes lots to chew on.

The Declining Influence of Japan’s GDP

Yesterday’s widespread selloff had fundamentally been a black swan nuclear meltdown story. In other words, the market priced the uncertainty of a prospective contagion from radiation leaks.

The pivotal question is: Is the nuclear issue a systematic risk or is it a common factor risk?

One way to resolve this is to see the issue from the GDP prism.

BCA Research has this to share, (bold highlights mine)

According to IMF data, Japan’s share of global GDP has fallen over the past two decades from a high of about 10% in the early 1990s to under 6% today. Even more noteworthy is that on a purchasing power parity basis, the IMF estimates that Japanese growth has only accounted for about 1% of the world’s growth over the past five years. This is of course mostly due to the rapid expansion in emerging economies, but highlights that even without the devastating effects of last week’s earthquake, Japan is quickly becoming a small player in global growth. It also helps to explain why the blow to financial markets in the region (excluding Japan) has so far been fairly mild. In terms of the advanced economies, the country that is likely most susceptible to a slowdown in Japan is Australia – about 20% of Australia’s exports are destined for Japanese markets. Bottom line: Last week’s devastating earthquake in Japan may have limited impact outside of the country, given that global growth dynamics no longer rely heavily on a demand impulse from Japan.

Japan’s share is still substantial but has been steadily declining. Said differently, seen from the GDP perspective, the diminishing share of Japan’s GDP becomes more of a specific factor related risk—that is unless the radiation leaks spread to other nations which would transform fear into reality.

Thus, if fears from such uncertainty don’t gain ground, then the emotionally charged selloff could pose as an opportunity.

As a reminder, Japan isn’t the only source of uncertainty, but it has surely has diverted most of the public’s attention.

Saudi Arabia Led GCC Intervention In Bahrain

As everyone seems fixated on Japan, which seems to have eclipsed most of the world’s problems, here is one important development: Arab dictators appear to have closed ranks.

The Bloomberg reports, (bold emphasis mine)

Saudi Arabian troops moved into Bahrain as part of a regional force from the Gulf Cooperation Council, the first cross-border intervention since a wave of popular uprisings swept through parts of the Arab world.

“This is war against the unarmed Bahraini people,” said Matar Ebrahim Ali Matar, a member of al-Wefaq, the largest Shiite opposition party.

Mainly Shiite protesters in Bahrain have been demonstrating since Feb. 14, demanding democracy through free elections from their Sunni monarch. Shiites comprise as much as 70 percent of the population. King Hamad bin Isa Al Khalifa has offered a national “dialogue” toward changes in response, which hasn’t quieted protesters. Clashes escalated on Sunday with more than 100 people injured.

The deployment signals that the Bahraini regime has lost confidence it can deal with the protests and underscores Saudi Arabian concerns about uprisings at home, according to Christopher Davidson, a scholar in Middle East politics at Durham University and author of “Power and Politics in the Gulf Monarchies,”

“It is in Saudi’s interest that nothing serious happens in Bahrain, because it would embolden similar protests in its eastern provinces,” Davidson said in a telephone interview late yesterday.

Why is this important?

We get some clues from the same Bloomberg article,

The protests in the tiny kingdom have fueled fears of a regional Shiite uprising supported by mainly Shiite Iran. Many Shiite Bahrainis retain cultural and family ties with Iran and with Shiites in eastern Saudi Arabia; Bahrain’s Sunni ruling family has close links with Saudi Arabia, which holds 20 percent of the world’s oil reserves.

The U.S. is urging Bahrain, home to the U.S. Navy’s Fifth Fleet, to allow nonviolent protests and encouraging Gulf nations to use restraint, White House spokesman Jay Carney told reporters at the White House.

If the revolutions were merely local then we would be dealing with residual common factor risks, or event risk that is limited to a specific nation.

However, when domestic events includes international political interventions, then the risk factor transforms into systematic or market risk.

This is more a problem, for me, than that of Japan’s risk of a full blown nuclear meltdown (which on my assumption would eventually be resolved as others before it).

The key difference between the event risks of Japan and Bahrain is one of technical (Japan’s nuclear power woes) relative to social (religion based geopolitics).

The GCC intervention into Bahrain could well play into rival Islam Shiite-Sunni sect belligerency, particularly Saudi versus Iran, and possibly dragging more participants. At worst, there could be a regional conflagration.

This is a very important variable that needs to be monitored because further deterioration can extrapolate to a shift in the tide of the underlying market trends.

Japan’s Disaster Recovery Program: Wishing Away Real Problems With A Tsunami of Money

The Bank of Japan (BoJ) thinks that by flooding its system with money it can wish away real problems such as the threat of a nuclear catastrophe.

The BoJ has injected more liquidity into the system following 2 successive days of stock market blood bath.

The Marketwatch reports, (bold emphasis mine)

Japan's central bank injected 20 trillion yen ($245 billion) into the money markets Tuesday in an effort to help calm financial markets, according to reports. The move was designed to ensure that banks have enough liquidity to meet a surge in demand from companies and households seeking to raise funds. The same-day funds injection came as Japan's unfolding nuclear crisis deepened on Tuesday, with an explosion at reactor No. 2 and as the danger spread to reactor No. 4 at the stricken Fukushima nuclear plant. Elevated radiation levels were reported in Tokyo as southerly winds carried the radioactive plume from Japan's eastern coast towards urban areas.

This is in addition to yesterday’s injection.

As Economic Policy Journal’s Bob Wenzel writes,

There is no sound economic theory that suggests printing money can in any way help in the case of a physical disaster, as always this money will end up in the hands of the banking elite to provide them with an edge over those who have lost their homes and don't really need elitist bankers bidding against them for resources.

Japan’s Highly Protected Insurance Industry Has Taxpayers On The Hook

Japan’s Insurance industry isn’t only heavily distorted as a result of protectionism but likewise exposes taxpayers heavily to losses.

That’s according to Economic Policy Journal’s Robert Wenzel.

Mr. Wenzel writes, (bold emphasis mine)

First, the Japanese government protected domestic insurers by limiting foreign insurance companies from providing insurance. Then, the government wrote regulations that limit payouts from earthquake damage.

Because of all this, many in the region, where the earthquake just struck, don't even have earthquake insurance.

There's also a loss-sharing agreement that remains in place and if the damage stretches into the billions (which it will), the Japanese government (read: taxpayer) will be on the hook for much of the bill that rightly should be picked up by the insurance companies involved.

No wonder the subtle cries over a prospective fiscal crisis.

No wonder too why the BoJ was quick to resort to massive inflationism.

Despite The Disaster, Japan Reports Less Incidence Of Looting

Despite the horrible disaster, Professor William Easterly posits a very interesting observation and asks, why has there been no looting in Japan?

I quote Prof. Bill Easterly’s entire terse post... (bold highlight mine)

Amidst the heartbreaking devastation in Japan, many have noticed (especially this blog from the Telegraph) how much social solidarity — and little stealing — there has been. The Telegraph blogger Ed West notes vending machine owners giving out free drinks, in contrast to large-scale looting after Katrina.

Economists have been saying for a while that trust is a good candidate to be a major determinant of development. Think how much contract enforcement is critical to make trade and finance possible. Think how much easier contract enforcement is when nobody tries to cheat. This is supported by empirical studies correlating per capita income with a measure of trust, like that shown below, which is computed as …oh forget that, the current example is much more compelling.

Responding to tragedy, the Japanese have resources because they are rich, and it was their social solidarity that helped get them there.

While it may be argued that Japan’s homogenous society-a strong sense of group and national identity and little or no ethnic or racial diversity-could be attributed to such social cohesion, this idea of 'homogeneity' isn’t entirely true as such differences exists in Japan, like in all societies, as Harvard University professors Theodore Bestor (anthropology) and Helen Hardacre argues.

The economic development paradigm based on “Social solidarity that helped get them there” is perhaps what Henry Hazlitt explained in his The Foundations of Morality (quoted by Bettina Bien Greaves) as, (bold emphasis mine)

For each of us social cooperation is of course not the ultimate end but a means … But it is a means so central, so universal, so indispensable to the realization of practically all our other ends, that there is little harm in regarding it as an end in itself, and even in treating it as if it were the goal of ethics. In fact, precisely because none of us knows exactly what would give most satisfaction or happiness to others, the best test of our actions or rules of action is the extent to which they promote a social cooperation that best enables each of us to pursue his own ends.

Without social cooperation modern man could not achieve the barest fraction of the ends and satisfactions that he has achieved with it. The very subsistence of the immense majority of us depends upon it.

In short, a culture of (trust) social cooperation brought about by the interdependence of people founded on the division of labor, respect for private property and voluntary exchanges is what has mostly led to Japan's civil society that has greatly reduced the incidences of violence and theft even during bleak moments.

Black Swan Moment: Nuclear Safety Concerns Hammer Asian Stocks

There is an ongoing meltdown in Asian stock markets spearheaded by Japan, as of this writing.

charts from Bloomberg

Before I get “I told you so” quips from perma bears, the reason this has been happening, according to media, has been principally about nuclear safety issues and hardly about debt or other mainstream issues.

According to the Los Angeles Times,

Panic selling looked like it was spreading across Asian financial markets on Tuesday after Japan warned of rising meltdown risk at the crippled Fukushima nuclear reactor complex.

The Japanese stock market’s Nikkei-225 share index was down a stunning 1,275 points, or 13.3%, to 8,344 at about 9 p.m. PDT, with about two hours to go in the trading session.

Of course, because of the state of panic, many other chain effects such as the impact on fiscal conditions or credit (default risk) concerns or economic growth will also be attributed. It's people instinct to add causal linkages, even if they are irrelevant, mostly for social signaling purposes (intellectual strawmen).

Let me add that perhaps fears of contagion from radiation leaks may have also affected Japan's closest neighbors which may have also prompted for a domino effect dynamic throughout the region.

So yes while we may be seeing a blackswan moment (low probability, high impact event) triggered by nuclear safety issues (which apparently no one has seen or predicted), for me this looks more like a knee jerk reaction rather than a strong case for structural reversal.

Here’s my guess, after Japan has expanded their engagement on their version of a Quantitative Easing (QE), expect the US to shift rhetoric from the farcical “exit” strategies to QE 3.

Japan’s disaster has just given the US Federal Reserve a crucial excuse or justification to undertake extensions of their money printing operations or ‘credit easing’ policies.

While I am not sure about the ECB or BoE, I am inclined to think that they might join the bandwagon too.

Is Japan At A Risk of Debt Default?

When tragic events hit, some people have the habit to resort to sensationalist babble.

They read one bad event as a trigger to even more untoward events.

Such thinking represents more of personal bias rather than a reflection of actual events.

For instance, some have argued that Japan faces a risk of a fiscal crisis following today’s catastrophic earthquake-tsunami.

While there may be some grain of truth to this, this view essentially ignores the option of having markets forces help in the recovery process and the role and the actions of Bank of Japan.

So far the markets have priced some concerns over Japan’s liabilities.

According to Bespoke Invest, (graphs and tables from Bespoke too)

At the moment, it costs $95 per year to insure $10,000 worth of Japanese sovereign debt for five years. As shown in the table of CDS prices below, Japan remains at the low end of default risk compared to other countries around the globe. With the resilient country fighting to get back on track, investors don't appear to be worried about Japan having financial problems.

Bottom line: There are concerns over Japan’s debt conditions alright, but this seems far far far away from real risks of default yet.

In other words, despite the uptick in Japan’s default risk, the Philippines still has higher CDS premium or that the Philippines is seen as more susceptible to a default than Japan.

I am not saying that Japan isn’t vulnerable. I am saying that concerns up to this moment represents more of exaggeration than what is being reflected on the marketplace.

Let me add that what appears to be hounding the markets are the uncertainty of the possible escalation of the meltdown of Japan’s nuclear reactors. Once news reveal of the containment of the problem, you can expect these string of bearish news to gradually get discounted.

Japan’s Solution To The Earthquake-Tsunami Problem: Inflate The System!

Central Bankers are almost so predictable.

For almost every social problem that crops up, the intuitive measures adapted appear to be always based on the path dependency of inflationism.

It’s no different with Japan.

From the Wall Street Journal, (bold emphasis mine)

The Bank of Japan jumped into action Monday to temper the economic blow from the earthquake, tsunami and nuclear emergency that hit northern Japan, doubling the size of its asset-purchase program and pouring a record 15 trillion yen ($183.17 billion) into money markets to ease liquidity concerns.

"What we were most concerned about was the possibility that increases in anxiety and risk-aversion moves would negatively affect the real economy, so we judged it appropriate to mainly boost purchases of risk assets," BOJ Gov. Masaaki Shirakawa said after the bank's policy board meeting, which was cut to one day from two because of the crisis.

The board boosted its purchases of riskier financial assets, such as corporate debt, exchange-traded funds and real-estate investment trusts, by a total of 3.5 trillion yen. It also will buy an additional 1.5 trillion yen of government debt.

That doubles the size of the central bank's asset-purchase facility—part of a temporary fund established on the bank's balance sheet—to 10 trillion yen. The BOJ also has a program under the fund to provide 30 trillion yen in three- and six-month loans at 0.1% interest.

To revise the popular quote of the late Senator Everett Dirksen, "A billion trillion here, a billion trillion there, and pretty soon you're talking real funny money."