The Impact of the Japanese Earthquake and Tsunami on US Savings, CD, and Mortgage Rates

Japan is the third largest economy in the world so any crisis in Japan has the potential to have an impact on what happens in the United States. While the extent of the humanitarian crisis is still being determined, the world is also beginning to look at the economic impact of the earthquake and hurricane. One question to naturally ask in the United States, is how will a shock to the third largest economy in the world impact what happens in the United States. Specifically, how will it impact interest rates?

Below, I've listed several different rate scenarios and the rationale behind each.

Reasons the Japanese crisis may lead to an increase in rates include:

• Japan sell-off of Treasuries to help finance reconstruction. While the Japanese hold a large percentage of their own debt, they also hold 9.6% of US debt (approximately $1.4 trillion). If the Japanese need money then it stands to reason they might stop buying US debt and begin selling.
• Insurance companies selling Treasuries to finance reconstruction. Insurance companies may need to liquidate some of their Treasury holdings in order to pay claims related to the earthquake and tsunami.
• Eventual burst in growth from reconstruction. Japan has had a moribund economy for the last 20 years because consumers have saved too much. A disaster like this may force Japan to inject more consumption into the economy and lead to stronger growth.

Reasons why the Japanese economy may lead to no impact on US rates:

• While Japan is a large economic power, trade between the two countries is still a very small percentage of overall US GDP. The US exported $51.2 billion in goods and services in 2009 versus a US GDP of $14 trillion. That means if Japan stopped trading with us altogether it would impact GDP by .37% per year.
• Japan keeps its debt to itself. According to the Economist in 2008, over 93% of Japanese public debt was held domestically. Japan may have huge debt but they owe it to themselves so the problems they are facing will not send cash running into Treasuries. The Japanese seem unlikely to pull stakes and run with their cash.

Reasons why the situation in Japan may lead to lower US rates:

• Lost Japanese production and consumption will drop global GDP. The disaster may trim 0.3 percent from Japan’s economy as power outages cut industrial production, Nomura Holdings Inc. estimated in a report. This report was released on Monday, March 13 before the true extend of the damage was known. The nuclear crisis in Japan is also ongoing and worsening.
• Japan is a critical supplier of components for many electrical components. Japan makes 44 percent of the world’s audiovisual equipment, 40 percent of electronic components, 19 percent of semiconductors and about 20 percent of all technology products, Bhavtosh Vajpayee, head of technology research at CLSA Asia-Pacific Markets in Hong Kong wrote in a report yesterday. High tech industries may see higher component costs if Japanese companies cannot get their production and transportation back to normal soon.

So which is it? For the short term, I think it’s the middle scenario – not much impact. In the future I think the bias swings to slightly higher rates. Just as the US economy is heating up in 2012 (right around the next Presidential election) a Japan in full rebuilding mode will cash out its savings in US Treasuries (raising rates) and begin a spending boom that will boost the global and US economy (putting upward pressure on rates).