First, my thoughts and prayers go out to the people of Japan, who have sustained a horrific loss from the earthquake, followed by a tsunami, and followed by serious radiation leaks. It must be unimaginable for them.
From an investment standpoint, this will not be good, especially in the short-term. While the world economy has sustained catastrophic losses in the past and will do so in the future, we are now in the period of maximum uncertainty. Markets can handle bad news, but not uncertainty. When we have a ballpark estimate on how many hundreds of billions of dollars of damage were caused, when we know how the property insurers will be impacted, when we know how the Japanese government will react, when we know how the Japanese central bank will react, and the many other variables, the uncertainty will subside and the markets will improve. That may take a week or longer. In the meantime, hold your breath!
A tiny silver lining is that this market swoon will allow time for the U.S. economy to catch up to the U.S. stock market. Undoubtedly, the re-construction of Japan will produce immense profits for many U.S. companies. This helps our recovery, just like World War II helped our recovery from the Great Depression.
The object lesson of this tragedy is that tragedies can easily occur when a country is most economically vulnerable. When the Kobe earthquake occurred in 1995, Japan enjoyed a strong economy, with ample foreign reserves. Today, Japan has the highest debt-to-GDP of any developed nation, over 200%. Admittedly, most of those government bonds are helped by the Japanese people, unlike the U.S. where most of our debt is held by foreigners. But, the Japanese people will have less money to buy their government bonds, and foreigners will not be anxious to buy bonds of such a heavily-indebted nation.
Austrian economics is focused on maintaining a balanced-budget and setting aside reserves. The Japanese government has not been doing that, and the Japanese people will now pay the price. To attract foreigners to buy their bonds, they will have to raise the rate on those bonds, which has the unfortunate effect in increasing their cost of their currency, which then makes their exports more expensive to the rest of the world, who then buy fewer of those exports, leading to higher unemployment for the Japanese, because manufacturers don't need as many employees to make exports if foreigners are not buying. This downward spiral can be broken, but it requires real government leadership, which Japan has not seen in many years.
The U.S. stock market will go down but will not crash. So, take some time off. Be grateful we are spared such natural disasters. The market will come back . . . healthier than before . . . but not tomorrow.
