By Neil Irwin
Thursday, March 17, 2011; 2:51 PM
The U.S. stock market fell for the third straight day Wednesday as Japan's nuclear crisis worsened and the global economic risks from Friday's earthquake and tsunami became more apparent.
The Standard & Poor's 500 was off 2 percent for the day and is now down slightly for the year. Its gyrations followed the news from Japan, rising on a report that an emergency power line to one nuclear plant was nearly complete and falling when it was reported that pools of used nuclear fuel were compromised. Also contributing to the losses were signs of more political turmoil in Bahrain and a weak report on U.S. housing starts.
Investors sold stocks and other risky investments - and pushed money into Treasury bonds, viewed as a haven - on fears that Japanese officials will not be able to contain the damage and prevent meltdowns at the nuclear reactors.
In trading Thursday, Japan's Nikkei stock average slid 1.4 percent to 8,962.67, and the yen soared against the dollar.
As Japan begins the complex and costly job of rebuilding the areas of the country that were destroyed, the task will be made more difficult by the government's vast debt.
Japan has the highest level of debt relative to the size of its economy of any major industrial nation - 234 percent of gross domestic product this year, the International Monetary Fund estimates, compared with 99 percent for the United States. With the cost of rebuilding devastated areas expected to be in the hundreds of billions of dollars, that debt level is likely to grow in the years ahead.
There are lessons for the United States. Even when borrowing rates are low, as they are for the United States and Japan, running high budget deficits can leave a country with less flexibility to respond to a disaster or an economic setback.
"When you have as much debt as the Japanese have, you're vulnerable to this kind of shock and can't do much about it," said Carmen Reinhart, a senior fellow at the Peterson Institute for International Economics whose research shows that financial crises frequently lead to high debt burdens, which in turn cause other problems.
Borrowing money to rebuild after a disaster is a productive use of debt, most economists say. It is likely to have a high economic payoff and is a one-time expense. But because of its already high debt levels, the Japanese government may be forced instead to raise taxes or cut other spending to pay for the reconstruction, further damaging Japan's weak economy.
A third option for funding reconstruction would be for the Japanese government to sell off some of its foreign assets, such as U.S. Treasury bonds. In theory, Japan maintains those reserves so it is prepared for an economic emergency, which surely this is.
The Japanese government, despite its hefty debt, has among the lowest costs to borrow money of any country or company on the planet, because Japanese citizens have traditionally put their savings into government bonds. That practice hasn't changed in the aftermath of the devastation: The interest rate the Japanese pay to borrow money for 10 years on the bond market was 1.22 percent Wednesday, down from 1.3 percent before the earthquake and tsunami. By comparison, the U.S. government pays 3.2 percent to borrow money for the same span.
However, although those low rates for Japanese bonds make the debt load manageable for now, demographic shifts will make for fewer domestic buyers of these bonds in the future, perhaps a decade from now. And given the immense size of the debt, even slight increases in interest rates could prove catastrophic for the nation.
One wrinkle is that the Bank of Japan, the nation's central bank, has been expanding its purchases of a wide variety of assets, including Japanese government bonds, as part of a long-standing effort to prop up the economy, which has been largely stagnant for two decades. Those bond purchases by the central bank could help reduce some of the upward pressure on interest rates.
"The Bank of Japan acted very quickly doubling the maximum size of its current asset-purchase program," said Andreas Utermann, chief investment officer of RCM, an asset-management firm. "These steps are turning the already supportive monetary policy in Japan even more expansive, which should support the ability to recover from the earthquake shock."