David Morris

THE first quarter of 2011 finished last week with a number of the world’s major stock indices registering impressive gains. This was quite an achievement given the geopolitical turmoil that erupted in January. Although the regime change that took place in Tunisia and Egypt has been relatively painless so far, the conflict in Libya is ongoing, and tensions are still simmering across the Middle East. Then there was the tragedy of the Japanese earthquake and subsequent tsunami.

No matter what the human cost, financial markets are typically quick to recover following natural disasters. Despite the extensive destruction of property and vital infrastructure, investors focus on the reconstruction that must inevitably take place. With Japan only recently displaced by China as the second largest world economy by GDP, the perceived wisdom is that the many trillions of yen that will be required for rebuilding will be made available and quickly put to work.

But the situation is made far more complex due to the damage done to the reactors at the Fukushima nuclear plant. On top of this, the Japanese economy is looking particularly vulnerable right now. The country’s public debt to GDP ratio has never been higher, while an ageing population means that its demographics have never been worse. As many Japanese companies have either had to halt or slow production, the drag on growth is likely to be severe. This will affect businesses around the world as Japan produces around 40 per cent of the world’s electronic components, 30 per cent of flash memory and 20 per cent of semi-conductors. Other economies are also in poor shape following the financial crisis. The US recovery is tepid, especially considering the huge fiscal and monetary stimulus that it has had. Unemployment remains unacceptably high, the housing market appears to be double-dipping and the country’s national debt is at record levels. Even a small increase in interest rates will put huge pressure on the ability of the US to service its debt. The Eurozone is crippled by its banking and sovereign debt crisis. China is desperately attempting to control inflation by a series of tightening measures. Put this together with Japan’s pivotal role in the global supply chain, and it can be seen how fragile the situation is.