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The Daily Reckoning

Oil prices, world markets affected by Japanese quake

Oil prices have dropped, and currencies in Japan, China, and Singapore will be affected.

By Chris GaffneyGuest blogger / March 14, 2011

Traders work in the oil options pit at the New York Mercantile Exchange in New York, Monday, March 14, 2011. Oil prices have begun to fall since the earthquake struck Japan last week.

Seth Wenig / AP

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The currency markets stuck to their established pattern on Thursday with the dollar pushing up versus the majority of the majors. As you have undoubtedly heard by now, Japan was rocked with an 8.9 magnitude earthquake and slammed by a tsunami shortly after. This is the news that is dominating the markets, so I will break from my usual pattern of talking about the US first, and instead, begin in the west and work my way east.

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The earthquake, which shook Northern Japan during their afternoon was the worst quake to hit Japan in over 300 years. The quake generated a Tsunami that slammed into the northeast coast of Japan causing additional damage. Surprisingly, the Japanese yen (JPY) rallied after the quake. This seems to be counter to what you would expect, as you would expect any catastrophic event to have a negative impact on the victims’ currency. The quake that hit Christchurch, New Zealand is a good example, as the kiwi (NZD) has been sinking ever since it hit. But the Japanese yen rallied. After digging a bit, I uncovered what seems to be the reason. Japanese investors are big savers, but rates in Japan have been near zero for over a decade. These Japanese investors have invested their savings into foreign markets, including the higher yielding currencies of New Zealand and Australia (AUD). But this natural disaster has caused these Japanese investors to bring their currency back home, as they fear they will need it to help rebuild. And this repatriation of funds has been even more pronounced for Japanese companies who are moving their reserves back into their home currency.

So this would account for the knee-jerk reaction to the disaster. But the question is what happens to the Japanese yen over the longer term? Will the yen maintain its strength, or sill it slide like the kiwi? Japan’s Prime Minister has mobilized Japan’s self defense forces (they still have to call them that after losing WWII) and the central bank has pledged to ensure financial stability. The government seems to have calmed the markets for now, but faces a tough choice in the future. The BOJ has been struggling to bring down its budget deficits, but the rebuilding in the aftermath of the quake and tsunami will certainly lead to more deficit spending. The economy will actually benefit from this disaster in the short run as there will be fiscal stimulus from reconstruction. But Japan’s budget deficits are already close to 10% of GDP, and this additional spending will only add to the problem facing Japan’s aging population. While the yen may benefit in the short run, I wouldn’t suggest it for longer term investors.

One Asian currency that I would suggest is the Singapore dollar (SGD). As we have explained to investors in previous Pfennigs, the Singapore Monetary Authority uses the value of their currency as their main monetary tool to combat inflation. So while most central banks are trying to find ways to devalue their currency, Singapore’s is actually letting theirs appreciate. The Monetary Authority of Singapore will be meeting again in April, and with inflation heating up throughout Asia, a boost to the Singapore dollar is expected. The central bank is expected to try and cool their inflation by strengthening the Singapore dollar according to 11 of 13 economists polled by Bloomberg. And Singapore has some very good economic fundamentals in addition to their aggressive central bank. So for investors looking to diversify into Asian currencies, Singapore seems like a logical choice!