Economic Implications of the Japanese Earthquake & Tsunami

I'd like to start this post by point out I am not a macroeconomist. I did obtain a B.S. in Economics from Northeastern University, but my transcript is anything but impressive. Please question everything I say here and if you see any flaws in my logic be sure to point them out to me in the comments.

The first reaction I saw in the twitter finance / economics crowd was that, while the destruction was very tragic, reconstruction would act as Keynesian stimulus, possibly helping the economy. Some even joked that the combination of increased demand and stimulus in ZIR environment could cause hyper-inflation. So, let's try to step through this piece by piece:

There was massive destruction of the capital stock of Japan. This helps nobody, we are all collectively poorer as a result. There is simply less goods in the world now than there was a week ago. The same can be said for wars. The economic damage to Japan is likely humongous, but that's partly because Japan is a very wealthy country.

Replacement of the damaged capital stock will likely take years, but certain things will be replaced quicker than others, like insured cars, homes, household staples and durables. This sudden replacement will goose demand in the short term, providing stimulus to the economy, putting people to work and utilizing capacity.

A large part of the money for cleanup, reconstruction and replacement will come from exposed insurers and re-insurers. These companies will pay out claims from their assets. Some of the claims will be paid out from their most liquid assets, like cash and cash-equivalents or highly liquid instruments, including but not limited to, sovereign paper. If there is need for additional liquidity to pay out claims, other assets will have to be liquidated. I am no insurance expert, but common sense would dictate that insurers would be likely to liquidate the most liquid and least risky assets first, and then gradually adjust their risk and liquidity exposure in order to avoid paying too much for liquidity or having to take unfavorable bids (I started writing this before the TSE opened, but as of now the JPYUSD has already hit 80.80 and the Nikkei was almost 200pts down).

The initial move up in the Yen is hardly surprising. However, repatriated currency and any carry unwind help support JGBs, especially the front of the curve. Additional liquidity provided by BoJ does the same (Y7T and counting). As supply is set to increase there will be a firm bid for safe haven assets. Risk assets will have it more difficult, especially until losses are sorted out, especially financials.

Overall, this will essentially be bearish for JGBs in the long term. The economy's Supply capacity was just reduced (S curve moves left) and demand is about to be goosed (D curve moves right). Because of increased demand and reduced supply, I'd expect to see price increases. I'm not talking about price gouging, but pricing power is moving to suppliers, both of goods and of labor. Whether this will be enough to shock the country out of the deflationary trap remains to be seen, though.   If it does succeed, the natural thing to expect would be a gradual uptick in nominal rates, which would be bearish for JGBs in Yen terms. The currency is a different matter.

At first, as we are seeing already, JPY is going to be strong. JPY is a flight-to-quality  currency and a carry funding currency. Any unwind of carry will come with demand for Yen and supply of the carry currency, putting upward pressure in the Yen. The carry trade is so big that there's no way in hell BoJ can do anything about it. After this, though. I see a bearish path for the JPY. What you are going to inevitably end up with is an increasingly indebted country and a reduced capital stock.  Best case scenario the crisis kickstarts the economy and deflation ends, but--again, in the long term--inflation will be bearish for the currency from a PPP standpoint.

PS: anyone telling you that the flight-to-quality is going to lower exports is in the wrong time frame. Techinically, yeah, a strong JPY would hurt exporters, but there's about to be such a HUGE boost to internal demand, that it ain't no thang.

For those of you that like to play, here's some long ideas. (no short ideas because if you short disaster victims you're a real asshole)
Managed timber; Durables and materials retailers; Equipment sales and leases; Construction; Auto dealerships; furniture retailers; electronics (TVs, computers, etc retailers). Basically go long the people who are going to sell the stuff that needs to be replaced and were either undamaged or probably protected by insurance. Also, anyone that rents out heavy machinery.