Libya, Japan crises will rock the economy

POLITICO

Libya, Japan crises could rock the economy

By BEN WHITE | 3/22/11 2:22 PM EDT Updated: 3/23/11 1:07 PM EDT

NEW YORK — The punishing allied airstrikes in Libya, coupled with the continuing nuclear crisis in Japan, threaten to push high oil prices even higher and undermine the fragile economic recovery in the United States and abroad.

If nothing else, some economists and market watchers warn, the volatility and uncertainty of both crises could cut into corporate and consumer balance sheets and shave enough off economic growth to help tip economies back toward recession.

Fears persist that Libyan leader Muammar Qadhafi could set fire to his country’s oil fields, which had been pumping about 1.6 million barrels a day before the country’s unrest turned into civil war, drawing U.S. and allied intervention.

And it’s not just Libya that’s stirring concern. Unrest has been growing in Yemen and other countries throughout the oil-producing region.

The biggest threat might be that turmoil will erupt in Saudi Arabia, a major U.S. oil supplier that pumps about 9 million barrels a day. A big drop in production there would certainly send U.S. gasoline prices, already nearing $4 a gallon in most places, skyrocketing.

“The fear factor may return with regard to Saudi Arabia,” said James Rickards, managing director of market intelligence for Omnis. “It is surrounded by Egypt (unstable), Yemen (unstable), Bahrain (unstable) and Iran (antagonistic). That story will play out over weeks and months, not necessarily days.”

Stocks were weaker Tuesday after a good day Monday. “But that’s a combination of a relief rally based on better news out of Japan and the fact that QE2 is continuing,” Rickards said, referring to the Fed Reserve’s latest program of “quantitative easing” in which it buys as much as $600 billion in Treasury bonds to help keep interest rates low and boost the economy.

It would be a mistake to use the stock market as the leading indicator for the underlying economy, given the Fed’s actions, Rickards said, adding that the movement of other market gauges was more troubling.

“The Fed will not tighten in this uncertain environment, and Wall Street loves cheap money, so stocks may continue to do well,” he said. “But if you look at oil, gold and silver, you see continued concerns about inflation and, in the case of oil, a potential drag on growth.”

The price of a barrel of oil has spiked to as much as $120 in the past month because of tensions in Egypt and now Libya.

“With reports of protests in Syria and Yemen, hostilities at the Gaza-Israel border and Saudi troops in Bahrain, the risk of political contagion remains,” Goldman Sachs analyst David Greely wrote in a recent report.

Then, there’s the pressing matter of the Japanese earthquake and tsunami and resulting nuclear crisis and massive rebuilding effort ahead.

Japan appears to be gaining some control over its ravaged Fukushima Daiichi nuclear plant, but the situation is still very fluid and significant radiation leaks remain a major concern.

Over the longer term, there’s some concern that Japan will become a significantly larger consumer of oil, given its reconstruction needs and the destruction of critical nuclear-power-generating capacity.

Indeed, Goldman Sachs wrote in its recent report that Japan may need 230,000 barrels a day of combined residual fuel oil and direct-burn crude oil to offset lost nuclear generating capacity

Additionally, significant interruptions to the global supply chain remain. Sony said Tuesday that shortages of parts and materials would cause it to close five more Japanese plants.

Already, the Japanese crisis has impacted U.S. automobile and airplane manufacturers. GM had to halt production at a plant in Louisiana, and Nokia and other mobile-phone makers are warning of supply chain disruptions.

So far, most of the disruptions have been minor and temporary. But given that Japan produces 40 percent of the world’s electronic components, analysts continue to warn of a significant longer-term impact on corporate profits.

Beyond the measurable impact of higher oil prices and disrupted supply chains, headlines about unstable situations around the globe threaten to dent consumer confidence. Sentiment had been rising on hopes for solid economic growth of as much as 4 percent in the U.S. this year, driven by companies beginning to spend their vast cash holdings.

But consumer confidence in a Reuters/University of Michigan survey fell to 68.2 earlier this month from 77.5 in February, the biggest decline since October 2008. And that was before the U.S.-led airstrikes against Qadhafi’s forces in Libya.

The economic recovery could be further endangered if consumers return to their recent pattern of debt reduction rather than consumption.

Still, many experts remain convinced that underlying growth in manufacturing, healthy corporate profits and an overall reduction in reliance on oil will help the U.S. and global economy push ahead, despite the crises in Japan and Libya or others that might emerge down the road.

These experts point to events such as JPMorgan Chase’s willingness to put forward a $20 billion loan to finance AT&T’s proposed takeover of T-Mobile and an increase in the market for risky corporate debt as signals that the recovery is real and sustainable.

“The U.S. recovery remains firmly on track,” Goldman Sachs Asset Management Chairman Jim O’Neill wrote in a recent note to investors. “Weekly [jobless] claims fell again [last week], and a clear trend for an improving job market seems under way. In addition, there was a gangbuster of a Philadelphia Fed business survey.

“The combination of a friendly Fed and an improving economy are both still present,” he added.