Yale’s Shiller: Quake Could be Final Tipping Point for Markets, Oil

One of the nation’s leading economic analysts, Yale University professor Robert Shiller, believes the Japanese earthquake could spark a huge worldwide stock market drop as early as this week.

He points to the fact that a similarly huge decline occurred within days of the Kobe earthquake in 1995, which did far less damage than Friday’s massive earthquake and tsunami.

“There was a huge worldwide stock market drop a full week after that earthquake. That’s the kind of thing we have to worry about now,” Shiller told CNBC.

One big reason for such a shift: Japan has the second largest public debt in the world, just behind Zimbabwe, a third-world nation. Shiller and other experts say the huge damage done by this earthquake could be the tipping point for a nation whose population is rapidly aging while its bloated bureaucracy remains imperious to tough economic reforms.

In the United States and Europe, the Japanese disaster could be the kind of fundamental change in perspective that causes a stampede for the exits in risk assets,

“What happened in the United States, a week after the Kobe earthquake, is the Nikkei fell 5 percent in one day. Now, there wasn’t necessarily any connection to the Kobe earthquake,” Shiller says.

“What happened? I think it was the news stories, the stories of human failure, of mistakes, that the Japanese government couldn’t handle that earthquake. It kind of created a different emotional atmosphere. It brought up reassessments of our general, basic outlook,” Shiller says.

Even worse, Japan’s woes are already being felt in oil prices that have climbed in the last few weeks because of the revolts in the Middle East.

That's because the 8.9-magnitude temblor forced the shutdown of a number of Japan's oil refining facilities as well as some of its nuclear power plants. The loss of substantial refining capacity in the world's third-largest economy is likely to inject more volatility into gasoline prices — raising the risk of even higher pump prices for American motorists, the Los Angeles Times pointed out Monday.

Industry experts say that if Japan can't get its refineries back on line quickly, there will be a spike in that country's demand for gasoline, diesel and jet fuel. Global suppliers, including refineries in California, may find it more profitable to increase shipments to Japan instead of selling the fuel domestically, resulting in a bidding-up of prices, the Times reported.

"It's a 'yikes' situation," James DiGeorgia, editor of the Gold & Energy Advisor, told the Times. "The sudden importation of large amounts of distilled products is expensive and it's a heavy logistics burden. That is going to drive up the market price for everything from diesel and gasoline to jet fuel."

Stock prices today reflect what’s to come, Shiller adds. “It prices the indefinite future. It’s very vulnerable to news stories that suggest new information and new emotions relating to that,” he says.

Shiller, who is widely credited with being the first to predict the collapse in home prices in the United States, is this time being echoed by other economists in saying that Japan could turn into a giant sinkhole for the global economy.

As aid pours into Japan, investors are eyeing events nervously for signs that confidence might be shaken by the disaster. Moody’s, the ratings agency, said that the quake could push Japan to a tipping point in terms of its enormous, long-standing debt problems. The agency had Japan on Aa2 sovereign rating with a negative outlook before the quake hit.

Shiller suggested that the markets might react by this Friday, as week after the earthquake, as happened in 1995. “That would be too precise of a mirror of what happened in ’95, but it’s the kind of thing to watch out for,” Shiller said.

Shiller is a professor of economics at Yale University and chief economist at MacroMarkets and is co-author, with George Akerlof, of “Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.” He also is co-creator of the S&P/Case-Shiller Home Price Indices, the widely followed measure of U.S. home prices.

Japan’s massive debt burden, now more than double the size of its economy, is part of the problem, Shiller says.

Stimulus from the energy and construction rebuilding effort to come might offset some of the economic problems, following the quake and the obvious immediate humanitarian need. But “I don’t know if it will offset all the negatives,” Shiller said.