Japan's Nikkei 225 stock index sinks 10% in worst losses since 1987

A new twist in the stock market, Japan’s Nikkei 225 went down by more than 10% on Monday, the worst single day drop since 1987.

Update: Nikkei plunges 12%, logging its worst two-day decline in the history of Japan Stock Market, JapanToday reported.

This free-fall has triggered a lot of turbulence across the world’s financial systems; many analysts and investors are trying to understand the factors that led to this crash.

But, what I think is, it is related to economic problems of the USA, here's why:

The cause of the selloff can be linked across the Pacific to the US where rising concerns over the health of the world’s largest economy has spooked investors.

Although recent efforts have been made by the Federal Reserve of the United States to calm the markets by giving statements of stability and gradual recovery of the economy, there is evidence that the economy of the United States is not as sound as was earlier expected.

Some of these signs include low consumer spending, slow employment growth and a rising rate of corporate failures that have raised doubts among investors over the ability of existing stock prices.

This has resulted in a steep drop in U. S equities and this has affected the global markets with the Nikkei 225 suffering most of the impact. The selloff was compounded by the reversal of the yen carry trade—a practice of borrowing yen at low interest rate to invest in other assets in other countries.

When markets in the US began to decline, there was a stampede to hedge which saw the yen rise and Japanese equities fall.

Well, we can compare this downfall with 1987 too as the magnitude and the pace at which the Nikkei has gone down have made many people compare it to the 1987 crash which is still fresh in the minds of many stock traders.

The financial market was shaken to the core on October 19, 1987 commonly referred to as Black Monday when the Dow Jones Industrial Average dropped by a remarkable 22%. The Nikkei 225 of Japan which was still a new comer in the world financial map was not left out as it posted a major drop that signaled poor economic activities in Japan that was to be referred to as the “Lost Decade”.

Today’s crash, although in percentage terms is not as dramatic as the one that occurred on Black Monday, has the same echoes. The economic environment is not the same anymore – Japan is a far more developed economy, and the world’s financial system is far more elaborate with better protection measures in place today.

Yet, the fundamental processes of fear, uncertainty, and the shocking collapse of confidence are still rather similar.

A Broader Economic Malaise?

Thus, while the reasons for the Nikkei’s decline may have stemmed from worries about global recession and a decline in the U. S. economy, the origins of the crisis are more profound.

Japan’s economy, which was stagnant over the past three decades and suffers from deflation, a shrinking population, and a high dependency on exports, is considered to be very sensitive to external conditions.

A research paper also noted that the country relies heavily on export, especially to the U. S and as such any drag in the American market is immediately reflected in Tokyo.

The domestic issues have been worsened by the global economy in which Japan is operating. The US continues to engage in a trade war with China, Europe is grappling with inflation, and there is political instability in the Middle East; all factors that have made the market sensitive.

It is for this reason that the Nikkei’s drop can be best viewed as a sign of a systemic problem, not simply an event in its own right.

Wait, but the question is what next for Japan?

The way that leads to the future for Japan is not free from obstacles.

• In the short run, the government and the Bank of Japan are expected to come in and support the markets. This could mean the use of liquidity funds to inject liquidity into the economy, buying of government securities or even directly intervening in the stock market. But these measures may only offer the window dressing effect.
• In the long term, Japan has to address its structural economic problems if it wants to prevent the occurrence of today’s scenario. This is in relation to its demographic problem, the low productivity, and the overdependence on export as the major source of income.

Also, Japan’s financial markets should be made less dependent on global markets, possibly through increasing the domestic demand for funds and decreasing the Japanese reliance on short-term foreign capital.

It is now really a big wake-up call to investors.

The Nikkei’s crash is not only a problem in Japan but it is a wake up call for the interconnectivity of the global economy.

Being the third largest economy in the world, Japan is an important player in the international market and therefore any disturbance in Tokyo will definitely have a domino effect on the rest of the world.

To the investors, the crash is a reminder of the need to change their risk profiles and also to look at the big picture when making investment decisions.

Over the next few days and weeks, Japan and its policy makers will be under a lot of pressure.

The world will be watching not only how Japan will react, but also how healthy the global economy is in what seems to be a rather unpredictable period.