Politics Roils the Markets

06/02/2010 4:39 pm EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

Political risk moves stock markets.

Investors are getting a reminder of that from Japan, where the resignation of Prime Minister Yukio Hatoyama has sent the yen falling against all but one of the world’s most traded currencies. The Nikkei 225 stock index is down more than 1%.

And they’re likely to get another refresher in coming weeks from Spain, where the government of Prime Minister Jose Luis Rodriguez Zapatero is struggling to stay in power.

In Japan, Prime Minister Hatoyama has said he will resign less than two months before elections scheduled for July 11. The move raises huge questions about whether Japan can pull itself out of the economic and political malaise that has gripped the country for the last 20 years. Hatoyama is the fourth Japanese prime minister to resign in the last four years.

Hatoyama’s Democratic Party came to power a year ago in an election that broke the 54-year near-monopoly on power of the Liberal Democratic Party. The hope was that his team would be able to revive Japan’s flagging economy and reform a political system that gives inordinate representation to rural districts with declining populations.

The retreat in the yen Wednesday morning—it fell 1.3% against the US dollar as of 9:00 am in New York—is related to speculation that whoever from the Democratic Party replaces Hatoyama in the run-up to the election will advocate a weaker yen to revive Japan’s economy and prevent deflation.

One potential candidate to replace Hatoyama is Finance Minister Naoto Kan. In his first day as finance minister back in January, Kan roiled global currency markets by saying he wanted the yen to fall, and he called on the Bank of Japan to support the national economy with cheaper money.

Meanwhile, back in the European Union, the Zapatero government barely survived a vote to cut $18 billion from Spain’s budget to reduce the county’s deficit to 6% of gross domestic product in 2011 from 11% in 2009. The margin of victory was a single vote.

No one expects a government presiding over an economy with 20% unemployment to be popular or have an easy time advancing its legislative agenda. But the Zapatero team has made things tougher on itself by initially denying that Spain had a budget problem.

International economic watchdogs and economists doubt that current plans will reduce the Spanish deficit by as much as the government is projecting.

Zapatero’s term ends in 2012, but if the government loses a key upcoming budget vote, the prime minister will be forced to call early elections. The government’s margin of error is minuscule: Zapatero’s Socialist Party does not control a majority in Parliament and relies on votes from minor parties to stay in power. It doesn’t help that the government’s budget plans have raised fierce opposition from the unions that traditionally provide much of his party’s electoral support.

What would replace a Zapatero government? That’s what worries international investors. The Popular Party, a likely winner in any early election, has voted against the government’s deficit-cutting plans, but doesn’t seem to have anything better to offer.

More dithering would seem to be in the cards.

Spain isn’t the basket case that Greece is, even though the country’s budget deficit and balance of trade deficit are worryingly large. The Spanish savings rate has climbed during the global financial and economic crisis to 19% now, so the country has a fair amount of domestic liquidity in reserve.

The Spanish central bank raised reserve requirements as the Spanish housing market overheated, so the country’s largest banks are in decent shape—as opposed to the regional and local cajas, which are in so much trouble that the central bank has begun to take them over or arrange for mergers. The International Monetary Fund estimates that Spanish banks need to raise just $31 billion against their bad loans. (For more on the health—or lack thereof—of Spanish banks, see this post.)

But none of that will stop investors from selling off Spanish assets and forcing down the euro even further if the Zapatero government totters and then falls. Markets just don’t like political uncertainty.

Full disclosure: I don’t own shares of any company mentioned in this post.

Related Articles on MARKETS