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If you are trying to beat China, it’s best not to act too Chinese. Japan might want to heed this warning as it edges toward effectively nationalizing its stock market.
Currently, the biggest holder of Japanese shares is Japan’s state-run pension fund, which is also the world’s largest, but the Bank of Japan is on course to overtake the Government Pension Investment Fund by 2020.
That raises prickly questions about government authorities’ out-sized role in the capital markets, marring Japan’s free-market street cred.
What about market forces?
The BOJ’s holdings of exchange-traded funds were $250 billion as of the end of March. That’s nearly 5% of the total market capitalization of the first section – which lists blue chips – of the Tokyo Stock Exchange. At the current pace of ETF purchases, its stockpile will head toward roughly $360 billion by November 2020.
That would put the BOJ above the Government Pension Investment Fund, which now has a 6% share of the Tokyo Stock Exchange’s first section.
From this, two big takeaways spring to mind. One: Forget fantasies about BOJ “tapering” or even an interest rate hike. Two: Tokyo officialdom is pushing its tentacles deeper into the financial system, deadening the market forces any Group of Seven economy needs to thrive.
Those “market forces” are getting lots of lip service in Beijing. There, President Xi Jinping has pledged for six-plus years now to give them a “decisive” role. Progress has been glacial, at best. Xi ramps up fresh stimuli at the slightest whiff of slowing growth, prioritizing short-term growth over structural change.
In the last six-plus years under Shinzo Abe, Japan has taken a similar strategy. Since 2012, the prime minister’s promised supply-side upgrades took a backseat to the most aggressive monetary stimulus in history.
Technically, that easing was the BOJ’s doing. But, really, how independent is a monetary authority that cuts rates to zero — and lower — and leaves them there for 20 years? Not very.
Abe’s handpicked BOJ governor, Haruhiko Kuroda, did his best to bestow an air of autonomy on the enterprise. But in essence, the BOJ is helping to effectively nationalize the government bond market. Its holdings have long since topped 50%, deadening secondary trading. There have been entire days since 2013 when the $10 trillion debt market didn’t record a single trade.
All that BOJ hoarding came at an even higher price: enabling government complacency. It was a blank check for Abe to increase spending, ramp up borrowing at ultra-low rates and delay structural reforms. Tokyo’s debt-to-gross-domestic-product ratio is approaching 250%. And yet it’s only halfway to the 2% inflation target. Growth is sputtering anew as the trade war slams exports. Overseas shipments fell 2.4% in March from a year earlier, the fourth straight monthly drop.
Now, the BOJ is pushing its tentacles ever further into the stock market, crowding out private investors.
Already, the BOJ is the biggest shareholder in at least 23 companies via ETFs. They include robot-maker Fanuc, motor manufacturer Nidec and electronics outfit Omron. As of the end of March, Kuroda & Co. was a top-10 investor in roughly 50% of Tokyo-listed companies.
It’s impossible to conclude that this influence won’t forever alter the nature of Japanese markets. Granted, its bourses have long danced to their own tune. That will happen when banks and insurers dominate the retail investor space. Ditto for the labyrinthine web of cross-shareholdings between friendly companies.
If you can’t beat ’em…
One could argue that the end justifies the means. Rising stocks often emanate a positive wealth effect that boosts household and business sentiment. This is the chain reaction the BOJ was hoping to spark with its epic bond purchases. To no avail. But extending that asset nationalization scheme to the stock market raised the stakes.
Incentives are getting out of whack. Companies are, and will increasingly be, rewarded by BOJ largess regardless of merit. That’s a dangerous undercurrent in a nation struggling to improve corporate governance. As the Organization for Economic Cooperation and Development put it on April 15: the BOJ’s ETF binge “is eroding market discipline as companies are rewarded simply for being in major market indexes, rather than for having new business strategies or offering more dividends.”
The BOJ would, in theory, limit the downside in ways that would irk Adam Smith and his free-market ilk. Just as the People’s Bank of China pulls out all the stops to protect the Shanghai and Shenzhen bourses, the BOJ would be obliged to put a floor under Tokyo indexes.
China is in the room in another way as Abe promises to make Japan great again. He took the premiership a year after China’s GDP surpassed Japan’s, a seismic moment for Asia’s traditional economic power.
Now, nearly seven years on, Abe is trying to beat China at its own game by cribbing from Beijing’s playbook. Little good will come of that.