Peter Tasker is an analyst with Tokyo-based Arcus Research.
If the Bank of Japan were a hedge fund, it would be congratulating itself on a blowout year, and getting ready to pay out enormous bonuses.
When stocks plunged across the world in March and April as fears spread of a global COVID-19 depression, the BOJ waded into the Japanese market and bought exchange-traded funds, or ETFs, worth 2.7 trillion yen ($26 billion). A highly successful contrarian call, by the end of November, the Nikkei Stock Average had rallied 60% from its spring lows.
Central banks are not usually noted for their market savvy. One unhappy example is the Bank of England, which -- on government orders -- sold a large part of the U.K.'s gold reserves at a price below $300 an ounce in 1999-2002, pretty much the bottom of the market.
The BOJ has preferred to mirror Warren Buffett's famous dictum: "Be greedy when others are fearful, and be fearful when others are greedy." Its purchase program requires it to accumulate ETFs every year, but the amount and timing are flexible. This year, the BOJ invested three times as much in March as it had in January and, as the Tokyo market recovered in the autumn, its purchases tailed off to negligible proportions.
The BOJ's ownership of public equities started in a small way 10 years ago, under the austere regime of Governor Masaaki Shirakawa. The idea was to allow distressed banks to unload shareholdings of related companies without crushing their stock prices. Purchases of equities became an explicit instrument of unconventional monetary policy when the current BOJ governor, Haruhiko Kuroda, took over the reins in 2013.
Intended to be a temporary measure, the policy has endured much longer than expected, and via ETFs, the BOJ now owns around 45 trillion yen of equities, equivalent to 7% of the Tokyo market. That makes it the largest single investor, overshadowing the Government Pension Investment Fund, once known as the whale of Tokyo. Thanks to its buy on weakness approach, the BOJ is currently sitting on an unrealized profit of 10 trillion yen -- enough to finance Japan's defense budget for 20 months.
Clearly, this is unusual, but no more so than a central bank owning half the outstanding stock of government bonds, which is the case in Japan, the U.K. and some other countries. Traditionally, government bonds have been considered the ultimate safe asset because buyers always get their money back at maturity. But in today's world of negative rates, they offer not a risk-free return but a return-free risk.
Indeed, if central banks succeed in boosting inflation, then their massive bond holdings are likely to incur significant real losses. Investors would get their money back, but its purchasing power would be less. In such circumstances, the BOJ's exchange holdings could provide a useful buffer, since equities have done well, historically, in times of sub-5% inflation.
The BOJ's explicit rationale for its ETF purchase program is to reduce the perceived riskiness of equities and thus push the equilibrium level of the stock market higher than it would be otherwise.
Higher asset prices have long been a policy goal in many countries. Homebuyer subsidies in the U.K. have had the inevitable effect of jacking up house prices. In the U.S., where the Federal Reserve's history of slashing interest rates whenever the stock market runs into trouble has helped to insulate investors from downside risk, the Fed has recently been buying packages of corporate bonds, included debt issued by Apple to finance the purchase of its own shares.
The BOJ has simply been more honest about its intentions. By taking equities onto its own balance sheet, it has cut out the middlemen. If the BOJ carries on with its current strategy, it will eventually end up owning enough of the Japanese economy to gladden the heart of Karl Marx. There must be an exit strategy -- especially as the goal of reducing the perceived riskiness of the stock market has now been met.
Bonds will eventually run off central bank balance sheets as they mature, but equities, having no fixed term, last forever. So, what to do? The BOJ could sell its holdings, but ETFs have limited liquidity. Winding down such an enormous portfolio might cast a pall on investor sentiment for years. Alternatively, it could hold on to them and remain the "Moby Dick" of the Tokyo market -- sending an uncomfortable signal that financial conditions are still highly abnormal.
A neater and potentially highly popular solution would be to put the assets directly into the hands of the public at a significant discount to their market value, on the condition that they must be held for several years. That would probably necessitate a recapitalization of the BOJ, but such technical matters could be easily handled, given the political will.
If done well, this could be a major financial event, to rank with the privatizations of the 1980s. In line with the government's promotion of a shift from bank savings to securities investment, it would give a major boost to the development of an individual investor-oriented equity culture. And it would get the BOJ out of a trap of its own devising.