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Opinion

US should heed warnings from Japan's free-money experiment

Expansive financial policies hold severe risks for central banks

| Japan
Federal Reserve Chairman Jerome Powell at the news conference on Mar. 3: will the Fed follow Japan's lead and prop up the stock market?   © Reuters

William Pesek is an award-winning Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades."

In Washington, a small army of Federal Reserve watchers spend their days divining how the U.S. central bank might surprise the world next. The real clues may be found not in reports, speeches or data sets, but at Bank of Japan headquarters in Tokyo.

The past few months have been the most disorienting in the institution's 107-year history. Chairman Jerome Powell has been letting Donald Trump's Twitter feed do his thinking for him, cutting interest rates pretty much whenever the U.S. president desires.

The biggest surprise of all, though, is how reminiscent of Japan the Fed is looking in the Powell era.

The BOJ has been an unintentional pioneer for two decades now. It started in 1999, when the BOJ cut benchmark rates to zero. That led to the globe's first experiment with quantitative easing, when a central bank buys financial assets to inject money into the system, in 2000. Decidedly radical at the time, both steps have since become standard operating procedure for the Fed, the European Central Bank and many other peers.

Now Powell's team is cribbing from the BOJ's once-controversial purchases of corporate bonds. For the BOJ, that step came in 2009 during the shock to global growth from the collapse of Lehman Brothers. For the Fed, loading up on corporate debt by buying exchange-traded funds comes as coronavirus fallout drives the U.S. into recession.

This leads to an obvious question: will the Fed follow Japan's lead and prop up the stock market?

Judging from the ferocity of market chatter, it seems more a question of when not if, given Powell's subservience to virtually every Trumpian whim. With the president facing a tough reelection fight, no priority looms larger than driving the stock market higher.

On April 6, Powell's predecessor, Janet Yellen, entered the debate. The Fed chair from 2014 to 2018 told CNBC that "it would not be a bad thing for Congress to reconsider the powers that the Fed has with respect to assets it can own," including "the ability to buy stocks."

Yellen said: "I frankly don't think it's necessary at this point." Yet for central banks to support shares so prominently ignores the lessons from Tokyo. Here are three worth heeding.

One, it warps market dynamics. In 2010, the BOJ began loading up on ETFs. Since 2013, the BOJ's latest governor, Haruhiko Kuroda, has aggressively expanded the central bank's balance sheet. By June 2018, the BOJ ranked among the 10 biggest shareholders in nearly 40% of listed Japanese companies.

Haruhiko Kuroda has aggressively expanded the central bank's balance sheet.   © Reuters

Now the BOJ is getting even deeper into Japan Inc. Last month, as coronavirus fallout hit global equities, the BOJ doubled its annual purchasing target for stocks to 12 trillion yen ($112 billion).

Yet none of these interventions is making companies more competitive, efficient or productive. Backstopping share prices is not catalyzing a wave of innovation or prodding CEOs to be more accountable to shareholders.

In fact, the opposite may be true. The BOJ's largesse is deadening the urgency for change. Its holdings amount to a huge block of ownership not demanding that companies diversify boards, per Prime Minister Shinzo Abe's reform drive.

Two, it does little for the real economy. All this corporate welfare is not incentivizing Japan to deploy mountains of cash. There is scant evidence that the BOJ's ETF buying resulted in the surge in new investment. It has not prompted CEOs to boost wages markedly, kicking off a virtuous consumption cycle.

The deflationary mindset the BOJ sought to change remains dominant. In 2013, inflation rose an annualized 1.67%. Last year, it advanced just 0.79%, a far cry from the 2% inflation target.

Everyone knows the stock market is not the real economy, everyone but Trump at least. He has already morphed the Fed into a White House ATM. The odds are high he will prod Powell and colleagues to underwrite stocks as the November election approaches, with the help of Congressional leaders also facing tough contests.

Three, it will be almost impossible to unwind. Extraordinary monetary policies become normalized rather quickly. Banks, companies, consumers and, of course, politicians get used to free money.

Unwinding the BOJ's huge bet on stocks will be no easier than selling the bonds it bought without causing turmoil. There is another problem with ETFs: they do not mature. The BOJ and Fed could, in theory, just let government bonds reach their terms. Since ETFs must be actively sold, they may be on central bank balance sheets long after today's crop of central bank heads move on.

Such bullish behavior comes with many risks. Last month, the BOJ admitted to as much as $28 billion of unrealized losses on ETFs. That could mean an annual loss on the BOJ's balance sheet, a first in almost four decades, should increasing COVID-19 cases result in a national lockdown.

The Fed might want to avoid a trap actively ensnaring its peer 7,000 miles away.

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