There are More Tools in the Kit—We Expect to See them Used in the U.S. and Europe Before the Current Economic Malaise has Ended
So far, Japanese Prime Minister Shinzo Abe’s aggressive monetary easing is following pretty closely the prescription laid out in 1999 by a Princeton economics professor named Ben S. Bernanke. Back then, before the dotcom decline of 2000 and the 2008 crisis, Mr. Bernanke wrote the following in his appraisal how to help Japan regain its economic footing after 10 years of stagnation:
“Despite the apparent liquidity trap, monetary policymakers retain the power to increase nominal aggregate demand and the price level… [and] increased nominal spending and rising prices will lead to increases in real economic activity.”
That paper goes on to describe four central bank policies available to boost nominal prices. Abe campaigned explicitly on two of them last year.
First, in Bernanke’s words, was a commitment to zero interest rates—with an inflation target. Second was a depreciation of the Yen. The recent G20 meeting, which we comment on below, put the world’s finance ministers’ stamp of approval on Japan’s monetary easing, and recognized that Japan’s action was first and foremost dedicated to overcoming deflation and not to devaluing its currency. So much—at least temporarily—for the shades of “currency wars.”
Nevertheless, this “side effect” of Japan’s massive and unprecedented QE will be welcome and beneficial. Mr. Bernanke was of the opinion in 1999 that “a policy of aggressive depreciation of the Yen would by itself probably be enough to get the Japanese economy moving again.” The charitable public interpretation of Japan’s actions by the world’s financial movers and shakers is important because it shows that they understand the value of a dynamic Japan to the world economy—so much so that they are willing to overlook the devaluation of the Yen, and not scold or interfere.
Bernanke’s next policy suggestion for Japanese policymakers was money-financed transfers. In other words, he is referring to his (in)famous “helicopter drops”—the direct infusion of cash into the economy by transfer to citizens via one or another vehicle. This has not come to pass yet—although in February it got a lengthy and favorable treatment by Lord Turner, the chair of the UK’s now-defunct Financial Services Authority. So although it seems to have a slightly rising profile, it hasn’t entered the realm of mainstream policy discussion quite yet.
The final proposal in Bernanke’s 1999 paper that closely matches Abe’s current road-map is nonstandard open-market operations. By this, Bernanke meant the purchase of assets by the central bank with the goal of raising those assets’ prices and stimulating spending. He says:
“I doubt that extensive nonstandard operations would be needed if the BOJ aggressively pursues reflation by other means. I would hope, though, that the Japanese monetary authorities would not hesitate to use this approach, if for some reason it became the most convenient.”
However, Japan stalled around for over a decade before implementing much of Bernanke’s advice. Now, Prime Minister Abe has begun to implement the program in a determined manner. So far, Abenomics’ anti-deflation drive is following the Bernanke playbook. Will it do so with this policy suggestion as well? In fact, it already has—and in the future, it may do more.
Kuroda and Bernanke: On Board With the Program
Source: Financial Post
Indeed, other central banks around the world have, in small ways, started down the same path. We see this as a trend which will gain adherents and momentum in Japan, Europe, the U.S., and elsewhere in the world.
Here are some precedents of central banks buying stocks to stimulate confidence or economic growth: The ball was started rolling by Hong Kong. In 1998, in the throes of the Asian financial crisis, Hong Kong faced a massive speculative assault on its currency via huge short positions in the Hong Kong stock market. The government, under Finance Minister Donald Tsang, responded by buying up some billion worth of equities—then about 6 percent of the total market capitalization of the Hang Seng Index. When a year later the government spun off its holdings into a trust to be listed on the stock exchange, it realized a huge percentage profit—and in fact, the Hang Seng rose 4.5 percent in response to the announcement.
This success story led to several implementations of similar policies by Japan in the next decade, albeit on a much smaller scale. From 2002 to 2004, and again from 2009 to 2010, the Bank of Japan purchased stocks held by Japanese banks. Those purchases have not yet been unwound and are generally profitable. From 2010 to the present, the BOJ has purchased Japanese REITs (real-estate investment trusts) and ETFs (exchange-traded funds). The purchases have not been large—they have been perceived as attempts to influence market psychology and shore up fragile sentiment more than anything else.
Other central banks have recently begun to follow suit. We read recently that the Swiss National Bank is opening an office in Singapore. The bank’s press release indicates that its primary interest is in facilitating access to Asian currency markets, but it also note: “Further investment opportunities are also being examined—this includes both bonds and equities.”
In 2012, Israel’s central bank began purchasing U.S. stocks, planning eventually on holding 10 percent of its foreign exchange reserves in this form; and South Korea’s holdings of foreign stocks grew to 5.4 percent of its reserves. From 2009 to 2012, the central bank of the Czech Republic grew its equities holdings to 10 percent of its reserves.
So far, these moves have been either crisis-related and short-term (as in the case of Hong Kong), largely symbolic and aimed at market psychology (as in the case of Japan), or were conducted by relatively small central banks. Nevertheless, the principle is significant, since these actions represent direct central bank intervention in the stock market. Of course there are various “moral hazards” and potential opportunities for corruption and cronyism present in such action—but it also represents a massive source of support for stock prices if officials decided to use the tactic with determination. It is significant that Japan has, so far, followed Mr. Bernanke’s prescriptions—and that they have experimented with this measure as well. We think the global environment will be setting this strategy squarely before the eyes of the world’s central bankers, and that if and when it becomes necessary, they won’t hesitate to use it.
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