Japan flirts with equity targets to drive a stake in the zombie economy

Sid Verma
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Japan has blazed a trail for activist G7 policymakers thanks to an unprecedented comment by the economy minister that he wants the Nikkei to surge 17% to 13,000 by the end of March. But the policy risks back-firing, even if it's a mere aspiration.

When Alan Greenspan lashed out against plans for an ill-fated "super fund" in 2007 – proposed by Citi, Bank of America, JPMorgan and Wachovia to take on the assets of troubled investments – his rationale was clear. Greenspan drew a distinction between the bailout of a single, large hedge fund to prevent the widespread sell-off of assets – as with Long-Term Capital Management in 1998 – and efforts to prop up an entire asset class, in this case bank SIVs.

Greenspan told Euromoney’s sister publication Emerging Markets that the disadvantages outweighed the benefits thanks to market psychology: "It could conceivably make [conditions affecting investor psychology] somewhat adverse because if you believe some form of artificial non-market force is propping up the market, you don’t believe the market price has exhausted itself.

"What creates strong markets is a belief in the investment community that everybody has been scared out of the market, pressed prices too low and they’re wildly attractive bargaining prices there. If you intervene in the system, the vultures stay away. The vultures sometimes are very useful."

Akira Amari, Japanese economy minister

Fast-forward to February 2013: in an unprecedented speech, the Japanese economy minister Akira Amari said he wants to see the Japanese stock market rise 17% to 13,000 by the end of March, in comments that break new G7 territory as the first policymaker to promote an equity index target.

The minister added that monetary and fiscal policies should be anchored with the express goal of sustaining the equity market rally – a direct, rather than indirect, consequence of stimulative policies. The idea: this forward guidance would become self-fulfilling, or close to, by nurturing confidence in the prospective deflation-fighting policies from the Shinzo Abe administration.

This is a logical extension of the adaptive expectations hypothesis in transatlantic vogue: consumption and production can be boosted if policymakers generate bullish expectations about the provision of growth-positive monetary stimulus, such as employment targets or forward interest-rate guidance, or in this unprecedented case: equity index targets. Thanks to aggressive pro-growth pronouncements, the Japanese government has successfully boosted domestic confidence, as figures in January lay bare.

"I have some sympathy for this," says Julian Jessop, chief economist at Capital Economics. "But I wonder if he was really attempting to give something as sophisticated as forward guidance. Rather, it’s pretty obvious he wants to see the stockmarket rise further so he appears to be articulating an aspiration."

Asian Development Bank president Haruhiko Kuroda – tipped as a leading contender to become the new governor of the Bank of Japan (BoJ) in March – has said corporate stock purchases by the BoJ "could be justified", sparking speculation of a more activist monetary stance under his leadership.

Says Jessop: "The outright purchase of equities is a step too far. Central banks should buy assets to raise prices in order to drive down interest rates or inject liquidity into the financial system. These measures are taken to boost growth and, indirectly, equity markets."

What would US central bankers make of the comments made by Japan’s economy minister? Although Greenspan argued rising US stock prices could help "offset the negative effects of declines in home equity" and thereby help cushion a US slowdown, Japan’s move flies in the face of his laissez faire posture.

Activist Federal Reserve chief Ben Bernanke would presumably be, at the margin, more sympathetic to the move, recognizing the virtuous circle triggered by reflationary expectations. In chastising the BoJ for its timidity, Bernanke in 2003 famously called on the Japanese authorities to consider a raft of stimulative options. These included targets for long-term interest rates, a weaker currency, a higher inflation target and fiscal expansion entirely financed by the central bank, though he did not mention the allure, or otherwise, of articulating stock index-level targets.

Bernanke, in the wide-ranging speech on Japanese monetary policy, said: "Declining asset values and the structural problems of Japanese firms have contributed greatly to debtors’ problems as well, but reflation would, nevertheless, provide some relief. A period of reflation would also likely provide a boost to profits and help to break the deflationary psychology among the public, which would be positive factors for asset prices as well.

"Reflation – that is, a period of inflation above the long-run preferred rate in order to restore the earlier price level – proved highly beneficial following the deflations of the 1930s in both Japan and the United States."

Bernanke knows a thing or two on indirectly reflating global equity markets. Since the Fed cut its target interest rate to an historic low of 0% to 0.25% in December 2008, 13 other central banks have followed suit with a zero interest rate policy. The Fed has grown its Treasury holdings to an all-time high of $2.9 trillion since December 2008.

According to one estimate, those 14 economies are host to a combined equity and bond market capitalization of $65 trillion, in which private financial markets are swimming for yield above the effective nominal policy rate of near-0%. What’s more, the debate about anchoring fiscal and monetary policy through the explicit lens of nominal growth – such as employment thresholds or formal NGDP targets – raises inflation expectations, a boost for equities over bonds.