It is December 2020 and the Bank of Japan is now
the single biggest shareholder of Japanese stocks. Over the span of a decade, the
central bank bought hundreds of billions of dollars in Tokyo-listed stock ETFs as part of its monetary easing programs,
sitting on a handsome $130 billion profit. You might be forgiven for wondering if it is
normal for a central bank to buy "stonks". It has never been done before in this
way. Yet as Japan threatened to enter another era of economic stagnation and deflation, the bank decided to go where no bank has
gone before in an effort to fight the future. In this video, I want to dive into a
controversial, groundbreaking program and the market-distorting effects that it has
wrought on the world's third largest economy. In 1985, Japan and four other
countries signed the Plaza Accord. This agreement depreciated the United
States Dollar against the Japanese Yen and the German Deutsche Mark in an effort to
improve the competitiveness of American exports. Over the next two years after its signing, the
dollar lost 51% of its value against the yen. Japan entered the Plaza Accord to avoid
having its goods tariffed and locked out of the American market. America faced
domestic political pressure to do something about its exchange rates and to reduce
the trade deficit. For what it is worth, the Japanese-American trade deficit continues
to this day so it is not like the Americans got what they wanted. But in Japan, the
accord nevertheless had significant effects. The Yen's appreciation plunged the Japanese
manufacturing sector into recession. In response to this, the Bank of Japan loosened monetary
lending policies and lowered interest rates. This cheap money was supposed to be
funneled into productive efforts like building factories and the like. Instead, it went
into stock, real estate, and asset speculation. This is when Japanese real estate and stocks
reached their peak price level. When prices in central Tokyo were such that the Tokyo Imperial
Palace was valued to be worth more than all the property in California. When Japanese bought
Pebble Beach, a golf club, for $850 million. The bubble popped hard in early
1990s when the Bank of Japan tightened lending regulations and monetary policy. Banks were left with over 90 trillion yen
worth of terrible non-performant loans. What came next is generally referred to
as the "Lost Decade". A period of time from 1991 to 2010 where average
real growth was barely above 1%. Japan entered a long period
of economic stagnation. We are not going to dive into all of the
effects of the Lost Decade and how to get out of it. There are more than enough theories.
But in general what we should come to understand is that the government racked up debt trying
to stimulate the economy, with little effect. In 1998, the Bank of Japan received
formal independence from the government in conducting monetary policy. In response
to the economy's consistent refusal to grow, policy got increasingly ... creative. In the 2000s, the Bank of Japan began what
is known as "quantitative easing". The bank would directly purchase Japanese bonds of various
maturities to raise bond prices and lower yields. They targeted an interest rate of zero.
The policy lasted for a few years. The effects of this work are well studied
but have not come to a general conclusion as to whether or not it “helped”.
They do seem to agree that QE lowered lending costs and interest rates for
banks, spurring them to lend more. But the quality of the borrowers was
debatable and tend to be riskier than most. America too would do a few rounds of QE
later in the decade with similar controversy. In 2010, the Bank of Japan expanded this
QE program to include corporate bonds and longer-duration financial assets. Rates in
the short term had already gone to zero and the benefits of buying more Japanese government
bonds were minimal. Thus for the first time, the Bank of Japan began to buy corporate stocks and
REITs as part of its quantitative easing program. So what is the central bank's intention in
purchasing stocks? With this new program, the BOJ hoped to stimulate
"risk-taking" amongst people and firms. Only 10% of Japanese people at the time
held stocks as compared to 36% in the US and 18% in the Eurozone. The majority of Japanese
literally just own cash and bonds. If they were to own stocks and see the value of those stocks
rise, then they can feel richer and be more willing to spend. Their increased spending equals
increased income within the Japanese economy. On the corporate side, Japanese
companies are famously conservative. Having the central bank buy their stock would
in theory make it cheaper to raise capital. Cheaper capital theoretically would
spur them on to do and invest more. Central banks have bought stocks before, but
only as a measure of financial stability. For instance, the Bank of Japan bought stocks
from failing banks twice during financial crises in 2002 and 2009 to shore up their cash
reserves and keep them from insolvency. And the Hong Kong Monetary Authority purchased $17 billion worth of Hong Kong stocks and
bonds during the 1998 Financial Crisis. I recounted this event in my video
about Hong Kong and George Soros. Go check it out. After the
crisis had passed, the HKMA sold the stocks it bought to private
investors, doubling its investment. Those two precedents are modest compared to what
was coming up next. No bank has ever bought stocks in volume to try and stimulate the economy. The
Bank of Japan was about to get weird with it. At first, the plan capped out at about 450
billion yen worth of stock purchases and was to end in December 2011. That is about $4.5
billion USD. Considering that the total market capitalization of the Tokyo Stock Exchange is $5.7
trillion, that was just a drop in the bucket. Through 2011 and into 2012, the BOJ increased the
cap four-fold to 2.1 trillion yen or about $19 billion. Japanese government bond yields fell.
But the Yen continued to appreciate in value as compared to the US Dollar, reaching an exchange
rate of 80 yen to the dollar. This is despite a series of currency market interventions by
central banks and the Ministry of Finance. This stronger yen counterbalanced the looser
monetary effects brought on by lower bond yields. It made Japanese exports more expensive, hurting
manufacturers in this export-heavy economy. Mild deflation continued and the
prospect of 2% inflation seemed a dream. In December 2012, Shinzo Abe won election as
Japan's prime minster. As part of his campaign promises, Abe would put up $120 billion
worth of emergency stimulus spending and force the BOJ to perform unprecedented monetary
moves to fight deflation and weaken the yen. After his win, the Yen quickly deflated in value,
falling from 84 yen to the dollar in December 2012 to 95 in March 2013. Stock prices began to
rise in anticipation of big changes afoot. In April 2013, Abe appointed Haruhiko Kuroda
as the governor of the BOJ. Kuroda was tasked with carrying out the monetary aspects of
Abe's economic policy, nicknamed Abenomics. Kuroda came through and announced the
QQE policy - Quantitative and Qualitative Monetary Easing policy. The goal would be
to go where no bank has ever gone before: To reduce the price of risk across all assets, lower interest rates in the long term,
and stimulate the people into buying more. The BOJ would do this by expanding the
economy's entire monetary base in the amount of 60-70 trillion yen annually. That is $540-630
billion USD, injected into the economy each year. Abenomics did show some promise early
on. Inflation spiked from 2013 into 2014. But the decade also saw disruptions
that struck at the economy’s health. For instance in 2014, the Japanese
government raised a consumption tax from 5% to 8% and that significantly impacted the
economy. In response, the BOJ bought yet more bonds and tripled its buying of ETFs.
Abe had to delay a second tax hike to 2019. Four years into the policy, the bank’s purchases
were warping the stock market on the whole. Such distortions forced it
to more specifically target its purchases. They diversified from the
Nikkei 225, adding the Nikkei 400, the Topix, and then ETFs tracking companies making
“investments in physical and human capital”. The intention was to reward companies making
suitable investments for growth. Examples include the Nomura Enterprise Value Allocation and the
Daiwa MSCI Japan Human & Physical Investment ETF. The companies in these ETFs are
some of Japan's biggest and most prominent companies. They include Toyota,
Nintendo, Tokyo Electron, and FANUC. Going into 2020, the BOJ had 40 trillion yen or
$360 billion of stocks on their balance sheet. The Bank's holdings accounted for over
5% of the country's entire stock market. For one out of every two Tokyo-listed companies, the BOJ was a top 10 shareholder.
It was Fanuc's biggest shareholder. And then came the pandemic and
everything went crazy after that. Direct stimulus from governments all over the
world fueled the Nikkei 225 to new heights. In response to the economic crisis from the virus,
the BOJ raised the ETF purchases' ceiling yet again to a theoretical limit of 12 trillion
yen, or $112 billion. For what it is worth, they fell short of that ceiling in 2020 - buying
only 7.1 trillion yen or $64 billion worth. The program has yet to formally end
but it does seem to be slowing down. The BOJ seems to be at the very least
fine-tuning. With that being said, in March 2021 the BOJ purchased nearly 300
billion yen or 2.7 billion USD worth of ETFs. So you are probably looking for
an answer to the big question: Did it work? Did people feel richer? Did
companies invest more? Did it help the economy? The reality is that evaluating
policy is complicated. Especially one that lasted ten years
across a number of business cycles. Japan has a 100 million people and the third
biggest economy in the world. It's complicated. Let us start with the most desired effect: Inflation. Looking at inflation from
2011 to 2019 short of the pandemic, it looks like the economy saw more inflation
than deflation during the ten year period. Real GDP growth over the same time period is
also kind of heartening. If you throw out the pandemic years of late 2019 and 2020 then
you can see that the Japanese economy grew. And if you chart the ETF purchases against
the stock return of the Nikkei 225, it seems to be that the purchases helped grow
and prop up the market's returns over the past few years. Stock prices went up. Presumably,
some Japanese stock holders got richer. Furthermore, the 2010s saw challenging global
economic conditions in the US and the Eurozone. That as well as the aforementioned consumption
tax hike in 2014 could have caused real, permanent damage to the Japanese economy. And
of course, we can’t forget about the pandemic. One can argue that were it not for the
BOJ's unprecedented monetary actions, things could have ended up much worse. To
have shown even this tiny bit of growth throughout this tricky time period,
you might see this as an absolute win. But now we need to look at the drawbacks and the cost of nearly a decade of your
central bank going YOLO on stocks. Is it okay that the Bank of Japan is the
country’s single biggest corporate stock holder? There are a few problems associated
with this activity that we can foresee. Actually, more than a few. I got five. Sit
down because this is going to be a long one. First has to do with corporate governance.
Japanese companies are not exactly known for taking care of their shareholders. There is a lack
of transparency on how the business is being run and shareholder money is spent. Shareholders have
few ways to replace management when things are not being run well. Management compensation
is less tied to how well the stock performs. The Bank of Japan, despite being the
single biggest holder of Japanese stocks, does not currently exercise its voter rights. On
one hand, that reinforces management's power over the company. But what if it were to decide that
it wanted to? We criticize the Communist Party of China for getting deeply involved in the workings
of private companies. Would this not be similar? Second is the problem of price discovery, a
criticism more generally tied to the idea of ETFs. As ETFs have grown more popular amongst investors, there comes the risk of "freezing" the relative
valuations of a country's biggest companies. The ETF's basket of stocks is determined by an
index, generally ranked by market size but not always. So as more ETFs are created, more of
the biggest stocks get bought - simply because they are already big or in a specific
index. This creates market distortions. For example, Fast Retailing, the company behind
Uniqlo, is over-represented on the Nikkei 225 as compared to the TOPIX with an 11% weight.
The BOJ's purchases of the Nikkei 225 turned the clothing company, which only made $18
billion USD in 2020, into a $80B giant. Its founder Tadashi Yanai is Japan's
richest man with a $40 billion fortune. When the BOJ announced that it would
phase out purchasing Nikkei 225 ETFs for the TOPIX in March 2021, Fast
Retailing lost 6% of its value. The third problem is: What is the Bank of Japan
going to do with all of its stocks? Are they going to hold them forever? If they sell, are they
going to take down the whole market with them? The anticipation of ETF sales down the line likely
dampens the effects of buying them in the first place. Sure you might feel richer right now, but
all that wealth is just on paper right now. Thus far, the Bank has not announced anything with
regards to its future plans for those ETFs. Fourth! I talked about the very weak inflation
and economic growth. What if it wasn’t because of the stock buying? Studies of the policy up to
2019 find that Japanese publicly listed companies neither spend more on R&D nor grew their
sales because the Bank bought their stocks. In fact, the price to earnings ratio of the index actually declined throughout the time
period despite the higher stock prices. One can argue that the market was more out
of favor entering 2019 than it was in 2011. Shares jumped a whole lot in 2020 and 2021
but it is more likely that jump was due to worldwide stimulus packages. Every stock,
bond, crypto, whatever went up in 2020. Public companies did sell shares into the stock
market to take advantage of the favorable stock environment. But they opted to just keep the
cash on their books - saving for a rainy day. Last but most concerning. I did a video about
Taiwan's low labor wages. People yelled at me. Well, Japan has a similar problem too.
As befitting an economy that sputtered through the last ten years, wages and
incomes have stagnated. Today's Japanese workers make less than they did 30 years ago.
Monetary easing likely worsens this effect. I wish I can talk more on this, but that is
for another video. But I wanted to at least mention it. We focus so much on companies that
we forget about the people. We should not. The Bank of Japan's actions and results should be
studied because it foretells what other central banks might do in the near future. The BOJ ran
quantitative easing during the early 2000s. The Federal Reserve and other central banks did
it in 2008 during the Global Financial Crisis. And then in May 2020, the Federal Reserve took
another step towards what the Bank of Japan did. They started buying ETFs too. But not of stocks.
Of corporate bonds. Bonds relating to downgraded companies suffering from the pandemic. It was
the first time the American central bank has ever done this. And if you ask me, corporate
bonds are not that far away from stocks. The Japanese and American economies are very
different from each other. So what might work for one country might not work for another. For
Japan, this stock buying spree seems to have had a limited effect on the country's actual
economic prospects. There was something but it did not last very long. The USA should think
about that when considering its next action step.
