Why the Bank of Japan Bought $300 Billion of Stocks - YouTube

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.