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.”
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| 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.
The argument that higher wealth – generated by lower rates and rising asset prices – will lead to more consumer spending has robust academic backing. However, we have seen this movie before. G7 stock indices recovered amid gigantic monetary stimulus in spring 2009 but as soon as these increases began to moderate in the summers of 2010 and 2011, central bankers revealed further “non-standard” measures to stimulate the animal spirits once more.
Playing with fire
Former BIS chief economist William White, who fears G7 policymakers are forever blowing bulls, said in a paper last year: “The empirical robustness of this relationship ... suffers from a serious analytical flaw ... Lower interest rates cannot generate wealth, if an increase in wealth is appropriately defined as the capacity to have a higher future standard of living.”
He added: “From this perspective, higher equity prices constitute wealth only if based on higher expected productivity and higher future earnings. This could be a byproduct of lower interest rates stimulating spending, but this is simply to assume the hypothesis meant to be under test.”
He said that the durability of real gains supported by the expansion of nominal instruments also seems highly questionable. He added the unveiling of each non-standard measures reveals the failures of standard measures to achieve stimulative targets and thereby risked producers and consumers waking up to the liquidity trap. In other words, this argument suggests Japan could be playing with fire, if the minister’s comments have their intended effect.
Stocks purchased with created credit, both real and financial assets – amid expectations of higher economic growth – could yield low or negative returns that are inadequate to service the debts associated with their purchase, the opposite intended outcome.
Finn Poschmann, economist at the CD Howe Institute, a public policy think tank in Toronto, adds: “Playing the expectations game invites trouble owing not only to uncertainty of communications and credibility, but the layering on of goals, as the policy mandate expands to include more potential targets than instruments, known as the Tinbergen problem. That aside, desperation seems unlikely to breed optimism, and unlikely to put a stake through the heart of Japan's now decades-long zombie problem.”
What’s more, Peter Hensman, global strategist at Newton, the asset manager subsidiary of BNY Mellon Asset Management, tells Euromoney: “Policies that drag future activity into the present and raise current equity valuations should dampen – not increase – the longer-term returns investors anticipate from equities.”
However, the counter-argument comes from Roger Farmer, economics professor at UCLA, who argues the Fed should set a stock market index level to control unemployment. Buttressing Keynes’ view that the economy fluctuates around multiple equilibrium unemployment rates – against the “natural rate” of unemployment view held by classical economists – he argued that the Fed should target stock market prices to boost confidence.
He wrote in 2009: “If confidence is low, the private sector places a low value on existing buildings and machines. Low confidence induces low wealth. Low wealth causes low aggregate demand, and low aggregate demand induces a high-unemployment equilibrium in which the lack of confidence becomes self-fulfilling.”
By contrast, central banks, faced with a perceived liquidity and growth trap, should target stock price indices in addition to domestic interest rate targets, he argued.
The Japanese government’s words could prove hollow, in terms of signalling a more aggressive fiscal and monetary policy action. What's more, many economists would argue that further stimulus policies in Japan is not a sustainable alternative to supply-side reforms. Says Poschmann at the CD Howe Institute: “Real sector supply also is influenced by expectations, particularly expectations regarding demand, but demand cannot exist without supply.”
Bernanke will be taking note.