AI
Thursday, September 12, 2002 4:34:40 PM
mlsoft, when you get a spare moment, {g}, would you care to comment on these two pieces regarding deflation in Japan? (They are from Morgan Stanley's Global Economic Forum.)
**************************************************************
Japan: Package Sein vs. Package Sollen
Robert Alan Feldman
(This is the first part of a two-part piece on the current policy debate in Tokyo. Part I deals with the current policy agenda -- the Sein of the debate. A second part of the essay will deal with the Sollen -- what should be done.)
Policy package talk has been flying around Tokyo for the last few days. The LDP anti-reform factions see an opportunity in the weaker economic outlook to turn fiscal and monetary policy more expansionary, and thus to kill two birds with one stone. They hope to impair Koizumi even while keeping him in power as a figurehead, but also to increase funding to their own political machines in the weak industries and companies of the country. The Koizumi forces actually saw this attack coming, and have already moved to expand tax cuts. In this environment, it is useful to list the various proposals now on the table, with comments on their content and their prospects. Even more important, it is useful to list some of the issues that are lurking in the shadows, and could tilt investor attitudes in one direction or another.
The Sein -- Issues on the Table Today
Exchange Traded Funds -- There has been a firestorm of debate over the question of exchange traded funds (ETFs). The anti-reform forces seek a major buy-up of ETFs by government agencies, including the public pension system and the Bank of Japan, as a means to prop up the equity market as half-year book closing approaches. Earlier in the year, the Financial Services Agency (FSA) advocated the expansion of ETFs as a way to bring domestic funds into the stock market as an alternative to foreign money. However, the public pension funds oppose the use of their fiduciary power for this purpose, and the Council on Economic and Fiscal Policy (CEFP -- the body entrusted with overall economic policy strategy) agrees. Some on the CEFP believe that the BoJ might buy such instruments, but there is also much opposition, in particular from the BoJ itself. If, after all, it is inappropriate for public pension funds to engage in "price-keeping-operations" for the equity market, surely the same is true for the BoJ.
Moreover, expanding the use of ETFs has practical problems, such as the reluctance of banks and other institutions to sell shares into ETFs at current prices -- which would require the booking of losses. Most damning is that the proposal for public purchase of ETFs violates PM Koizumi’s basic philosophy that "activities that the private sector can do should be left to the private sector." Valuation of equities, whether individually or in ETFs, is surely one such activity. My sense is that there will be no public purchase of ETFs at the current stage. Even if the BoJ were to agree to some purchases, the amounts would likely be small.
Deposit Insurance -- The second major issue is capping deposit insurance. Already insurance on time deposits has been capped at ¥10 million per person. The second phase of the cap, to be implemented on all deposits, was due to take effect on April 1, 2003. However, there has been a ground swell of complaint from the LDP’s small business clientele, who fear that outflow of deposits from weak institutions might cut off their sources of low-cost (and low conditionality) funding. Hence, the anti-reform forces in the LDP have called for an indefinite postponement of implementing the cap.
The Koizumi forces have retreated partially -- but less than meets the eye. They have recognized that the banking system is not ready for full implementation, because the system does not have the confidence of the populace. The Financial System Council, an advisory body to the government, last week submitted a report on how to deal with this problem. The Council recommended that full deposit guarantees be given to "settlement deposits" (defined as filling three conditions (a) payment on demand, (b) availability for standard payment services, and (c) zero-interest rates), but with some crucial prerequisites. First, the deposit insurance premium for such accounts would be above that for regular accounts. Second, the taxpayer would NOT bear the burden of the special insurance for settlement deposits, implying that either the depositor or the bank would bear the burden. Third, the government would NOT direct institutions on how the higher insurance premium burden should be shared; rather this would be a business decision by the individual institutions and their customers. Through these measures, there would remain market discipline on the banks, while protecting the settlement function in the financial system.
The Council proposal is clearly a retreat from the initial intention of the government. Moreover, the question of why the financial system authorities have not been able to deliver on their promise, first made in 1995, to cap deposit insurance was hardly touched by the Council. That said, the concept of market pressure on financial institutions remains very much at the center of the debate. My view is that the Council report recommendations will be adopted. However, PM Koizumi will have to impose accountability for the failure to implement the full deposit cap on schedule, in order for the reform process to maintain credibility.
RCC Purchase of Bad Loans -- The anti-reform forces in the LDP are again proposing that the Resolution and Collection Corporation (RCC) purchase bad loans from banks at "adjusted book value", i.e., the booked value of the loan minus any loan loss reserves already taken by the bank. For example, if a loan is booked at 100 and reserved at 5, the RCC would buy it at 95. After the purchase, the RCC would dispose of the loan, and take the loss, with the taxpayer footing the bill. The government has resisted this approach for many months, on the grounds that the RCC should buy at market value of the loans; indeed, packages earlier this year stressed this very point. My sense is that the government view will continue to prevail, for political reasons. The adjusted book value method is merely a surreptitious method of injecting capital into the banks, without conditionality. The populace would be furious -- as shown by reactions to earlier bailout schemes -- and the politicians know this. Although I do expect enhancements to the methods usable by the RCC, I doubt that much will come out of such enhancements at this time. As my colleague Hideyasu Ban reminds, the amount of bad loans that the RCC is capable of processing is extremely small, relative to the size of the bad loan problem. In the US in the 1989-94 period, the Resolution Trust Corporation (RTC) eventually had 10,000 employees and 90,0000 subcontractors to deal with a problem that was far smaller than the one Japan faces now.
Tax Cut Debate -- The government has taken the initiative of putting the figure of ¥2.5 trillion (or more!) on the table as a desirable level of tax cuts. The anti-reform forces have no particular objection to a larger tax cut. The debate comes in whether and how and when to prevent the tax cuts from leading to larger deficits. The anti-reform forces in the LDP would simply allow the deficit to rise. When bond yields are low and falling, why should one worry about the deficit, they ask. The Koizumi forces believe that the deficit is a major problem for both economic and political reasons. They are committed to improving the primary balance (fiscal balance excluding interest payments) from the current large deficit (estimated by the OECD to be 5.3% of GDP) to a surplus over the next 10 years. The political reason is that the populace is increasingly negative of public spending, particularly on public works. Even though public works as a share of GDP have returned to their lows of the late 1980s, they remain far higher than in other industrial countries. The landslide reelection of Gov. Yasuo Tanaka, who ran on a "no new dams" platform in Nagano Prefecture, attests to the political necessity of cutting public works more. Equally important is that Koizumi’s main political enemies are closely tied to the public works lobby. The more damage he can impose on them, the more likely his reform program is to succeed. My expectation is that a larger tax cut will be enacted (about ¥2 trillion), with the express declaration that it will be funded through spending cuts (not by tax hikes as the Ministry of Finance wants). However, the exact nature of the spending cuts is not likely to be specified, leaving investors worried that the anti-reform forces may use delaying tactics to prevent actual spending cuts.
While I expect an outcome on the agenda of policy items to represent a modest victory for Koizumi, there are other policy actions that will be needed before investors can judge that momentum has turned clearly in favor of reform. Part II of this essay will consider those other actions.
Important Disclosure Information at the end of this Forum
--------------------------------------------------------------------------------
Japan: Anti-Deflation Policies Likely to Reinforce Deflation
Takehiro Sato (Tokyo)
FILP Capital vs. BoJ Credit for Stock Purchases
Key anti-deflation measures under consideration by the ruling parties and Council of Economic and Fiscal Policy (CEFP) are (1) raising the value of advance tax cuts (fiscal measure), (2) expanding liquidity provision techniques including stock (ETF) purchases (monetary measure), and (3) having the RCC purchase NPLs at effective book value (NPL-related measure). These proposals are proceeding in line with the scenario we outlined in our end-August review of the April-June quarter GDP data. Outstanding issues include economic and market neutrality to a joint package of tax increases and cuts in the case of #1 above, and strong resistance to measures that are effectively the same as public capital injections in the case of #3 above. Stock (ETF) purchase operations (#2 above) are thus attracting attention in terms of having the potential to impact markets. Calls for stock market intervention (ETF purchase operations) utilizing either FILP capital or BoJ credit are escalating from the administration and ruling parties with stock prices falling below bottom levels ahead of the interim period close.
The most realistic choice for short-term action is employing pension funds and other FILP capital along the lines of past PKO strategies, rather than BoJ purchases, in our view. Public acknowledgement of the possibility of carrying out stock price PKO, something previously hidden behind the scenes, has added novelty to the latest round of anti-deflation measure discussions. Yet resistance to explicit PKO from the Ministry of Health, Labor, and Welfare is turning attention to BoJ credit. This approach may appear attractive to policymakers given the extra dynamism of not having to worrying about asset allocation as required in the case of pension funds. Given these circumstances, the BoJ Monetary Policy meeting scheduled for September 17 and 18 is likely to focus on the need for stock market intervention as a policy measure as well as an expansion of JGB outright purchase operations.
Direct intervention in the stock market by the central bank, however, is unlikely to be decided immediately given potential distortion of the market price formation function and an adverse impact on corporate governance. Another problem is that the proposed purchase scheme lacks feasibility, since ETF value is currently only ¥1.8 trillion, well below the ¥3 trillion target suggested by the ruling parties, and there is not much chance of this significantly increasing absent incentives to reduce unrealized stock losses incurred by the banks that contribute stock to form ETFs. From this perspective, the best that can be expected from next week’s BoJ MPM is expansion of JGB outright purchase value as part of efforts to deal with undersubscription and diversify liquidity provision methods.
Yet there is a possibility that the Bank may reach a political compromise to consider stock purchases over the medium term in exchange for protecting its organizational autonomy amid threats of revisions to the BoJ Law. It has also been noted that stock purchase operations would violate the BoJ Law, but this point is still unclear. According to Article 43, the Bank may conduct activities other than those specifically defined in the law as long as it receives authorization from the finance minister. This article should enable the BoJ to carry out stock purchase operations with finance minister approval and not require changes to the BoJ Law.
Simple Purchase Operations vs. Loan or Investment in a Stock-Buying Entity
There is little chance that BoJ stock purchases would be carried out directly as a market operation similar to its money market ops in light of the Bank’s strong resistance to bringing the credit risks of individual companies onto its own balance sheet and the differences between short-term money market participants and ETF and other stock holders.
More likely schemes would involve (1) accepting stocks as eligible collateral for Bank operations or (2) indirect stock purchases via a government-guaranteed investment in or BoJ loan to the public stock-purchasing entity. The former could be most readily executed prior to the period close once the collateral weighting is finalized. A very low weighting relative to the market price, however, would inevitably diminish the attractiveness of this scheme as a new type of liquidity injection tool. Additionally, counterpart banks have almost no capital demand given the saturated short-term money market situation.
The latter, meanwhile, would take more time since it requires revisions to the current law that restricts the unwinding of cross-shareholding activities for the buying entity only to banks, but should not face significant hurdles from the BoJ if the government guarantee can be secured. Government-guaranteed BoJ loans or investments actually do appear to match administration requests for diversification of liquidity provision measures by postponing the immediate fiscal burden and expanding monetary base supply through increasing the level of BoJ credit. Loans to the Deposit Insurance Corporation (DIC), which have already been implemented in the past (though the current balance is at zero), have the same economic effect on total money volume in terms of providing monetary base. To achieve a sustained expansion of money supply volume, of course, demand for BoJ notes must increase within general economic activities. Unless this happens, BoJ credit supplied to the stock-buying entity or others winds up being absorbed again by the BoJ in daily money market operations.
Can Stock Purchase Operations Influence Prices?
According to efficient market theories, government and BoJ intervention in the market should be a neutral factor for prices over the medium to long term, just as the collapse of market conditions from unwinding cross-shareholding positions is also unlikely to affect market levels over time. Past PKO failures are clear on this point. If near-term stock market intervention aimed at boosting prices prior to the accounting period close is conducted through ETF purchases, it is likely to preserve excess supply capacity in the economy by acquiring the shares of both healthy and unhealthy companies. While public intervention in the market may have a temporary impact in the desired direction, the ultimate result over a medium- to long-term span will be distorted resource allocation through damage to the market’s price formation mechanism and preservation of inefficient companies and reinforcement, rather than easing of deflation expectations, we believe.
We thus do not expect stock purchase operations or similar strategies to lead to higher long-term JGB yields. Assertions that such operations might lead to yen depreciation and lower bond prices as deterioration of the BoJ balance sheet erodes confidence in the yen are not convincing, if an indirect purchase approach backed by a government guarantee is adopted. Recent JGB market reaction, rallying on the view that anti-deflation policies are unlikely to have much near-term impact, offers a good answer, in our opinion.
Importance of Maintaining Macro Policy Consistency
Besides the possibility of reinforcing market deflation expectations, intervention in the stock market runs the risk of violating the principles of capitalism by making the government and BoJ direct or indirect stakeholders in private-sector companies. Nevertheless, a strategy of BoJ stock purchases should not be completely rejected, if it is carried out with certain conditions, such as the government making a strong commitment to fiscal policy stability over the medium to long term, and names are selected with full awareness of potential adverse side effects. While the screening process for name selection must be transparent and uphold market principles, selective investment is more likely to foster mild inflation expectations than buying the entire market. Hitotsubashi University’s Professor Makoto Saito comments that "the BoJ’s current asset portfolio centered on long-term JGB ownership implies a rapid deterioration of Bank financial standing, if inflation progresses. Conversely, BoJ concerns about adverse impact on its financial standing may prevent a transition to policies that promote mild inflation (the real goal)" and suggests "this situation is making it necessary for the Bank to consider long-term stock ownership by the central bank, a policy option previously seen as taboo."
Fiscal policy must be resolutely committed to stability aimed at restoring confidence, rather than unbridled spending, over the medium term, in order to support this type of experimental policy approach. In fact, fiscal policy since the 1990s has been characterized by inefficiencies and repeated stop-and-go cycles, resulting in a substantial loss of market trust and dilution of fiscal measures to a temporary stimulus effect. We believe Ricardian equivalence, which describes the invalidation of economic stimulus measures that rely on fiscal deficit expansion, is highly relevant to the recent situation facing the Japanese economy. Efforts by the Koizumi administration to regain fiscal trust through a mild austerity stance are hence very important for freeing the economy from above-mentioned Ricardian equivalence. Expanding the scope of advance tax cuts currently being considered may appear to have a neutral impact on the economy over the medium term from the standpoint of the Koizumi administration’s policy framework, since future tax increases are also planned. Yet we assume that perseverance with efforts to maintain a commitment to policy stability should be paradoxically positive for the market. What matters is stimulating the supply side by adhering to this type of moderate fiscal austerity and encouraging forward-looking market expectations.
http://www.morganstanley.com/GEFdata/digests/latest-digest.html#anchor1
(:
Most recent Charts @ MDA Thread #board-1320
My Trading Stuff #board-1220
PPT Archive #board-1280
Charting Experiments #board-1263
**************************************************************
Japan: Package Sein vs. Package Sollen
Robert Alan Feldman
(This is the first part of a two-part piece on the current policy debate in Tokyo. Part I deals with the current policy agenda -- the Sein of the debate. A second part of the essay will deal with the Sollen -- what should be done.)
Policy package talk has been flying around Tokyo for the last few days. The LDP anti-reform factions see an opportunity in the weaker economic outlook to turn fiscal and monetary policy more expansionary, and thus to kill two birds with one stone. They hope to impair Koizumi even while keeping him in power as a figurehead, but also to increase funding to their own political machines in the weak industries and companies of the country. The Koizumi forces actually saw this attack coming, and have already moved to expand tax cuts. In this environment, it is useful to list the various proposals now on the table, with comments on their content and their prospects. Even more important, it is useful to list some of the issues that are lurking in the shadows, and could tilt investor attitudes in one direction or another.
The Sein -- Issues on the Table Today
Exchange Traded Funds -- There has been a firestorm of debate over the question of exchange traded funds (ETFs). The anti-reform forces seek a major buy-up of ETFs by government agencies, including the public pension system and the Bank of Japan, as a means to prop up the equity market as half-year book closing approaches. Earlier in the year, the Financial Services Agency (FSA) advocated the expansion of ETFs as a way to bring domestic funds into the stock market as an alternative to foreign money. However, the public pension funds oppose the use of their fiduciary power for this purpose, and the Council on Economic and Fiscal Policy (CEFP -- the body entrusted with overall economic policy strategy) agrees. Some on the CEFP believe that the BoJ might buy such instruments, but there is also much opposition, in particular from the BoJ itself. If, after all, it is inappropriate for public pension funds to engage in "price-keeping-operations" for the equity market, surely the same is true for the BoJ.
Moreover, expanding the use of ETFs has practical problems, such as the reluctance of banks and other institutions to sell shares into ETFs at current prices -- which would require the booking of losses. Most damning is that the proposal for public purchase of ETFs violates PM Koizumi’s basic philosophy that "activities that the private sector can do should be left to the private sector." Valuation of equities, whether individually or in ETFs, is surely one such activity. My sense is that there will be no public purchase of ETFs at the current stage. Even if the BoJ were to agree to some purchases, the amounts would likely be small.
Deposit Insurance -- The second major issue is capping deposit insurance. Already insurance on time deposits has been capped at ¥10 million per person. The second phase of the cap, to be implemented on all deposits, was due to take effect on April 1, 2003. However, there has been a ground swell of complaint from the LDP’s small business clientele, who fear that outflow of deposits from weak institutions might cut off their sources of low-cost (and low conditionality) funding. Hence, the anti-reform forces in the LDP have called for an indefinite postponement of implementing the cap.
The Koizumi forces have retreated partially -- but less than meets the eye. They have recognized that the banking system is not ready for full implementation, because the system does not have the confidence of the populace. The Financial System Council, an advisory body to the government, last week submitted a report on how to deal with this problem. The Council recommended that full deposit guarantees be given to "settlement deposits" (defined as filling three conditions (a) payment on demand, (b) availability for standard payment services, and (c) zero-interest rates), but with some crucial prerequisites. First, the deposit insurance premium for such accounts would be above that for regular accounts. Second, the taxpayer would NOT bear the burden of the special insurance for settlement deposits, implying that either the depositor or the bank would bear the burden. Third, the government would NOT direct institutions on how the higher insurance premium burden should be shared; rather this would be a business decision by the individual institutions and their customers. Through these measures, there would remain market discipline on the banks, while protecting the settlement function in the financial system.
The Council proposal is clearly a retreat from the initial intention of the government. Moreover, the question of why the financial system authorities have not been able to deliver on their promise, first made in 1995, to cap deposit insurance was hardly touched by the Council. That said, the concept of market pressure on financial institutions remains very much at the center of the debate. My view is that the Council report recommendations will be adopted. However, PM Koizumi will have to impose accountability for the failure to implement the full deposit cap on schedule, in order for the reform process to maintain credibility.
RCC Purchase of Bad Loans -- The anti-reform forces in the LDP are again proposing that the Resolution and Collection Corporation (RCC) purchase bad loans from banks at "adjusted book value", i.e., the booked value of the loan minus any loan loss reserves already taken by the bank. For example, if a loan is booked at 100 and reserved at 5, the RCC would buy it at 95. After the purchase, the RCC would dispose of the loan, and take the loss, with the taxpayer footing the bill. The government has resisted this approach for many months, on the grounds that the RCC should buy at market value of the loans; indeed, packages earlier this year stressed this very point. My sense is that the government view will continue to prevail, for political reasons. The adjusted book value method is merely a surreptitious method of injecting capital into the banks, without conditionality. The populace would be furious -- as shown by reactions to earlier bailout schemes -- and the politicians know this. Although I do expect enhancements to the methods usable by the RCC, I doubt that much will come out of such enhancements at this time. As my colleague Hideyasu Ban reminds, the amount of bad loans that the RCC is capable of processing is extremely small, relative to the size of the bad loan problem. In the US in the 1989-94 period, the Resolution Trust Corporation (RTC) eventually had 10,000 employees and 90,0000 subcontractors to deal with a problem that was far smaller than the one Japan faces now.
Tax Cut Debate -- The government has taken the initiative of putting the figure of ¥2.5 trillion (or more!) on the table as a desirable level of tax cuts. The anti-reform forces have no particular objection to a larger tax cut. The debate comes in whether and how and when to prevent the tax cuts from leading to larger deficits. The anti-reform forces in the LDP would simply allow the deficit to rise. When bond yields are low and falling, why should one worry about the deficit, they ask. The Koizumi forces believe that the deficit is a major problem for both economic and political reasons. They are committed to improving the primary balance (fiscal balance excluding interest payments) from the current large deficit (estimated by the OECD to be 5.3% of GDP) to a surplus over the next 10 years. The political reason is that the populace is increasingly negative of public spending, particularly on public works. Even though public works as a share of GDP have returned to their lows of the late 1980s, they remain far higher than in other industrial countries. The landslide reelection of Gov. Yasuo Tanaka, who ran on a "no new dams" platform in Nagano Prefecture, attests to the political necessity of cutting public works more. Equally important is that Koizumi’s main political enemies are closely tied to the public works lobby. The more damage he can impose on them, the more likely his reform program is to succeed. My expectation is that a larger tax cut will be enacted (about ¥2 trillion), with the express declaration that it will be funded through spending cuts (not by tax hikes as the Ministry of Finance wants). However, the exact nature of the spending cuts is not likely to be specified, leaving investors worried that the anti-reform forces may use delaying tactics to prevent actual spending cuts.
While I expect an outcome on the agenda of policy items to represent a modest victory for Koizumi, there are other policy actions that will be needed before investors can judge that momentum has turned clearly in favor of reform. Part II of this essay will consider those other actions.
Important Disclosure Information at the end of this Forum
--------------------------------------------------------------------------------
Japan: Anti-Deflation Policies Likely to Reinforce Deflation
Takehiro Sato (Tokyo)
FILP Capital vs. BoJ Credit for Stock Purchases
Key anti-deflation measures under consideration by the ruling parties and Council of Economic and Fiscal Policy (CEFP) are (1) raising the value of advance tax cuts (fiscal measure), (2) expanding liquidity provision techniques including stock (ETF) purchases (monetary measure), and (3) having the RCC purchase NPLs at effective book value (NPL-related measure). These proposals are proceeding in line with the scenario we outlined in our end-August review of the April-June quarter GDP data. Outstanding issues include economic and market neutrality to a joint package of tax increases and cuts in the case of #1 above, and strong resistance to measures that are effectively the same as public capital injections in the case of #3 above. Stock (ETF) purchase operations (#2 above) are thus attracting attention in terms of having the potential to impact markets. Calls for stock market intervention (ETF purchase operations) utilizing either FILP capital or BoJ credit are escalating from the administration and ruling parties with stock prices falling below bottom levels ahead of the interim period close.
The most realistic choice for short-term action is employing pension funds and other FILP capital along the lines of past PKO strategies, rather than BoJ purchases, in our view. Public acknowledgement of the possibility of carrying out stock price PKO, something previously hidden behind the scenes, has added novelty to the latest round of anti-deflation measure discussions. Yet resistance to explicit PKO from the Ministry of Health, Labor, and Welfare is turning attention to BoJ credit. This approach may appear attractive to policymakers given the extra dynamism of not having to worrying about asset allocation as required in the case of pension funds. Given these circumstances, the BoJ Monetary Policy meeting scheduled for September 17 and 18 is likely to focus on the need for stock market intervention as a policy measure as well as an expansion of JGB outright purchase operations.
Direct intervention in the stock market by the central bank, however, is unlikely to be decided immediately given potential distortion of the market price formation function and an adverse impact on corporate governance. Another problem is that the proposed purchase scheme lacks feasibility, since ETF value is currently only ¥1.8 trillion, well below the ¥3 trillion target suggested by the ruling parties, and there is not much chance of this significantly increasing absent incentives to reduce unrealized stock losses incurred by the banks that contribute stock to form ETFs. From this perspective, the best that can be expected from next week’s BoJ MPM is expansion of JGB outright purchase value as part of efforts to deal with undersubscription and diversify liquidity provision methods.
Yet there is a possibility that the Bank may reach a political compromise to consider stock purchases over the medium term in exchange for protecting its organizational autonomy amid threats of revisions to the BoJ Law. It has also been noted that stock purchase operations would violate the BoJ Law, but this point is still unclear. According to Article 43, the Bank may conduct activities other than those specifically defined in the law as long as it receives authorization from the finance minister. This article should enable the BoJ to carry out stock purchase operations with finance minister approval and not require changes to the BoJ Law.
Simple Purchase Operations vs. Loan or Investment in a Stock-Buying Entity
There is little chance that BoJ stock purchases would be carried out directly as a market operation similar to its money market ops in light of the Bank’s strong resistance to bringing the credit risks of individual companies onto its own balance sheet and the differences between short-term money market participants and ETF and other stock holders.
More likely schemes would involve (1) accepting stocks as eligible collateral for Bank operations or (2) indirect stock purchases via a government-guaranteed investment in or BoJ loan to the public stock-purchasing entity. The former could be most readily executed prior to the period close once the collateral weighting is finalized. A very low weighting relative to the market price, however, would inevitably diminish the attractiveness of this scheme as a new type of liquidity injection tool. Additionally, counterpart banks have almost no capital demand given the saturated short-term money market situation.
The latter, meanwhile, would take more time since it requires revisions to the current law that restricts the unwinding of cross-shareholding activities for the buying entity only to banks, but should not face significant hurdles from the BoJ if the government guarantee can be secured. Government-guaranteed BoJ loans or investments actually do appear to match administration requests for diversification of liquidity provision measures by postponing the immediate fiscal burden and expanding monetary base supply through increasing the level of BoJ credit. Loans to the Deposit Insurance Corporation (DIC), which have already been implemented in the past (though the current balance is at zero), have the same economic effect on total money volume in terms of providing monetary base. To achieve a sustained expansion of money supply volume, of course, demand for BoJ notes must increase within general economic activities. Unless this happens, BoJ credit supplied to the stock-buying entity or others winds up being absorbed again by the BoJ in daily money market operations.
Can Stock Purchase Operations Influence Prices?
According to efficient market theories, government and BoJ intervention in the market should be a neutral factor for prices over the medium to long term, just as the collapse of market conditions from unwinding cross-shareholding positions is also unlikely to affect market levels over time. Past PKO failures are clear on this point. If near-term stock market intervention aimed at boosting prices prior to the accounting period close is conducted through ETF purchases, it is likely to preserve excess supply capacity in the economy by acquiring the shares of both healthy and unhealthy companies. While public intervention in the market may have a temporary impact in the desired direction, the ultimate result over a medium- to long-term span will be distorted resource allocation through damage to the market’s price formation mechanism and preservation of inefficient companies and reinforcement, rather than easing of deflation expectations, we believe.
We thus do not expect stock purchase operations or similar strategies to lead to higher long-term JGB yields. Assertions that such operations might lead to yen depreciation and lower bond prices as deterioration of the BoJ balance sheet erodes confidence in the yen are not convincing, if an indirect purchase approach backed by a government guarantee is adopted. Recent JGB market reaction, rallying on the view that anti-deflation policies are unlikely to have much near-term impact, offers a good answer, in our opinion.
Importance of Maintaining Macro Policy Consistency
Besides the possibility of reinforcing market deflation expectations, intervention in the stock market runs the risk of violating the principles of capitalism by making the government and BoJ direct or indirect stakeholders in private-sector companies. Nevertheless, a strategy of BoJ stock purchases should not be completely rejected, if it is carried out with certain conditions, such as the government making a strong commitment to fiscal policy stability over the medium to long term, and names are selected with full awareness of potential adverse side effects. While the screening process for name selection must be transparent and uphold market principles, selective investment is more likely to foster mild inflation expectations than buying the entire market. Hitotsubashi University’s Professor Makoto Saito comments that "the BoJ’s current asset portfolio centered on long-term JGB ownership implies a rapid deterioration of Bank financial standing, if inflation progresses. Conversely, BoJ concerns about adverse impact on its financial standing may prevent a transition to policies that promote mild inflation (the real goal)" and suggests "this situation is making it necessary for the Bank to consider long-term stock ownership by the central bank, a policy option previously seen as taboo."
Fiscal policy must be resolutely committed to stability aimed at restoring confidence, rather than unbridled spending, over the medium term, in order to support this type of experimental policy approach. In fact, fiscal policy since the 1990s has been characterized by inefficiencies and repeated stop-and-go cycles, resulting in a substantial loss of market trust and dilution of fiscal measures to a temporary stimulus effect. We believe Ricardian equivalence, which describes the invalidation of economic stimulus measures that rely on fiscal deficit expansion, is highly relevant to the recent situation facing the Japanese economy. Efforts by the Koizumi administration to regain fiscal trust through a mild austerity stance are hence very important for freeing the economy from above-mentioned Ricardian equivalence. Expanding the scope of advance tax cuts currently being considered may appear to have a neutral impact on the economy over the medium term from the standpoint of the Koizumi administration’s policy framework, since future tax increases are also planned. Yet we assume that perseverance with efforts to maintain a commitment to policy stability should be paradoxically positive for the market. What matters is stimulating the supply side by adhering to this type of moderate fiscal austerity and encouraging forward-looking market expectations.
http://www.morganstanley.com/GEFdata/digests/latest-digest.html#anchor1
(:
Most recent Charts @ MDA Thread #board-1320
My Trading Stuff #board-1220
PPT Archive #board-1280
Charting Experiments #board-1263
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