TOKYO — Since 2013, Governor Haruhiko Kuroda has been morphing the Bank of Japan into the world’s biggest hedge fund – and, all in all, it’s not going well.
On Saturday (April 8), Kuroda will leave BOJ headquarters, handing successor Kazuo Ueda the worst job in international finance. As Ueda gets to work, all eyes are on how he plans to manage the BOJ’s ginormous bet on Japanese government bonds — it owns more than 52% of the market — and stem mounting losses.
Yet that may be the easy part. Far more challenging is how BOJ Advisors LLC plots an exit from its massive and market-warping long position in Japanese stocks. That is, even if it can find a way out of this titanically large trade.
On Kuroda’s watch, the BOJ plowed 1.55 quadrillion yen (US$11.7 trillion) into government bonds, stock funds and corporate debt. By 2018, the central bank’s balance sheet topped the size of Japan’s entire $5 trillion economy. Two years after that, it surpassed the Government Pension Investment Fund as the largest investor in Japanese stocks.
It now falls to Ueda to mull an exit. As he weighs options, the stock market piece of the puzzle will prove particularly precarious. The BOJ is, after all, the glue holding together Japan Inc’s financial universe. Any whiff of the BOJ pulling back could crash the entire exchange.
Yet that’s not the only danger. Far harder to calculate is how Kuroda’s nationalizing stocks deepened the economic complacency he was hired to address with turbocharged quantitative easing.
Kuroda was meant to be the first wave of former Prime Minister Shinzo Abe’s grand scheme to end deflation and resurrect Japan’s innovative animal spirits.
Back in 2013, when Abe tapped Kuroda, the plan was to fire three “arrows” at Japan’s decades-old malaise: monetary easing, fiscal consolidation and a structural reform Big Bang.
Only the first arrow was fully deployed. The fiscal piece was a wash, considering Tokyo’s debt-to-gross domestic product (GDP) ratio swelled considerably on Abe’s watch. Bold supply-side upgrades to cut bureaucracy, loosen labor markets, catalyze a startup boom, increase productivity, empower women and lure top global talent never arrived.
That left Team Kuroda the only game in town. Here, Abe’s bet was that aggressive BOJ easing – and a sharply weaker yen – would kick off a virtuous cycle of profits that corporate CEOs would use to boost wages and, in turn, consumption.
Yet chieftains didn’t pass the spoils to workers. Instead, they hoarded the BOJ-driven gains and bought back shares.
Rather than incentivize change, all that BOJ largesse deadened the urgency for government officials to recalibrate growth engines and for companies to innovate, streamline and take big risks. The Kuroda era unleashed, arguably, the most generous corporate welfare modern capitalism had ever seen.
Why do the hard work of restructuring, recalibrating, reimagining or reanimating the innovative energy that paved the way for the likes of Apple, Samsung and Tesla when the central bank is propping up your shares?
In fact, BOJ largesse has arguably stymied the creation of a Japanese Silicon Valley. His talk of fostering a dynamic risk-based culture became a punchline.
“Not only are most of Japan’s giants resistant to open innovation, but Japan has too few innovative startups to work with,” explains economist Richard Katz, publisher of Japan Economy Watch newsletter.
“One reason is that new companies can’t get the external financing they need to get off the ground and do the necessary R&D,” Katz said. “But another big reason is that star scientists and engineers at the bigger companies do not leave to start their own firms, as they do elsewhere.”
Katz adds that “it’s hard to imagine today’s product lineup in electronics or pharmaceuticals without open innovation. And yet, with a few important exceptions, most leading Japanese companies are missing out on this trend.”
In Japan, Katz says, 70% of all R&D is done in-house, and only 0.7% is done with young firms.
“The consequences are manifest,” he says. “No longer is electronics a star industry for Japan because it’s no longer turning out new, must-have products that can compete globally. Despite a 40% surge in global electronics sales from 2008 to 2021, every one of Japan’s top ten electronics hardware manufacturers saw its global sales slump, while total sales of Japanese electronics firms plunged about 30%.”
Japan’s problem, Katz argues, “lies not in a fallback in technological prowess, but in commercial imagination. Producing patents is not the same as producing successful products based on those patents. Japanese companies spend a lot on digital technologies but do not get much bang for all those bucks – or yen. In fact, out of 63 countries in an IMD survey of digital competitiveness, Japan ranked dead last in ‘business agility,’ the ability to benefit commercially from this investment.”
The fact Japan trails Indonesia in minting new tech “unicorn” startups is an indictment of the Abe era, one to which Kuroda’s legacy is tightly linked. So is the extent to which the BOJ, like a hedge fund drowning in paper losses, is essentially trapped with its colossal equity portfolio.
In mid-February, BlackRock, the world’s largest asset manager, cut its advisory on Japanese stocks to “underweight.” The reason: the specter of new BOJ leader Ueda stepping away from the ultra-dovish policies of the last decade.
“We downgrade Japanese stocks on policy uncertainty and a worsening economic environment,” BlackRock said. It added that “monetary policy uncertainty and the sensitivity of Japan’s economy to the slowdown in other major economies spur the change.”
What’s more, BlackRock said, a “policy change could come at any moment. Scrapping the yield curve control (YCC) cap risks pushing global yields higher and reducing risk appetite.”
BlackRock won’t be alone if the Ueda-led BOJ begins withdrawing from Tokyo stocks. In February, Ueda told Tokyo lawmakers that “we may consider revising the direction of the YCC to a more normal one if the consumer price trend improves.”
That shocked Tokyo stocks as rarely before. Over the last decade, the Kuroda BOJ juiced stock prices through its purchases of exchange-traded funds (ETFs). While noting that the BOJ is the top holder of ETFs, Ueda said figuring out how to draw down purchases will be a major focus for his first term as governor.
Yet that was before the collapse of Silicon Valley Bank in the US and Credit Suisse’s epic stumble. Fears of another 2008-like global crisis will now play into the BOJ’s rate deliberations. In the two days after SVB collapsed, the BOJ was scrambling to buy hundreds of millions of dollars of EFTs to stabilize the Japanese stock market.
All this is changing BOJ dynamics in fundamental ways. Back on December 21, the BOJ experimented with the slightest of policy tweaks. Its move to allow 10-year yields to rise as high as 0.50% panicked markets and sent the yen skyrocketing. The BOJ spent the next few weeks buying assets to communicate that policy hadn’t changed.
Nomura analyst Naoya Fuji figures that trimming bond-buying programs will take precedence over normalizing ETF buying. True, the BOJ began throttling back in 2022. Last year, its holdings of ETFs for domestic stocks hit a 12-year low with just 630.9 billion yen ($4.8 billion) of purchases. That’s a fraction of the 7.1 trillion yen the BOJ bought in 2020.
“The obstacles to reducing purchases are lower than those to stopping them, but as this would merely constitute a tweak that does not involve any major change from the current situation, it would be hard to describe it as a bold change in policy,” Fuji argues.
Kuroda could have done Ueda a solid by beginning the process of unwinding BOJ Advisors LLC’s unthinkably large ETF portfolio. He didn’t, leaving it to his successor to exit a trade that arguably no central banker ever should have done.
Follow William Pesek on Twitter at @WilliamPesek