How Japan can escape financial socialism

THE latest Bank of Japan (BOJ) comprehensive policy review is significant not for what it says but what it does not. The cumulative effects of the central bank's steadfast buying of exchange-traded funds (ETFs) have de facto turned Japanese equity markets into an unprecedented experiment in financial socialism. Officials seem to have no idea how to restore the functioning of free markets.

Like many central banks, the BOJ has aggressively intervened in bond markets and now owns almost half of its country's public debt. Unlike others, the BOJ also now owns about 10 per cent of Japan's benchmark Tokyo Stock Price Index (Topix) equity capitalisation. This casts a shadow over Japan's markets. The first question investors usually ask me is: "When will the BOJ start to sell?"

There is no question that governor Haruhiko Kuroda's firm commitment to buying Japanese equities was an important catalyst for stopping asset deflation and building confidence in Japanese stocks. But now, almost a decade later and with the market up almost threefold from its bottom, the BOJ's equity holdings are beginning to work as a cap on the market's upside potential. Unwinding a bond portfolio is easy - you can wait until they mature and roll off the balance sheet. In contrast, equity ETFs will have to be sold sooner or later.