Government stock buys pose risk

David MoonBlog

by David Moon

In an attempt to boost investor confidence and economic activity, the Bank of Japan (BOJ) has been purchasing between 3 and 7 trillion yen worth of Japanese stocks during each of the past several years.

These purchases, funded with newly-created money, make the BOJ one of the 10 largest shareholders in 200 of the 225 stocks in the Nikkei Stock Average. The Japanese central bank now owns more Japanese blue-chip stocks than Blackrock, the largest money management firm in the world.

Why would the BOJ do this? Because it has run out of other stimulus tools.

Driving stock prices up by purposely obfuscating the true demand for equities may create investor confidence in the short term, but it is a false confidence. It’s akin to the confidence an SEC football team gets playing ETSU.

Japan is not the only country playing economic sugar daddy to the stock market.

A Bloomberg survey found 23 percent of central banks reported owning shares of common stocks or had plans to initiate purchases. In a circuitous reasoning, central banks in Israel, Switzerland and Czechoslovakia justify their stock purchases, in part, on the miserable rates available on traditional fixed-income investments.

Interest rates around the world hover around zero, of course, because of a Pandora’s Box of open-ended dollar, shekel, franc and koruna quantitative easing by these same central banks.

Thus far the U.S. central bank has limited its market manipulation activities to the U.S. bond market. While most sources agree that the Federal Reserve is prohibited from directly purchasing common stocks, it is possible that the U.S. central bank could create and fund a special purpose vehicle to do so.

Both stock prices and corporate earnings are already buoyed to some extent by artificially low interest rates. A new stock buyer with its own monetary printing press could have a significant impact on prices—until it doesn’t. A correction from that type of disequilibrium could be substantial.

A correction of central bank manipulated stock prices, however, is not the only risk of government ownership of stocks.

China’s State Administration of Foreign Exchange is now the world’s largest public sector holder of equities—and not just Chinese companies. China Premier Li Keqiang not only controls an estimated 260 nuclear warheads and an army of 2.3 million soldiers, he also owns shares of some of the largest companies in Europe.

It is difficult to know for certain which U.S. companies’ shares are owned by the Chinese government.

Most investors in public companies are passive. Their only recourse if they are displeased with the investment is to sell. Other investors, however, take large positions in a company’s stock with the intent of exerting control over its board, policies, products or management.

The prospect of unfriendly, sovereign, activist investors creates significantly more danger than misguided monetary policy.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).