The recent announcement that the Bank of Japan will be buying ETFs and REITs surely has Richard Koo upset. After all, he has shown time and time again that such government intervention does nothing in the long-run. The U.S. government is currently hoping for a similar asset response as they attempt to keep “asset prices higher than they otherwise would be”. The problem, according to Koo, is that this is nothing more than a short-term psychological injection that separates fundamentals from reality. In the end, government buying real assets does nothing to alter free cash flow and always fails. In his Holy Grail of Macroeconomics he writes:
“Investors suffer heavy losses when the bubble collapses. The speculative demand that had been supporting prices falls away, and chastened investors start to rely on upon DCF as a gauge of value. Therefore, investors will not view asset-price increases brought about by the central bank purchases as being sustainable unless they are certain that the future cash flows generated by those assets will also increase.
Many governments have attempted to sustain or boost asset prices after the collapse of asset-price bubbles, but with the exception of the short squeeze orchestrated by the Hong Kong government in 1997, all have failed. The reason is simple: market participants did not believe that these efforts would lift the DCF value of assets. In October 2002, for example, the Bank of Japan launched a much publicized effort to buy shares held by Japanese banks. But this effort not only failed to arrest the decline in Japanese shares, but left the Bank of Japan with large capital losses six months later. Even in the U.S., aggressive easing by the Fed in the wake of the Internet Bubble collapse in 2000 failed to stop the NASDAQ’s decline. It was only after demand for IT products had to pick up-that is, after the DCF of IT firms began to rise-that the NASDAQ shares began to stabilize and recover.”
This gets to the real crux of this sort of government intervention in markets. It does not make people more productive, it does not create jobs, it does not increase output and it does not increase future cash flows. The Fed and BOJ hope to spark an investment and hiring boom. Unfortunately, there is no evidence that this sort of intervention can lower rates, increase borrowing or increase sustained economic activity. The conclusions should be obvious to everyone. A shuffling around of Fed assets does not alter private sector net financial assets. It might alter perceptions in the near-term, but hoping for a sustained recovery generated by the Fed’s balance sheet is sheer fantasy. Herding investors into risk assets that do not show the underlying fundamental improvement to sustain higher prices is nothing more than Ponzi finance. Or what Brian Sack prefers to call ” United States monetary policy”.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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