Friday, July 29, 2016

When Central Banks Buy Equities

Yesterday, the BOJ (Bank of Japan) announced further stimulus in the form of purchase of stock ETFs. Of course, ETFs are each aggregated owners of stocks, rather random in composure, and freely exchanged on the market. What is the effect of this action from a mechanical money perspective?

The mechanical money perspective treats money as physical object. Money becomes property, freely exchanged for other property of any nature. Money is always owned by someone or some entity.

The first question to ask is "Where does the BOJ get money for these purchases of ETFs?". The answer: The BOJ can 'print' all the money it desires. It does not need previously earned resources, it does not need to ask the government of Japan for a grant or gift. It can just 'print' the money needed to buy ETFs.

We can ask "From whom does the BOJ buy these ETFs?". Apparently they are to be purchased from the open market at times selected by the BOJ. This has several implications: First, the purchases are between willing buyer and willing seller. We can make a general observation that the seller has a motive to sell and the buyer has a goal and expectation. The two exchange participants have different goals. The goal of the BOJ is to increase the amount of monetary property available to the economy (to put a charitable motive forth for some decision maker acting on the behalf of the BOJ).

From the mechanical money perspective, this sequence of events is easy to analyze. The sellers of ETFs walk away with more money than they expected because a buyer with NEW MONEY appeared. The price of ETFs would close (in the daily market) HIGHER than market conditions would otherwise have supported. It is also clear that the money supply would necessarily increase if money supply is measured in a mechanical fashion.

How is money supply measured in a "mechanical fashion" ? We could begin by considering that the seller began the exchange with no money but walks away with cash. If we measured his bank account (or the accounts of his agent), we would necessarily see an increase. There would be no corresponding decrease in deposits anyplace in the system if the purchaser was the BOJ.

We would hope that the BOJ would at least keep track of the creation of new money later used to buy ETFs. It could easily do this by recording a liability for cash spent for equity. The balance sheet of the BOJ would show an increase in total size.

What would be the future mechanics of central bank purchases of equity? What would the seller do with the sale proceeds, knowing that a central bank was the purchaser? What would the attitude of the market become under these conditions?

I can only speak for myself. I see a market distortion that inserts an unpredictable element into pricing. The unpredictable risk is obviously to the high side, requiring a negative factor to compensate. If I wanted to buy an ETF, I am competing with a central bank who is spending unearned money. How can I possibly compete with that kind of competition? I see a conundrum for the forward looking investor.

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