An article I wrote in the October issue of FinanceAsia, The JGB Conundrum, dealt with how foreign bond fund managers have taken a bath because they wrongly assumed Japan’s markets operate on an Anglo-Saxon model of supply and demand. In fact Japanese bureaucrats are adept at twisting the arms of domestic insurance companies, trust banks and other institutions into buying government bonds to lap up the government’s oversupply. This out-of-control supply problem is tilting global bond indices out of whack and creating big problems for overseas investors.
The article prompted some comments by a Westerner with extensive experience working for Japanese companies in Southeast Asia. In a series of emails to me, he writes, “You had uncovered and detailed the fact that the Japanese have an almost unbelievable ability to levitate their bond market when it looks to all the experts that free market forces are about to take it down ... I learned of this ability from the Japanese people I knew and worked with. They can keep many things levitated. I believe the Japanese are also good at levitating their stock market.”
Our reader, who requested anonymity because of his ongoing business relationships in Japan, notes the Nikkei 225 index never seems to go below 14,000, except during the extraordinary moment of the recent financial crisis. Temporary up-ticks in sentiment drive the Nikkei to 21,000, at which point it falls back. The market hit bottom in 1992, 1995 and 1998. Every three years it seems to collapse, but then around 14,000 important bureaucrats and key institutions collude to buy up the market.
“You can see this pattern repeat itself three times in the past eight years,” he says. “If you buy into a Japanese index fund at 14,000 and then automatically sell out the next time the index reaches 21,000, you make a 33% profit over, say, a two-year period. That’s not so spectacular by US hi-tech standards, but it has the important advantage that the downside loss potential is limited by Japan’s ability (through manipulation) to keep the index from falling too low.”
In subsequent messages, he goes on to point out that the Nikkei at 14,000 to 15,000 is not just a chart point. “There are specific important implications to the Japanese economy at this level,” he says. “Below 15,000 the banks are impeded in writing off bad debt and making new loans.”
Indeed, recent articles in other media have noted that a falling stock market deprives banks of a key tool to control their high debt levels – selling off their prodigious holdings of stocks. Whereas typical large Western banks own up to 50% of their core capital in stocks, most Japanese banks own up to 150% of their capital in domestic equities. The Asian Wall Street Journal, for example, highlighted the danger to Japanese banks in a story dated October 26.
But our reader says these articles are missing a key point: “I have seen articles [such as the one from the Journal] the last few times the market dived, but none recommended that the average investor could profit from it.”
