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Government intervention is a proven recipe for disaster for Japan's markets

Members of Japan's ruling coalition of the Liberal Democratic Party, New Komeito and Hoshuto (New Conservative Party) have encouraged the government to take steps to prop up the stock market. They also urged the government to accelerate spending from the public works reserve fund of ?500 billion that is earmarked in the fiscal 2000 budget. They also recommended that appropriate measures be taken to prevent the yen from fluctuating rapidly.

All these proposals involve considerable interference in market transactions. Although the logic is to avoid adverse effects of a recipitous decline in stock prices or rises in the value of the yen, it will be a case of short-run gains that lead to long-run losses. In the case of foreign exchange intervention, recent history provides considerable evidence that trying to control currency values is doomed to failure.

What is worse is that attempting to fix an exchange rate often leads to more extensive economic problems. For example, most observers blame such policies for the East Asian crisis that began in 1997.

In the case of public spending, the evidence of the failure of Japanese government stimulus packages is so immense that it is unimaginable that anyone would take such a proposal seriously. Indeed, not even the LDP would be so foolish were it not so dependent upon financial support of the large engineering companies that benefit from public work projects.

However, the most vexing issue is the proposal to inject public funds to prop up the local stock market with public funds. Their suggestion is for a commitment of ?1 trillion in public funds to be injected by the financial institutions that hold the funds in trust. These so-called price-keeping operations (PKO) were in use in Japan until the end of the 1990s. Until then, funds from postal saving accounts and post office life insurance program were used to buy up shares when markets began to slump.

One of the plan's supporters urged that the government should only purchases blue chip stocks whose prices are expected to go up. This is a breathtakingly uninformed view of how markets work. As recent volatility in the Dow and Nikkei has indicated, even blue chips get the blues.

This sort of economic illiteracy is quite rampant in parts of Asia. China has attempted to boost its stock markets through directives or patriotic appeals.

The Taiwanese government has a history of manipulating share values by instructing government-linked funds to prop up sagging values through share purchases.

And Hong Kong's government took similar steps in 1998 when its government used assets from its Monetary Stabilization Fund to purchase about 25 percent of the freely circulating shares in the local bourse.

The essential problem is that government involvement in economic matters is never politically neutral. Adding a high political content into stock markets simply pump air into inflated asset values while increasing market volatility and making it impossible to make a clear assessment of the value of traded shares.

One case of the consequence of a high political component in stock markets can be seen in Hong Kong's "red chip" index that measures share values of companies with connections to China.

In the months before Britain handed over the former Crown Colony to Beijing, shares of red chip companies ran up to highly exaggerated levels before falling back sharply once patriotic euphoria subsided. The high prices paid for red chip shares implied that many believed political connections were more important than commercial viability.

More recently, Beijing has undertaken a campaign to talk up values on its domestic exchanges. The fragility of the current values was made evident when rumors that Zhu Rongji (朱鎔基) was forced to resign caused the Shanghai stock market to shed nearly 10 percent in a single day.

Another example of injecting high political content in a stock market was seen in the response to heightened tensions across the Taiwan Strait.

As in the case of the politically-inflated value of the red chips, the first whiff of instability will encourage a herd-like response where market participants shift their assets out to protect their wealth.

Large net outflows of foreign and domestic capital can have an exaggerated impact on stock market values that can spillover into the rest of the economy.

In looking at the sharp ups and downs on these various markets, it seems evident that political interferences contributes to speculative fever and promotes instability.

While many countries are seeking ways to protect their economies from harmful effects of short-term capital flows, government intervention in market valuations in Japan as well as China, Hong Kong and Taiwan seems to be making matters worse, not better.

Christopher Lingle is an independent corporate consultant and adjunct scholar of the Center for Independent Studies in Sydney who authored The Rise and Decline of the Asian Century. His e-mail address is: CLINGLE@ufm.edu.gt.
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