This Scholar Says the Government Should Buy Stocks When They Plunge

(Bloomberg Businessweek) -- Last week, my Bloomberg colleague Moxy Ying in Hong Kong wrote a fascinating QuickTake headlined, “When Stocks Crash, China Turns to its ‘National Team.’” She explained that government-related entities in China, known informally as the national team, step in to buy shares of mainland-based companies on a large scale to stop market routs. “Worry not, Chinese stockholders, the ‘national team’ is here to (try to) save the day,” she wrote.

Economist Roger E.A. Farmer thinks other nations need to emulate China, and even go beyond it. He’s been banging this drum for years, as I have written in previous stories. Now, he thinks it’s bound to happen. After I emailed him Moxy Ying’s story, he wrote back, “Asset price stabilization policies are coming to a central bank near you. It’s just a question of when.”

Added Farmer: “My best guess is that it will take another stock market crash” to induce governments to actively stabilize their stock markets. “That crash will happen, most likely within the next five years,” he added, “but its timing is unpredictable.”

Farmer has surprising ideas but is far from a fringe character. He is the research director of the nonprofit National Institute of Economic and Social Research, founded in 1938, Britain's longest-established independent research institute. He taught at the University of California, Los Angeles and is now on the faculty of the U.K.’s University of Warwick. 

The economist sees market crashes as potentially dangerous to the real economy. “Depressions are self-fulfilling prophecies,” Farmer writes in his latest book, Prosperity for All: How to Prevent Financial Crises. Depressions happen when people lose confidence, and that often happens after a steep decline in the stock market. The government can short-circuit the self-fulfillment of the depression prophecy by buoying stocks when they sink, he argues.

“My own recommendation is that an asset stabilization fund should be transparent and trade only in ETFs [exchange-traded funds],” he wrote in an email. Farmer also noted that China isn’t exactly alone in intervening. “Japan, Hong Kong, and Taiwan have all intervened with differing degrees of success in the past,” he wrote. “None of these economies has yet, in my opinion, gone far enough.”

Some help from a national team probably sounds good to a lot of investors, with most stock indexes down for the year as of late November. On the other hand, investors might not be as happy with another part of Farmer’s prescription, which is for the government to sell shares massively when things seem to be getting frothy. In his email, he suggests a rule to guide the fund’s trading, one that “sells the ETF when the unemployment rate is too low and buys the ETF when it is too high.”

Farmer acknowledges one problem with his prescription: Global investors could overwhelm the U.S. government’s effort to prop up (or push down) stock prices. To keep that from happening, the U.S. could ban them from buying or selling stocks traded in the U.S., Farmer says. That would be similar to what China does. To be sure, it’s hard to imagine the U.S. going that far. “A less draconian proposal,” Farmer wrote, “would be a system of graduated taxation on the withdrawal of foreign capital based on the length of time the money has been parked in the U.S.”

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net

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