Aug 28th 2021
nOBODY PURCHASED Japan’s ten-year government bond over the counter on August 3. Such a lull in the world’s second largest government bond market would once have been remarkable. But in fact, this wasn’t even the first time activity has dried up. The once hectic trading desks in Tokyo have fallen silent over the past half decade.
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Skeptics of the central bank’s massive quantitative easing (QE) program warned that this moment was coming. As the Bank of Japan (BoJ) sucks up stocks, benchmark bonds would run short, creating price volatility and preventing investors from properly pricing in risk. Financial institutions would be deprived of the collateral they need to operate. But strangely enough, there is little evidence that the drying up of the Japanese market has had such an impact. Should anyone but the poor souls who used to buy and sell the bonds for a living lose sleep over it?
Perhaps nowhere is QE more central to the history of QE than in Tokyo. During the economic crisis of the 1930s, the country’s treasury made sure that the BoJ took over all government bond issues. In 2001, Japan became the birthplace of modern day QE when the BoJ launched a small asset purchase program.
The volume of bond purchases over the past eight years has been astonishing. The BoJ’s assets amount to around 130% of GDP, almost twice that of the European Central Bank and almost four times that of the American Federal Reserve. The BoJ holds nearly half of Japan’s government bonds (and after years of sluggish economic growth that forced the government to run into budget deficits, the country has quite a few). These were largely bought by commercial banks – both domestic and foreign lenders based in Japan. In 2012 banks held over 40% of government bonds; now they own less than 13%. Since they typically do a lot of bond trading, it may come as no surprise that activity has dried up like a stagnant stream.
For its critics, Japan’s experience of buying bonds as the most important form of economic growth discredits the monetary policy instrument. The massive asset purchases since 2012 have clearly failed to achieve the goal of sustainable inflation. Even the BoJ doesn’t think it will hit its 2% inflation target before 2024.
However, there also seem to have been few of the negative market consequences feared by critics. Bond traders complain about liquidity in surveys, but bid-ask spreads – a measure of the difference between the price at which buyers are willing to buy and sellers are willing to sell – have been curbed in the trading that takes place. Prices are kept in a stable band by the BoJ’s policy of “yield curve control”. Average private sector lending rates are at an all-time low. Large-scale quantitative easing could make certain maturities tighter, but this effect was dampened by the willingness of the central bank to lend bonds to the private sector through various collateral systems. When the pandemic panic peaked in March last year, the BoJ lent more than 24 trillion yen (221 billion yen) in government bonds. While the impact of persistently low interest rates on asset prices and financial markets may still be justified, at least it has to in Japan worries about the functioning of the government bond market are yet to be realized.
The lack of direct financial consequences of a bond market slowdown says something interesting about QE and monetary policy in general. Politics is usually seen as something that makes changes in the economy. But it is also a consequence of the existing economic reality.
Movements in the bond markets usually provide useful information about investor expectations for growth and inflation. But in Japan both are so consistently low that there is little useful information to be found in a busier market. QE may have helped suppress trading activity, but ultimately, trading desk euthanasia, like the QE program itself, is a result of a stagnant economy and static prices.
That is perhaps the best lesson for other countries – and as the last 30 years have shown, what happens in Tokyo today will often repeat itself tomorrow. Should they find themselves in a similar economic situation, perhaps the least of their worries is concern about the impact of the bond purchase on the functioning of the market.
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This article appeared in the print edition in the Finance & Economics section under the heading “Closed for business”