NOTOBODY PURCHASED Ten-year Japanese government bond traded over-the-counter on August 3. Such a lull in the world’s second-largest sovereign bond market would already have been remarkable. But in fact, it wasn’t even the first time that activity had subsided. The once frantic 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 would come. With the Bank of Japan (BoJ) By sucking up securities, they argued, benchmark bonds would become scarce, causing price volatility and preventing investors from properly assessing risk. Financial institutions would be deprived of the collateral they needed to operate. But, oddly enough, there are few signs that the drying up of the Japanese market has had such effects. Should anyone, aside from the poor souls who bought and sold bonds for a living, lose sleep over them?
Perhaps nowhere is it more central in the history of QE than Tokyo. During the depression of the 1930s, the country’s finance ministry organized the BoJ guarantee all government bond issues. In 2001, Japan became the cradle of modernity QE when the BoJ launched a small asset purchase program.
The scale of bond purchases over the past eight years in particular has been astounding. The BoJassets of approximately 130% GDP, almost double the share held by the European Central Bank and almost four times that of the US Federal Reserve. The BoJ owns nearly half of Japan’s sovereign bonds (and, after years of sluggish economic growth, which forced the government to run budget deficits, the country has had enough). These were largely purchased from commercial banks, both domestic and foreign based in Japan. In 2012, banks held more than 40% of the stock of government bonds; now they own less than 13%. Since they usually do a lot of bond trading, it’s no surprise that activity has dried up like a dammed stream.
For its detractors, the Japanese experience of buying bonds as the main form of economic stimulus discredits the political tool. The huge asset purchases since 2012 have clearly not achieved the goal of generating sustained inflation. Even the BoJ don’t think it will hit its 2% inflation target until 2024.
Yet there also appear to have been few negative market consequences that critics feared. Bond traders complain about liquidity in polls, but bid-ask spreads – a measure of the spread between the price at which buyers are willing to buy and sellers are willing to sell – in the exchanges that occur were contained. Prices are kept in a stable band by the BoJ“yield curve control” policy. Average private sector loan rates are at their lowest. Large-scale quantitative easing may have made some maturities scarce, but this effect was mitigated by the central bank’s willingness to lend bonds to the private sector through various guarantee programs. As the pandemic panic peaked in March last year, the BoJ loaned more than 24 trillion yen ($ 221 billion) in government bonds to the private sector, mainly to provide the collateral needed by banks to access the Fed’s dollar swap lines. While it may still be reasonable to be concerned about the effect of persistently low interest rates on asset prices and on broader financial markets, in Japan at least concerns about the functioning of the asset market. government bonds have not yet materialized.
The absence of direct financial consequences of strangulation activity in the bond market speaks volumes about QE and monetary policy in general. Politics is generally seen as something that brings about changes in the economy. But it is just as much a consequence of the existing economic reality.
Movements in bond markets generally provide useful information on investors’ expectations for growth and inflation. But in Japan, both are so low that there is little useful information to glean from a more vibrant market. QE may have helped kill trading activity, but ultimately the euthanasia of trading desks like the QE program itself, is the result of a stagnant economy and static prices.
Perhaps this is the best lesson for other countries and, as the past 30 years have shown, what happens in Tokyo today is often repeated in the rest of the wealthy world tomorrow. If they find themselves in similar economic circumstances, worrying about the effect of buying bonds on the functioning of the market may be the least of their concerns.
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This article appeared in the Finance and Economics section of the print edition under the title “Closed for Business”