A few weeks ago, some senior officials at Bank of Tokyo Mitsubishi spotted a fascinating fact: for the first time the volume of Japanese government bonds sitting on the bank’s balance sheet swelled above corporate and consumer loans.
Yes, you read that right: at an entity such as Bank of Tokyo Mitsubishi, it is now the government – not the private sector – which is grabbing most credit, as the bank gobbles up JGBs, notwithstanding rock-bottom low rates.
Welcome to a key theme of 2012. During the past four decades, it was widely assumed in the western world that the main role of banks and asset managers was to provide funding to the private sector, rather than act as a piggy bank for the state. But now, that assumption – like so many of the other ideas that dominated before 2007 – is quietly crumbling. And not just in Japan.
In Europe, French President Nicholas Sarkozy indicated earlier this month that he is keen for banks to use their €489 billion European Central Bank bonanza to purchase more eurozone government bonds. Asset managers in places such as Spain and Ireland are now facing pressure to acquire more sovereign debt, or quasi-sovereign bonds, as debt pressures bite there. More subtly, British banks are being required to buy more sterling bonds, as a result of regulatory reform. Even in the US, government officials and bank leaders have recently taken to muttering that American banks have an unusually low holding of US government bonds, by international standards. The unspoken assumption, then, is that as western debt levels rise, banks and asset managers’ holdings of state debt will grow too – never mind that western sovereign debt is looking riskier by the day.
Now, in part this is simply a knee-jerk consequence to the current crisis. And in a sluggish world where private sector demand for credit is limited, it arguably might make macroeconomic sense for the banks to lend more to government. But the really big question now, that investors would do well to ask, is whether this trend also reflects a stealthy slide towards a wider process of quasi-financial repression.
To understand this, it is worth taking a look at a fascinating recent working paper by Carmen Reinhart and M Belen Sbrancia, published by the Bank for International Settlements*, but drawing on earlier work for the International Monetary Fund.
The arguments in this paper are complex. But what Reinhart and Sbrancia argue is that if you want to understand how the west cut its debts during the last great bout of deleveraging, namely after the second world war, then do not just focus on austerity or growth; instead, the crucial issue is that during that period, the state engineered a situation where the yields on government bonds were kept slightly below the prevailing rate of inflation for many years. This gap was not vast. But since asset managers and banks continued to buy those bonds at unfavourable prices, this implicit, subtle subsidy from investors helped the government to cut its debt pile over several years. Indeed, Reinhart and Sbrancia calculate that such "repression” accounted for half of the post-second world war fiscal adjustment in the US and UK, due to the magic of compounding.
Now, these days, it is hard to imagine any western government overtly calling for a second wave of such "repression”. After all, as Kevin Warsh, a former Fed governor, recently pointed out, the drawback of financial repression is that it curbs private sector investment and credit growth. And in any case, it is a moot point whether such repression could even be implemented today, given the globalised nature of markets.
Nevertheless, the political incentives to flirt with this concept are clear. After all, the beauty of a stealth subsidy is precisely that: it is too subtle for most voters to understand. It is also arguably a more equitable form of burden-sharing, and thus less politically divisive, than, say, state spending cuts. Moreover, governments do not necessarily need to be "repressive” to achieve the "repression” trick; as the economist Alan Taylor observes, if investors are so terrified that they cannot see alternative investment choices, they may end up buying government bonds by default – even at unattractive prices. Indeed, that is arguably what is already occurring today in the Treasuries market, or the world of JGBs. And, perhaps, in the eurozone too; after all, when eurozone banks were given €442 billion of ECB money two years ago, they used half of this to buy government bonds – without compulsion at all.
Whatever you want to call it, then, the state and private sector finance are becoming more entwined by the day. It is a profound irony of 21st century ‘market’ capitalism. And in 2012, it will only deepen.
*BIS working paper 363; the Liquidation of Government Debt, by Carmen Reinhart and M. Belen Sbrancia (with discussion by Ignacio Visco and Alan Taylor.)
Copyright The Financial Times Limited 2011.