How Long Can Japanese Bond Prices Defy Gravity?

James Hamilton of UCSD asked this important question the other and I think it’s a good opportunity to once again highlight a key understanding of the institutional design structure of our monetary system (and Japan’s).  Dr. Hamilton highlights a paper by another UCSD Professor Takeo Hoshi and University of Tokyo Professor Takatoshi Ito that offers some thoughts on the issue.  They essentially say that Japan’s bond market is sustained due to domestic ownership of bonds and the currently affordable low interest rates.  But they conclude that this is not a sustainable trend.  They may or may not be right, but I think their findings can be elaborated on a bit.

(For the unitiated I would highly recommend reading my paper on the modern monetary system and JKH’s Contingent Institutional Approach, which I believe is the finest explanation of the institutional design structure of the monetary system that has yet to be produced).

First, Japan has a monetary system design that is very similar to that of the USA’s.  That is, they’re an operational currency issuer by virtue of the fact that their Treasury can always procure funding by harnessing the domestic banking system and using the central bank as a support mechanism.  In the USA, the Primary Dealers are required to bid at Treasury auctions in return for doing business with the US government.  The US Treasury is an operational currency user (like you or I) in that it must always procure funding for its daily spending.  The Treasury can always procure funds via taxation.  But it is also backed by its own central bank which could, at least in theory, always fund the US government’s spending (though this is currently illegal in the form of direct bond purchases).  These powers make the US government and the Japanese government very different from a household, a business or a European nation (all of whom are operational currency users by virtue of lacking this institutional relationship).

For whatever reason, fixed income traders seem to know all of this – rather, they know that payment is never an issue.  They know that the Treasury is not going to stiff them on payments.  I.e., the US government can’t “run out of money”.  For anyone lending money that’s your primary concern – “will I get paid back?”.  US banks love doing business with the US government because Uncle Sam doesn’t “run out of money” (nor can it).   The same goes for Japan’s banks.  Of course, the other concern for bondholders is not just “will I get paid back”, but “what will the value of my Yen be when I am paid back”.  This gets into a more complex facet of this debate, but I want to first emphasize the primary conclusion here – Japanese bond investors (domestic or foreign) aren’t going to stop buying JGB’s because they know they will always get paid back.

But what about the purchasing power of the paper in which these JGB’s will be paid back?  As you likely know, Japan has been suffering a horrid deflation for 20 years as a result of a multitude of factors.  So we’ve witnessed an endless stream of JGB bond traders diving out of windows as they short JGB’s and lose out to ever increasing prices.  One interesting conclusion in the Hoshi/Ito paper is their view on Japan’s “unrealistically optimistic assumption that Japan’s GDP will grow at 2% annually for the next 40 years”.   If growth is to stagnate then where will the inflation come from?  What could scare these bondholders into a massive JGB revolt leading to higher rates (something which, mind you, did not even occur in the USA during the great stagflation of the 1970’s)?   I am lost for a cause here because Japan’s central bank controls interest rates and as the supplier of reserves to the banking system they can always control the entire yield curve (yes, if they wanted to pin the 30 year bond at a specific rate they would just have to name it and challenge the bond traders to compete with their endless reserve position – the bond traders would lose quickly).

So the question remains – how long can Japanese bond prices defy gravity?  Well, the short answer is – as long as the Japanese central bank is willing to keep rates low.  The more important question is when will Japan experience an environment which forces their central bank to alter the current structure of the yield curve?  Will a stagflation occur similar to the 70s in the USA?  Will a hyperinflation occur for whatever reason?  Will growth rebound?   Or what if Hoshi and Ito’s pessimistic GDP projections are correct?  Then we’re likely to continue seeing JGB traders jumping out of windows following unsuccessful attempts to fight the Bank of Japan.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

More Posts - Website

Follow Me:

  • LVG

    You should hop over to UCSD and have a chat with these guys. That’s near you I presume?

  • Wulfram

    Considering that Japan owns most of its own debt, maybe their central bank should think about raising rates to allow their seniors — and they have so many of them — to have some retirement income. Between that and the natural expansion of the monetary base, they just might find the inflation they are looking for!

  • Bond Vigilante

    As long as there’s demand Japan can “kick the can down the road”. And that demand comes from:
    1. the BOJ. But printing money equals to “kick the can down the road”.
    2. Japanese investors. But these investors are dissaving, especially with these low rates.
    3. foreign investors when Japan starts running Current Account Deficits. But they WILL demand higher interest rates.

    Conclusion: trying to kick the can down the road will solve the problem for a while but somewhere the road WILL end.

  • LVG

    Interest outlays are fiscal stimulus. So yeah, it might actually help.

  • Edmund

    Reading analysis of Japan is like seeing the world gone mad. A lot of the same people who are cool with QE fo’eva basically go, “Nope – hyperinflation!” when you suggest that they should just do QE and fiscal stimulus together.

  • JK


    Since the Treasury technically could mint a coin of any denomination and instruct the Fed to deposit it into it’s accounts..

    Are you saying, merely because the Treasury doesn’t choose to do this in it’s day-to-day operations, that makes it a operational currency user?… even though technically it is a issuer because it can mint coins of any denomination?


  • Jack

    “foreign investors when Japan starts running Current Account Deficits”, Bond Vigilante is right to emphasize Japan’s CA position. But with one trillion dollar and still counting reserves (positive CA) in BOJ, it will probably take dozens or even hundred years before Japan has to ask foreigners to buy its bonds. Furthermore, Hoshi and Ito’s assumes that Japanese people will run out of saving to buy their bonds someday in the future without considering BOJ’s action. This, as Cullen suggests, is institutionally implausible. As Japan can always deficit-spend by to increase private sector’s financial assets as long as BOJ accommodates. Overall, I agree with Cullen.

  • InvestorX

    Instead of shorting JGBs why does not one buy CDS on Japan? It should be cheap now if one believes a disaster might be coming.

  • Apj

    They don’t need to ask foreigners to buy JGBs – Buba has just announced it will buy them.

  • LRM

    When a primary dealer buys any and all treasury issue, what portion of PD funds come from existing currency and what portion comes from new borrowing/ increased leverage?
    It was mentioned previously that the bond is the net financial asset added from deficit financing but is this multiplied in any way due to ability of PD to use leverage?

  • In Accounting

    Aren’t CDS priced in USD though? A big part of the JGB short is expectations on JPY FX rate weakening.

  • os

    Hi Cullen,

    With those comments in mind, why wouldn’t both the Fed and the Japanese central bank simply control the yield curve in perpetuity?

  • Bill

    If someone wanted to buy a 3 year call option on a 5 year constant maturity JGB *yield* struck @ 0.35%, does anyone know how much that might cost on $1 million worth of bonds?

    I understand that betting against the Japanese gov’t has been futile to date and that, consequently, the realized vol on these bonds must be nil. That said, I wonder if dealers are on-board with the Japanese Central Bank or whether they’re a bit paranoid to sell that upside?

    Paul Tudor Jones was buying puts on the Nikkei prior to its crash, I believe he paid something silly like a 7 or 8 vol because insurance companies believed stocks would only go up. The insurance companies sold the downside relentlessly.

    Also, relatedly, the EURCHF peg is kinda interesting. If the peg persists, I wonder what vol an ATM call on EURCHF is offered at for a one year option? I guess the SNB can hold the peg as long as the EU does not break up. But if the EU does break up and the EUR goes to hell, one imagines the SNB will relent. Currently, the SNB is printing about 60B CHF per month, then selling them for EUR. There’s been no real talk of swapping those EUR for real assets. That’s a big position the SNB is carrying.

  • The Undergrad

    They do. Cullen uses the analogy, which I quite like, of a dog on a leash; the farther out on the yield curve you go the more control the market has in setting interest rates. If the market deviates too much from the Fed’s policy target it will do something to pull the market in.

  • Cullen Roche

    This is a legal loophole, which, if ever tapped, would almost certainly be closed. Think about this logically. The Tsy is not designed to be able to fund its own account. We’ve dispursed the power of money creation away from the govt intentionally. If the Tsy can just fund its own account without checks and balances then what’s the point of having a Fed or a Congress? This loophole reminds me of the idea of the Fed doing muni purchases and funding states directly. It’s legally allowed, but the second it started to happen Congress would close the loophole because only they can control the power of the purse. Some other systems might be designed to allow this to occur (and we both know in theory like MMT, the govt does not need to procure funds to spend, but in reality that is precisely what it does). I use the example of a country having nuclear bombs, but being bound by international laws and treaties so as to avoid abusing that power. Technically, the USA could drop nukes where ever it wants. Who will stop us? We could nuke everyone who got in our way. But the laws exist for a reason. In other words, there’s a difference between govt having the power to do something and existing in a system in which that power is controlled/reduced/limited. Govt spending is no different. Yes, you and I both know the Tsy could just go out and fund accounts. But the system is designed not to allow that and I think there would be outrage if the Tsy did that. Unfortunately, the laws surrounding govt spending are misunderstood (some, like the debt ceiling are just plain stupid) and abused by the ignorant who think the US govt cannot “afford” to spend.

  • Cullen Roche

    They indirectly do and could directly if they wanted to. Long rates are really an extension of short rates. But more importantly, the Fed could set long rates just like they set short rates. Yes, Undergrads dog on leash applies. The dogs get some slack for the most part. But the Fed can always yank them back if it wants. The dogs know this so they stay nice and vigilant, but always listen to their master’s communiques for clues about when they might be allowed to run forward a bit….

  • Johnny Evers

    It’s the Fed’s job to fund the government. When the Treaury needs money for government spending, the Fed provides it.
    At the same time, if the Fed decides to buy up housing agency bonds, Congress can’t do anything about that.
    So they are a stange combination of subservience and independence.

  • Cullen Roche

    The Fed doesn’t fund the govt. The Fed serves primarily as a payment facilitator to ensure the smooth operation of the payments system (among other roles though this is their most important role). The entire reserve system is in place to facilitate settlement of payments between its various actors. In a one bank system there would be no need for the Fed in this role since there wouldn’t be multiple banks settling payments among one another. In the case of Tsy bond auctions the Fed does not and cannot buy at auction. It can help facilitate payment settlement, but it does this in a secondary manner. The US Tsy is ALWAYS funded by tax dollars or bond issues in transactions that are funded by the private sector. In theory, the Fed could always just credit the Tsy’s account, but the US system is not designed to allow this to occur. So the Fed must always buy on the secondary market. Think of it like this – if you buy Facebook shares today you’re not “funding the company”. You’re swapping shares for cash on a secondary market. That’s what the Fed does. They swap reserves for bonds on a secondary market. They don’t provide the initial funding….

  • Alberto

    Rates in Japan are totally controlled by BOJ. In the US and GB it’s the same. A default is impossibile… BUT… n a recent post on Project Syndicate, Kenneth Rogoff wrote:

    “It is nonsense to argue that central banks are impotent and completely unable to raise inflation expectations, no matter how hard they try. In the extreme, governments can appoint central bank leaders who have a long-standing record of stating a tolerance for moderate inflation – an exact parallel to the idea of appointing “conservative” central bankers as a means of combating high inflation.”

    This is the end game for me. Central banks (in perfect sync with the respective goverments) will inflate away most of the debt via financial repression and devaluation. The first who will do it will win. Probably Germany will win because most of the people think that they will never devalue the euro/mark

  • Johnny Evers

    My understanding of what you have written is that the Fed issues bonds that the primary dealers must buy. If the primary dealers balk, then the Fed can go out in the secondary market and buy bonds, freeing the primary dealers to buy the new bonds.
    Or, and I’m not sure how this would work, as the U.S. is sovereign in its currency, either the Fed would buy the bonds directly or just credit the Treasury’s account.
    My point is that the Fed merely facilitates the procurement of the money. Can you envision a situation in which the Fed were to say: ‘Wait a minute, you want $3 trillion this year? Can’t do it, wouldn’t be prudent.’
    Let’s say, for example, we’re five years out, the economy is booming, lending is up again and inflation is suddenly a threat — in a situation like that does the Fed have to ability to act independently?

  • Cullen Roche


    The Tsy sells bonds at auction and the PD’s must bid. The only environment in which the PD’s would balk would be a hyperinflation in which the bonds were pointless to own due to price deterioration. In this case, the Fed could theoretically buy directly on the primary market (would require an emergency law change), but the currency would be in collapse so it’s kind of a moot point. This is true monetization…requiring central bank funding when there is no private sector demand for the debt.

    I think the key lesson from this understanding is that currency demand is multi-faceted. MR calls it acceptance value and quantity value. Acceptance value is largely driven by legal mandate, the govt enforcing the currency, enforcing taxes, etc. This is entirely controlled by the govt. Quantity value is the purchasing power of the currency. This is in control primarily of private actors and is far more important than acceptance value. This ultimately comes down to the quality of the goods and services we create and the demand for currency is a result of demand to obtain these goods and services. The govt does not control this. So yeah, the govt can always try to maintain demand for its own currency by crediting its own account, but it can’t control the value of the currency merely by enforcing acceptance value. So no, the Fed won’t just roll over and say that they won’t credit the Tsy’s account, but I think that’s a meaningless point (they’re enforcing acceptance value when quantity value is collapsing). If they ever get to the point where they have to do that then we’ve really missed the ball on what drives the currency and the economy – the quality of the goods and services we produce…..

    Hope that helps clarify my thinking a bit.

  • Johnny Evers

    It clarifies the process, but it confirms my impression that the Fed has no check on how much debt can be issued.
    In your own words, the primary dealers would balk on buying debt only if we were in the throes of hyperinflation, which would be too late.
    Would the Fed signal if it saw hyperinflation coming?
    Would the Congress cut spending if it seemed that borrowing was getting out of hand? Maybe yes, maybe no, but there would have to be an immediate crisis, and by the time the crisis is here, it will be too late.
    This seems to be the weakness of being sovereign in your own currency. If you are not, then you have to be a worthy credit risk; if you are, then you can borrow with little real restriction.

  • LRM

    So do the PD’s use existing inside money to buy the issues from the treasury or do they create new inside money first then use this as the existing inside money.
    Does the fact that primary dealers can create inside money help them to always have enough to meet the demand of the treasury?
    Why can these PD’s always have inside money to buy from the Treasury no matter how much is asked for?
    I am going through the rx readings but it would be nice to see some diagrams for the visual learner!!!
    JKH has a lot of stuff there and it will take multiple readings to get a tiny understanding

  • Pierce Inverarity

    The Fed is not a check on how much debt is issued. Correct. That would be Congress first, then PDs, nominally. Congress determines EVERY YEAR how much it’s going to spend in relationship to what it’s receiving in tax receipts. Both Houses of Congress & the President have to sign off on this budget annually before appropriations get doled out. The debt is a natural consequence of any imbalance between receipts and outlays. If you don’t think this is a sufficient check on how much debt is issued, it appears you’re not a big fan of how our government has been structured for 224 years.

  • Cullen Roche

    The real restriction is almost always the quality of the goods and services your nation produces. If you study hyperinflations you’ll find one consistency amongst almost all of them – they suffer some sort of production collapse for varying reasons. This leads to a decline in quantity value, collapse in currency demand, collapse in tax receipts, continual govt spending and what looks like a monetary phenomenon is actually something totally different. So yes, we’re always constrained by the quality of our output. The govt can’t really control that. It’s an event that is largely exogenous of govt though it can certainly be exacerbated by govt incompetence.

  • Pierce Inverarity


    Been asking for some visuals for a while now.

    C’mon Cullen! Doesn’t Sankowski have some graphic design connections?

  • REN

    Japan Postal Bank, a public bank which is an arm of their post office, has the largest private holdings of savings in the world. Japan Post recaptures and mobilizes income from the private sector, funding government bonds at low rates. US 3.2 Trillion of private savings is on hand, so Japan owes their debt to themselves by way of their high savings rate. Note, they are recycling “savings” which is money already in the supply, rather than having their Central Bank create new money. Big difference.

    I understand the U.S. Postal Service is also considering a post bank, this in order to reach the “unbanked.”

  • jt26

    One thing that TPC has taught me is that I never really understood the monetary system and can’t really articulate a model of cash, bonds, and savings vs. investment. Until someone can show that they can, ignore their projections on bond prices. It’s taken 4 years, but I’ve learned I don’t know no nuttin.

  • Cullen Roche

    It’s confusing because reserves exist (in large part) as a result of settling interbank payments from inside money. Think of it like a regular payment settlement. The reason the Fed facilitates payment settlement between two different banks (and not a payment occurring at the same bank between two customers with accounts at that bank) is because the system requires an intermediary for payment settlement. This is one of the key purposes of the reserve system. It provides a place for banks to settle interbank payments. So when you buy a car from GM you can transfer money from BAC to JPM smoothly as if BAC and JPM are the same bank. The Fed serves the same purpose in settling payments at auction. The Tsy borrows from the private sector resulting in a debit to inside money and a credit to the banks reserve account which is then cleared by the Fed in the interbank market in the procurement of funds. This allows the Tsy’s account at the Fed to be credited and then debited again in the form of a new deposit somewhere in the banking system as govt spending. The NFA is the residual of the buyer of the bond so you are not only left with a bond in the pvt sector, but ALSO the new deposit that was spent into existence….The govt is actually a redistributor of money. Not a creator of money in this process. They’re a creator of NFA though in the form of the bonds and this can have an enormously positive impact on private sector solvency.

  • REN

    New money enters the supply. The dollar is about 3% of what it was in 1971. Inflation of the money supply borrows value from existing stock of money already in the supply. Central Banks in the Anglo Saxon world came into being in order to fund government deficits.

  • Cullen Roche

    Most “new money” in our monetary system is bank issued inside money. It’s important to get the emphasis right here. I think something like 97% of all money in the world is bank issued inside money. NOT govt created forms of money like notes, coins or reserves.

  • REN

    Inside money buys itself down when the money cycles back to the Liability Column. Economists today call it a net zero, but obviously it is not zero due to the debt dimension. Due to the exponential of interest/usury, inside money has trouble inflating a supply. A 100K home may cost $300K over time. Bank money (inside money)can inflate for awhile, but always with a counter in debt. Eventually the debts are wiped out with a recession or depression; banker forecloses on an asset to wipe out the debt contract when it cannot be paid. Inside money can inflate a supply also with asset inflation, which eventally falls down as there is no counter in productivity ((today’s BSR).

    To have current money value at 3% of its 1971 value implies that there is more at work than MMR postulates. The theory doesn’t pass the smell test of reality.

    The FED spends into the supply and the Treasury counters with a new bond. If the FED spends and there is no Treasury counter, that will contract the supply causing deflation…not inflation.

  • REN

    Sorry, if the FED spends with no Treasury counter, it is an asset swap. No change to the supply, but an exchange of different types, liquid money for non liquid “bonds”.

  • Cullen Roche

    In the aggregate, loans are not being repaid and money is not being destroyed. Loans are largely rolling over in what is a perpetual increase in assets and liabilities within the private sector as private sector net worth expands. Just like the federal government doesn’t “pay down” its debt, neither does the aggregate private sector over the long-term (though this idea should not be confused with the differences in having a solvency constraint which all private sector actors do). The private sector debts grow perpetually along with the real economy:

  • Ben Dover

    The answer, my friend, is blowin’ in the wind
    The answer is blowing in the wind

  • Lance

    BV, how are they “dissaving”? Even low yields are augmented by deflation. If they do get the inflation they claim to be looking for, I’ll agree, then. But not now.

  • Andrew P

    Of course Japan can keep low rates forever if it so wishes. The real question is why the FX rate of the yen is so high relative to the dollar? Could it be because Japan is so productive and runs a trade surplus? Could this continue if Japan ditches all its nuclear plants and has to import increasing amounts of expensive fuel like everyone else?

  • Johnny Evers

    Hello, Pierce.
    I believe that Congress has lost control of the budgeting process, largely because of the entitlement process.
    I’m just trying to get Cullen on record as stating what the check is on federal deficits. He says its hyperinflation, so then the question is: How do we recognize hyperinflation coming down the road and who or how do you prevent it?

    Could we have a stimulus package of $5 trillion? What are the limits?

  • LRM

    The IMF has recently produced a white paper
    From Karl Denningers interpretation it calls for a change in in lending to require one dollar of capital for each dollar of loan. I remember someone on this site talking about this so mention it here for anyone interested.

  • Colin, S.Toe

    ‘REN’ has argued strongly for a 100% reserve requirement for bank lending. This might be a way of achieving something close to that, while enabling banks to continue to function as risk-managing providers of credit.

  • phil

    “The reserves are a settlement facilitator and nothing more”

    That’s like saying that if you owe me $100 and I owe you $90, and when we settle you give me a $10 note, the note is just “a settlement facilitator and nothing more”.

  • phil

    - The $10 is the means of final payment, just like reserves are between banks.

  • phil

    As you say the US government can always afford to spend (“the government has no solvency risk”), so the separation of Fed and Treasury (among other self-imposed institutional arrangements) does not actually provide a ‘check-and-balance’ on government spending. Current institutional design does not in fact control, reduce, or limit the government’s ability to spend.

    The only thing that can really limit government spending (in dollars) is the government itself, i.e. Congress and the President (leaving aside your hypothetical hyperinflationary scenario for the moment).

    Even if the Treasury were to start minting trillion dollar platinum coins, it still wouldn’t be able to spend any of that money without the approval of Congress! Minting trillion dollar coins would make no difference to who controls “the power of the purse” – Congress would still be in charge!

    (Btw: as well as being able to issue coins in any quantity and of any denomination, the Treasury can also issue United States Notes, though in limited quantities).

    – Plus of course the Treasury actually prints all the Federal Reserve Notes – “subject to the order of the Secretary of the Treasury” – and then supplies/sells them to the Federal Reserve! (Look at your notes – signed by the Secretary of the Treasury and the Treasurer of the United States, and stamped with a Treasury stamp. Guess where they come from).

    Let’s also not forget that Fed liabilities (cash, reserves etc) and Treasury liabilities (bills, bonds etc) are both US government liabilities!

    This is why (I think) MMTers say that the government does not actually “procure funds” – because even when the Treasury has a positive balance in its Fed account, the US government is simply holding its own liability. i.e. the government has net 0 – zero “funds”!

    (Also, if the Treasury has a deposit in a TT&L account, that deposit is the commercial bank’s liability – i.e. the bank effectively owes that amount of money in the form of reserves to the Treasury).

    – Smoke and mirrors rather than ‘checks and balances’, methinks.

    p.s: The idea that commercial banks and unelected central bankers might somehow provide a good ‘check and balance’ on the will of the elected government is quite odd. I think it would be more accurate to describe this as a type of ‘democratic deficit’ or perhaps ‘rule by technocratic and financial elites’, if it were indeed the case.

  • phil

    If a primary dealer were, for some hypothetical reason, to refuse to bid in Treasury auctions, then they would presumably lose the right to be a primary dealer, along with the advantages/privileges that such a position offers:

    “Primary dealers that do little business with the New York Fed over a period of time, that repeatedly provide bids and offers in the New York Fed operations or Treasury auctions that are not reasonably competitive, or that fail to provide useful market information and commentary, are not meeting the New York Fed’s expectations of a primary dealer. In those situations, the New York Fed may limit a primary dealer’s access to any or all of the primary dealer facilities or operations, and may suspend or terminate a primary dealer if it continues to fail to meet these business standards.”

  • REN

    Thanks Colin and LRM.

    I still think that you need some form of Public Credit though. The Archbishop of Canterbury said so as well in 1946. Public credit would be of high power, which would match reserved bank money (credit based on past wealth accumulation). In that way, the money supply waters are not muddied with two unequal types of money. (10 % reserved Bank Money and Government money are not equal in today’s scheme.)

    To my eye, it looks like our private banking system had the nature of their base money changed in 1971 when we went off the gold standard. Base money became very easy to acquire, which allows easy credit to follow. Add to that, the three week window for finding reserves; which means we loan first then look for reserves later. This point is made pretty conclusively by MMR folks. If banks don’t have enough reserves, then they can borrow from the FED at the discount window, or from other banks overnight.

    In other words, my worldview is that private banks are a big lever, and government is a rump on the system. Government provides reserves as necessary (TARP, etc.) Is the FED going to make a private bank recall loans if they don’t have enough reserves? No, the system would appear unstable if that happened. The FED’s dual mandate also means support for private banking.

    So, this malformed system of ours must eventually code for some sort of predatory financial capitalism. We can do better if we human’s decide to.

  • REN

    This paper stunned me into submission. Since it came from the IMF I was expecting a bunch of neoliberal economic gibberish. But no, it is even more heterodox than MMR.