Ever since the 2008 financial crisis, there has been a persistent shortage of high-quality government debt. More than just a safe haven in times of financial stress — the so-called ‘flight to quality’ — the supply of  high-quality sovereign debt has been steadily shrinking. This shortage became acutely apparent with the results of the Brexit referendum as investors worldwide bid up bond prices to the point where most long term bond yields reached historic lows in the US, UK, Germany and Japan. Brexit only exacerbated a shortage problem that bond investors have had to contend with for nearly a decade. The current squeeze in supply is just the latest manifestation of this wider issue in today’s financial markets.  

To claim that there is a shortage of government debt must seem counter-intuitive to many readers. After all, there is no end of studies demonstrating that major economies have record high government debt-to-GDP ratios, signifying that there is too much debt, not too little. Many critics call for governments everywhere to issue less debt, arguing that such high levels of debt ratios contribute to sluggish growth, if not, outright stagnation. European governments continue to exercise spending restraints and, in general, austerity is the byword throughout the industrialized world. Governments have been very reluctant to open up their coffers by issuing more debt to fund expenditures.

However, a case can be made for more government debt. In a recent article, The World Needs More U.S. Government Debt, former FOMC member Narayana Kocherlakota argued this case, succinctly, when he wrote:

But scarcity is not about supply alone. In the wake of the financial crisis, households and businesses are demanding more safe assets to protect themselves against sudden downturns. Similarly, regulators are requiring banks to hold more safe assets. Market prices tell us that the government needs to produce more safety in order to meet this increased demand……… The inadequate provision of safe assets also has profound implications for financial stability. Without enough Treasury bonds to go around, investors “reach for yield” by buying apparently safe securities from the private sector …if such behavior becomes widespread, it can create systemic risks that tip the financial system into crisis.   

To better understand how bonds became scarcer, we begin by looking at who is buying government debt and why.

The Expanding Role of Central Banks

As the Federal Reserve sought ways to stimulate the economy, it became the first major central bank to start a bond-purchase program– Quantitative Easing (QE) Soon after the Bank of England (BoE), the Bank of Japan (BoJ) and most recently the European Central Bank (ECB) developed their own versions of QE. ( Chart 1). The US Fed holds nearly 20 percent of all Federal government debt; the BoJ owns over 30 percent; the BoE, 25 percent; and the ECB has so far bought about 15 percent of German debt. The Fed is no longer purchasing debt, while the other central banks continue with their QE programs.