Government liabilities are private sector assets
As we have seen so far, government bonds are debt issued by the government to raise funds. Therefore, the explanation that “government bonds are government debt” is not incorrect.
However, that alone does not provide a full understanding of what government bonds are.
Government bonds issued by the government are purchased and held by someone. While they are liabilities that the government must repay, for the individuals and financial institutions that hold them, they are financial assets that carry the right to receive principal and interest in the future.
In other words, while government bonds are liabilities from the government’s perspective, they are assets from the private sector’s perspective. Government debt and private financial assets are two sides of the same coin, representing the same government bonds viewed from different positions.
Thinking of it this way, an increase in the balance of government bonds means that government debt is increasing, but it also means that the financial assets held by the private sector are increasing. Government bonds are entities that have a major impact not only on government finance but also on the financial market as a whole.
Financial assets that generate interest
One of the reasons government bonds are held as financial assets is that they can earn interest income.
For example, if you hold a government bond with a face value of 1 million yen and an annual interest rate of 3%, you will receive a fixed interest payment of 30,000 yen every year, and the 1 million yen principal will be redeemed at maturity. Unlike stocks, where dividends fluctuate based on corporate performance, interest and principal are paid according to predetermined conditions.
Of course, government bonds also carry credit risk, as principal and interest may not be paid as scheduled depending on the fiscal situation of the issuing country. However, Japanese government bonds are bonds issued by the Japanese government and are considered one of the most creditworthy financial assets in the country. For this reason, they are held by many investors as an investment target that combines safety and profitability.
In recent years, with the rise in interest rates, the interest income earned from government bonds has also increased. Being able to manage assets relatively safely while earning interest is one of the major attractions of government bonds.
A foundation for fund management
Government bonds are held in large quantities not only by individual investors but also by many financial institutions, such as banks, insurance companies, and pension funds.
Banks need to manage the funds entrusted to them by depositors safely and efficiently. Therefore, government bonds, which allow for stable interest income while ensuring liquidity that can be cashed in at any time through sales or other means, are a powerful investment target. Banks, in particular, make wide use of government bonds ranging from those with relatively short maturities to those with maturities of around 10 years.
On the other hand, life insurance companies bear the responsibility of paying insurance claims to policyholders over a long period. Pension funds also manage assets while preparing for future pension benefit payments. For this reason, ultra-long-term government bonds with maturities of 20, 30, or 40 years are also important investment targets.
As such, even for the same government bond, the maturity period emphasized varies depending on the entity holding it. The reason government bonds with various maturities, from short-term to ultra-long-term, are issued is also because each investor has different management needs.
Furthermore, financial institutions do not just hold government bonds; they manage their assets by buying and selling them according to market conditions and funding needs. Therefore, government bonds are not only an investment target for individual investors but also play a role as a foundation that supports fund management for the entire financial system.
Assets that preserve value
When we hold assets, we do not necessarily choose only cash or deposits.
Cash is convenient for daily payments, but it does not earn interest. Deposits are highly safe and can be withdrawn when needed, but they have limited profitability from the perspective of asset management. Additionally, deposits exceeding the deposit insurance limit carry the bank’s credit risk. On the other hand, while stocks have the potential to generate large profits, their price volatility is also high, and they lose value if the investment target fails.
In contrast, government bonds are positioned as assets that combine safety and interest income. Also, because they can be sold on the market, it is possible to convert them into cash as needed. For this reason, they serve as a means for individual investors to manage assets stably, and they are important assets that support long-term fund management for financial institutions.
Admittedly, the value of government bonds is not always constant. As financial assets traded on the market, their prices fluctuate daily under the influence of factors such as market interest rates.
To understand government bonds as financial assets, it is essential to know the mechanism by which prices fluctuate due to market interest rates.
In the next section, we will look at the relationship between market interest rates and government bond prices.