Hello, viewers, and welcome to “Qin Peng Observation.”
Today’s focus: The People’s Bank of China announces a large-scale borrowing of government bonds. Is the era of “unanchored printing of money” really approaching?
Many experts’ understanding of China’s quantitative easing (QE) is wrong! Massive liquidity injections by the central bank won’t necessarily lead to significant inflation in China. Prices in certain industries will continue to plummet!
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On Monday, the People’s Bank of China (PBOC) issued a notice that caused a stir in the market, sparking various speculations and analyses.
The announcement stated, “To maintain the stable operation of the bond market, based on a careful observation and evaluation of the current market situation, the People’s Bank of China has decided to conduct government bond borrowing for some primary dealers in the open market in the near future.”
The news led to a plunge in Chinese government bond prices, with the 30-year benchmark contracts falling by 0.6%, the 10-year ones by 0.15%, and the 2-year ones by 0.02%. Many are wondering: what’s going on?
Some prominent financial analysts believe that the PBOC borrowing government bonds signifies the beginning of unanchored printing of money, a significant historical moment.
The term “unanchored printing of money” is very ominous. Many immediately think of Zimbabwe, Venezuela, and the issuance of Gold Yuan Coupons during the final period of the Republic of China on the mainland, where bags full of money could only buy a small amount. So, the situation is alarming.
But will it happen? The answer is: not likely! To understand why, we must first discuss China’s monetary issuance mechanism.
As is common knowledge, during the gold standard era, a country’s currency issuance had to be backed by an equivalent amount of gold, known as anchoring… you can imagine a ship sailing on the sea needing to drop its anchor in a harbor; otherwise, the ship may be overturned by big waves or blown away by strong winds. This changed after the Bretton Woods system ended. The United States no longer anchored to gold but stabilized the international currency with its robust production capacity and overall national strength. Therefore, the majority of national currency issuances worldwide have, in reality, been anchored to the U.S. dollar for a long time. Mainland China and Hong Kong have issued currency in this manner for an extended period.
In China, foreign currency generated through foreign investments or exports must be exchanged for Renminbi by the People’s Bank of China as it’s not permissible for enterprises or individuals to hold foreign currency. This forms foreign exchange reserves. The Renminbi thus issued becomes the base currency, multiplied by the money multiplier, resulting in China’s M1 and M2 markets, supporting the entire Chinese economy’s operation for over a decade.
However, as China’s economy has grown larger, its foreign exchange reserves have become insufficient compared to its size. At its peak in 2014, the reserves totaled $4 trillion, but later dropped to $3 trillion, equivalent to 20-30 trillion Renminbi, which was not sufficient to sustain China’s economic growth. Therefore, since 2014, the Chinese government has introduced new monetary policy tools, such as the well-known Medium-term Lending Facility (MLF) and Standing Lending Facility (SLF). In this way, they effectively began anchoring their currency issuance to debt.
So, since then, China has effectively been operating with two anchors: foreign exchange reserves and debt as anchors.
Although China has been printing money at a breakneck pace, with M2 exceeding 300 trillion Renminbi, nearly surpassing the sum of the U.S., Eurozone, and Japan combined, many can feel that the Chinese Communist Party (CCP) is currently in dire need of money. Local governments lack funds, leading to corruption even in schoolchildren’s meal subsidies, diverted to repay government debts; even the central government lacks funds, thus issuing 50-year government bonds, mocked by netizens, compared to Guge City in the film “Let the Bullets Fly,” where taxes were collected for 90 years.
What can be done about this? Therefore, since the beginning of this year, the exposure of Xi Jinping’s directive from October last year, indicating the need to enhance monetary policy tools, and gradually increasing the People’s Bank of China’s purchase of government bonds in the open market, has raised concerns that the CCP might engage in unanchored printing of money through the central bank, similar to the U.S.’s Quantitative Easing (QE).
This concern is indeed reasonable. When the CCP is at its wits’ end, it will undoubtedly resort to extensive monetary easing. However, in my view, the CCP has not yet initiated this suicidal move!
This time, the genuine reason for the People’s Bank of China borrowing government bonds is the asset shortage in the Chinese market. Large sums of money have nowhere to be invested, with the real estate industry, worth 40 trillion, collapsing, and many of the 30 trillion investment products also failing, causing widespread devastation in physical industries. Consequently, substantial funds have flooded into the government bond market, driving up government bond prices, particularly those of long-term bonds such as the 10-year and 30-year bonds, which have seen recent price increases.
However, it’s important to remember that government bonds are unique commodities. The lower the price, the higher the yield, while a higher price signals a lower yield for government bonds. The market price resulting from large-scale government bond trading forms long-term interest rate expectations for a country.
This market interference can disrupt the central bank’s setting of long-term interest rates. Remember why the Silicon Valley Bank of the USA went bankrupt? It held a large amount of U.S. government bonds, which significantly depreciated following the inflation and Emergency Reserve Hikes by the Federal Reserve, leading to a run on the bank. Similarly, many commercial banks in different countries are significant holders of government bonds. Therefore, the mismatch between actual interest rates and nominal yields could raise a country’s financial risks. Mismanagement can lead to financial crises!
This is why the People’s Bank of China is on edge. On June 19, the Governor of the People’s Bank of China, Pan Gongsheng, issued a warning at the 15th Lujiazui Forum, reminding people to pay attention to the “maturity mismatch and interest rate risks faced by some non-bank entities holding a large amount of mid-to-long-term bonds” and reiterated the central bank’s high concern for the long-term bond yields.
Pan Gongsheng further stated, “The risk incidents of the U.S. Silicon Valley Bank should serve as a warning to us. From a macro-prudential perspective, the central bank needs to observe and evaluate the financial market situation, timely correct and mitigate the accumulation of financial market risks, especially focusing on the maturity mismatch and interest rate risks faced by some non-bank entities holding a large amount of mid-to-long-term bonds, maintaining a normal upward-sloping yield curve, and sustaining positive incentives for investment in the market.”
So, why did they borrow government bonds from major securities firms? It’s because as of February 2024, the People’s Bank of China held only about 1.52 trillion Renminbi in government bonds. Market participants believe this holding is relatively low, hence the need to borrow a sufficient amount of government bonds from primary dealers first to facilitate selling government bonds in the open market later. This selling would then suppress government bond prices, effectively raising market rates.
In fact, following the signal from the central bank regarding the borrowing of government bonds, government bond prices did decline.
The question remains: will the authorities take the opportunity to engage in extensive monetary easing?
At the moment, there are no visible signs. Typically, a central bank’s operation with government bonds involves both buying and selling, offering flexibility rather than one-way operations. China’s market experts also believe that as an important manifestation of strengthening the coordination between monetary and fiscal policies, smooth advancement of government bond trading into the monetary policy toolbox requires joint efforts by the People’s Bank of China and the Ministry of Finance to optimize the issuance pace, maturity structure, and custody system of government bonds, gradually and steadily.
This explanation may be difficult to grasp. Essentially, it suggests that the two entities have differing demands and goals, where the Ministry of Finance needs to continually issue government bonds to raise funds, wishing for reasonable prices and easy sales, while the People’s Bank of China aims to maintain reasonable market rates. Therefore, these two entities need to negotiate frequently… in simpler terms, they often disagree behind closed doors.
In summary, I also believe that we need to pay attention to whether the CCP will engage in unanchored printing of money during local debt and financial crisis outbreaks in the next 1-2 years. However, I think the CCP will not easily resort to starting the printing press unless absolutely necessary as it would lead to its rapid demise.
Lastly, I would like to address a crucial topic and correct some mistaken viewpoints of the majority of financial analysts in recent times. The most unreasonable prediction is that once the CCP starts the Chinese version of QE (Quantitative Easing), it will cause massive inflation in China like in Venezuela and Zimbabwe. Some financial analysts even suggest that there’s no need to sell houses because during hyperinflation periods, those holding assets in China would be the real winners.
However, I have to say these claims are unfounded and, in fact, harmful.
China’s economic foundation, social reality, and current economic cycle are different from historical experiences and those of other countries. One cannot simply apply the same solutions.
Let’s talk about the economic foundation. China has the world’s largest and most complete manufacturing industry and a fundamentally complete agriculture sector. It’s been said that former CCP Standing Committee member Wang Qishan once mentioned how resilient Chinese people are to hardship, even able to survive on grass for a year. Therefore, when crisis looms, the Chinese manufacturing industry will continue to drive prices down, and Chinese manufacturing workers will accept continually decreasing wages. This unmatched ultra-“thrifty” state is unparalleled globally. Some even say that this thrift of Chinese companies conceals the secret of economic growth. It’s a heartbreaking statement, but it reflects reality.
Moreover, Chinese conglomerates (such as BYD) and platform companies are very developed, differentiating themselves from their counterparts around the world by relentlessly squeezing their industrial chain supplier partners. So, in reality, China has been moving towards a “Pinduoduo” style in recent years, particularly evident in the field of new energy vehicles, as many have experienced.
This uniqueness is due to China’s specific economic foundation and industrial environment. Looking at the economic cycle, don’t be swayed by the CCP’s boasting about maintaining GDP growth. As I’ve mentioned before, now is a period of deflation and recession. During times of recession, prices across society continuously decrease.
There’s also a distinct social reality in China that disrupts the regular patterns of inflation—wealth distribution. To create the large-scale inflation seen in Venezuela and Zimbabwe, money must flow into society. However, as many have experienced, China’s M2 money supply is unparalleled, with a vast amount of money either circulating within the financial system or accumulating in the hands of a tiny minority of CCP elites and the affluent, as noted by the statistics released by China Merchants Bank and Minsheng Bank a few years back, stating that 2% of the Chinese population owns over 82% of the wealth. Meanwhile, over a billion people have little to no wealth! How can inflation occur under such circumstances? Moreover, many actively choose to “lie flat,” entering a period of low desire and non-ambition.
Furthermore, under Xi Jinping’s leadership, the issuance of currency primarily flowed into the military-industrial complex, high technology, and some heavy industries, with little relevance to general livelihood sectors. Professor Sun Liping, a sociology and economics expert at Tsinghua University, calls this strange allocation of funds and resources China’s binary structure.
Therefore, don’t solely focus on China’s skyrocketing debt and M2 money supply. In my view, even if the central bank begins printing money in large quantities, China’s real estate prices are unlikely to rise. On the contrary, they will likely continue to decline. Wealthy individuals will not foolishly play the role of bargain hunter! Aside from special commodities like gold, the popular collectibles and high-consumption products of recent years will continue to depreciate! That’s why we recently saw prices and stock prices of Maotai falling, and on Monday, it was reported that the company of renowned collector Ma Weidu laid off employees, with some staff revealing their wages stopped at April. Why is this happening? A large portion of the middle-class has been eliminated, and the super-rich are either lying flat or fleeing!
Of course, we must acknowledge that due to the looting nature of the CCP, some essential goods will experience price hikes. However, general industrial and durable goods will continue to decrease in price.
This paints the picture of China’s unique landscape of simultaneous deflation and the era of massive money printing, where one side is the sea, and the other is the flames.
What lies ahead? I will continue to provide analysis in the future.
That concludes our discussion for today. For those who enjoy my program, please subscribe to my new channel in the comment section. Let’s stay tuned for the historical turning points of 2024 together!
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