Recently, the Chinese Ministry of Finance officially announced its support for the central bank’s buying and selling of government bonds. On the same evening, the People’s Bank of China (the Central Bank of the Chinese Communist Party) stated that it would engage in trading government bonds in the secondary market. This signifies a significant shift in China’s monetary policy, and the related news immediately attracted attention, with comments like “China’s version of QE (quantitative easing) has finally arrived” becoming a hot topic.
The so-called secondary market refers to the stock market. Some analysts believe that the direct buying and selling of government bonds by the Chinese Central Bank indicates a shift from anchoring the renminbi to the US dollar to anchoring it to government bonds. It also legalizes past unauthorized rapid currency printing, and the next phase of renminbi issuance may be even larger. With the lack of checks and balances on the Chinese government’s issuance of government bonds, there is a concern that it could lead to malignant inflation.
Not long ago, the Chinese Ministry of Finance’s Party Committee Theory Learning Center issued a statement supporting the gradual increase of government bond trading in open market operations by the central bank to enhance the monetary policy toolkit. On the same day, the head of the Chinese Central Bank stated to the media that trading government bonds in the secondary market could serve as a liquidity management method and a monetary policy tool reserve.
Back at the end of March, Chinese media reported that Chinese leader Xi Jinping had instructed during the Central Financial Work Conference held in October of last year to enhance the monetary policy toolkit, with the Chinese Central Bank gradually increasing the buying and selling of government bonds in the open market.
The central bank’s direct purchase of government bonds has sparked much discussion, notably about whether the “China version of QE has finally arrived.” North American investment advisor Mike Sun told Dajiyuan that the collapse of the Chinese real estate sector has led to economic decline, prompting the Chinese Central Bank to seek policies to stimulate the economy. However, with the current deposit reserve rate at around 7.0%, the space for liquidity release through reserve requirement cuts is limited. Authorities are trying to mimic Japan’s financial policies after the bubble economy collapse, attempting to implement a Chinese version of QE to push down long-term interest rates, influence funds into the stock and bond markets, and stimulate the economy. Yet, the effectiveness may not be significant based on Japan’s experience.
Chinese state media claims that the central bank’s purchase of government bonds is not a Chinese version of QE, nor is it fiscal deficit monetization.
Mike Sun believes that the authorities are reluctant to admit to implementing “quantitative easing” as it would contradict Xi’s statement about “enhancing the monetary policy toolkit.” Additionally, explicitly announcing “monetary easing” could exacerbate the depreciation pressure on the renminbi.
Regarding the primary intent of the Chinese Communist Party’s official announcement of the central bank’s buying and selling of government bonds, American economist Huang Dawei pointed out in an interview with Dajiyuan that the Chinese government has fallen into a pattern of stimulating economic growth by increasing the renminbi base currency. However, they have also fallen into a “liquidity trap.”
“Huang Dawei stated, “From last year to this year, the broad money supply M2 of the renminbi has been maintained at double-digit rates, but we have not seen significant changes in economic growth. The reason is that much of the funds are not flowing into industries that genuinely need funds, such as small and medium-sized enterprises, manufacturing, and private companies.”
Official Chinese data indicates that in March 2024, the M2 balance exceeded 30 trillion yuan (approximately 4.225 trillion US dollars). In March 2013, M2 first exceeded one trillion yuan (approximately 160 billion US dollars), taking 57 years to achieve this milestone. By January 2020, it surpassed two trillion yuan (approximately 290 billion US dollars) in less than seven years and reached three trillion yuan in just four years and two months.
Huang Dawei explained that, “In 2008, the United States faced a financial crisis that impacted the global economy. To stimulate the economy, China issued 4 trillion yuan (approximately 552.5 billion US dollars). From that moment, the issuance of the renminbi entered a path of accelerated issuance.”
He indicated that based on the amount and growth rate of the renminbi M2 issuance, the Chinese government has long been printing money on a massive scale irregularly. The current announcement of the central bank’s trading of government bonds in the secondary market is simply a legalization of past irregularities, and the next phase of renminbi issuance may be even larger.
Chinese-American economist Li Hengqing mentioned, “In 2008, China issued 4 trillion yuan to stimulate the economy, which brought temporary prosperity but also left many problems. The current government wants to stimulate the economy by increasing the currency issuance, thus imitating the United States’ quantitative easing method during the financial crisis. However, compared to the United States, there are significant flaws in implementing quantitative easing in China.”
Li Hengqing pointed out that implementing quantitative easing could lead to price inflation, causing significant economic pressure on the poor and low-income individuals and families. He highlighted the lack of a comprehensive social assistance system in China to address this issue, unlike in the United States where stimulus payments were distributed to the public during the pandemic. Additionally, he mentioned that the Chinese government has not implemented a similar system or provided direct financial support to the people because they do not prioritize the livelihood of their citizens.
Li Hengqing further stated, “Former Chinese Premier Li Keqiang once revealed that there are 600 million poor people in China with monthly incomes of less than 1000 yuan (approximately 138 US dollars). If the central bank begins large-scale government bond purchases and excessive currency issuance, it could lead to severe hyperinflation and inevitably trigger social unrest.”
He also noted, “In recent years, the rapid growth of the renminbi M2 has been unprecedented. However, this has not stimulated the Chinese economy as many people are unable to find jobs, and both businesses and individuals are pessimistic about the economic outlook, refraining from lending and choosing to hold onto their money, leading to a large influx of funds back into banks.”
Previously, the Chinese central bank issued the renminbi through two main ways: foreign exchange reserves and giving loans to commercial banks. Foreign exchange reserves began in 1994 when then-Premier Zhu Rongji implemented foreign exchange reforms. This included fixing the exchange rate of the renminbi to the US dollar, allowing the rate to float within a certain range, and enforcing compulsory purchase and exchange of foreign currencies like the US dollar into renminbi. Based on the exchange rates of foreign currencies such as the US dollar, the Chinese central bank issued a corresponding amount of renminbi, anchoring the renminbi issuance to the amount of foreign exchange obtained.
The exchange reform of 1994 resolved the frequent occurrence of currency inflation during the period when the renminbi was anchored to government bonds. Data shows that in the 1980s, China was plagued by high inflation, with monthly Consumer Price Index (CPI) exceeding 5% from January 1987, reaching a peak of 28.4% in February 1989 during the inflation cycle from 1986 to 1988. This high inflation cycle was one of the significant reasons that led to the eruption of the 1989 Tiananmen Square protests.
After anchoring the renminbi to the US dollar, especially after joining the WTO, China’s continuous trade surplus led to a rapid accumulation of foreign exchange reserves, making foreign exchange reserves the primary method for the central bank to issue the renminbi. However, starting from 2014, the growth rate of the US dollar and other foreign currencies began to decrease. To maintain the growth rate of the renminbi’s basic currency, the anchoring expanded to include issuing loans to commercial banks. With the recent real estate sector crisis, the method of lending to commercial banks has come under scrutiny. Now, the central bank’s trading of government bonds in the secondary market signifies another anchoring, this time to government bonds.
At present, countries like the United States also anchor their currency to government bonds. So, how does the issuance of the renminbi compare to the issuance of the US dollar?
Huang Dawei explained, “The issuance of US Treasury bonds is monitored and requires congressional authorization. The functions of congress restrict how much government debt can be issued. In contrast, China does not have these restrictions or a third party like Congress for power balance. The Chinese government has unlimited printing authority, which could lead to currency printing and spending according to the government’s intentions, resulting in a vicious cycle.”
Li Hengqing also noted that democratic countries have mechanisms to check government’s printing of money; the US government once faced shutdowns because it wanted to increase spending without congressional approval. “However, it is entirely different in China. If Xi Jinping taps one trillion yuan on his office computer in Zhongnanhai, then one trillion must be printed; they really dare to do this, and they have done so in the past,” he stated.