Between November 1st–18th, 2019, I returned to China and visited Beijing, Shanghai, Guangzhou, Haikou, and Datong, Shanxi. I had extensive discussions with many domestic governors, think tank friends, CEOs of high-tech enterprises, and investment fund partners. I introduced several innovative German products and services. I also connected with Chinese partners, sharing with them my thoughts on the opportunities current global macroeconomic trends provide for China.
To satisfy China’s hard currency foreign exchange needs for transformation and development, I suggest the following approaches to the internationalisation of RMB bonds:
- Issuing hard currency foreign bonds such as the Euro or US dollar
- Increase the opening of the financial sector, giving up financial sovereignty to attract foreign investment
How zero / negative interest rates and increased liquidity impact the western economy
Before its suspension in 2018, the European Central Bank’s 2015 bond-buying plan had already injected 2.6 trillion euros of liquidity into the market. While keeping the interest rate at zero, the European Central Bank announced it would restart the buy-back of government bonds on September 12th, 2019. On October 10, the Federal German 10-year bond interest rate dropped to -0.53%. By the end of the day, the European Central Bank had expanded its balance sheet to 4.65 trillion euros. At the same time, the ECB announced that, in view of the planned 20 billion euro bond buy-back per month, it would soon reach the ceiling of 33% of each country’s bonds. So it proposed to increase that ceiling to 40% by 2021 at the latest. According to the Wirtschafts Woche, the ECB can help eurozone economies achieve 0.2-0.8% growth for every trillion euros of expansion.
At a time when German corporate loans are generally charged with negative interest rates by banks, the FED’s November data showed that after three consecutive interest rate cuts, it also plans to restart the 540 billion US dollar bill printing and expansion plan. Perhaps worried that other countries will be dissatisfied with this, the FED still denies that it is a new round of quantitative easing, though it is reminiscent of their actions after the financial crisis in 2008, when they initiated three rounds of quantitive easing (with a total expansion of about 2 trillion US dollars) to help the United States against the financial crisis. At the same time, it exported inflation to the world at the cost of demand and growth in developing countries.
The United States, like all developed countries in the West, has neither the desire nor the feasibility to increase taxes on voters. The majority of voters don’t understand the impact of QE and zero/negative interest rates and choose to vote accordingly. The direct negative interest rate and indirect devaluation of savings are the means to import liquidity to their real economy as much as possible and reduce financing costs.
Since 2015, the European Central Bank has increased liquidity in the economy in this way. Theoretically, this should have made inflation inevitable – but what are the facts?
In the case of Germany, the consumer price index in 2015 was 100 and in 2018 was 103.8 (an increase of 3.8% within three years). Considering the complementary economic growth between Germany and China, we will take the changes of various price indexes after Germany’s reunification as an example to show the impact of the zero/negative interest rates and liquidity on the consumer price index, based on its high-end export-oriented globalization development strategy.
Between 1991 and 2018, the growth in energy prices was the heaviest burden for Germany, but its negative impact has been absorbed by the German economy. The price of electricity increased by 117%; the price of various (imported) oil and gas increased by 119%; Other rising price categories were: drugs 116%, housing rent 87%, decoration/watch 71%, bread/grain 56%, milk/egg products 47%, tourism travel 48%, beer 47%, telecommunications 43%, books 42%, cars 36%, furniture & lighting 31%, footwear 30%. There are two categories with CPI decreases: TV/radio-75%, and home appliances-12%.
Despite the fact that Germany’s disposable income per capita nearly doubled during this period, it is the energy, power, and medicine supply (mainly controlled by the United States, Britain, and France) still exceeds income growth. The price index of all goods manufactured by developing countries, such as China, has risen much less than the growth of disposable income in the markets that rely on them.
China, like all developing countries that rely on exports to developed countries to gain economic growth, is absorbing inflation for the developed world. In this way, it is similar to Germany. Price increases in the energy, power, and pharmaceutical industries (with huge monopolistic profits) exceed the income growth in developed countries. Export-driven developing nations have directly suffered from inflation, which has affected all manufacturing industries in the developed world. They have and will continue to pay for the liquidity overflow in western countries.
How should China address these challenges and opportunities in its next phase of transformation and development?
The transformation and development of China’s real economy requires additional access to Western countries’ liquidity
How can China, as the owner of the world’s largest western hard currency reserve, and the fastest-growing economy relying on exports, cope with the long-term depreciation of western hard currency and imported inflation while benefiting from the overflow of liquidity in western countries?
The focus of my Ph.D. research was post-Keynesianism. My dissertation was based on the theoretical model of neoclassical Walras commodity goods, labor, and capital markets. It expands and enhances the essence of short-term Keynesian unbalanced theory, with capital market investment activities, thus carrying out dynamic long-term modelling. Western economic theory fails to provide a theoretical basis for understanding the true interaction of commodity goods, labor, and capital between open economies and the complementary competition of related financial and macroeconomic policies. Essentially, open economies are in permanent disequilibrium.
Since its reform and opening-up in 1978, China’s macroeconomic approach has been to reduce domestic supply by US $1 for every US $1 exported. If that US $1 is used to import western advanced products and technologies (services), China’s economy will have qualitative progress. If the US $1 export revenue is exchanged by the Central Bank for 8-10 yuan to build/increase foreign exchange reserves, then the US $1 export will bring US $2 inflation. Therefore, China’s export-oriented macroeconomic development will inevitably bring inflation while earning relevant overseas jobs and incomes at home. This is also one of the reasons why the income of ordinary Chinese employees has increased from 36 yuan per month to 4000-5000 yuan in the past 40 years.
Of course, the other two main drivers of income growth are the substantial increase in the labor productivity of China’s economy and the expansion of the high-end manufacturing value chain.
At present, the US mainly uses tariffs to suppress low-end manufacturing cost competitiveness and profit margins to contain the further economic transformation and growth of China. As a result, the US needs to transfer to other lower labor cost countries in Southeast Asia. At the same time, they limit Chinese enterprises that have occupied the high-end of the value chain (such as Huawei), to gain access to high-end markets in western developed countries and effectively cutting off their hard currency profits and capital sources for sustainable R&D and innovation.
It is a must to continue investment in hard currency to fully utilize the R&D innovation abilities and achievements of developed countries.
China has no more (or only limited room) for hard currency market (export) growth in developed countries. This is an issue that China’s real economy faces. Under these circumstances, China should continue to generate the necessary capital income and profit in hard currencies for independent innovation. It is a must to continue investment in hard currency to fully utilize of the R&D innovation abilities and achievements of developed countries. China’s real economy must be directly connected to the increased liquidity of western developed countries to enjoy as many sources of liquidity channels as possible.
As China’s total debt has reached more than 200% of GDP, the biggest advantage China’s economy has compared to the United States is that foreign exchange reserves are still sufficient to cover existing hard currency foreign debts. Therefore, the financing challenge China’s real economy faces is internationalizing domestic debt, in exchange for hard currencies. That is, it should use RMB government bonds, local governments, and corporate bonds as much as possible in exchange for western liquidity (hard currency such as the British pound, euro, and US dollar). No matter what kind of RMB bonds are sold to investment institutions and individuals in developed countries, with or without security, China won’t have a problem as long as existing hard currency foreign exchange can be obtained and the future RMB can be used for payments and repayments. The essence of this kind of debt is the internationalization of domestic debt, which is the most effective hedging for China’s foreign exchange reserves of up to 3 trillion US dollars.
Strategic needs and the feasibility of RMB bond internationalization
From a geopolitical perspective, the biggest strategic advantage that can be created by the internationalization of RMB domestic debt is that western countries, especially Wall Street and financial capital, will inevitably rescue countries like Greece (that have a systematic survival influence on the western financial system), and will thus have no motivation to suppress or even destroy their debtors and capital investment market demand. China’s export oriented approach, because it eliminates potential competitors worldwide, creating excess capacity, is a challenge for China when it comes to further development.
China’s inherent geopolitical weakness is that it relies on western markets and faces relentless suppression that will intensify more and more going forward.
China’s inherent geopolitical weakness is that it relies on western markets and faces relentless suppression that will intensify more and more going forward. Therefore, sterlingization, euroization, or even dollarization of RMB domestic debt is an improvement on China’s current export-driven development model and of strategic interest to the Western world. It is also a protection requirement for the source of foreign exchange funds for China’s domestic demand-driven growth.
The reasons all developing countries fail to get rid of the middle-income trap are the loss of financial sovereignty and the collapse of local currency caused by domestic inflation and ballooning foreign debt. The real economy suffers financially. Southern European countries, such as Greece, Portugal, Spain, and Italy, have joined the euro system. As a result, their real economy is basically eliminated by powerful industrial exporting countries such as Germany, France, Netherlands, and Northern European countries with increasing high-income needs. Their finances rely on the natural euroization of domestic debt and their systematic risks to Europe and the West’s overall financial system to preserve and sustain their high-income status quo.
The China International Import Expo (CIIE) in 2019 was generally regarded as a publicity stunt by German media and political decision-makers. This because in the past few years, due to the need for foreign exchange reserves, China’s import decline has always been driven by export decline. China has no real incremental source of foreign exchange capital to increase imports. Before the planned attendance of French President Macron at the CIIE 2019 became known, Germany had only planned to send a state secretary instead of the Minister of Education and Research to Shanghai. Germany and the European elite have yet to understand that the China-US trade war has helped Chinese policymakers, who are convinced that building and sustaining the huge domestic demand are the most powerful premises for China to maintain its unique development system advantages.
Germany and the European elite have yet to understand that the China-US trade war has helped Chinese policymakers.
The foreign exchange needed for China’s economic transformation, development, and incremental investment needs for the Belt and Road initiative are difficult to obtain through China’s export-orientated real economy. It requires further internationalization of the RMB to be secured by the huge foreign exchange reserve. RMB bond internationalization is definitely the best available source. Of course, the next question this raises is: is there a viable external market environment for this strategic initiative?
As early as March 7, 2017, Citibank announced that China’s government bonds would be listed in its three fixed-income indexes. On March 23, 2018, Bloomberg, as the owner of three major government bond indexes in North America (plus Citibank and JPMorgan), announced that RMB government bonds would be included in the Bloomberg Barclays index, which would increase the proportion of RMB government bonds from 0 to 5%. But after one year’s operation, the investment proportion of the RMB government bond fund is only at 1-2%, far less than the planned 5%. According to the Financial Times, there is an investment gap of at least 500 million US dollars, not met by a supply of RMB bonds.
According to my analysis, there are two reasons: firstly, the supply of products and information on RMB bonds is insufficient. Secondly, the risk assessment and concerns over the RMB exchange rate. Of course, as a core component of RMB internationalization, China’s policy and financial decision-makers need to commit to this in the same way as they have previously committed to their export led development model. Until then, it cannot gain the necessary coordination from the finance ministry and the People’s Bank of China required for success.
On September 4, 2019, JPMorgan announced it would gradually integrate China’s government bonds into its developing country index (GBI-EM), with a maximum of 10%. Goldman Sachs immediately estimated that this would mean that 3 billion US dollars would flow into China’s government bond market. It is estimated that by the end of October, the RMB bonds held by overseas investors will have exceeded 2 trillion RMB, which is far lower than the global proportion of China’s total economic volume. Historically, JPMorgan, much like the Rothschild family in Europe, have proven that the issuance, distribution, and agencies of bonds are both profitable and sustainable.
Exchanging various RMB bonds for pounds, euros, or even US dollars is essentially the same as the Central Bank of developed countries exchanging RMB as reserves from the People’s Bank of China. Only the RMB is bought by the Western Central Banks according to the exchange rate, while bonds rise 1.03 to 1.04 according to the exchange rate (considering the current interest rates of government bonds). The reason why international financial markets are optimistic about RMB bonds is that the interest rate of developed countries’ bonds is generally within 2% (such as US 10-year treasury bonds) or even negative (such as German government bonds). RMB bonds still provide a 3-4% yield. Secondly, the RMB government bond market has reached a scale between 20-30 trillion RMB, making it the most attractive fast-growing market to be claimed by both Wall Street and London’s financial capital.
When discussing the opportunities and operation of the Guangdong Hong Kong Great Bay District with Chinese governors, top think tanks, and financial experts, I compared it to Silicon Valley in the United States. If China’s innovative small and medium-sized enterprises have channels connecting them seamlessly to foreign bond financing markets, complementing or even avoiding the high costs of the single financing approach (like with Alibaba, where Softbank made countless profits as a shareholder), then China’s financial market will realize the goal of truly transforming the real economy and integrating the best practices of Europe and America’s per capita GDP of 40,000 to 60,000 US dollars. The market operations of government and corporate bonds in Europe and the United States have been internationalized and transparent. The Chinese financial industry has the ability to realize this concept now.
In order to meet China’s hard currency demand for transformation and development, if we compare the suggestions above, there are two other options: issuing hard currency foreign bonds such as the euro or US dollar and/or surrendering the financial sovereignty for foreign investment in the financial industry.
It should be permitted only if the cost of hard currency foreign bonds is far lower than the yield of foreign exchange reserves, and the return of foreign exchange funds can be higher than the financing cost. However, if the purpose of foreign bond borrowing is to meet domestic consumption demand, then the painful lessons of all developing countries in the world will inevitably require China to give priority to the internationalization of domestic bonds. Only when there is no other way can it consider foreign bonds.
As for the latter (increasing the opening of transfer industries in financial sovereignty to attract foreign investment), it is totally different from the internationalization of domestic bonds. It is a consideration of the optimization of the development model and system. Compared with the internationalization of domestic debt, this option surrenders control. Compared with my proposal for the internationalization of domestic bonds, this option exchanges sovereignty for foreign investment, which is not an initiative way. Various risks should be considered and prevented, following painful examples of e.g. Japan and Argentina.
The tolerance of the United States and the European Union for China’s development approach and its political system is close to a turning point. In fact, China’s transformation and development, especially the supply side reform intention, will bring unmanageable threats and risks to their real economy, rather than any hugely exciting or attractive profit and growth opportunities. The internationalization of RMB domestic bonds has been recognized as one of the biggest win-win growth benefits, especially for British and American financial capital. It is a most promising financial market option for China, seeking the most effective integrating opportunities with European and American economies.