Economic market depends on bonds, bonds are let who to buy?

On May 25, The State Council held a “national teleconference to stabilize the economic market”.

Before that, on May 23, the Standing Committee of The State Council had arranged 33 measures to stabilize growth in six aspects: fiscal policy, monetary policy, stabilizing industrial chain and supply chain, promoting consumption and effective investment, energy security and stabilizing employment. But this “stabilizing the economic market” meeting was essentially a downward arrangement of the previous 33 measures to stabilize growth. It is expected that the follow-up measures for key links and areas will be implemented one after another, and the intensity of the policy is expected to be further improved.

The 33 initiatives focus on three areas:

First, we will continue to give top priority to stabilizing market entities and employment. Our policy tools include increasing the amount of tax rebates left over (an increase of over 140 billion Yuan, totaling 2.64 trillion Yuan for the year), delaying social security payments (projected to be 320 billion Yuan this year), and increasing the state financing guarantee Fund’s guarantee cooperation business (an increase of 1 trillion Yuan). And improve the scale of structural credit support and other monetary policies.

Second, we will steadily resume work and production, with a focus on logistics, transportation and energy. In particular, 150 billion Yuan of emergency loans and 200 billion Yuan of bonds will be issued in the aviation sector.

Third, focus on expanding domestic demand, focusing on the deployment of automobile, real estate and infrastructure projects. It is expected that after this meeting, the implementation of policies in related fields will be accelerated to form a physical workload.

In 9 words:

Ensure employment;

Ensure production;

Protect consumption.

Some have calculated that the main policy for China’s own economy this year will be to stimulate growth by issuing local government bonds and other special bonds.


The problem is

Who will buy the trillions of Yuan in new local government bonds?

Considering the hidden debt, the debt ratio of local governments in China is generally above 300%. In this case, the ability of local governments to repay their debts is still worth worrying about. Under such circumstances, how can we sell new local government bonds worth several trillion Yuan each year?

Here, it should be noted that due to the influence of the fiscal system, transfer payments and other factors, the index of local government debt in China is not the balance of debt divided by GDP, but the balance of debt divided by the comprehensive financial resources of local governments, which includes the income in three aspects:

General public budget revenue (local taxes)

+ Budgetary revenue of government-managed funds (revenue from land sales, local fines, etc.)

+ Transfer payments from the central government.

What is to be said about who is going to buy local government bonds?

B: Well, don’t worry about it. It can be sold 100%!

In both the United States and China, the law clearly prohibits central banks from printing money directly to buy government bonds. So who, and why, is willing to spend so much money to buy these bonds?

In the wake of the March 2020 outbreak, the U.S. government started issuing Treasury bonds like crazy. In just one year, the national debt ballooned from $23.4 trillion to $28 trillion today. How do you sell $4.6 trillion worth of Treasury bonds? Bear in mind that yields in the US were incredibly low back then, with ten-year Treasuries yielding less than 1% (they are now around 3%).

Who was stupid enough to buy it?

The immediate answer is:

Large commercial banks and other large financial institutions

From the perspective of the Ministry of Finance and the central bank, to put it more accurately and professionally:

Primary dealer

The so-called “-grade dealers” are a group of dealers with certain qualifications, including commercial banks and securities companies with strong financial strength, who can directly underwrite and tender Treasury bills to the Treasury bond issuing department. For example, the eight US GSIBs (global systemically important banks, see US banks in the chart below), which are the Federal Reserve’s main primary dealers in financial markets, also happen to be the largest buyers of US Treasuries from the US Treasury in 2020-2021.

And, contrary to what you might think, these big financial institutions aren’t stupid. They’re the best of the best, and they’re the middlemen who make the difference when the government issues debt.

Whenever the government is going to issue a lot of Treasuries, the primary dealers are going to rush to buy them, because they know that when the U.S. government is going to issue a lot of Treasuries, the Federal Reserve is going to buy a lot of Treasuries — the big financial institutions can buy them, they can sell them to the central bank at a markup, they can change their name on their account, and they make a big profit.

The money earned, that is a relief…

Just think, whether it is after the global financial crisis in 2008 or the pandemic crisis in 2020, once the US government needs to borrow on a large scale, whether the Federal Reserve has already “announced in advance” that it will implement large-scale QE and unlimited QE…

Instead of selling to the central bank at a markup, these large financial institutions could keep the bonds and use them to get cash (with collateral financing) from the Federal Reserve at the lowest interest rate in the market. In this case, these large financial institutions are paying the lowest short-term interest rates in the market, and they are getting Treasury yields. Tell me, did these financial institutions make money or lose money?

Under the credit monetary system, this is the eternal “tacit understanding” and “secret” between the government and the central bank.

Central banks appear to be pretending to be “independent”, but in reality they are constantly interceding with governments. When this happens, primary dealers are needed to act as reliable “middlemen”, so how about giving the middlemen a bit of lard?

Or look at China’s local government bonds.

On May 15, 2015, the Ministry of Finance, the People’s Bank of China and the China Banking Regulatory Commission jointly issued the Notice on Matters Related to the Issuance of Local government Bonds through directional underwriting in 2015 (Treasury [2015] No. 102). At the end of the document, a sentence seems to be inadvertently mentioned:

Local government bonds shall be included in the scope of collateral for the cash management of the central Treasury and the cash management of the local Treasury in pilot areas. Local government bonds that meet the requirements may be included in the scope of collateral for some monetary policy operations, in the scope of collateral for loans pledged by commercial banks, and may carry out repo transactions in accordance with regulations.

These short 100 words, in fact, is equivalent to the determination of local government bonds and national debt has similar credit.

Since China’s central government rarely issues national bonds, the sales process of local government bonds has been basically similar to that of foreign countries since mid-2015. Every time the central government sets quotas for local governments to issue general bonds and special bonds, major primary dealers rush to buy them.

Then, in the central bank’s various open market operations, such as reverse repos, MLFS or standing lending facilities, these primary traders would take local government bonds as collateral and provide them with cash at rock-bottom market rates, as much cash as is available.

Like GSIBs in the US, these Chinese primary dealers pay the lowest short-term interest rates in the market in return for higher yields on local government bonds. From the central bank to the local government, to earn a risk-free return, you say, are they willing to actively buy local government bonds?

On May 20, 2022, our central bank published a list of 49 primary dealers for 2021, specifically before the local government bond issuance.


So, we must remember, credit money era:

If the government wants to sell bonds in its own currency, no matter how much it wants to sell, it can.

In addition, for the latest article on “The Position of the Rich”, “On the advanced nature, greatness, glory, correctness, perfection and absolute truth of Chinese Economics”, please click the “Read the original” in the lower left corner of this article.


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