The anchor of the renminbi, has changed?

Say money every day

2024-04-24 12:30Posted on the official account of Guangdong Tiantian Say Money

Original Liu Xiaobo

The change in the way the central bank prints money, I did an analysis yesterday. Many readers reported that they did not understand it.

Due to the relatively large matter, after the Ministry of Finance made a statement, the central bank also made a statement. So I decided to write it again and try to make it understandable.

Yesterday (April 23), which can be called an important day in the history of China's currency, a blockbuster monetary policy tool was officially announced, that is: the central bank will normalize the trading of treasury bonds in the secondary market.

This means three things:

First, the "anchor" of the renminbi has undergone important changes. In the past, it was more anchored to hard currencies such as the US dollar, and in the future, it will mainly be anchored to Chinese government bonds.

Second, there has been a major change in the way the central bank releases base money (that is, money printing, as it is said by the people), and in the future, it will be mainly through the purchase of government bonds. The way to withdraw money is to reduce the holdings of government bonds.

Third, the reserve requirement ratio will be dormant for a long time in the future, when the PBOC, like the Fed, will have a real sense of "balance sheet reduction" and "balance sheet expansion".

Let's look at the statement of the Ministry of Finance first.

On April 23, the People's Daily published an article signed "The Theoretical Study Center Group of the Party Group of the Ministry of Finance" on the front page of the tenth page.

The title of this article is "Persisting in Deepening the Structural Reform of the Financial Supply Side", and when it comes to the coordination and cooperation of fiscal and monetary policies, it has the following statements:

We will improve the mechanism for the supply of base money and the regulation and control of money supply, support the gradual increase in the purchase and sale of treasury bonds in the open market operations of the central bank, and enrich the monetary policy toolbox.

Last month, there was a big debate about whether the central bank should buy Treasury bonds in the secondary market, and I did an analysis at that time, thinking that it was a matter of time.

Now, the Ministry of Finance has expressed its support for the central bank to gradually increase the purchase and sale of treasury bonds through open market operations.

At the same time, the Ministry of Finance has linked this behavior to "enriching the monetary policy toolbox" and "improving the base money delivery mechanism".

This shows the importance of the central bank buying and selling treasury bonds in the secondary market.

On the same day, the Financial Times, which is in charge of the central bank, interviewed the central bank's official in a report headlined "Long-term government bond yields will operate within a reasonable range to match long-term economic growth expectations". Because it's too professional, not too many people pay attention.

At the end of this report, there is a very important statement about the central bank's buying and selling of government bonds:

The central bank has also confirmed that it will soon start buying and selling government bonds in the secondary market as a liquidity management method and monetary policy tool. Moreover, it is said that this kind of operation can be used to finance the deficit in conjunction with the government!

For ordinary people, what you need to know is: first, there has been a major change in the way the central bank prints money, and second, there has been an important change in the anchor of the renminbi.

Since the reform and opening up, the most important way to print the renminbi is "foreign exchange appropriation".

The so-called "foreign exchange appropriation" means that after China's exporters have obtained a trade surplus, they have received a lot of foreign currencies such as US dollars and euros, but these money cannot be used directly in China and need to be exchanged for RMB.

After China's accession to the WTO, there was a huge foreign exchange surplus, and the central bank printed a lot of renminbi to buy these foreign currencies. The acquired foreign currency constitutes foreign exchange reserves, and the printed renminbi becomes the incremental currency.

Because there was too much incremental renminbi, the central bank was worried about inflation, so it continued to raise the bank's reserve requirement ratio and froze some banknotes.

In order to prevent financial risks, the central bank requires each bank to pay a deposit reserve ratio to the central bank according to the proportion of deposits absorbed, which is the deposit reserve ratio. Assuming that the reserve requirement ratio is 10%, for every 1 billion deposits attracted by banks, 100 million yuan will be frozen by the central bank.

At its peak, China's reserve requirement ratio for banks reached 22 percent. In this way, the RMB over-issued by foreign exchange accounts will be frozen, and slowly released by reducing the reserve requirement ratio when needed.

Before China's foreign exchange reserves peaked in 2014, the issuance of the renminbi was basically "foreign exchange appropriation", and the anchor of the renminbi during this period can be understood as hard currencies such as the US dollar and the euro.

Since 2014, central banks have diversified the way they print money. One part is the RRR cut, which is to release the RMB that was previously "anchored to the US dollar", and the other part is the MLF (medium-term lending facility) and PSL (collateral supplementary loan) and other ways. The anchor of the latter method is domestic high-grade bonds such as treasury bonds.

From 2014 to the beginning of 2024, the way money was printed during this period was "hybrid".

Now, the central bank's reserve requirement ratio has been reduced to 7%. Given China's national conditions, it will be difficult to fall below 5% in the future (in order to prevent risks). The West is significantly below 5% because the "excess reserve ratio" is significantly higher than in China.

Therefore, China still has some room to continue to cut the reserve requirement ratio and release foreign exchange to occupy and over-issue currency. But there is not much space, and the renminbi that was previously over-issued with the US dollar as an anchor is about to be released.

The central bank's purchase of government bonds in the secondary market will become the new way of printing money.

According to the PBOC law, the central bank cannot directly purchase treasury bonds from the Ministry of Finance or underwrite treasury bonds issued by the Ministry of Finance, in order to avoid monetizing the deficit and reducing the creditworthiness of the currency. Many central banks do the same.

But buying government bonds through the secondary market is allowed in all countries. For example, major banks buy treasury bonds and then sell them to the central bank in the secondary market, which is allowed because of the risk isolation layer.

The money used by the central bank to buy government bonds is generated out of thin air, that is, printed. Buying treasury bonds and reflecting them on the central bank's balance sheet as assets can record how much money the central bank has printed, which is convenient for public supervision and increases monetary credit.

The Fed is currently printing money, also buying Treasury bonds in the secondary market, or MBS (mortgage-backed bonds) in the real estate sector. This means that the anchor of the dollar is US Treasuries.

When the People's Bank of China (PBOC) changes its method of printing money from "foreign exchange appropriation" to "buying treasury bonds", it means that the anchor of the renminbi has changed from the US dollar to Chinese government bonds.

This is a major historic change.

The chart above shows the central bank's latest balance sheet.

The "foreign exchange" in the red box is the RMB issued in the form of foreign exchange appropriation, and there was 22.69 trillion yuan at the end of March.

And the current base money is only 37.09 trillion. China's current 304.8 trillion broad money M2 is derived from this 37.09 trillion base currency.

At present, the share of foreign exchange (also issued with the US dollar as the anchor) has reached 61% of the RMB base currency.

Other collateral for issuance is mainly claims against other depository companies, i.e. PSL, MLF, re-lending, etc.

The central bank currently holds 1.524 trillion yuan of government bonds, which are special government bonds, bought during special periods, and have remained stable for a long time. In the future, the numbers under this project will change from month to month, and the trend is to increase and increase. Because the future way of currency issuance will be dominated by the central bank's purchase of treasury bonds.

What changes will be brought about by the shift from the US dollar as an anchor to the Chinese government bonds?

First, get rid of dependence on the US dollar and US Treasury bonds, and increase the pricing power and discourse power of our own currency.

The strategic game between China and the United States will become normalized and long-term, the United States often uses long-arm jurisdiction in finance, and China needs to reduce its dependence on the US dollar and US Treasury bonds.

In recent years, China has been reducing its holdings of U.S. Treasuries, from a peak of $1.3159 trillion in 2013 to less than $800 billion last month. The share of the US dollar in foreign exchange reserves is also declining.

Second, the central bank's regular trading of treasury bonds can better coordinate with the fiscal sector for deficit financing. This is conducive to solving the pressure of fiscal revenue after the inflection point of real estate.

There has been a historic inflection point in real estate. This is not only an inflection point for the real estate industry, but also an inflection point for the fiscal system, and an inflection point in the relationship between the government and the market.

At present, the balance of the central government's debt, that is, the national debt, is 30 trillion yuan (at the end of 2023), and the balance of local government debt is 40 trillion yuan. In addition, local governments have 60 to 70 trillion yuan of urban investment bonds. The debt of local governments exceeds 100 trillion yuan.

In the case of residents' sluggish desire to buy houses and their unwillingness to increase leverage, the only way to revitalize the economy is for the government to increase leverage, especially the issuance of additional treasury bonds.

When the government bonds are issued, there needs to be enough buyers and enough activity. The central bank's use of new money to buy Treasury bonds is a timely solution to a number of difficult problems.

Third, how can the renminbi increase its international credit with treasury bonds as its anchor? I am afraid that it is highly probable that we will continue to increase our holdings of gold.

The chart below shows how central banks in major countries or regions have increased their holdings of gold over the past 10 years.

Russia and China, because of the strategic game with the United States, have increased their holdings of gold in large quantities. Given the size of China's economy, it may have to hold gold reserves equivalent to those of the United States in the future.

When the renminbi is anchored by Chinese government bonds, gold is needed to help it out.

Fourth, the central bank's purchase of government bonds also means that the money from "printing money" will first go to the treasury.

You've seen this before: at weddings or celebrations, the goblets are stacked on top of each other like pyramids, and the wine or champagne is poured from the top glass, and then the wine gradually flows into the lower glasses.

The process of printing money by the central bank can also be understood in this way. When the new money is generated, it flows into the cup at the top, when the interest rate is lowest, when the cup is full, it flows into the four cups on the second level, and the interest rate rises, and then it flows into the third layer, and the interest rate continues to rise.

In the past, money was printed through medium-term lending facilities, collateral supplementary loans, and re-loans, and the first cup was often large banks, policy banks, or enterprises that were supported by key points.

When the way of printing money changed to buying government bonds, the first cup actually became finance. The way of printing money to buy treasury bonds will be stronger and more concentrated in fiscal support.

Therefore, it is often said that the central bank's purchase of government bonds is associated with QE (quantitative easing).

In this regard, the central bank's statement is that the central banks of some advanced economies are forced to buy large-scale one-way government bonds to achieve monetary policy goals when the conventional monetary policy tools are exhausted, while the mainland insists on implementing normal monetary policy, and the PBOC's buying and selling of government bonds is completely different from the quantitative easing (QE) operation of these central banks.

My judgment is that the central bank's purchase of treasury bonds is good for China's domestic asset prices as a whole and good for solving fiscal problems. It also constitutes an indirect and long-term support for international gold prices.

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