Sat, July 13

China’s 50-Year Government Bonds and Fiscal Policy

Overview of 50-Year Government Bonds

Recently, government bonds have been trending online. This time, the focus isn’t on the size of the issuance but on the duration. How long? A full 50 years. On March 20th, a plan was announced to issue 23 billion yuan in bonds, each with a 50-year maturity. Many people expressed scepticism, noting that for most adults, a working life generally spans 50 years. In that time, no one can guarantee they’ll even be around. With widespread doubt, the question arose: will anyone buy these 50-year bonds, and what are potential buyers thinking?

Government bonds, also known as national debt, represent the total debt a country’s government owes. In the past, Western nations were heavily influenced by Adam Smith’s free-market principles, believing in minimal government intervention and letting the market function independently. However, non-interference doesn’t absolve responsibility. After multiple economic crises, particularly the Great Depression from 1929 to 1933, the devastating impact of an economic collapse became evident. Mass bankruptcies and a surge in unemployment saw rates soar above 30%. Amid widespread misery in the capitalist world, the Soviet Union’s economy seemed to thrive, presenting a stark contrast. This prompted Western governments to reconsider the relationship between planning and the market.

Keynesian Theory and Government Bonds

In 1936, Keynes published “The General Theory of Employment, Interest and Money.” Even before releasing this book, Keynes had criticized classical economics for overly focusing on currency and prices while neglecting the relationship between these factors and employment. As indicated by the title, he considered employment to be the central issue in economics. Keynes argued that capitalism lacks an automatic mechanism to achieve full employment equilibrium. Thus, he advocated for government intervention in the economy to stimulate consumption and increase investment, ultimately aiming to achieve full employment.

Issuing government bonds is a key feature of fiscal policy, and the U.S. ultimately survived the Great Depression precisely because Roosevelt embraced government intervention in the economy. It’s worth clarifying that government bonds existed long before Keynes. For instance, during the American Civil War, both the North and South issued government bonds to raise funds for the conflict. Later, during World War I, the U.S. also issued bonds.

What changed after Roosevelt’s New Deal is that issuing government bonds became the “bread and circuses” of government economic stimulus programs. Using Depression-era America as an example, when Roosevelt took office in 1933, the national debt was close to $20 billion. By 1936, it had risen to $33.7 billion. In 1939, the New Deal had yielded positive results, yet the national debt had climbed to $40 billion.

The Role of Government Bonds in Fiscal Policy

So, how should government bonds be understood? During an economic crisis, the government can issue bonds as part of its fiscal policy to increase its spending, stimulating the economy and helping address unemployment. After Roosevelt took office, from 1933 to 1939, unemployment in the U.S. fell from 17 million to 8 million, demonstrating the impact of government bonds. This also contributed to economic growth; during this period, U.S. GDP rose from $74.2 billion to $204.9 billion. Today, government bonds across the world continue to break records each year. As of 2023, global government debt reached a record $313 trillion, with U.S. national debt alone exceeding $30 trillion, accounting for about one-tenth of the total.

Does issuing more government bonds always mean a better outcome? Issuing government bonds implies that the government will increase public investment. According to Keynes, employment is central to the economy, so if the government increases investment, should that always lead to more jobs? Not necessarily, because the multiplier effect of public investment decreases over time.

This concept can be understood by examining China’s situation. Infrastructure projects in China are a one-time deal; each year, they drive growth once, requiring a new boost the following year. Initially, before infrastructure projects began, the employment generated and the economic growth achieved were significant. However, over time, these projects pushed up related costs in the industry, with increases in raw material prices and worker salaries. As a result, investment needs to increase, and the marginal effect diminishes. Public investment also has a significant rent-seeking potential. As urbanization progresses, traditional infrastructure projects will eventually be completed, leading to a decline in marginal effects and less impact than before.

The Purpose of Issuing Government Bonds in China

So, what’s the purpose of issuing government bonds now? Based on current observations, there are two primary objectives. The first is new infrastructure. On March 26th, it was announced that the government would moderately advance the construction of infrastructure like 5G networks and computing power. The emphasis on “moderately advancing” signifies stronger fiscal policy support.

The second objective is technological upgrades and transformation. The use of government bonds for technical improvements dates back to the 1990s. From 1999 to 2001, interest-subsidized bonds provided 26.54 billion yuan in funding, resulting in 281 billion yuan in investment for upgradesā€”a more than tenfold increase, which was twice the impact of other government bonds at that time.

In the current environment of overcapacity and insufficient demand, equipment upgrades could provide a breakthrough. In 2023, key sectors like industry and agriculture in China saw equipment investments totalling about 4.9 trillion yuan. According to estimates by Founder Securities, this investment scale will reach 7.22 trillion yuan by 2027.

The logic is simple: since industries need adjustment and consumer demand must increase, if the invisible hand cannot take effect, government intervention should lead the way. Starting in 2024, ultra-long-term special government bonds will be issued for several consecutive years. Recently, there has been considerable interest in ultra-long-term special bonds in the market.

The Historical Context of Ultra-Long-Term Government Bonds in China

According to historical data from Wanlian Securities, there have been three instances where the issuance of special government bonds exceeded 500 billion yuan in a single round. In August 2007, 600 billion yuan was issued, followed by another 750 billion in December of that same year. The other instance occurred in December 2022, with the issuance of 750 billion yuan.

Regarding years when the total annual issuance surpassed 1 trillion yuan (excluding rollovers and counting only new issues), only 2007 and 2023 saw such a scale. For 2024, issuance is also expected to exceed 1 trillion yuan in special government bonds. Whether this will all be new issuance or include some rollovers will only become clear in time.

The Reasons for Issuing Ultra-Long-Term Government Bonds

These statistics show that China’s issuance of special government bonds has been growing rapidly in recent years. How should this be understood? A deeper reason lies in debt swapping: increasing central government debt to relieve the debt burden on local governments, which currently face significant pressure, especially from hidden debt.

When government bonds are issued, whether to promote new infrastructure or to upgrade equipment and technology, the resulting funds flowing to local systems can help stimulate local economies. It’s important to note that local governments do not have to repay these government bonds; the central government does. Issuing larger-scale government bonds to replace local government debt is recommended.

Currently, China’s national debt accounts for only 23% of its GDP. In comparison, Japan’s ratio is 255% and the United States is 123%, leaving China with considerable room for growth. Globally, there’s a consensus on this. For a specific example, Greece, which ranks second in national debt, experienced a government bond default crisis in 2009. At the time, Greece’s government debt ratio to GDP was 113%, far exceeding the EU’s maximum debt ratio limit of 60%. Moreover, the Greek debt crisis triggered a broader European debt crisis. Sovereign defaults differ from personal defaults. If an individual can’t repay debt, the worst that can happen is being labelled a delinquent debtor. However, a sovereign nation cannot simply refuse to repay its debt.

Individual Impact of China’s Ultra-Long-Term Government Bonds

After discussing the broader macro perspective, let’s focus on specifics, like this 50-year ultra-long-term government bond. People have asked whether anyone will buy it or if it’s worth purchasing. The reality is that these bonds will likely be snapped up quickly. This time, the bond has a coupon rate of 3.27% and is set to be issued at the end of the month.

Earlier in the month, two other government bond issues were launched. The first had a 3-year term, a maximum issuance of 15 billion yuan, and a coupon rate of 2.38%. The second had a 5-year term, a maximum issuance of 15 billion yuan, and a coupon rate of 2.5%. Both issues were quickly sold out. With this bond offering a rate of 3.27%, it’s highly unlikely that there will be a lack of buyers.

Secondly, it’s challenging for individuals to buy this 50-year government bond because it’s most likely a targeted issuance. As of January 2024, banks are the largest holders of Chinese government bonds, particularly the major banks, which hold approximately 70% of them.

A quick note: understandably, people might feel uneasy about bond issuance, especially for a 50-year term. The purchasing power of these bonds might drop to a fifth of its original value over that time. However, this shouldn’t cause too much concern. On a larger scale, buying government bonds reflects confidence in the country’s future. Trust in the wisdom of future generations is what counts.

Government bonds are tradable, so those currently unavailable will eventually enter the market, serving as a haven for risk-averse funds. The essence of government bonds is pre-collecting taxes from citizens. The government issues bonds and pays interest, but where does this interest come from? The answer is tax revenue. Ultimately, issuing government bonds is just a means to an end. The primary goal is to use the funds raised through bonds to stimulate growth and generate tax revenue, which will provide a solid foundation for future debt repayment.