China’s central bank recently triggered a frenzy of domestic speculation over the imminent threat of profligate money printing, by announcing plans to step up purchases of Chinese treasury bonds.
This speculation revolves around the notion the Chinese central bank is about to change its “anchor” for the yuan from the US dollar to treasury bonds issued by China’s Ministry of Finance.
One veteran of China’s banking system has sought to calm the agitated nerves of the public, however, by addressing confusion surrounding the nature of the Chinese yuan, and the distinction between backing by reserve assets as opposed to pegging against other currencies.
On 23 April, both the Ministry of Finance (MOF) and the People’s Bank of China (PBOC – the Chinese central bank) issued separate statements on changes to the implementation of monetary policy.
The statements indicate that PBOC will “improve the control mechanisms for the issuance of base money and the money supply, and gradually increase the central bank’s purchase of treasury bonds in open market operations.”
PBOC and MOF also said that they will work to “expand the monetary policy tool kit and increase methods for managing liquidity and interest rates.”
Despite its ostensibly dry nature, the announcement sparked furore on Chinese social media, over the possibility that PBOC is about to engage in profligate money printing or large-scale devaluation of the yuan.
Much of this speculation focused on the notion that PBOC is paving the way for quantitative easing in China, by first making a “major change to anchoring for the yuan” as a preparatory measure.
Some remarks on social media claimed that the anchor for the yuan is shifting from the US dollar to domestic treasuries, in order to “completely change the way that Mama Central Bank irrigates (prints money)” (央妈放水（印钞）方式将彻底改变).
Other remarks predicted that that the move paves the way for “Chinese-style QE,” leading to “historically unprecedented [monetary] flooding (史无前例的大放水就要来了), and “massive devaluation of the currency that will have an impact on everyone” (货币大贬值，所有人都会受影响).
Concerns over money printing by central banks are ubiquitous in the modern era it would appear, and rife even in socialist republics with strong censorship controls.
The online panic has prompted the former head of one of China’s big four state-owned banks to speak out publicly, in order to quell the rattled nerves of Chinese retail investors.
Wang Yongli (王永利), former executive director of the Bank of China (BOC) published an opinion piece widely circulated by state-owned media, in a bid to put to rest the monetarist concerns of the Chinese public.
According to Wang, panic over money printing has likely arisen due to confusion surrounding the nature of the Chinese yuan, and widespread misconceptions over the distinction between a currency with a pegged exchange rate, and a currency that is backed by reserve assets.
Does China “anchor” its currency?
Online discussion of a change in the “anchoring” for the yuan has perhaps succumbed to confusion, due to the ambiguous nature of the term “anchoring” (锚定) in Chinese when used with reference to monetary policy.
This confusion is perhaps further compounded by the need for Chinese officials to maintain an ambiguous stance on exchange rate matters, in order to contend with accusations of currency manipulation made by other countries.
On the one hand, “anchoring” could refer to the pegging of a currency such as the yuan to another currency, at a given exchange rate set by monetary authorities.
On the other hand, it could also refer to the use of reserve assets to back up a currency, as was the case during the era of the Gold Standard. If a currency is backed by gold, this means that bearers of the currency should be able to redeem it for a given amount of specie upon presentation to the issuing authorities.
If “anchor” is interpreted in the former sense, then it’s true that China currently employs what it refers to as a “managed exchange rate,” that keeps the value of the yuan within set boundaries determined by the central bank.
China did apply a fixed rate peg to the yuan in the recent past. For a period of more than a decade, from 1994 to 2005, PBOC kept the yuan at a rate of 8.28 to the dollar.
Beijing eventually rescinded the peg in July 2005, however, amidst pressure from the US and other trading partners who levelled accusations that China was undervaluing its currency to boost exports.
PBOC now publishes a daily reference rate for the yuan to the US dollar, against which the Chinese currency is permitted to fluctuate within the confines of a fixed band.
While PBOC claims its managed exchange rate system gives greater play to market forces, the system has failed to allay criticism from the US and other countries over the issue of currency manipulation.
The matter was recently used by the Trump administration to bolster arguments for applying a raft of tariffs to Chinese imports in 2018.
For this reason, PBOC is tactful – perhaps some would say disingenuous, in the phrasing it uses to describe its managed exchange rate system, describing it as “a regime based on market demand and supply with reference to a basket of currencies.”
Is the Chinese yuan backed by reserves?
Wang Yongli says that online commentators are undoubtedly mistaken if by “anchor” they mean that the Chinese yuan is backed by reserve assets, in the same manner that the US dollar and the British pound were once backed by gold, making them redeemable for a given amount of specie.
According to Wang, there is no backing for the Chinese yuan because the central bank has never committed to the redeemability of the renminbi for reserve assets of any kind, whether they be in the form of forex, gold or treasury bonds.
“The central bank has never promised that the renminbi will be exchangeable for reserve assets at a fixed rate,” Wang writes.
As a veteran of the Chinese banking system, Wang instead considers the yuan to be “credit money” under the protection of the state, or what is generally referred to as fiat money.
“Under a credit monetary system, money fundamentally does not require any kind of an anchor,” Wang writes.
“Instead, the total money supply can change in tandem with changes in the total value of wealth, making it adjustable.
“Money is completely transformed into the shadow or counterpart to the value of wealth…[it is placed] under the sovereign control or legal protection of the government and becomes state credit money or fiat money.”
China’s forex interventions a source of confusion
Public confusion in China has likely arisen from the fact that in order to maintain its managed exchange rate for the yuan, the Chinese central bank has long engaged in the copious purchase of greenback as one of its key reserve assets.
China began to amass an immense volume of foreign reserves in the decade following its ascension to the World Trade Organization (WTO), as it transformed into the largest export power on the planet and ran up a string of huge trade surpluses.
By 2006, China had become the world’s largest holder of foreign reserves, after their size nearly quadrupled in the five years after it obtained WTO membership. The mass influx of foreign capital as a result of export growth prompted intervention by PBOC.
The central bank purchased foreign currency from exporters to maintain the stability of China’s exchange rate, and prevent the yuan from appreciating to the point where Chinese goods were no longer appealingly priced for overseas buyers.
Wang believes that the current furore over PBOC’s increase in treasury purchases stems from confusion surrounding these forex purchases, with some people perhaps mistaking them for the acquisition of reserve assets to back the yuan and make it redeemable in US dollars.
“Because the central bank’s purchases of forex are chiefly for maintaining the fundamental stability of the renminbi against the US dollar, some people said that during [the period from 2000 to 2014], issuance of the renminbi used the dollar as an anchor, leading to the abandonment of monetary sovereignty, Wang writes. “This is an incorrect view.
“When the Chinese central bank purchases reserve assets in its implementation of monetary policy, it doesn’t matter whether it’s gold, forex or treasuries…it’s all just a channel for releasing and adjusting base money.
“The central bank’s injections and withdrawals of base money are driven primarily by the need to maintain the stability of monetary value, including exchange rates.
“The reserves are not any kind of anchor or backing, because the central bank has never promised that the renminbi will be exchangeable for these reserve assets at a fixed rate.
“For this reason, it’s pure exaggeration to believe that the central bank’s potential purchase of treasuries in the secondary market means a fundamental change in the anchor for renminbi issuance.”
Can you back a currency with bonds?
At first blush, the idea of a country using treasury bonds issued by its government to back its own currency would appear to be an improbable arrangement.
This would mean that the government is attempting to shore up its currency by creating a toggle for switching between the maturities of its outstanding debts.
The government would be offering to redeem its short-term IOUs – currency issued by the central bank, with its long-term IOUs, in the form of bonds issued by the treasury.
There is a historical precedent, however, for the use of debt instruments to back money in the US.
Towards the end of the American Civil War, US banks issued National Bank Notes that served as currency during the two-year period from 1863 – 65. These notes were backed by US bonds that banks deposited with the Treasury.
A key distinction was that those arrangements involved commercial banks, as opposed to a central bank, using US bonds to back their own issues of marketable debt in the form of bank notes.
This is distinct from a central bank buying the IOUs of the treasury (bonds) as a reserve asset for its own IOUs (bank notes or reserves), when both the central bank and treasury are the arms of a single government entity.
The distinction highlights the difference in any monetary system between base money originated by the central bank, and money created by commercial banks via fractional reserve lending, whether in the form of bank notes or demand deposits.
Why is PBOC flagging more treasury purchases?
According to Wang, PBOC’s plan to step up the purchase of treasuries are simply part of standard procedures to inject more liquidity into the Chinese economy.
Consequently, while Wang may consider online claims of a change in the yuan’s “anchor” to be “pure exaggeration,” it would appear that such speculation could be closer to the truth when it comes to plans by PBOC to expand the money supply.
Such an increase will likely be necessitated by China’s ongoing implementation of active fiscal policy, as signalled by the Two Sessions congressional meeting held in March of this year.
The Government Work Report delivered by Premier Li Qiang said that active fiscal policy would continue in China, as part of efforts to keep growth on an even keel as the economy recovers from the lingering impacts of the Covid pandemic.
Domestic analysts point out that this will also result in a loosened money supply, given fiscal and monetary policy in China are tightly coordinated by economic decision-makers under the aegis of the State Council.
Lian Ping (连平), economics professor at Shanghai Jiaotong University, expects “dual expansion of fiscal policy and monetary policy” and the “joint forceful exertion of both” in 2024.
For this reason, he foresees the possibility of further cuts to China’s required reserve ratio later in the year, as well as downward adjustments to key interest rates, including rates for PBOC’s medium-term lending facility, as well as the loan prime rate (LPR) that Chinese policymakers now designated as the benchmark rate.
