Over the past two years, the global economic markets have been in a state of upheaval, largely due to geopolitical risks and conflicts. This has significantly increased the risk in the markets, underscoring the need for proactive measures to mitigate potential losses.
However, other factors are causing disruption. Recent turmoil in Chinese bond markets and the growing debt crisis in the US are a recipe for trouble.
Trouble in China
A CNN article points out that money is rushing into Chinese government bonds, sending their prices soaring and yields plunging to record lows as investors hunt for a safer alternative to the country’s ravaged real estate market and volatile stocks.
The yield on China’s onshore 10-year government bond, which is a benchmark for a wide range of interest rates, touched 2.18% Monday, the lowest since 2002 when records began. Yields on 20-year and 30-year bonds are also hovering around historic lows. Bond yields, or the returns offered to investors for holding them, fall as prices rise.
The article adds that lower borrowing costs should be welcome in an economy struggling to recover from a property crash, sluggish consumer spending and weak business confidence. However, the sharp move in bonds is sparking talk of a bubble and triggering acute anxiety among China’s policymakers, who fear a crisis similar to the collapse of Silicon Valley Bank (SVB) last year.
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Also emerging is the extent of regional and city debt and emerging liquidity crisis in those markets with Beijing stepping in to provide regional liquidity.
Since April, the People’s Bank of China (PBOC) has issued over 10 separate warnings about the risk that a bond bubble could burst, destabilising financial markets and derailing the Chinese economy’s uneven recovery. Now, it’s doing something unprecedented—borrowing bonds to sell them to tamp down prices.
“SVB in the United States has taught us that the central bank needs to observe and evaluate the situation of the financial market from a macro-prudential perspective,” PBOC Governor Pan Gongsheng said at a financial forum in Shanghai late last month.
“At present, we must pay close attention to the maturity mismatch and interest rate risks associated with the large holdings of medium and long-term bonds by some non-bank entities,” the central bank governor added. Those entities include insurance companies, investment funds and other financial firms.
Lessons from the US
The article indicates that SVB was the biggest US bank failure since the global financial crisis. The roots of its demise lay in the fact that SVB had ploughed billions into US government bonds, a safe bet that came unstuck when the Federal Reserve began hiking interest rates to tame inflation. Prices of the bonds SVB was holding fell, eroding its finances.
Policymakers in China fear the risk of a similar crisis in the world’s second-largest economy if the bond frenzy goes unchecked. Prices of Chinese bonds have risen fast since early this year as investors pile into them because of the uncertain economic outlook. Businesses also borrow less, leaving banks with excess cash to park somewhere.
He added that a “deflationary outlook” for the economy has also taken hold among investors, prompting them to flock to long-term sovereign bonds.
The article adds that similar to SVB, China’s financial institutions have invested a significant amount in long-term government bonds, which makes them vulnerable to sudden interest rate changes.
Beijing is concerned that those lenders could suffer big losses if the bond bubble pops, sending prices down and yields up.
“What worries policymakers is the interest rate risk, which will rise once the dominant narrative shifts from deflation to reflation,” Hu from Macquarie said.
The article points out that, in the first half of this year, net purchases of sovereign bonds by financial institutions, mostly by regional banks, were 1.55 trillion yuan ($210 billion), up 61% from the same period last year, according to an analysis of central bank data by Zheshang Securities, a state-controlled brokerage firm.
Official interest rates in China are low after cuts in recent years by the PBOC aimed at supporting the economy. Deflationary pressures have persisted — consumer prices rose less than expected in May and factory prices declined for the 20th month in a row.
Economic risks
The rapid decline in Chinese bond yields also poses significant economic risks. In addition, the bond market frenzy may counteract the PBOC’s efforts to boost economic activity and increase money supply, as it encourages capital to flow into the bond market rather than going to riskier assets such as stocks, property, and other investments that drive economic growth.
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Debt burden
Another CNN article points out that Governments owe an unprecedented $91 trillion, an amount almost equal to the size of the global economy, and one that will ultimately affect their populations.
Debt burdens have grown so large — in part because of the cost of the pandemic — that they now pose a growing threat to living standards even in rich economies, including the United States.
Yet, in a year of elections around the world, politicians are largely ignoring the problem, unwilling to level with voters about the tax increases and spending cuts needed to tackle the deluge of borrowing. In some cases, they’re even making profligate promises that could, at the very least, jack up inflation again and could even trigger a new financial crisis.
Last week, the International Monetary Fund reiterated its warning that “chronic fiscal deficits” in the US must be “urgently addressed.” Investors have long shared that disquiet about the long-term trajectory of the US government’s finances.
“(But) continuing deficits and a rising debt burden have (now) made that more of a medium-term concern,” Roger Hallam, global head of rates at Vanguard, one of the world’s largest asset managers, told CNN.
Growing anxious
The article points out that investors are growing anxious as debt burdens mount worldwide. In France, political turmoil has exacerbated concerns about the country’s debt, sending bond yields, or returns demanded by investors, soaring.
The first round of snap elections Sunday suggested that some of the market’s worst fears might not pass. But even without the spectre of an immediate financial crisis, investors demand higher yields to buy the debt of many governments as shortfalls between spending and taxes balloon.
Urgent intervention is needed
The article points out that higher debt servicing costs mean less money is available for crucial public services or for responding to crises such as financial meltdowns, pandemics, or wars.
Since government bond yields are used to price other debt, such as mortgages, rising yields also mean higher borrowing costs for households and businesses, which hurt economic growth.
As interest rates rise, private investment falls, and governments cannot borrow to respond to economic downturns.
The article adds that tackling America’s debt problem will require either tax hikes or cuts to benefits, such as social security and health insurance programs, said Karen Dynan, former chief economist at the US Treasury and now professor at the Harvard Kennedy School. “Many (politicians) are not willing to talk about the hard choices that are going to need to be made. These are very serious decisions… and could be consequential for people’s lives.”
Conclusion
South Africa has always followed a prudent fiscal deficit policy but that has deteriorated since covid and the general economic stagnation. Expansive spending must be curtailed and the economy revitalised, with the right fiscal management SA might escape the worst of the squeeze.
If the US blows out due to unfinanced tax cuts and expanded public spending the outcome will be bad for everyone. China debt crisis and property meltdown seems unavoidable.
This can be achieved by rigorous planning and resource allocation. Drive productivity and outcomes that foster economic inclusiveness that will lead to growth. Stop the waste and misdirection of money (including graft and theft). There is a lot of headroom in these areas that increasing debt should be the last resort.
Public debt is a tax on future generations not an investment.
