September’s annual IMF-World Bank meeting in Washington DC was a strange affair. Delegates fretted about Europe, about Brexit and, given recent weather events, about the escalating threats posed by a warmer planet. But hovering over everything was the spectre of Donald Trump. The US President was absent in person, yet his views on America’s place in the world filtered into every discussion. Bankers and ministers groused about him all day, then reconvened in bars to vent more steam after the sun had set.
Trump’s America seems destined to be an isolated place. Since his election, he has removed the US from the Trans-Pacific Partnership and questioned the future of Nato and the North American Free Trade Agreement. At the Washington meeting, Takehiko Nakao, president of the Asian Development Bank, said the US seemed ‘fatigued’ at having to play the twin roles of global policeman and sovereign funder of last resort as chief financial contributor to the World Bank and the IMF. But with the US no longer willing or able to lead the economic world, who picks up the baton?
Britain is consumed by Brexit; Europe is a non-starter; Japan is too removed from global affairs. Only China, with vast stores of foreign currency and huge clout as both importer and exporter, can step into the breach. Beijing sent a small army of politicians and experts to Washington. Zhou Xiaochuan, the governor of China’s central bank, pledged to continue opening his economy to foreign investors. Jin Liqun, chairman of the Beijing-led Asian Infrastructure Investment Bank, said America’s retreat ensured China ‘has to play a bigger role’.
China is rich and powerful, to be sure. Its ‘Belt and Road’ development strategy will help it channel goods faster and cheaper to markets in Europe, Africa and Asia. But it is also playing catch-up after centuries of under-performance, not to mention misrule. And while its finances at a central level are strong, its financial markets are, to put it kindly, a work in progress. Its stock markets are crammed with corporate duds. Although Beijing wants its currency to compete for global influence with the US dollar, the yuan remains little used beyond its borders.
But there’s one area of the financial world where China is set to lead soon, and it isn’t where you think. Chinese debt markets are a complete mystery to the casual investor — yet the asset class is huge and it’s the chosen form of funding for government, banks and big corporations. So far, China’s bond markets have flown under the radar, in large part because Beijing controls which securities foreign funds can buy. Licensed institutional investors have been buying mainland equities for years but government bonds aside, most debt securities were off-limits. That changed when regulators spotted a sharp rise in capital flight. An estimated $725 billion fled the country in 2016: a mix of outbound acquisitions and wealthy mainlanders squirrelling money in foreign safe havens.
China’s industrial economy relies on repeated capital injections to maintain breakneck growth — forcing its leaders to cast around for new sources of cash. The only answer has been to open their bond markets to foreign investors, with Beijing quietly handing bond-trading licences to lenders it trusts, such as Citi, JPMorgan and HSBC — and investors have rushed to buy corporate debt.
According to the Bank for International Settlements, the value of China-issued debt at the end of June was $9.9 trillion, making it the world’s third largest bond market behind Japan ($13 trillion) and the US ($38 trillion). UBS tips the asset class to double in size over the next five years, then double again. Citi expects annual purchases of Chinese bonds to hit $3 trillion by the mid-2020s. You may not be plugged into China’s bond markets now, but you will be once insurers and fund managers begin to diversify their holdings.
Doubts remain, however. China’s economy is more fragile than it looks. Crisis will strike at some point — and how will Beijing cope if bondholders react by dumping their paper en masse? And what of defaults? A few smaller corporates have failed to meet interest payments on their bonds: a solar-panel maker, Shanghai Chaori, was first to do so in 2014. But what if a major state-run firm defaults, or a debt-laden government body? Investors assume Beijing will backstop such events. But for answers, students of financial history might turn to China’s last serious dalliance with debt markets.
Between 1900 and 1940, a series of unstable Chinese regimes flooded global markets with bonds. In 1913, the year after the fall of the last Qing emperor, a rudderless state sold £25 million worth of ‘gold loan’ bonds. But after Mao’s communists took power in 1949, they refused to meet previous debt obligations. The worthless but elegant bonds became collectors’ items of a different kind.
It may be hard to imagine the current iteration of Mao’s party, refined and modernised as it is, collapsing and being replaced by a new political movement. But come the 2030s, maybe a new emperor will be on the throne, or maybe China will be a vibrant democracy. And one thing’s for sure, my pension fund and your wealth-manager-generated investment portfolio will contain a big bundle of Chinese bonds. Will China’s new leaders honour the obligations of their predecessors? Or will history repeat itself? Only time will tell.