China is set to expand its range of government bonds in the near future. That may interest Australian investors looking for stable, long term returns on their cash.
Think of a bond as a loan you make to the government. In return, the government repays the loan to you over a period of time. They pay you interest on that loan too. This is what’s commonly referred to as a bond yield.
The new Chinese government bonds don’t exist on the market yet. But they will soon. The full details haven’t been released, but investors will be able to buy a much wider range of bonds including newly converted local government debt. That could prove enticing to investors. Especially those still seeking haven from low bond yields across the developed world. Chinese 10 year bond yields are at a competitive 3.45%. That compares favourably to the 0.12% yield in the Eurozone.
The problem is that countries issue bonds using their own currency. That means the Renminbi (RMB) will need to become fully convertible. In order for it to do so, it would need acceptance into the IMF’s basket of currencies. The IMF has indicated that it’s likely to include it when it makes a decision later this year.
Convertibility is important because it makes the trading of currencies easier on international markets. Without it, international investors have no reason to buy non-convertible currencies. And they have even less reason to buy bonds. That makes convertibility key to foreign investment flowing into Chinese bonds.
And just what kind of difference would convertibility make? Bloomberg thinks it would create a seismic shift in China. They believe up to $1 trillion of global reserves would flow into Chinese assets. That shows the extent to which investors are seeking higher interest rate environments. And why wouldn’t they?
Every new rate cut in the West pushes investors further towards riskier assets like stocks. Australian interest rates are at a record low of 2%. Europe is even worse off. Their negative interest rates provide no benefit to people invested in cash. All it leads to is weaker currencies and lower returns on cash investments. As a result, this search for yields is only inflating risky asset bubbles like stocks.
But few believe the share market will keep rising forever. That’s what makes China’s commitment to expanding its class of government bonds so promising for investors.
How China can maintain higher interest rates for foreign investors
Interest rates in China need to remain near present levels of 5.1 % if they’re to attract foreign investors. But for that to happen, Chinese consumers need to start spending more money in the economy. The more that people consume, the less pressure there is to lower interest rates.
But people aren’t going to consume more if China’s high savings rate persists. Currently the national savings rate sits at around 50% of GDP. By relaxing these rates, China can better manage its transition towards consumption driven growth. If people are saving less, it usually means they’re buying more. And if they’re spending more, it means the economy is ticking along.
So how is the Chinese government going to get people to spend more?
One of the ways they hope to achieve this is by improving pensioners’ safety nets. China does have a social security fund. But it doesn’t yet have a mature superannuation system like Australia. If it did, people would feel more confident about spending. They’d rest easier knowing they had a retirement fund to fall back on.
A stronger safety net would open up an enormous amount of domestic capital to flow into Chinese assets. And it would release some of the pressure facing interest rates. Again, that’s because China would have less need to cut rates to boost their economy if consumer spending picks up.
Stable interest rates would ensure Chinese government bonds remain an attractive long term investment for foreign investors.
And it would be a big boost to Aussie investors looking to find long term stability in a world of low interest rates.
Contributor, The Daily Reckoning
PS: The Daily Reckoning’s Contributing Editor, Phillip J. Anderson, has been writing for years that China’s boom is only beginning. We’ve already seen the opportunities in China’s burgeoning stock market. Now opportunities for long term investors are arising through government bonds.
Phil’s written a report showing how you can profit from China’s growth this decade. He’ll show you how to arrange your portfolio to maximise your investment opportunties. To find out how to download his report, ‘The Cassandra Syndrome: After This Report, You Won’t Worry About China Again for Another Decade’, click here.