Just when you think you’ve seen it all…. up pops the People’s Bank of China (PBoC), the Chinese central bank, to warn markets against getting too bullish on its government’s debt. China’s 10-year bond yield has been on a steady decline since the end of November when it was marked at 2.72 per cent. It is now trading at close to 2.20 per cent. The PBoC’s line is that the economy is doing just fine and that, with the current stimuli in place, it will soon be doing much better. Buyers of the 10-year bond at ever lower rates must be betting that they will go lower still and are scrapping to lock in the yields as they are in order to, pardon that old chestnut, avoid future disappointment. 

Finding the appropriate yield is always a tricky exercise, a game of pinning the tail on the donkey. I well recall a debate in the British parliament in the earlier days of the eurozone debt crisis. Gilt yields had for years been trading higher than those of German Bunds, the measure of all things sovereign in European debt markets. I think George Osborne was still Chancellor of the Exchequer and the verbal punch-up was over whether, during a crisis, having yields higher than other countries was a good or a bad sign. Higher yields had generally pointed to a less well-liked credit. But now, in the midst of the crisis, lower yields pointed to a country in greater economic trouble. So, was the higher yield of the UK gilts’ market pointing to the UK being in better or worse shape than the eurozone? Especially as Italian yields – the risk premia attached to Italy were not where they are today – were below those of Britain. 

The argument was of course fatuous. What else would you expect when politicians who generally have no clue of the inner workings of bond markets start comparing yields in two fundamentally different currency areas and begin to draw conclusions. Either way, the UK’s refusal to join the currency union had meant that the country had not been able to ride the lower cost of money train which was being pulled by Germany and which eurozone members could. In due course, the close association of all members within the union with Germany would go horribly wrong and Greece’s attachment came close to breaking the euro. Though now forgotten, with Greek 10-year debt trading a mere 104 bps higher than that of Germany, 50 bps higher than that of France and 30 bps cheaper than Italy, it took a Herculean effort by the German authorities to prevent the Hellenic Republic from going to the wall. Even so, the numbers belie the facts. 

At the end of 2023, Greece reported a debt to GDP ratio of 162 per cent. Italy follows at 137 per cent, then France at 110 per cent, Spain at 107 per cent and Belgium at 105 per cent. There is obviously more to the pricing of bonds than a single boil-in-the-bag algorithm that divides or multiplies the debt to GDP or the deficit to GDP ratios and comes up with an interest rate differential to Germany which sets the eurozone benchmark. The Greek debt crisis was not a short-term thing so defining the year in which it happened is not easy although 2010 was when it hit its nadir. As a small country with a small economy, Greece was deemed not to be too big to rescue and with all the big guns pulling in the same direction at the same time it was held within the currency union, albeit at a staggering cost to the Greek people. The irony was that at the bottom of the problem lay some pretty creative accounting – aided by a network of interest rate swap jiggery-pokery provided by none other than Goldman Sachs – that had permitted the Greek government to declare that it was in compliance with the Maastricht criteria of a deficit of no more then 3 per cent of GDP and a debt/GDP ratio of no more than 60 per cent. 

Please don’t get me wrong. Greece was not alone in playing at that game although Athens found the most egregious way of bending the rules. In the end, they bent them until they snapped. Italy was not far behind although with it being truly too big to rescue the powers that be decided the best way forward was not to look too closely and to leave the world uncertain of what might happen if markets pushed too hard. So, if markets don’t like the outlook for a country, do they push yields higher or lower? The answer of course is linked to the troubled country’s ability to issue debt and to find buyers for it. Argentina’s debt/GDP ratio is 85 per cent, that of Japan is 234 per cent. Q.E.D.

So, what’s with China? Firstly, and that has not changed in all the years I’ve been watching the Middle Kingdom,  Beijing’s individual economic releases are best taken with not a pinch but with a sack of salt. What the authorities cannot change, however, is the trend. The real estate crisis is there and with all the monetary stimulus in the world, it cannot be made to go away. Aggressive buying of the 10-year notes has now pushed the yield below that of the leading short-term rates and thus, for the first time ever, inverted the Chinese yield curve. Comparisons to Japan in the late 1980s and early 1990s, especially in terms of a bursting real estate bubble, are not hard to draw and predictions of a Japanification of China are easy to follow. Now the PBoC is telling markets they are wrong. Sorry guys: the more you tell markets they have nothing to fear, the less they will believe you. For all its failings and for all its mistakes, I have never seen the Fed panic. The PBoC is panicking. And with so many investors, both industrial and financial, banking on China replacing the USA as the engine pulling the global growth train that is not good.