What “gold rush” of Central Banks tells us about credit risk in US Treasuries?
A central bank’s demand for gold
The data on China’s foreign exchange reserves, which is reluctantly and irregularly released by the PBOC, indicated another increase in gold reserves for three consecutive months (December-February) to 60.26 million ounces. The value of Chinese gold reserves rose by almost $3 billion to $79.5 billion compared with the same period last year.
Goldman Sachs believes that the price of gold could rise to 1,400 per troy ounce in the next 6 months due to increased demand from central banks.
At the same time, investments in US Treasury bonds by the PBOC declined again reflecting a shift of investment accent on gold:
Given the money supply in circulation, it is difficult to imagine that the Central banks – active buyers of gold are considering a return to the gold standard in the long run. The price of gold in this scenario has to be much higher, which, in fact, should naturally follow from the failure of the concept of fiat currencies. However, in the presence of more realistic reasons, there is no need in mental exercises for constructing conspiracy theories. After a 10-fold increase in the Hungarian Central Bank of gold reserves in October last year, it became clear that, considering the Central Bank as an organization that is not without goals for profitability, diversification and liquidity of its asset portfolio, the increase in gold reserves should pursue one or more of these goals. Given that the choice of assets for the Central Bank is limited, we can assume that there is a so-called concentration risk, as for an ordinary bank – that is, when investments are focused on one or several assets. In turn, this naturally implies reduced portfolio diversification.
It is easy to see that in the asset portfolio of China, Russia and other Central banks, significant share of total assets accounts for non-resident securities, in particular, US treasury bonds. Recalling costly tax reform, funded from the government’s pocket, debates on the Trump wall construction, the Green Deal, which are also expected to be funded by the government, we can clearly understand the Central Bank’s concern about the growing risk of asset concentration in their portfolios. United States not only opted to postpone reduction of the fiscal spending, but also wants to deviate from stable path of expenditures further. In this case, there are certain expectations that the credit risk in the “risk-free” US government bonds may eventually increase and their price fall.
And Central Banks’ forecasts, as you know, are often credible signals.
After the January generosity of the Central Bank of China, when cheap loans flooded the economy with an aggregate volume of 4.6 trillion. yuan, the “horn of credit plenty” suddenly disappeared in February, leaving “credit addiction” rumors with little proofs. The data released on Sunday showed that the total social financing in China grew by only 703 billion yuan, which is two times lower than the forecast and almost 7 times less than the January liquidity surge.
Thus, the “demand for liquidity before the celebration of the Lunar Year” argument turns out to be the leading one in understanding China’s monetary policy. Switch to the higher timeframe, it can be seen that, in annual terms, total financing (including municipal bonds) increased by 10.1% in February, after rising by 10.4% in January, and the figures don’t look quite surprising.
The head of the PBOC said at a press conference that the data for January and February should be considered together, but the intensity of easing still exceeds the level of the same period last year. The indicators of credit expansion for March should give even more evidence that the policy adheres to the long-term target level and that the January growth was due to a seasonal increase in demand for money.
New loans increased by 886 billion yuan instead of the expected 950 billion, and that significantly exceeds the total social financing. This implies that the government resumed “tightening the screws” on shadow banking i.e. money market financing of capital markets. In January, the figure grew by 343 billion yuan, but in February it turned around dropping by 364.4 billion, including such components as entrusted loans (-54.4 billion), bank acceptance bills (-310 billion)
Tough measures against shadow financing followed Premier Keqiang criticism of the central bank in January, urging banks to focus on long-term loans to the real sector, instead of trying to revive economic activity by inflating a bubble of short-term financing.
Considering the distortions in export and import activity in the period before the Lunar New Year celebration, which I explained in my Friday article, extraordinary credit growth in January fits into a number of macroeconomic effects resulting from seasonal economic challenges.