My friend Bob suggested I comment on yesterday’s feature article in the Financial Times on the steps China is taking toward the internationalization of its currency. What seem to me to have sparked interest in this topic is the recent renminbi bond issues by McDonald’s and Caterpillar. But this is only the latest step n a journey that arguably began in 2003.
1. China sees the enormous economic power that comes from your currency being the form in which the world stores its wealth and the medium of payment used in international trade. It’s like having your own brand name in front of everyone involved in any sort of commerce anywhere in the world every minute of every day.
It also makes you like the owner of a bank–you can issue yourself a loan any time you want, just by (metaphorically) printing up a new batch of money that you then use to pay your creditors. It’s the mark of a superpower, one China aims to have for itself as it rises to the pinnacle of world influence.
2. China is no longer happy holding tons of US dollars.
Why the dissatisfaction? On some very abstract level I’m sure it thinks that economic power ceded to its rival, the US, is power it doesn’t have itself. But its real concerns are far more pragmatic.
It’s like the old joke that if you owe the bank $1,000, you’re in trouble; if you owe the bank $10,000,000, the bank is in trouble. China holds trillions of dollars in US Treasury bonds. It seems to be convinced–and who could blame it–that the US has no intention of honoring this obligation. As an American, I’d say something a bit less harsh. I don’t think Washington is malevolent. I think it’s clueless. The last dollar debt crises were in 1978 and 1987, so no one remembers. As an academic might put it, however, this is probably a distinction without a difference.
This money isn’t as usable as China might have thought. Virtually every attempt Chinese interests have made to spend its dollars on assets in the US has been blocked by Congress on “national security” grounds. Some of this may be legitimate. Most isn’t, in my opinion. But it’s a fact of life. And it has the effect of channelling the dollars back into Treasuries–that is, back into the hands of Washington, a borrower who inspires no confidence.
Also, from a Chinese domestic political point of view, the large dollar holdings have a ticking time bomb aspect to them. Powerful interests in Beijing are responsible for holding and investing the country’s reserves. No one wants his career wrecked by being the person in charge as and when the world loses confidence in the dollar and these holdings rack up hundreds of billions of dollars in losses.
Looking at Chinese foreign aid to Latin America and Africa, not only does this win local favor but it also helps get rid of large chunks of money that might become a future liability.
3. For the moment, China has no alternative. Japan never had any interest in having the yen act as a world currency. Euroland has. If you remember, China had already begun a couple of years ago to shift its reserve composition away from the dollar, not by selling anything (it owns too much to do so without creating a value-depressing panic), but by focussing on euro instruments for new purchases. But then Greece announced a year ago that it had been faking its national accounts for years. This launched the current euro crisis–and gave the dollar a new lease on life.
4. China’s ideas are colored by having lived through the Asian currency crisis of 1997-98. If you remember, the speculative attack on smaller Asian economies by large commercial banks and hedge funds focussed initially on Thailand, where overleveraging (in US dollar-denominated debt) had created substantial instability. But toward the end even financially prudent economies like Singapore, and lastly Hong Kong, were also caught up in the turmoil. The economic “problem” in the latter two cases was only that they were open economies and relatively small–and that international speculators were playing with “house money” they had made in Thailand, Korea and Indonesia.
The lessons …don’t have an open economy. Keep strict control of your currency and domestic financial instruments.
5. China’s defenses created big barriers to use of the renminbi in trade… These included:
–restrictions on who can officially own renminbi
–restrictions on currency flow in and out of China
–restrictions on who can buy renminbi-denominated financial assets, like stocks and government bonds
–restrictions on the exchange of renminbi-denominated financial assets for physical assets in China
–inability to hedge renminbi holdings through currency derivatives
–the fact that the exchange rate is set by government fiat, not market trading.
As a practical matter, trade is relatively easy to deal with. Let’s say I’m a department store that sources overcoats in China for sale in the US. If I agree to a renminbi price for the coats, I have a currency risk. If the renminbi moves up by 20% against the dollar in the time between contract signing and payment for the completed merchandise, I probably can’t raise the selling price of the coats so I may be facing a loss on selling them rather than a gain. To eliminate this possibility, I lock in a currency rate at contract signing through a hedge. I can do this, even with the renminbi, but why bother. Better just to source in dollars.
6. …that China has been addressing, little by little, for some years.
The “why bother” is that China has increasingly signaled that it wants trade to settle in renminbi. So it has set out to make such settlement progressively cheaper and easier. In particular:
–in 2003, the mainland allowed Hong Kong banks to accept renminbi deposits
–in 2007, it allowed domestic banks to begin to tap the pool of offshore renminbi by issuing renminbi bonds in Hong Kong (and repatriate the proceeds to the mainland)
–in 2008 with the Hong Kong Monetary Authority, and subsequently with other regional central banks, the Peoples Bank of China set up currency swap lines, that would enable these non-mainland institutions to offer renminbi to local banks (to use in trade settlement)
–in 2009, Beijing allowed renminbi settlement of import/export between Hong Kong plus some ASEAN countries and a number of big trading centers in the export belt of eastern China
–this year, Beijing expanded this program to include all foreign parties and a much larger number of mainland entities.
—–Also, both non-mainland banks and other corporations have been allowed to issue renminbi bonds. This is what MCD and CAT have done.
As the pool of offshore renminbi the Beijing is encouraging to form gets progressively larger, the costs of doing business–including hedging–in the Chinese currency will fall. HSBC thinks that within a few years, half China’s trade with emerging markets will be settled in renminbi. By 2020, the bank projects that its renminbi business in Hong Kong will be as big as all its trade settlement is today.
there is a catch to all this
Once the renminbi leave the mainland, they are only allowed back in to pay for exports. Otherwise, a holder needs explicit government permission to use the funds in China. Therefore, internal financial markets are sheltered from any speculative storms that may hit Hong Kong.
So far no one minds. Global interest rates are low, so there’s little opportunity cost to holding renminbi. Also, the consensus among individuals is that the renminbi is an appreciating currency, making it an attractive alternative either to HK$ or US$. In addition, borrowing rates for renminbi are low in Hong Kong than on the mainland. So firms that can get government permission to transfer the proceeds are better off financing in the offshore renminbi market.
how fast will liberalization proceed?
No one knows. Some, like the FT, speculate that the fact of liberalization will produce a pace of liberalization that’s faster than Beijing wishes. I’m more skeptical. But, since I don’t see any stock that’s a pure beneficiary of a surprisingly sharp pace of liberalization, I haven’t given the matter much thought.