China’s risk in the unlikely case of a US default – Arthur Kroeber

 

Arthur Kroeber

A default of the US is highly unlikely, even in the current chaotic political setting in the United States, says leading China economist Arthur Kroeber, but today the risks for China are much higher than during the 2008-2009 crisis. A crisis would not offer an opportunity to build an international financial system around the Renminbi, next to the US dollar, he adds in the ChinaFile.

Arthur Kroeber:

As in 2008-2009, a global economic meltdown would hurt China a lot. It would fare slightly better than most other countries because it runs a closed-off financial system that relies mainly on domestic savings, and is protected from the ups and downs of global financial instability by capital controls. But the impact of a U.S. debt default would still be devastating. In 2008-2009, the loss of trade finance and collapse in global demand sent China’s exports plummeting by nearly 20 percent, and upwards of 20 million workers lost their jobs.

Fifteen years ago, China’s government could respond by unleashing a massive debt-financed economic stimulus program, because the country’s debt level, at 140 percent of GDP, was relatively low and it still had significant needs for infrastructure and housing. Today, the space for maneuver is far narrower: debt has soared to nearly 300 percent of GDP, and both infrastructure and housing are seriously overbuilt.

Though severe, the economic consequences to China of a U.S. default would probably not be regime-threatening. Whatever pain the Chinese people were forced to suffer could rightly be blamed on outside forces. And in a pinch the government could still support a minimum level of growth by adding to its debt pile, since it would be borrowing from its own future, not from foreign creditors.

This leads us to the second question. If the U.S. defaults, could China create a substitute system, built around the renminbi? The short answer is no.

The U.S. treasury market is huge, and deeply intertwined with the rest of the world. (That’s why a default would be so bad.) There are $23.9 trillion in treasury bonds outstanding; foreigners hold $7.5 trillion, or 31 percent, of that pile; daily trading last year averaged $600 billion. In practice, this means it is easy for large companies and governments to hold treasuries in any amount, trade large volumes quickly, and easily obtain or dispose of as much collateral as they need for borrowing.

China’s government bond market is nowhere near big enough, liquid enough, or integrated enough with the rest of the world to substitute for U.S. treasuries. According to calculations by my colleagues, the total value of Chinese government bonds (CGBs) on issue—$3.3 trillion—is less than half the value of U.S. treasuries held by foreigners. The foreign holdings of CGBs are a mere $340 billion, one-twentieth of the country’s treasury holdings. The daily turnover of China’s government bond market is $30 billion, about 5 percent of the treasury market average.

After the 2008-2009 crisis, because it decided it was too dependent on the dollar-driven global financial system, China tried hard to internationalize the renminbi. Its efforts have borne little fruit. The renminbi accounts for just 2.8 percent of global official central bank reserves (compared to 60 percent for the U.S. dollar and 20 percent for the euro), a figure that has not changed much in the past several years. Similarly, it makes up just 2.4 percent of global trading in foreign exchange.

China has failed to internationalize the renminbi for the same reason it is relatively insulated from global financial shocks: capital controls. Bringing money in and out of China still requires permission from Beijing. From the Chinese government’s point of view, this is good. When economic conditions worsen in China, it is hard for Chinese citizens to take their money out and park it abroad. And by limiting the amount of money foreigners can bring in to China, and controlling the conditions under which they can take it out, Beijing reduces the risk that a global financial panic leads to a damaging outflow of foreign investor capital. As a result, Beijing does not have to work so hard to maintain domestic financial stability.

More in the ChinaFile.

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What China needs to do to make the yuan more international – Shirley Yu

 

Shirley Yu

China’s currency, the yuan, still has a long way to go on its road to become an international currency, says political economist Shirley Ze Yu at the S&P Global. The need for China to internationalize its currency “is both strategic and opportune,” Yu said.

The S&P Global:

“The BRI (Belt&Road Initiative) region is China’s natural region to succeed in building a multilateral currency order, to rival the 20th-century U.S.-dominated global monetary system,” said Shirley Ze Yu, a political economist and a fellow at Harvard Kennedy School’s Ash Center.

To be sure, China needs to allow the yuan to float more freely. The digital yuan won’t be “a standalone entity,” Yu said, adding, the digital yuan cannot become a global center currency, unless the yuan “itself becomes one.”

The depth and width of the capital market is still the most significant variable, because no country or individuals would hold on to a yuan-denominated asset if there is insufficient market liquidity globally. The yuan “has a long road to travel still,” she said.

Yu said that it is crucial for China to internationalize the yuan now, especially since the U.S. dollar has enjoyed its reign as “the ultimate currency of last resort” post-World War II and dominates the global monetary system. The need for China to press the gas pedal on its yuan internationalization agenda also became more pronounced recently as the U.S. announced sanctions against Chinese and Hong Kong officials. China has to be prepared for its banks to be excluded from international monetary clearing systems, including SWIFT and CHIPS systems, down the line, she said.

The need for China to internationalize its currency “is both strategic and opportune,” Yu said. “In the current decade, we might inevitably see two parallel global monetary systems” — the dollar-based system and a rising and regional yuan-based system.

More at the S&P Global.

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Why China’s digital yuan does not create a reserve currency – Victor Shih

 

Victor Shih

The creation of a digital currency does not mean China can create a reserve currency for the international markets, says financial expert Victor Shih in Quartz. Domestically, it could mean the digital currency could try to catch back the financial room now occupied by commercial players like Alibaba’s Alipay and Tencent’s WeChat, he adds.

Quartz:

What investors are looking for in a reserve currency isn’t the technology—it’s a currency that’s stable, underpinned by a strong economy, freely convertible, and able to be used widely.

Victor Shih, an expert on China’s political economy and a professor at University of California San Diego, explained that merely introducing a digital currency “doesn’t solve the problem that some people holding renminbi offshore will want to sell that renminbi and exchange it for the dollar,” which is widely considered to be a safer asset. Here the gap is even larger: Nearly two-thirds of the world’s currency reserves are held in US dollars, compared with 2% in renminbi, the currency’s official name.

Suppose Iran sold China a large amount of oil, and accepted the digital yuan as payment. That would help with Beijing’s goal of pursuing more widespread use of the yuan in international transactions. But Tehran would probably want to use at least a quarter of those earnings to buy goods from Europe, said Shih, so they would need to convert a portion of the digital yuan into dollars and euros, the second-most used currency for global payments.

“If that happened on a very large scale, you’d have hundreds of billions of renminbi accumulating in Hong Kong,” a major clearing center for yuan-denominated transactions. And if those yuan were converted to another currency in large amounts, “the renminbi will be under downward pressure and the PBOC will have to step in” to prop up its value.

Still, the digital yuan could be one way for the state to try and wrest back control of digital payments from commercial companies, but it’s unclear what that would mean for the two dominant digital wallets, Alipay and WeChat Pay, who handle 94% of electronic payment transactions (link in Chinese). The central bank could theoretically ban commercial wallets like Alipay outright to eliminate competition, Shih said, but “that would be pretty terrible.”

One key advantage of people using digital yuan, Shih said, is enabling China’s central bankers to track exactly where every yuan is going in greater detail than possible at present. If Iran made purchases with its digital yuan earnings, for example, the PBOC would be able to see what it’s bought, and from whom, down to the cent. Yet the same thing that makes a virtual currency attractive to China’s government could work against it elsewhere—there are lots of situations when even perfectly law-abiding people don’t want governments to know what they’re doing, particularly when that government is the Communist Party of China.

Shih does see one potential opportunity: weaving the digital yuan into a payment systems on platforms like TikTok, the viral video app owned by Chinese tech giant ByteDance and boasting hundreds of millions of users, or in popular video games like Fortnite, developed by Epic Games, which is 40%-owned by Chinese tech firm Tencent.

“That’s the thing about the digital world,” said Shih. “Everything is potentially linkable so you can leverage popularity on one platform to get popularity on another platform.”

More in Quartz.

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How China uses the digital yuan to go international - Shirley Ze Yu

Shirley Ze Yu

China's central government is embracing the digital currency, expands its usage domestically and might use it to internationalize its yuan, explains financial expert Shirley Ze Yu at CNA. 

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Renminbi lost its chance as an international currency - Arthur Kroeber

Arthur Kroeber

For a while, China's Renminbi or Yuan looked like a potential competitor in international markets. But China has lost that opportunity, says economist Arthur Kroeber in OZY. “Who’s going to issue or buy bonds in a market where liquidity can be turned off at the drop of a hat?” he asks.

OZY:

Global use of the renminbi would reduce exchange rate risks for Chinese companies and minimize exposure to sharp drops in dollar liquidity — one driver of the fall in Chinese exports during the financial crisis. 

“There was both an objective to use renminbi internationalization as a wedge to drive finance sector reform, but there was also a very strong and widely held view that having a more fully independent currency was really important to secure China’s economic sovereignty,” says Arthur Kroeber, managing director of research company Gavekal Dragonomics. 

Zhou (Xiaochuan, then governor of the People’s Bank of China)’s initiative came at an awkward time. Despite having a large economy, China had neither deep financial markets facilitated by an open capital account nor widespread confidence in its currency — elements deemed “fundamental determinants” of international currency status by Harvard economist Jeffrey Frankel. 

Yet the central bank pushed on, creating an offshore market for renminbi debt centered in Hong Kong. By 2014, annual offshore issuance had climbed to Rmb112 billion ($16 billion), according to Dealogic. The offshore exchange rate is independent of the controls used by the central bank on the onshore rate, which limits moves against the dollar to 2 percent in either direction of a daily fix. 

But in August of 2015, the central bank set the daily fix sharply weaker, inducing a shock devaluation in the normally stable onshore rate. Global markets convulsed and the offshore rate pushed below its onshore counterpart, spurring massive capital outflows on fears of a further sharp depreciation. Ultimately, Beijing tightened capital controls to stem renminbi outflows, which cut off liquidity to the offshore market. 

Kroeber contrasts this move to the U.S. decision in the 1960s not to throttle the nascent eurodollar market when an offshore pool of dollar liquidity began ballooning in Europe. China’s decision stabilized the renminbi, he said, but left it bereft of credibility as an international financial currency. “Who’s going to issue or buy bonds in a market where liquidity can be turned off at the drop of a hat?” he asks. 

This year, offshore renminbi bond issuance totaled just Rmb16 billion ($2.3 billion) at the end of September compared with onshore issuance of Rmb4.5 trillion ($635 billion), Dealogic data show.

More in OZY.

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US dollar is heading for a crisis - Jim Rogers

Jim Rogers

The trade war between China and the US is taking another casualty, says super-investor Jim Rogers: the US dollar. He will no longer bet on the US currency, as a downturn is nearing fast in a few years' time, he tells according to News Max. Although for gamblers, buying US dollars for the short run might be an opportunity. In the long run he will switch to China's renminbi or gold.

News Max:

International investor Jim Rogers reportedly says “doomed” dollar fundamentals are “horrible,” but he’s buying it to prepare for the U.S. currency’s last-gasp rally. 

“People would think the U.S. dollar is a safe haven, it’s not. The fundamentals are horrible,” the chairman of Rogers Holdings told Real Vision in a recent interview. “Nobody in his right mind would buy the U.S. dollar, but I own a lot…because I’m not in my right mind. I’m assuming that the rest of the world is not in its mind either and they’re all going to buy it,” said Rogers. 

He predicts the dollar will eventually get overpriced and turn into a bubble, and then the veteran investor, who founded the Quantum Fund with billionaire George Soros in the 1970s, will sell, MarketWatch explained. 

“I’m not very good at market timing but I would expect it to be in the next period of turmoil, which will be coming in the next two or three years,” he said. 

He doesn’t hold out much hope for the American economy because while he claims the U.S. is “the biggest debtor nation in the history of the world,” countries such as China, Russia and Brazil are seeking an alternate international currency.

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Devaluation: no manipulation, just basic economics - Jim Rogers

Jim Rogers

China is not manipulating its currency, says trader Jim Roger. When your currency gets hit by massive tariffs it is basic economics your currency goes down, he says to RT. "No trade war is good for anybody. Everybody loses."

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Renminbi: not yet close to US dollar as world currency - Wang Haiyan

China's Renminbi is not coming close to the US dollar as the world's reserve currency, says business analyst Wang Haiyan to Money Talks. Even though more trade is done in the Chinese currency, the US dollar is still dominant. China cannot expect export to save its economy but relies on domestic consumption. But that transition is not going overnight, Wang adds.

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Conservative resistance against liberalization of the yuan - Victor Shih

Victor Shih

Retiring central banker Zhou Xiaochuan called this week for the liberalization of China's currency, the Yuan. But conservative forces might find this step from the People's Bank of China (PBOC) a step too far, says financial expert Victor Shih to Bloomberg.

Bloomberg:

While it’s widely expected that Zhou will retire, there are no guarantees as China’s political appointments are often unpredictable. The PBOC chief bucked expectations he would leave back when he was 65. Instead he was promoted, taking on the title of vice chairman of the Chinese People’s Political Consultative Conference, where the retirement age typically is 70. Zhou turns 70 in January. 

“It seems there is a concerted push from within the PBOC to liberalize the capital account and exchange rate a bit while the yuan is relatively strong,” said Victor Shih, a professor at the University of California in San Diego who studies China’s politics and finance. “The conservative views of the higher leadership may stand in the way of significant progress.”

More in Bloomberg.

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Brexit fallout: pressure on the Renminbi - Victor Shih

Victor Shih

China has been preparing for the fallout of a decision of the Federal Reserve, but find themselves dealing with an unexpected black swan, says financial and political analyst Victor Shih to Bloomberg. The Renminbi might be under pressure.

Bloomberg:

Victor Shih, a professor at the University of California at San Diego who studies China’s politics and finance: 

"The value of China’s foreign-exchange reserves just dropped significantly. If the euro devalues along with the pound, the renminbi will also be under pressure. Brexit also shows that it’s hard to anticipate black swans as China’s technocrats try to do. They had been preparing for a Fed rate hike, but a somewhat different shock hit which may require a different response."

More in Bloomberg.

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Chinese lose trust in their currency - Shaun Rein

Shaun Rein

Almost a trillion US dollar worth of capital has left China over the past year, showing a profound lack of confidence among its citizens, tells business analyst Shaun Rein in the New York Times. “Companies don’t want renminbi and individuals don’t want renminbi."

The New York Times:

For years, China soaked up much of the world’s investment money, as the economy grew at annual rates in the double digits. A largely closed financial system kept China’s own money corralled inside the country. 

Now, with growth slowing, money is gushing out of the country. And the government has a looser grip on the spigot, because China dismantled some currency restrictions to open up its economy in recent years. 

“Companies don’t want renminbi and individuals don’t want renminbi,” said Shaun Rein, the founder of the China Market Research Group. “The renminbi was a sure bet for a long time, but now that it’s not, a lot of people want to get out.” 

Managing the situation has proved complicated for the government... 

Unofficial methods abound (to export capital out of the country). 

Companies have inflated trade invoices to keep more profits outside the country, although Chinese authorities have cracked down on the practice. 

Mr. Rein described doing market research with a wealthy woman in Shanghai who changed $7 million this winter from renminbi into dollars, by using 140 relatives, friends and even friends’ relatives who each carried $50,000 a piece.

More in the New York Times.

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Slowly China´s central bank will let the Renminbi float - Sara Hsu

Sara Hsu

Nothing is moving fast, but slowly China´s central bank PBOC will loosing its traditionally iron grip on its currency, writes financial analyst Sara Hsu in the Diplomat. Linking the Renminbi to a basket of currencies in stead of only the US dollar failed in the past, but might work out now.

Sara Hsu:

China’s efforts to peg the RMB to a basket of currencies, with less emphasis on the dollar, have failed in the past, particularly in the face of the global financial crisis. A tighter peg to the U.S. dollar helped China’s economy to maintain monetary stability as real economic indicators slid. Now that the global crisis appears to be somewhat contained, the time may be ripe for China to remove its strict adherence to the dollar. Moreover, inclusion of the RMB in the IMF basket of reserve currencies was a watershed event for China that leaves Beijing on the hook for picking up the pace of capital account and exchange rate liberalization. While some analysts believe that the RMB will not be freely floated anytime soon, adherence to a more equally weighted basket of currencies is a possibility, especially given China’s call to remove the dollar from its central role in the wake of the global financial crisis. China’s gradual opening of its capital account through the issuance of panda bonds, reduced restrictions on participation by foreign central banks, sovereign wealth funds and multinational firms in the interbank market, and implementation and expansion of the Shanghai-Hong Kong FTZ and Stock Connect will necessitate freer currency flows. Eventually, China will need to allow the RMB to better reflect market forces. 

We do not know for sure whether the People’s Bank of China will really break away from the dollar at this time, but there are gains to be made in doing so. Maintaining a somewhat rigid peg to the dollar has required the central bank to heavily intervene in the currency markets and to maintain high levels of dollar reserves. This is a costly process that is generally considered undesirable. Now that the RMB has SDR currency status, China may have more latitude in valuing its currency. A decline in reliance on export production also reduces the need for China to peg the RMB to the currency of its largest trading partner. So will they or won’t they? It seems likely that China will reduce its grip on the dollar and it makes sense that it would do so in the short to medium run. This will certainly mark a change in China’s development trajectory, as its currency has closely tracked the dollar for two decades.

More in the Diplomat.

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How the Renminbi goes global - Sara Hsu

Sara Hsu

Step by step, China takes its currency global. The latest move, the launch of the China International Payment System (CIPS) this fall, marks another step forward, writes financial analyst Sara Hsu in the Diplomat.

Sara Hsu:

The system will be located in Shanghai and will facilitate cross-border trade settlement, direct investment, and other RMB-denominated deals. This will reduce transactional costs for RMB clearing and make such transactions easier. The international payment system is expected to expand internationalization of the RMB as China continues down the long path of market-oriented reforms. 

China currently uses the China National Payment System (CNAPS), with a 2014 settlement amount of 6.55 trillion RMB, according to the People’s Bank of China. The transition to CIPS will better allow use of both Chinese and English and will run on SWIFT ISO20022 standards, consolidating a system of multiple clearing houses. The system is currently being tested among 20 banks and will be rolled out to other banks in the fall. Cross-border use of RMB is expected to rise as it becomes easier to engage in foreign currency transactions. 

Improving the ability to conduct international RMB transactions is an essential component of China’s capital account and exchange rate liberalization process, as well as of its “Going Out” policy and the One Belt, One Road initiative. Under the Third Plenary Session of the 18th Communist Party Congress, China committed to further opening up its capital account and increasing exchange rate liberalization. This will allow transactions to be further carried out in RMB and to somewhat loosen the rate at which the RMB is internationally traded. The One Belt One Road initiative aims to expand the scope and scale of the bilateral currency swap and settlement.

More in the Diplomat.

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Offshore RMB bonds to expand - Sara Hsu

+Sara Hsu

China´s central government is pushing offshore RMB bonds as a tool to support Chinese firms to go abroad. Financial analyst Sara Hsu looks at the current state of offshore RMB bonds, and expects a massive expansion, she writes in the Diplomat.

Sara Hsu:

The offshore bond market has been highlighted in recent months by the financial troubles of Kaisa Group, a mid-size Chinese property developer that has faced potential default on offshore bond debt due to a graft probe. Kaisa’s woes reflect the troubled financial climate among mainland property developers, some of which are offshore bond issuers. Holders of offshore RMB bonds have demanded higher yields to cover potential risks in the past three months. The market is expected to rebound as the RMB continues to appreciate and the Chinese economy recovers from its downturn. 

Despite increased risk in the property market, confidence in the RMB has expanded rapidly in recent years, as RMB clearing hubs have been initiated all over the world. RMB clearing centers have been set up in London, Paris, Sydney, Luxembourg, Doha, Frankfurt, Seoul, Singapore, Taipei, and Hong Kong. The offshore RMB bond market has grown in step; for example, the U.K. Treasury issued 2 billion RMB ($322 million) in sovereign bonds in October 2014, the Bank of China Paris issued the same amount in July 2014, and so on. Some analysts have even gone so far as to predict the RMB will soon become an international reserve currency, the ultimate symbol of currency internationalization. Whether or not this is indeed a reality, there is great enthusiasm for holding RMB and issuing RMB-denominated bonds. 

Expanding offshore RMB bond issuance is one aspect of China’s aim to increase the international scope of its corporate sector under the “go out” strategy. This strategy, which has been in place since 1999, is gradually allowing increased financial and real business activity overseas. Offshore RMB bonds allowed foreign investors to obtain a “piece of the action,” in the hopes that China’s economy and currency will continue to advance over time.

More in the Diplomat.

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The offshore Renminbi trade - Sara Hsu

Sara Hsu

Lower barriers to capital accounts, make it easier to trade in China´s currency, the Renminbi. Offshore trading centers expand, at the country builds up it financial leverage. Financial analyst Sara Hsu has a look at the expanding RMB clearance banks in the Diplomat. After Hong Kong, London, Frankfurt and Seoul, Paris and Luxembourg followed.

Sara Hsu:

The offshore RMB market, with more development, will ... assist the Chinese leadership in reaching some of its financial goals. The leadership confirmed at the National People’s Congress in March that one main target of the reform process is to liberalize the exchange rate; People’s Bank of China Governor Zhou Xiaochuan confirmed that this would be completed by 2020. To this end, the offshore RMB market provides financial infrastructure through which to exchange, hold, and speculate upon the Chinese currency. China is also aiming to further liberalize the capital account. While the extent to which the leadership is willing to go to open up to foreign capital flows is unknown, the offshore RMB market creates a base for foreign holdings of the RMB. As the capital account opens further, increasing amounts of RMB currency transactions and holdings are given a foothold via offshore RMB centers. While the CNH and CNY currencies have diverged in value, it is expected that with further capital account liberalization, the currencies will over time converge, making offshore RMB markets a critical component of a developed financial system. 

The ultimate aim of Chinese authorities in establishing offshore RMB markets is to promote the RMB as a major international currency. The RMB is currently the seventh most-used payments currency in the world. However, the RMB accounted for only 1.47 percent of global payments in May, and has a long way to go before it overtakes heavily used currencies such as the euro, the Swiss franc, or even the Canadian dollar. Expansion of offshore RMB markets is a key step in this process, and happily, both international regions and the Chinese leadership are in favor of this move.

More in the Diplomat.

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Changed rules for the Renminbi - Arthur Kroeber

+Arthur Kroeber 

The way the central government is ruling its currency, the Renminbi, has changed profoundly over the past months. Economist Arthur Kroeber argues in the Brookings Institute that the rules for the currency have changed profoundly.

Arthur Kroeber:

It is clear that China has entered a new phase of currency management, and the rulebook that has worked well since 2005 must be heavily revised. Two observations inform this judgment. First, the main aims of the strong renminbi policy have been achieved. The current account surplus has been virtually eliminated, and at least one serious technical study of the currency (by Martin Kessler and Arvind Subramaniam of the Peterson Institute for International Economics), the structural undervaluation of the renminbi has been eliminated.

Second, the adoption of a 2 percent daily trading band means that, on a day-to-day basis, the renminbi rate can now be determined mainly by the market most of the time (since only at times of extreme stress do currencies move more than 2 percent in a day). This newfound capacity seems consistent with the broad aim articulated in the Communist Party’s reform agenda last November, of having market forces play a “decisive role” in resource allocation. A willingness to let the currency float more freely is also consistent with the apparent agenda to liberalize deposit interest rates within in the next two years, which implies shifting from a monetary policy that mainly targets the exchange rate to one that mainly targets a domestic money-market interest rate.

It is also clear, however, that the renminbi will not simply be left to its own devices: the float will be a heavily managed one. Mechanically, it will likely operate much like the Singapore dollar “basket, band and crawl,” or BBC system, with an undisclosed trade-weighted index target, a 2 percent daily trading band puts a limit on extreme movements and a periodic readjustment of the slope of the policy band to prevent a major misalignment of the currency emerging (as it did at the end of China’s hard-peg era).

Strategically, the two most important aims of Beijing’s exchange rate regime will be maintaining stability of both the current and capital accounts, and providing support for the emergence of the renminbi as a serious international currency.

Much more at the Brookings Institute.

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• Chinese Central Banker: "Renminbi Will Become Reserve Currency"