China may not be an exception after all.
A creditor than lends in its own currency doesn’t have to worry all that much about the risk that it its lending is denominated in a currency that will depreciate. The borrower assumes the risk its currency will depreciate against the currency of its creditor as a condition for getting financing.
That is good for the creditor, and not so good for the borrower.
Back its days as a large creditor, the US (both the US government and private US creditors) generally lent in dollars. That meant that if a Latin currency depreciated against the dollar, the borrower had to find the dollars it needed to repay the US – or default and accept the consequences. Latin countries couldn’t allow their currencies to fall against the dollar and, in the process, reduce the real value of their foreign debts.
China is now a major creditor. But its foreign assets though are denominated in dollars, euros and yen – not RMB. That means that if the dollar depreciates against the RMB, it is China’s problem, not the United States’ problem. The amount of dollars the US has to pay China doesn’t change. But the amount of RMB that China gets for each dollar will fall
China’s willingness to take on this risk in some sense part was a core part of the Bretton Woods 2 system where reserve growth in emerging countries like China financed the United States external deficit. Had the United States external debt not been denominated in dollars, Dr. Roubini and I would have been even more worried by the size of the United States external debt than we were back in 2004. If United States debt structure hadn’t been as favorable, the dollar’s slide from 2002 on would have generated much, much larger problems.
China seems to have woken up, belatedly, to the fact that lending to the United States – or any other country – in its borrowers currency is risky. It probably should have started to worry some time ago, before it had $1.6 trillion or so of dollar-denominated claims. As the FT noted in a recent leader, “The People’s Republic has, however, over-exposed itself to the US, piling up dollar-denominated securities.” China is currently struggling with a problem that is very much of its own making.
China could, in theory, address this problem by ending its accumulation of dollar and euro and yen denominated reserves and instead making RMB denominated loans to the rest of the world.
Internationalizing the RMB poses two problems though.
First, most debtors, including the US, currently do not issue any RMB denominated debt – and I would strongly argue that they shouldn’t start. The countries able to borrow in their own currency at low rates should do so. And countries that have to pay more to borrow to borrow in their own currency also should generally do so, to avoid dangerous currency mismatches. Brazil has benefited immensely in the recent crisis from the fact that most of its debt is now denominated in real.
Second, expanding the “international use” of the RMB is rather hard when China doesn’t want foreign investors to hold RMB denominated assets. If say Argentina had RMB denominated debts, it also might want to hold some RMB denominated reserves as well.
And that would mean allowing foreigners to buy some of the RMB debt that China’s government issues and to hold it as part of there reserves.
That is the rub. Remember, buying RMB debt is also a way of speculating on the RMB.
If China made the RMB fully convertible, anyone could buy long-term RMB denominated debt and benefit if the RMB rose over time. That isn’t something China that has wanted. Remember all the complaints about speculative capital inflows a year ago?
Still, China’s willingness to provide RMB credit to Argentina suggests that China is beginning to recalibrate its definition of its interests.
It is further evidence that China is defining its interest as a creditor – not just as an exporter willing to accept losses on the “vendor financing” it supplies on subsidized terms to those it hopes to encourage to buy its goods.
I was surprised by how conservative China was in the immediate aftermath of the crisis.
It seemed to be concerned almost exclusively with the need to minimize the credit risk in its reserve portfolio. That meant turning down requests from countries like Pakistan for bilateral financing – as well as selling Agencies and buying Treasuries. Now it seems that China has concluded that it has reduced the credit risk in its reserve portfolio to an acceptable level and is turning its eye toward reducing its currency risk.
That though may be a tougher nut to crack.
Perhaps the state council was spooked by a memo the PBoC sent up the food chain laying out all of the risks that remained in China’s portfolio. If the rumors that China’s leaders were surprised to discover the extent of their exposure to Fanny and Freddie are true, the PBoC has every incentive now to make sure that China’s top leaders aren’t surprised by any future currency losses on China’s reserves.
But the state council has also historically been response to the concerns of China’s exporters – and the core tension between China’s interest as an exporter and its interest as a creditor remains.
Moreover, I am not exactly sure it would be a good thing for China to replace a lot of dollar lending to the world with a lot of RMB lending to the world. China would take on less currency risk to be sure, but all the problems created by China’s large surplus would remain. Actually, they would get worse -- as more risk would be in the hands of the world’s big borrowers.
The FT leader again: "[China] must not just replace its mountain of dollar assets with heaps of other currencies." Exactly right.