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‘Don’t want credit risk? Don’t lend!’
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Holders of US Treasuries are becoming increasingly upset with the brinkmanship in Washington. The latest political standoff over raising the debt ceiling has reportedly made Chinese officials all the more determined to push forward with globalization of the yuan as a means to lessen China’s reliance on the dollar and protect its reserves.
China holds US$1.28 trillion of Treasuries. It doesn’t want chaos in Washington to blow a hole in any of it. If only the yuan were “globalized!” If only its reserves were denominated in yuan instead of dollars! That would solve everything, wouldn’t it?
In fact, no, it wouldn’t solve anything. China’s problem has more to do with its 20 years of trade and current-account surpluses than it does with whether the claims it has amassed are denominated in dollars or yuan.
The easiest way to see this is to follow the buildup of China’s Treasuries and then consider a hypothetical attempt to re-denominate them in local currency terms.
Current-account surplus
China began running current-account surpluses back in 1990, but only in 1998-99 did they start to become significant. In 2000, its cumulative surplus of the entire preceding decade amounted to a mere US$120 billion, and it held US$60 billion of Treasuries.
By 2007, these figures had grown eightfold. The cumulative current-account surplus had risen to US$1 trillion and Treasury holdings to US$480 billion. Since 2007, both have grown by another two-and-a-half times. As of September 2013, China’s surpluses since 1990 added up to some US$2.5 trillion and US Treasury holdings stood at US$1.28 trillion.
Imagine such a scenario. China becomes worried about all this dollar debt. It wishes it were denominated in its own currency, the yuan.
China asks the US if it might take back all its Treasuries in exchange for new ones denominated in yuan. The US obliges but explains there is no need to issue new bonds. The US simply crosses out the “US$100” written at the top of each existing bond and scribbles “612 yuan” in its place, reflecting the prevailing exchange rate.
With the stroke of a pen, China’s Treasuries are now denominated in yuan. Its money is safe. The dollar’s dominance in global markets has fallen by US$1.275 trillion, and the yuan’s stature has risen by the same.
Of course, China’s money is no safer than before, as the parable continues. Six months go by and China needs to cash in some of its “yuan Treasuries” in order to help finance its banks at home instead of printing new money.
Even if the US would like to help, there’s a problem: China is still running surpluses; the US, deficits. The US has even fewer yuan to offer China today than six months earlier. In short, China’s yuan-denominated Treasuries are utterly worthless. Unless, of course, China might accept dollars instead?
Plainly, China’s problems have nothing to do with the dollar’s dominance in world markets and everything to do with China’s current-account surpluses. Globalizing the yuan won’t turn surplus into deficit. Renminbi-izing the dollar won’t make China’s foreign reserves any safer. The moral is a simple one: If you don’t want credit risk, don’t lend.
None of this is to say that prudent currency diversification wouldn’t lower China’s dollar risk. It would. Buying euros, yen and pounds would go a long way toward stabilizing the value of China’s US$3.5 trillion of foreign-exchange reserves. But China is doing that already. Holdings of US Treasuries as a percentage of foreign reserves have remained a fairly steady 37-38 percent since 2003. In this light, the dollar doesn’t appear that dominant to begin with.
Preventing collapse
Nor is this to say that globalizing the yuan wouldn’t lower other kinds of risks that China, indeed the world, faces as regards the dollar. A credit crunch brought Asia’s foreign trade to a standstill in late 2008. The use of yuan for trade settlement might have prevented much of that trade collapse.
A global yuan market could also help finance the vast expansion in Asian trade volumes expected over the coming decade. We estimate that Asia’s two-way trade will expand by US$5 trillion to US$6 trillion by 2020, an amount that surpasses the entire offshore dollar market by 40 percent to 50 percent at present. A globalized yuan may be necessary to take some of the burden off the dollar.
Bottom line? There are good reasons for China to want to globalize the yuan. Protecting the value of its foreign reserves from chaos in Washington is not one of them.
The article was based on a DBS Bank research note issued on October 14. Shanghai Daily edited it for length.
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