China seems to be waiting patiently in the wings, as the
U.S. Dollar may be starting its next
decent just in time for another EU crisis to emerge.
China has been negotiating currency swaps in preparation for
the day it must intervene on the world monetary front, perhaps making its
currency the Yuan a defacto candidate for reserve currency status as the
Dollar’s fortunes decline.
Currency swaps are typically motivated by comparative
advantage, and the term can refer to two different types of transactions as
In the foreign exchange market, a currency swap
is an agreement between counterparties to exchange one currency for another on
one value date and then reverse the transaction on another value date.
In the interest rate swap market, a currency
swap can also refer to the exchange of principal and/or interest payments of a
loan in one currency for an equivalent loan in another currency. This sort of currency
swap should be distinguished from a liquidity swap performed by a central bank.
In the 2008 global financial crisis, the Fed used forex currency
swap transactions to enter into central bank liquidity swaps. In these foreign exchange
deals, the Fed and the central bank of another major economy agreed to exchange
their national currencies at the prevailing market exchange rate and simultaneously
agreed to reverse the transactions at the prevailing forward market exchange
rate on a specified future delivery date.
The stated goal of these central bank liquidity swaps was to
"to provide liquidity in U.S. dollars to overseas markets." Although central
bank liquidity swaps and forex currency swaps are structurally identical, currency
swaps are commercial transactions driven by comparative advantage, while
central bank liquidity swaps instead represent emergency loans of U.S. Dollars
to foreign markets via their respective central banks.
It is currently undetermined if these transactions will benefit
the U.S. Dollar or the United States over the long run, although they do
represent an extension of credit to overseas nations.
China’s Currency Swap
China has recently made a well-publicized series of currency
swap deals with other major economies, such as the UK and France, over the past
Regarding China’s recent currency swap line deal with
France, Bank of France governor Christian Noyer reportedly said that, "The
Bank of France has been working on ways to develop a RMB liquidity safety net
in the euro area with due consideration of a supporting currency swap agreement
with the People's Bank of China".
Note here that the Renminbi is the Chinese currency, but the Yuan is its
unit of account, so it is referred to by the currency code RMB.
In doing such swap deals, the country apparently intends to
promote the more widespread use of the Chinese Renminbi in foreign trade and
investment, although the currency still remains officially and intentionally
undervalued due to forex market intervention by the People’s Bank of China.
The Chinese are also stealthily buying gold, and China has
become a net importer of silver too, along with just about anything else of
real value the country can get its hands on to avoid being left with a pile of
paper in the case of a fiat currency devaluation crisis.
China has Its Own
The threat of a deflationary collapse in the Chinese economy
seems to be growing. Another important issue is the growth of China’s own huge
The Chinese seem to be playing it cool, perhaps waiting
until the BOJ’s recent money printing experiment ultimately fails. This already
appears to be happening, as evidenced by the Japanese equity market collapse in
response to the latest version of Abenomics.
In essence, this survival move on China’s part will be seen
as a threat to other nations due to the emerging Chinese economy’s massive
China is Not an Enemy
The Chinese depend on the United States to buy their cheap
products as much as Americans depend on the Chinese to make cheap items for
them to buy.
Cheaper products are usually in greater demand in
challenging financial times, while in abundant times people tend to seek out
and pay up for higher quality items.
A sudden disruption to U.S. Dollar based trade would
potentially set the United States and its trade position back decades, and preparation
for this day’s ultimate arrival has been happening for years.
Nevertheless, too many systems at the heart of survival and
functioning depend on a stable financial trade mechanism. In the end, the only
budget that matters is yours, and it is also the only place where you have some
control. This remains the one to study, plan and forecast for.