In the incomplete architecture of the developing multicurrency reserve system, one key element is missing: a swap line between the US and China. It is time that the world’s two largest economies filled this lacuna by negotiating a Federal Reserve-People’s Bank of China swap agreement in each other’s currencies, with the aim of supplying dollar and renminbi liquidity on international financial markets.
Most of the more than 30 swap lines agreed between the PBoC and foreign central banks in the last eight years have been designed to help renminbi settlement of international trade and investment – though they have also been used in currency support for some emerging market trading partners.
A Fed-PBoC accord, with the full-scale backing of the US Treasury, would command more headlines. It would emphasise steadying the renminbi against its main trading partners, with a major potential effect in calming financial markets.
A Sino-American swap line would also strengthen the US Treasury’s bid to regain ground in international financial diplomacy, following Washington’s less than sure-footed handling of the establishment of the China-backed Asian Infrastructure Investment Bank last year.
In line with these ambitious goals, a Fed-PBoC accord would probably have to exceed the RMB350bn ($52bn) swap lines that are currently in force between China and the Bank of England and the European Central Bank. Even a $100bn swap line might appear of limited relevance, in view of the strains on official Chinese reserves, down to $3.3tn from the $4tn peak in mid-2014. But the symbolic effect in shoring up the Chinese authorities’ exchange commitment would be unmistakable.
Questions might be asked in Congress about the possible repercussions for US taxpayers of a contingent credit accord between the US and Chinese central banks, exposing the Fed to renminbi exchange rate risk. But Fed and Treasury officials would able to argue that such an agreement would be similar to standing arrangements between the Fed and other major foreign central banks. Typically, swap agreements are decided at the operational and policy levels between individual central banks, and do not require legislative approval.
A further factor helping calm the political environment for such an accord is that it would lower the probability that Chinese depreciation would spark further ‘currency wars’ between major trading partners, harming US exporters in a US election year.
It would pave the way too for more constructive engagement between the US and China extending beyond present dollar strength, preparing for the inevitable time – perhaps in two or three years – when the US currency starts to weaken again.
Under arrangements formalised in 2007 and made permanent in 2013, the Fed maintains swap lines with the Bank of Canada, the Bank of England, the ECB, the Bank of Japan, and the Swiss National Bank. The Fed earlier built swap lines with Australia, Brazil, Denmark, Korea, Mexico, New Zealand, Norway, Singapore and Sweden, though these were withdrawn after the acute phase of the trans-Atlantic financial crisis.
The five permanent swap accords cover arrangements with the institutions issuing Canadian dollars, sterling, euros, yen and Swiss francs – currencies used globally, accounting for the bulk of the foreign currency funding of US financial institutions.
The renminbi is still not fully convertible for capital transactions. But following November’s decision (backed by the US Treasury) for the renminbi to enter the International Monetary Fund’s special drawing right (joining the dollar, euro, sterling and yen), the PBoC’s swap accord absence appears glaring, promoting the need for inclusion before the SDR decision takes effect on 1 October.
There has been considerable international focus on the renminbi’s weakness against a generally strong dollar, but less so on its relative trade-weighted stability. According to indices from the Bank for International Settlements, the renminbi rose by 3.7% last year on a nominal trade-weighted basis, 3.9% in real (inflation adjusted) terms, compared with 6.2% nominally and 6.1 in real terms in 2014.