Since the start of the global financial crisis and the emergence of regional trade alliances in the global economy, “a currency swap network” has emerged in financial and monetary fields, setting off a wave of currency swaps. Especially since the US subprime crisis triggered the global financial crisis, more and more central banks have been signing currency swap arrangements. The financial structure based on this network will therefore likely become more common in the development of the global monetary system.
Zhang Monan
Currency swaps are important instruments of international financial cooperation and liquidity management among central banks. In November 2011, in order to inject dollar liquidity into the market and maintain the confidence of dollar assets, the US Federal Reserve established “temporary dollar liquidity swap facilities” with the European Central Bank, Bank of England, the Swiss Central Bank, and the Bank of Japan. In October of 2013, the US Federal Reserve, European Central Bank, Bank of England, Bank of Japan, Bank of Canada and the Swiss Central Bank restarted the dollar swap lines. However, these six major central banks turned temporary bilateral liquidity swap arrangements into long-term currency swap arrangements.
As a result of these long-term currency swap arrangements among the six central banks, the US Federal Reserve has once again become the last lender. In 2008, when the global financial crisis was at its worst, it was the temporary currency swap facilities approved by the US Federal Reserve that supplied about US$600 billion worth of liquidity to the European Central Bank and the Bank of Japan, thus avoiding an intensification of the global crisis because of a shortage of the US dollar.
In fact, an exclusive supply and demand network of international reserve currencies has formed, centered around the US Federal Reserve and joined by the central banks of developed economies. This network has integrated various currency supply and demand mechanisms into one. It is worth noting that this currency swap involves not only the currency liquidity of the swapping countries, but also their exchange rate arrangements, as well as the coordination of their macro-economic policies.
For a long time, the capital of the global financial and monetary system circulated in two ways. Firstly, countries with a trade-deficit had to pay trade-surplus countries for goods, thus bringing capital liquidity to the current account. Secondly, countries with a trade-surplus reinvest their accumulated foreign exchange assets into the assets of the trade-deficit countries, bringing the capital liquidity to the financial account. These two tactics form a complete monetary circulation. This means that the more serious the imbalance of the global trade is, the more liquidity will be produced.
However, since the global financial crisis, this situation has changed, and started to reverse. Developed economies have tightened their consumption and increased investment; and newly emerging economies have reduced their trade surplus. On the whole, the global trade imbalance has become smaller than before the global financial crisis in 2008, so the liquidity produced by the global trade imbalance has been driven lower. This improvement is more evident, especially as the US has substantially adjusted its quantitative easing policy, and will start the process to raise its interest rates.
In view of the central role of the US dollar in deciding global liquidity, the actions of the US Federal Reserve to gradually reduce its monthly purchase of securities, will certainly stagnate or reduce the global monetary base. This is the important driving force behind the reflow of international capital, and the Fed’s actions will certainly lower the level of China’s “capital pool”.
China has no other choice but to actively head off this challenge, as the upcoming cycle of the global currency swap network will certainly have a large impact on the international financial pattern and will present fresh challenges to China’s economic and financial security.
China should actively participate in “bilateral swap lines,” advocated by the US. Although China’s foreign exchange reserves are as high as US$3.95 trillion, the Chinese central bank should also put forward a currency swap with the US Federal Reserve, just like Japan in 2008, despite having US$1 trillion worth of foreign exchange reserves. If this happens, when capital begins to flow out of China and foreign exchange reserves are needed, the Chinese central bank will have more US dollar options because of the currency swap with the US Federal Reserve.
Besides, China should promote the “Chiang Mai Initiative Multilateralization”, expand the scope of an Asian bilateral swap, raise the existing loose bilateral assistance network to a closer multilateral capital bailout mechanism and, in particular, push the financial cooperation in Asia to a new level, in order to ward off any financial risks.
In the longer run, from the strategic perspective of promoting the globalization of the Renminbi, China should actively establish a Renminbi swap pool in order to effectively guard against any international financial risks. In the system where Renminbi is swapped and cleared in many other currencies, establishing a swap pool can greatly expand the system, thus further consummating the clearance function. To be specific, China can follow the practices of the Bank For International Settlements and make an annual bilateral balance swap and settlement, including both the current-account system and a gradual establishment of the capital-account system, so as to quickly get integrated into the global currency swap network.
Zhang Monan is a researcher at the China Center for International Economic Exchanges.
