We wrote yesterday about how the revival of dollar swap lines on far more relaxed terms was by far the most important thing the Federal Reserve has done thus far.
However, there are some flaws – chief among them that there is no swap line between the US central bank and its Chinese counterpart, the People’s Bank of China.
Anyone trying to understand why that’s so important should take a look at a note published by Pierre Ortlieb, economist at OMFIF, a think tank. Ortlieb’s note is here.
But for the time poor, here’s a summary.
The crux of the argument is that many of the sectors hardest hit by the coronavirus outbreak, such as airlines and real-estate development, are also among the most likely to have high dollar-denominated debt burdens. The chart below shows the situation for six of China’s airlines:
And here is the total dollar-denominated debt burden:
The sharp cuts in the federal funds rate would clearly help these firms in normal times. But with global corporate bond markets under stress, it is easy to see how firms such as these could struggle to roll over their debts.
A wave of defaults on dollar-denominated debts will do no one much good right now.
China is the most important trading nation on the planet. And trade is overwhelmingly denominated in dollars. So why not grant a swap line?
The reason is that the politics of the moment precludes it. As Ortlieb puts it:
In the light of China’s ongoing reliance on the dollar, it would intuitively make sense to grant them a dollar liquidity swap line; yet geostrategic pressure not to act in favour of China has precluded this and will continue to do so.
He does, however, think that the use of swap lines elsewhere will aid Chinese firms by freeing up the global supply of dollars.
And there is always the option suggested by Credit Suisse’s Zoltan Pozsar (and noted here): that the PBoC sells of some of its holdings of US Treasuries and uses the cash to cover any dollar funding difficulties China’s lenders might have.
The concern there is that this offsets one of the things the Fed is trying to do through its $700bn-worth of new QE. That is, make Treasuries as cash-like as possible.
China is one of the biggest holders of US government debt – and the biggest foreign holder after Japan, with more than $1th worth of Treasuries as of January. A not insubstantial concern if it begins selling that stock in large amounts, then.
The loud cries of swap lines being a “US bailout of the rest of the world” will drown out anyone who puts forth this case. But if the dollar is to maintain its status as the pre-eminent global reserve currency (a status that allows the US to borrow cheaply and impose sanctions far more aggressively that it would otherwise be able to), then the most common-sense thing is to offer greenback liquidity direct to Beijing.