How China Covered The World In "Liquidity Swap Lines"

As we’ve discussed on a number of occasions and at great length, the market is periodically hit by systemic dollar shortages. For instance, in 2007 European commercial banks found themselves staring down a dollar funding gap on the order of several trillion (all in). Meeting USD funding requirements became immeasurably more difficult as the crisis intensified, necessitating what amounted to a Fed bailout via dollar liquidity lines to foreign central banks.

Then, in November of 2011 (so right around the time when, just like today, the financial world was glued to Greece), the Fed extended its “temporary” swap lines with The Bank of Canada, the BoJ, the BoE, the ECB, and the SNB, and also lowered the price of dollar liquidity. 

The most recent global USD funding shortage began to show up earlier this year and as we noted in March, has been ironically created by central banks themselves (for those interested in a detailed account of the conditions which lead to episodic dollar dearths, see the articles linked above).

Central bank liquidity lines like those the Fed used to bailout the world seven years ago have become a fixture of the post crisis financial system and as you can see from the following maps, their growth since 2007 has been remarkable. Perhaps the most striking thing about the following graphics is the extent to which China has (literally) covered the world in renminbi swap lines. Essentially, China has used bilateral swap agreements to help embed the yuan in international trade in the the post-crisis era. As you'll see below, counterparty countries have also tapped their yuan liquidity lines when they're cut off from dollar funding, making China a critical lifeline for bolstering FX reserves and helping to alleviate shortages of imported goods.

Click here for the full interactive map 

Here's more from The Council on Foreign Relations on the history of the Fed's international dollar liquidity bailouts:

During the crisis, banks became highly reluctant to lend to one another, owing to fears about the true financial condition of counterparts. This drove up the cost of borrowing, as lenders demanded higher interest rates to compensate for rising counterparty risk. While central banks could provide local currency to their domestic banks to lower the cost of borrowing in that currency, their ability to provide foreign currency was limited by the amount of foreign currency reserves they held. To address these foreign currency funding issues, developed-economy central banks agreed to provide swap lines to one another.

 

On December 12, 2007, the Federal Reserve extended swap lines to the European Central Bank (ECB) and Swiss National Bank (SNB). European bank demand for dollars had been pushing up, and creating accentuated volatility in, U.S. dollar interest rates. The swap lines were intended “to address elevated pressures in short-term funding markets,” and to do so without the Fed having to fund foreign banks directly.

 

On September 16, 2008, two days after the collapse of Lehman Brothers, the Federal Reserve Open Market Committee (FOMC) gave the foreign currency subcommittee the power “to enter into swap agreements with the foreign central banks as needed to address strains in money markets in other jurisdictions.” This enabled the subcommittee to extend swap lines to other central banks and to expand the size of the existing swap lines, without the need for the full FOMC to vote on it.


 

In 2011, the Bank of Canada, Bank of England, European Central Bank, Bank of Japan, Federal Reserve, and Swiss National Bank announced that they had established a network of swap lines that would allow any of the central banks to provide liquidity to their respective domestic banks in any of the other central banks’ currencies. In October 2013, they agreed to leave the swap lines in place as a backstop indefinitely.

If you needed further evidence of China's growing influence, consider that Beijing has essentially blanketed the globe with yuan liquidity lines, inking swap agreements with nearly three dozen countries with the primary goal of increasing the degree to which the renminbi is used in international trade...

Since 2009, China has signed bilateral currency swap agreements with thirty-one counterparties. The stated intention of these swaps is to support trade and investment and to promote the international use of renminbi.

 

Broadly, China limits the amount of renminbi available to settle trade, and the swaps have been used to obtain renminbi after these limits have been reached. In October 2010, the Hong Kong Monetary Authority and the People’s Bank of China (PBoC) swapped 20 billion yuan (about $3 billion) to enable companies in Hong Kong to settle renminbi trade with the mainland. In 2014, China used its swap line with Korea to obtain 400 million won (about $400,000). The won were then lent on to a commercial bank in China, which used them to provide trade financing for payment of imports from Korea.

...and in fact, Argentina used their swap agreement with Beijing as a bailout mechanism...

In addition to using the swaps to facilitate trade in renminbi, China is also using the swap lines to provide loans to Argentina in order to bolster the country’s foreign exchange reserves. In October 2014, a source at the Central Bank of Argentina reportedly told Telam, the Argentine national news agency, that the renminbi Argentina receives through the swap would be exchanged into other currencies. Argentina has had difficulty borrowing dollars on international markets since it defaulted on its debt in July and has faced shortages on a range of imported goods as a result. Swapping renminbi into dollars enables companies to import more than they would be able to otherwise.

We'll close with the following two maps which display only swaps lines set up by China. As you can see, the evolution is quite remarkable...

2009

2015