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International Financial Management

Notes 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.
Central Bank Liquidity Swaps
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 Lines
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 three years.
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 Problems
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 credit bubble.

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 size.
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.
Contd...

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