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| Panda bulls |
| Martin Hutchinson / Jun 10, 2009, 00:43 IST |
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Panda bonds: US borrowing in renminbi, as China Construction Bank chairman Guo Shuqing just recommended, wouldn’t be wise because of China’s exchange controls.
However, Treasury funding in euros and yen could reduce the “crowding out” effect on US private-sector borrowing caused by the need to finance huge deficits. If currency risk was kept manageable, the discipline imposed would be valuable.
Guo’s recommendation fits with China’s previously expressed concern about excessive US borrowing and the risk of a dollar decline. Foreign investors in long-term Treasury securities take four risks: the risk of default, the risk of a dollar decline against other currencies, the risk that US inflation will reduce the value of dollar principal, and the risk of rising dollar interest rates through crowding out. The last occurs when private investors have to compete with a government for a limited pool of credit, pushing up rates.
By borrowing in foreign currencies, the Treasury would mitigate investors’ risks from currency decline, inflation and crowding out. Given the Treasury’s huge borrowing needs, it would be wise to provide such accommodation. Investors would bear a greater credit risk, since the United States could no longer avoid default by printing money, but would mitigate the other three risks and diversify their holdings.
If the US floated enough foreign currency debt to provide liquidity, it could increase global investor appetite for US government paper and free up the dollar market for borrowing by mortgage finance agencies (which cannot conveniently borrow in foreign currencies) and private sector fundraising. Such issuance might also mitigate upward pressure on long-term dollar interest rates.
The renminbi itself is an unattractive borrowing currency, because its value and exchange remain tightly controlled. However US borrowings in yen and the euro would offer international investors attractive, liquid alternatives to domestic Treasuries. Moreover, borrowing in yen would allow the US to tap lower Japanese interest rates while dampening the yen’s rise against the dollar, which would be welcomed by the Japanese authorities.
Provided its foreign currency borrowing was limited to no more than 20-25 per cent of its liabilities, say $3 trillion in total, the Treasury’s currency risk would be limited. Even so, the need to repay in “real money” would impose a beneficial element of fiscal discipline to the otherwise profligate US government.
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