Jump-starting an international currency
Saleem Bahaj and Ricardo Reis
Only a handful of currencies are regularly used for cross-border payments: the euro, the yen, the pound, the yuan and, of course, the US dollar, which dominates almost any measure of international use. But how does a currency achieve an international status in the first place? And which government policies assist in that jump-start? Economic theory and the rise of the renminbi (RMB) in the last decade offer some clues.
Our analysis shows that for the rising currency to be used, three thresholds must be met. First, the cost of trade credit must be predictably low. Firms that borrow in the rising currency also want to denominate revenues in that currency to hedge against currency fluctuations. But, they will only borrow in the rising currency in the first place if the credit will almost always be available at a low cost. Hence, policies that backstop the cost of trade credit, be it a trade acceptance discount facility like the Fed operated in the 1920s or a swap line like the PBoC operates today, can help push a currency towards being used internationally.
The recent policy interventions of the PBoC offer a testing ground for these ideas, particularly on the importance of the availability and cost of trade credit. In particular, the swap lines it signed with different countries at different times provide variation that one can exploit to judge their effects. The swap lines are effectively a collateralised bilateral loan between central banks. The PBoC lends RMB to a counterparty central bank, taking a deposit in the counterparty’s currency as collateral. Operationally, this is similar to the swap lines currently employed by the Federal Reserve. However, the aim of the PBoC’s swap lines is to aid trade settlement in RMB (McDowell (2019)): the counterparty central bank uses the funds to lend on the RMB to banks based in its country to provide trade credit. So the PBoC swap lines share a similarity to the Fed’s discounting of trade acceptances a century ago. The difference is the PBoC relies on a foreign central bank to intermediate the funds it lends.
The full article is available at https://bankunderground.co.uk/2020/09/21/jump-starting-an-international-currency/