The US–China clearing balance
How to collect on a trillion-dollar debt?
Debate over the future of the global monetary system is wide open: clever and well-informed observers have taken every stance on the issue from continuity to a complete remaking. FT Alphaville’s Claire Jones makes the case for the continued dominance of the dollar, citing a recent survey of central bank reserve managers. The IMF’s Gita Gopinath sees fragmentation, but with the US dollar retaining a central role. Rana Foroohar argues that we are headed for a bipolar world, with China emerging as the center of a new non-dollar bloc. And Credit Suisse’s Zoltan Pozsar posits a Bretton Woods III with a diminished and decentered dollar.
I don’t have a take on the big question, but I have a keen interest in understanding the evidence as it comes to light. One important data point comes from recent reporting by the FT’s Sun Yu on a meeting last month of China’s top bankers and government officials. On the agenda was the question of whether and how the country’s US dollar assets could be protected in the event the country were to be targeted by sanctions.
Balance of payments
Chinese nationals have substantial claims on the US. It is a simplification, but not too much of one, to say that these claims arise from the export-led growth strategy the country has pursued in recent decades. Mechanically, a country that runs a current-account surplus (a trade surplus, more or less) must save abroad the funds arising from its net exports; a country that runs a current-account deficit (a trade deficit) must borrow from abroad the funds to pay for its net imports.
By itself, the accounting identity says only that someone in the US is borrowing, and someone in China is lending. It does not say who within each country is doing borrowing or lending; neither does it say that the financial connection between borrower and lender is direct. But from the Fed’s data on foreign holdings of US securities, it is clear enough that much of the surplus has been accumulated in the form of US Treasury debt:
Time to settle up
In other words, China has for many years been accepting payment for its exports in the form of US securities, Treasury securities in particular.
These security holdings are serving the function of a clearing balance, a token that keeps track of the accumulated trade flows. But clearing balances are meant to be settled up from time to time, with the buyer eventually sending something of value to the seller to zero out the account. This has not happened between the US and China, and instead the outstanding clearing balance has remained high.
These securities are promises to pay by the US government. The dollar serves as international money, so it is not surprising that China, a big country with a lot of trade and financial flows, would hold a lot of them. The institutional makeup of the international monetary system means that there is very little risk associated with Treasury debt.
But the US’s appropriation of Afghanistan’s foreign reserves earlier this year, and the financial sanctions directed at Russia since that country’s invasion of Ukraine, cast a new light on this arrangement. An observer might conclude that the institutional makeup of the international monetary system can no longer be assumed to be fixed.
China has accumulated its wealth in the form of dollars, so-called inside money whose value is its status in the institutions of the global monetary system as it is today. That system seems to be in flux, so it makes sense that Chinese bankers would give some thought to how they might get their money back. It seems significant that the bankers reached the conclusion that cutting China off from its dollar assets would be impossible:
No one on site could think of a good solution to the problem. … China’s banking system isn’t prepared for a freeze of its dollar assets or exclusion from the Swift messaging system as the US has done to Russia.
Of course this presents two possible interpretations: either the relationship between China and the US will not break down, or it will break down, but in a way that no one is prepared for.