Chapter

Currency Mismatches on the Dollar's Periphery

Ronald I. McKinnon

in The Unloved Dollar Standard

Published in print December 2012 | ISBN: 9780199937004
Published online January 2013 | e-ISBN: 9780199980703 | DOI: http://dx.doi.org/10.1093/acprof:oso/9780199937004.003.0011
Currency Mismatches on the Dollar's Periphery

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An immature international creditor generates large saving surpluses, but its own currency is not used in lending to foreigners. Domestic financial markets are not sufficiently developed, possibly still with interest rate restrictions and capital controls, for foreigners to voluntarily borrow in that currency. In China's case, foreigners typically don’t solicit RMB-denominated loans from Chinese banks or seek to issue RMB-denominated bonds in Shanghai. The risk to foreign borrowers would seem even greater if China bashing inculcated the fear that the RMB might appreciate in the near future. Given dollar dominance, the only alternative for Chinese private (nonstate) financial institutions—such as banks, pension funds, and insurance companies—is to build up liquid assets denominated in dollars for financing China's trade (saving) surplus. But since their principal liabilities to domestic depositors, pensioners, and annuity holders are in RMB, any buildup of dollars assets would lead to a currency mismatch. A dollar depreciation could wipe out their net worth. The upshot is that they would be unwilling to accumulate the dollar claims from the trade surplus. Thus a pure float, where the People's Bank of China withdrew from the foreign exchange market, would result in an indefinite upward spiral in the RMB.

Keywords: immature international creditor; saving surplus; currency mismatch; pure float; upward spiral

Chapter.  2368 words. 

Subjects: Financial Markets

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