For example, US Treasuries are denominated in dollars, and when the purchaser
redeems or sells the bond he receives dollars in return. A panda bond would be
denominated in the Chinese currency, the yuan. That means any purchaser would
pay yuan to own the bond and he would receive yuan when he redeemed or sold the
bond. Remarkably, however, the issuer of a panda bond would not be any Chinese
entity (central bank, state bank, company and so forth) under this relatively
new proposal. Instead, the issuer would be the IMF, the US Treasury and/or US
corporations. Potentially, issuers could include other non-Chinese
entities as well. At this point, let's step back a bit of a distance and
analyze what this proposal really means.
Since any bond issuer is a borrower from international lenders, what we're
saying here is that the IMF, the US Treasury and/or US corporations would be
issuing panda bonds for the purpose of borrowing in foreign currencies, in this
case specifically the yuan. Why would these issuers even consider such a
possibility? In fact, it has been done before in the recent past.
You may have heard of the term "Carter bonds". In the 1970s, the dollar was
declining so rapidly that foreign lenders became afraid the US Treasury would
repay its debts in much weaker dollars, so they soured on buying US sovereign
debt. In order to defend US finances, president Jimmy Carter directed the US
Treasury to issue billions of dollars of US Treasuries denominated in German
marks and Swiss francs so as to attract foreign investors into Treasuries.
Fundamentally, then, issuers like the US Treasury prefer not to issue bonds
denominated in foreign currencies but may be forced to consider doing so when
the dollar (or the currency of another issuing government) declines too far too
fast and foreign lenders become concerned that the issuer is attempting to
inflate away its debt. In such situations, regarding the US, foreign demand for
the dollar and for Treasuries sinks, forcing the US Treasury's hand. In fact,
we are now nibbling on the edges of just such a perilous situation for the
dollar and for Treasuries as yields escalate and foreign demand is undermined.
How does a panda bond work? The issuer (the IMF, the US Treasury or a US
corporation) issues the bond denominated in yuan and sells it on the
international bond markets. The buyer (a private or official Chinese or other
investor) pays yuan to own the bond. The issuer doesn't want yuan, but does
want dollars. Therefore, he goes to the international currency markets and
exchanges (sells) his yuan for US dollars.
Now he's happy because he has succeeded in borrowing dollars, his original
intent in issuing the panda bond in the first place. The owner of the panda
bond is happy because he holds a financial asset that isn't denominated in the
ever-more worrisome US dollar. When the owner wishes to redeem his panda bond,
the issuer uses dollars to buy yuan on the international currency markets and
pays the owner yuan to redeem the bond.
You can begin to see that to the extent the issuers of panda bonds increase the
supply of such bonds, then they bear the currency risks associated with the
dollar, relieving the rest of the world of such risks. Thus, panda bonds are an
effective way of focusing dollar currency risks back onto the US.
Very importantly, they are also an effective way for China's central bank to
decrease its exposure to the dollar. How so? When the issuer (the IMF, the US
Treasury, a US corporation) of a panda bond receives yuan at the point of sale
of the bond, he must then buy dollars on the international currency markets.
China's central bank enters the picture here - it can provide the dollars
sought from its excess of dollars held in its forex reserves. Therefore, from
the perspective of China's central bank, it is selling dollars for yuan, thus
decreasing the dollar portion of its massive reserves, and all the while the
issuer (the IMF, the US Treasury, or whoever) bears the full currency risk
associated with the dollar. In effect, China's central bank is lending its
undesirable excess of dollars to foreign borrowers. But here's the best part
from the perspective of China's central bank - when the loans are repaid with
interest, they are repaid in yuan, not dollars. So it becomes a win-win
situation for China's central bank.
There are obstacles. One is that the yuan is not yet convertible; another is
the traditional desire of the Chinese to control bond issuance. But these
obstacles are by no means insurmountable. In fact, both the Asian Development
Bank and the World Bank's International Finance Center issued panda bonds in
October 2005 as part of attempts to deepen China's domestic bond market.
Additionally, China's leaders are taking meaningful steps to increase the
international role of the yuan. And in late May this year, China has paved the
way for international companies to issue securities in its currency for the
first time, telling two foreign commercial banks they have its backing to sell
yuan-denominated bonds to overseas investors. The China units of London-based
HSBC Holdings and Hong Kong's Bank of East Asia each confirmed an official
notice that they have been granted permission by authorities in China to launch
international bonds denominated in yuan. The banks plan to issue the debt in
Hong Kong to fund their China-incorporated banking networks, which are the two
largest among foreign banks operating in the world's most populous nation.
Historically, China uses Hong Kong as a trial point for new financial
instruments. So this new development strongly suggests that China's leaders are
very serious about instituting this mechanism sooner rather than later.
The reader should be careful not to push such a development far off in his own
mind, for, against the backdrop of rapidly increasing worries about the dollar,
international pressure is building fast upon the IMF and the US Treasury to
issue panda-type bonds - bonds denominated in foreign currencies. For example,
late last year, a number of top Japanese economists called for the US Treasury
to issue Treasuries denominated in yen. Japanese officials are increasingly
worried that Japan's huge holdings of Treasuries are at risk from a declining
dollar.
The fact is that a situation is rapidly developing where foreign demand for
Treasuries is coming under rapidly increasing pressure - remember the strategic
shift to the short end in the patterns of lending by foreign investors that is
detailed in Part I of this series.
The tipping point is rapidly approaching where foreign lenders will be unable
to justify deepening their exposure to the dollar. In a sense, this becomes a
game of chicken between the lenders and the borrowers to see who blinks first.
The lenders, already massively exposed to the dollar, most certainly are not
the ones that will blink first. The borrowers (primarily the US Treasury),
increasingly at risk of a full-blown implosion of their finances, will be the
ones to blink first by agreeing to issue panda-type bonds. This development
could be mere months away.
When it does unfold and builds sufficiently, then it is possible to envision
within the next very few years the development of a bond market centered in
Asia to rival the depth and liquidity of the present Treasury market.
Especially is that foreseeable if the dollar's troubles continue to mount.
Increasing numbers of global investors will want to hedge against dollar losses
and they will see an alternative bond market as more and more appealing.
If China and its emerging market partners do emerge from this crisis as the new
collective driver of global demand and growth, as now predicted by a number of
expert sources and institutions, then such an Asian bond market will be part
and parcel of such a global role.
Next: Decoupling from the US
W Joseph Stroupe is a strategic forecasting expert and editor of Global
Events Magazine online at www.globaleventsmagazine.com
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