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China Currency Swaps and Prepping For the Last Monetary Frontier

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China appears to be waiting patiently in the wings, perhaps preparing for the next U.S. Dollar descent, or for another EU crisis to emerge.

China has been negotiating currency swaps in preparation for the day it must intervene on the world monetary front, perhaps making its currency the Yuan a defector candidate for reserve currency status as the Dollar's fortunes decline.

Currency Swaps

Currency swaps are typically motivated by comparative advantage, and the term can refer to two different types of transactions as follows:

· In the foreign exchange market, a currency swap is an agreement between counterparties to exchange one currency for another on one value date and then reverse the transaction on another value date.

· In the interest rate swap market, a currency swap can also refer to the exchange of principal and/or interest payments of a loan in one currency for an equivalent loan in another currency. This sort of currency swap should be distinguished from a liquidity swap performed by a central bank.

Central Bank Liquidity Swaps

In the 2008 global financial crisis, the Fed used forex currency swap transactions to enter into central bank liquidity swaps. In these foreign exchange deals, the Fed and the central bank of another major economy agreed to exchange their national currencies at the prevailing market exchange rate and simultaneously agreed to reverse the transactions at the prevailing forward market exchange rate on a specified future delivery date.

The stated goal of these central bank liquidity swaps was to "to provide liquidity in U.S. dollars to overseas markets." Although central bank liquidity swaps and forex currency swaps are structurally identical, currency swaps are commercial transactions driven by comparative advantage, while central bank liquidity swaps instead represent emergency loans of U.S. Dollars to foreign markets via their respective central banks.

It is currently undetermined if these transactions will benefit the U.S. Dollar or the United States over the long run, although they do represent an extension of credit to overseas nations.

China's Currency Swap Lines

China has recently made a well-publicized series of currency swap deals with other major economies, such as the UK and France, over the past three years.

Regarding China's recent currency swap line deal with France, Bank of France governor Christian Noyer reportedly said that, "The Bank of France has been working on ways to develop a RMB liquidity safety net in the euro area with due consideration of a supporting currency swap agreement with the People's Bank of China". Note here that the Renminbi is the Chinese currency, but the Yuan is its unit of account, so it is referred to by the currency code RMB.

In doing such swap deals, the country apparently intends to promote the more widespread use of the Chinese Renminbi in foreign trade and investment, although the currency still remains officially and intentionally undervalued due to forex market intervention by the People's Bank of China.

The Chinese are also stealthily buying gold, and China has become a net importer of silver too, along with just about anything else of real value the country can get its hands on to avoid being left with a pile of paper in the case of a fiat currency devaluation crisis.

China has Its Own Problems

The threat of a deflationary collapse in the Chinese economy seems to be growing. Another important issue is the growth of China's own huge credit bubble.

The Chinese seem to be playing it cool, perhaps waiting until the BOJ's recent money printing experiment ultimately fails. This already appears to be happening, as evidenced by the Japanese equity market collapse in response to the latest version of Abenomics.

In essence, this survival move on China's part will be seen as a threat to other nations due to the emerging Chinese economy's massive size.

China is Not an Enemy

The Chinese depend on the United States to buy their cheap products as much as Americans depend on the Chinese to make cheap items for them to buy.

Cheaper products are usually in greater demand in challenging financial times, while in abundant times people tend to seek out and pay up for higher quality items.

A sudden disruption to U.S. Dollar based trade would potentially set the United States and its trade position back decades, and preparation for this day's ultimate arrival has been happening for years.

Nevertheless, too many systems at the heart of survival and functioning depend on a stable financial trade mechanism. In the end, the only budget that matters is yours, and it is also the only place where you have some control. This remains the one to study, plan and forecast for.

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