China's USD Bond

Summary

In this live stream, the speaker addresses the recent issuance of a Chinese bond in Saudi Arabia, debunking the idea that it represents a major shift in global financial power. He explains that the issuance is part of the Eurodollar market, a long-standing system where the demand for dollars outside the US is high. While the move aligns with Saudi Arabia's ambitions to become a financial hub, it is not a game changer for the US dollar’s dominance. The speaker cautions against overestimating the impact of such events, emphasizing the importance of context and the challenges posed by currency fluctuations.

Takeaways

• 😀 The live stream serves as the weekly episode for 'Milkshakes Markets and Madness,' as the host is out of town attending the New Orleans Investment Conference.
• 😀 The focus of the discussion is a recent bond issuance by China in Saudi Arabia, which has sparked a lot of attention and speculation in the media.
• 😀 The bond issuance is not unique; it is part of the larger Eurodollar market, where countries issue bonds in dollars outside the United States to meet demand for US dollars globally.
• 😀 The bond was issued in Saudi Arabia to position the country as a financial hub in the Middle East, not necessarily to shift control of the dollar market to China.
• 😀 While China benefits from obtaining US dollars through the bond issuance, the majority of the bond buyers were Chinese financial institutions, which participate for regulatory and tax advantages.
• 😀 The bond was issued in US dollars rather than Chinese yuan because Saudi Arabia's economy is dollarized, and the country prefers to hold dollars due to its currency peg to the dollar.
• 😀 Issuing bonds in dollars is a common strategy for countries outside the US, but it can be risky if the dollar strengthens, as repayment becomes more expensive.
• 😀 The notion that China can now control the global flow of dollars is exaggerated; while China can issue dollar credit, it cannot create base dollar money, which remains under US control.
• 😀 During times of credit contraction or a financial crisis, no country other than the US can recapitalize the global financial system, reaffirming the US's dominant position in global finance.
• 😀 The host advises caution in interpreting headlines that suggest major shifts in the global financial system, reminding viewers that the true test of success will come during a credit crunch, not during a credit expansion or bull market.

Q & A

What is the significance of the recent bond issued by China in Saudi Arabia?

The bond issued by China in Saudi Arabia is part of China's effort to raise dollars outside of its own currency, the yuan. While it may suggest deeper economic ties between China and Saudi Arabia, it is primarily a financial maneuver to access US dollars, which are needed for China's economy. The bond was sold to investors in Asia, mostly Chinese financial institutions, rather than directly to Saudi investors.

Why did China issue a dollar-denominated bond instead of a yuan-denominated one?

China issued a dollar-denominated bond because Saudi Arabia, where the bond was issued, operates a dollarized economy with its currency pegged to the US dollar. This ensures that Saudi entities and banks are more comfortable purchasing bonds in dollars rather than yuan.

What is the 'Eurodollar' market, and how does it relate to this bond issuance?

The Eurodollar market refers to US dollars held outside the United States, typically in foreign banks and financial institutions. The bond issuance is part of this larger Eurodollar market, where countries and entities outside the US issue bonds in dollars to meet their financial needs. This practice is not new, and China's issuance of a dollar bond is just another example of this market in action.

Why is it misleading to claim that this bond issuance marks the beginning of China controlling the global dollar market?

While the bond issuance is interesting, it doesn't signal China gaining control of the global dollar market. The bond was issued in Saudi Arabia, but most of the buyers were Chinese financial institutions, which is more of a tactical financial move for China. Additionally, the ability to issue dollar-denominated debt does not equate to controlling the flow of US dollars globally. The US still has the power to dictate monetary policy, especially in times of financial crises.

How does the 'Milkshake Theory' relate to the bond issuance and the broader global financial system?

The Milkshake Theory suggests that the global demand for US dollars is so high that the US can pursue loose monetary policies without causing severe inflation or financial instability. The bond issuance is an example of how other countries, including China, are tapping into the demand for US dollars, but it doesn't change the fact that the US controls the flow of dollars in global markets, especially during a crisis.

What are the risks associated with issuing bonds in a foreign currency, like China's recent bond in dollars?

Issuing bonds in a foreign currency, such as the US dollar, exposes the issuer to exchange rate risk. If the value of the local currency (like the yuan) declines relative to the US dollar, the issuer may face higher repayment costs. This is a common risk in carry trades, where investors borrow in one currency and invest in another, hoping for favorable exchange rate movements. If the dollar strengthens, repayment becomes more expensive.

Why did Saudi Arabia want the bond to be issued in US dollars instead of yuan?

Saudi Arabia wanted the bond to be issued in US dollars because its economy is dollarized, with the Saudi riyal pegged to the dollar. By issuing the bond in dollars, Saudi institutions align their liabilities with their dollar-denominated assets. Additionally, the US dollar is widely preferred in global trade and investment, making it a more attractive option than the yuan.

How does the concept of 'carry trades' apply to China's dollar bond issuance?

Carry trades involve borrowing in a currency with low interest rates and investing in assets denominated in a currency with higher yields. In the case of China’s dollar bond issuance, Chinese banks and institutions buy these bonds because they receive a tax advantage and better financing rates. However, if the dollar strengthens relative to the yuan, these institutions will face higher costs when repaying the debt, as they must convert yuan into dollars.

What does a credit contraction mean in the context of the US dollar market?

A credit contraction refers to a situation where credit is no longer freely available, typically because banks and financial institutions stop lending. In such a scenario, the demand for US dollars increases, as everyone scrambles to secure the few dollars available. This can lead to a global financial crisis, as countries with dollar-denominated debts struggle to meet their obligations due to the higher cost of borrowing.

What does the US have that no other country has when it comes to managing global monetary crises?

The United States is the only country that can create US dollar base money, which is crucial for managing global monetary crises. While other countries can extend credit in US dollars, only the US government and the Federal Reserve can print more dollars or inject liquidity into the global financial system during a crisis. This gives the US unparalleled control over the global monetary system, especially during times of economic stress.