There's a lot of discussion these days about de-dollarization and whether the US dollar will lose its standing as the world's sole reserve currency. Generally, people seem open to the idea, but they also don't see many good alternatives out there. The renminbi is the obvious candidate to take share away from the dollar, given the size of the Chinese economy and China's role in global trade. But for various reasons, the currency isn't suited to be a global reserve currency. So what would it actually take to become one? And what would be the effects if it started to play a major role in global trade? On this episode of the podcast, we speak with Karthik Sankaran, a longtime FX veteran, about what China would have to do if it really has global aspirations for its currency, and why a more multipolar FX landscape might be good for world financial stability. This transcript has been lightly edited for clarity.
Key insights from the pod:
Are countries really trying to move past the dollar? — 4:00
Does a reserve currency issuer need to run a trade deficit? — 6:43
Should Brazil issue RMB-denominated debt? — 9:06
Why it’s so hard to issue debt in RMB — 11:18
Does China need to internationalize its currency? — 14:39
What types of domestic reforms would China need to make? — 17:40
Is the dollar a burden for the US? — 19:48
Would an international RMB make the world less fragile? — 24:11
Is a change already underway? — 26:32
What are the domestic costs of RMB internationalization? — 31:01
What are the signs to watch of reform taking place? — 33:59
Why hasn’t Belt & Road lending been done in RMB? — 37:24
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Joe Weisenthal: (00:10)
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (00:14)
And I'm Tracy Alloway.
Joe: (00:16)
Tracy. Dollar strength. Dollar dominance. The conversation is not going away.
Tracy: (00:23)
No I mean it's never gone away. That was our intro for the last episode we did on this topic, which is, it seems like every couple of years you get this resurgence about, “oh, the end of the dollar, the dollar's going to lose its exorbitant privilege.” I remember my dad sending me articles about like Iraq is invoicing oil in euros, like in 1998 or something . Lots of conspiracy theories around that one.
But I will say we had that conversation with Paul McNamara. It was a really good overview of some of the talk that's happening right now and why certain countries, specifically emerging markets like China, might want to get away from the dollar. But I feel like there's more to say,.
Joe: (01:06)
Well, alright, I'm going to make a confession, which is that in all of these conversations, there are certain things that people say and I just sort of like nod my head. I’m like “mm-hmm, mm-hmm.” And I say “mmhmm, that's right. That's right.”
But I don't totally get them. And one of them, and it's not even so much about the dollar per se, but about dollar alternatives. And the big one is like, well, the RMB cannot be a real dollar alternative until China runs a current account deficit. And I’m like “that's right. That's right.”
But beyond that, I actually do not totally get what that means or what actual constraint China's trade position with the rest of the world means for the future of RMB internationalization.
Tracy: (01:41)
Well, I think the way I would frame it is, one thing we hear is that there isn't a viable alternative to the dollar. There are no other currencies/country economies that are at the level the US is, that could possibly replace the dollar. And so I think we need to talk about why that is and what exactly that means. I get the idea that okay, maybe a country doesn't have enough financial assets for savers to buy to put their excess money in. I get that, but what does it mean that it's not a viable alternative?
Joe: (02:15)
Right. And I guess the question is like, okay, but what would it take? Like yes, we can sort of agree this basic premise. Maybe there's some impulse for some countries to move away from the dollar. Also, there are no real alternatives at this point, but maybe at one point there will be. But actually what would it take for another currency — maybe the RMB maybe the Euro — to actually become a meaningful global reserve asset.
Tracy: (02:38)
If China woke up tomorrow and put this like at the top of its agenda — I don't think it's going to — but what would that sort of 10 step plan actually look like?
Joe: (02:47)
That's a great way to frame the conversation. What would it actually look like? So we are going to sort of have part two to our recent conversation with Paul, actually a long time a friend of Paul's. So maybe a similar different perspective, but sort of a follow-on of what would it take for some other currency to be a meaningful global reserve currency. I'm very excited. We're going to be speaking with Karthik Sankaran, a true FX veteran recently at Corpay. He's been at Eurasia Group, multiple banks, an avid maker of dad jokes and puns on Twitter.
Tracy: (03:19)
And he used to actually cover Paul when he was trading.
Joe: (03:21)
So a perfect guest for this conversation in many respects. And someone who I feel like I've wanted to have on the show for years and is in my mind, already an Odd Lots guest, even though he hasn't been on the show before. Karthik Sankaran, thank you so much for finally joining us here.
Karthik Sankaran: (03:36)
Thank you very much for having me. It's an absolute pleasure to be here. And honor.
Joe: (03:40)
What does that mean? Actually, I want to get to the alternatives, just before we do though, real quickly. I mean, you listened to our recent episode with your long time friend and colleague Paul McNamara, in which he said there is some global impulse for countries to stop using dollars, but there really aren't many alternatives. Do you basically agree with that premise?
Karthik: (04:00)
Yeah I'd say two things about that. One is I think going to replacement — and that's how this usually gets framed as replacement; I think that's silly — and the way I think about it is, would it make sense to see creeping regional displacement rather than replacement? And I think that's a possibility. And I would argue that the euro has already done that to some extent. Not just in the euro area, but also in central and Eastern Europe.
You know, and I remember when I started my career, you know, if you wanted to trade zloty you traded dollar polish. And if someone asked for a price in mark-zloty, you traded through the legs. Now it's the other way around. You know, if someone asked for a price in dollar-polish, you trade euro polish in euro dollars.
So it's taken a long time. But, and I think that's this regional displacement idea, but what this also brings out to me at least, is everyone is so excited about the renminbi, kind of this Brics currency and so on. And one way to frame why I think there is the desire, but it's a very long way from being fulfilled, is that look at what the euro has, which is kind of a solid number two. Kind of like Avis to the dollar's Hertz, at least that's the way the old commercials used to go. But the renminbi is really, really far behind. And one thing, just because I've been introduced as an avid maker of dad jokes...
Joe: (05:35)
Okay, here we go...
Karthik: (05:38)
You mentioned a 10 step program for renminbi internationalization? And I was reminded that the last person who had a 10 steppe program that really worked was Genghis Khan
Joe: (05:54)
Okay.
Tracy: (05:58)
<Laughing> Okay. Sorry, I'm going to lose it at the dad jokes. Just to back up a second...
Joe: (06:03)
Oh! It took me a second to get that one actually. Sorry, that took me a second to get that. That's a good one. Okay, we're going to have a fun time here.
Tracy: (06:10)
Just to back up and ask this question in a different way, I mean, there is this assumption that China would want to have renminbi internationalization. Should they want that? If you consider China as an export-driven economy that exchanges goods in return for US dollars, which are a relatively stable currency, does it make sense that it would want to have a different economic model? What are the benefits that it gets out of that?
Karthik: (06:43)
I mean, I disagree with this and this something that Joe mentioned in the beginning, does the country at the center of the international monetary system need to run deficits? And I don't think that's necessary in fact, because you have a model, Britain under the gold standard was a huge exporter of capital. The US until the mid 1960s was the center of the Bretton Woods system and was also a huge exporter of capital.
So what that suggests is that it is possible for a surplus country to be at the center of the monetary system. You just have to find a way to get that currency out the door in size, in massive size. And you can do that either through the trade account, by running very large external deficits, or you can do it by externalizing great gobs of capital either in your currency or that other countries are denominating in your currency.
So I think that's one way to think about it, but clearly China is not there and they’ll have a very long time getting there. Not just because of the issues with capital account convertibility, but there's a lot of things in the basic way that Chinese financial markets operate that make it difficult even for other people to issue in renminbi in size.
Joe: (08:10)
So let's jump into this because I think this is a point that I have not really heard many people make. People make the point that one way to get your currency out there into the world is to run a big trade deficit.
But as we know, and I'm even thinking back to some of our conversations with Lev Menand about the rise of the shadow banking system and eurodollars, the other way is just for other entities to start issuing your currency or assets that are denominated in your currency. And theoretically, I could issue a renminbi denominated loan and tell someone I'm going to pay them back in renminbi.
But you made this point with respect, you had great thread with respect to Brazil, which is that actually what we need to see is countries like Brazil being willing to take out renminbi-denominated debt. Can you talk a little bit about the importance of that? I think that's a very powerful thing not many people have talked about this element of it.
Karthik: (09:06)
Yeah, and I think there are actually two issues. In some ways it might actually be a good idea for Brazil to issue renminbi debt, right? And I think this is one of the arguments for a multipolar system more broadly, is if you're a country whose terms of trade are driven by what's happening in China, if your business cycle is much more responsive to China, then it makes sense to be able to issue in the Chinese currency.
Because what you don't want is to be in the situation that you see emerging markets end up in all the time they've issued in dollars, they’re commodity exporters, commodities are priced in dollars, the world slows, China slows commodity prices tank, the dollar goes up and they're hosed. I mean this is like this rinse and repeat cycle in the international financial system. So it might actually make sense for, in that thread, I was saying like, I'll get excited when CBRD issues a huge amount in Panda bonds, but that's difficult. That's really difficult. And there's so many different reasons for that related to the way Chinese financial markets work.
One is if you issue in renminbi, which renminbi do you want to issue in? Do you want to issue in the onshore market which is deeper. Or do you want to issue in the offshore market, where you might have more people able to transact, but it's a much [more] seller market. If you do end up issuing the offshore market, obviously they're, you know, and you may not want to, the reputation that Chinese investors have is of being somewhat more excitable. I think we've seen that in the equity markets. On the other hand, if you issue offshore, the problem is that China not only has two currency, CNY and CNH and offshore currency and offshore currency that trade reasonably closely together a lot of the time. But one of the ways they do that is by having different interest rates.
Joe: (11:16)
Ah...
Karthik: (11:18)
And one of the things the Chinese do periodically is when they're worried about the speculative pressure on the renminbi, which they think is coming from offshore players, is they will jack up interest rates on CNH, they will take it to the moon. We've seen it a few times, which might work in deterring the speculators, bring speculative pressure back down again, get CNY and CNH to converge. But that's really not that comfortable if you've issued debt in the offshore currency.
So one of the things that the US has the dollar, has is incredibly deep derivative markets, for instance. So if you issue in dollars and you want to hedge your interest rate risk, you can do it by trading your eurodollars — probably one of the most liquid financial futures contracts of the world. And renminbi financial futures — interest rate futures are just a very, very, very small fraction of that.
The other issue with issuing onshore is, you know, China has this huge domestic debt market. It's the world's second largest domestic debt market, but to a very significant extent, it's composed of entities with opaque finances, right? The CGB market, the Chinese government bond market is a relatively small fraction of the onshore market.
And Treasuries are not the entirety of the US market either, but the opacity of entities issuing domestically is significantly hard. My one-liner on this is everyone talks about China not having a rule of law. My view is that the real problem is that China doesn't have rule of accounting. That's the real issue here.
Tracy: (13:06)
I was expecting another dad joke. I was steeling myself. Karthik, so I guess this brings me to the big question, which is how much of this boils down to just capital controls and the fact that China does not have an open economy? And you might expect that one of the requisites for having an international currency would be to have relatively free movement of that currency.
Karthik: (13:29)
Absolutely. I think capital controls are a, and that's the obvious one. And they're trying to tinker with it at the edges, allowing more inflows and outflows. But even at those edges, you know, what I was trying to get at was this idea that you have an offshore renminbi that's much more freely tradable than the onshore renminbi. But there are very sizable disincentives to issuing in size in the offshore renminbi because of these things like a smaller market. How do you hedge? So capital controls are a huge part of it, but if you dig deeper into capital controls issue, I think it raises more questions.
Joe: (14:12)
Well then I would sort of want to maybe just go back to a question Tracy asked, which is, is there a reason China should pursue the internationalization of the renminbi? Or should pursue having more global central banks hold renminbi as part of their reserve stock? Is there some obvious reason why it's not going to be number one on the agenda, but is there a reason why it should be on the top 10 or top 20 of the agenda?
Karthik: (14:39)
I mean, one of the things that they've said for years is that they want to see a more internationalized renminbi. But I think when they look at the trade-offs that they might need to make, I don't think they're ready to take a huge jump. And I think the the other issue is that we've seen this before, right? Japan didn't want to either.
And about 30 years ago, people were talking about the extent to which Japan and the yen could act as another reserve currency, and the Japanese just decided they simply didn't want to because of the pressure it would put on the profitability of their industrial base. Things are somewhat different from China in the sense that they seem to have a hankering for kind of broad spectrum global power in a way that the Japanese did not have.
And maybe having an international currency is, is part of that, but to the extent that it happens, it would likely be much more halting. But they've got a really, really long way to go in this regard.
Tracy: (15:57)
So, Karthik, just going back to the deficit idea, and I know you kind of spoke to this already, but what if instead of telling China to run a massive deficit, what if China was able to retool its economy in some way where... I mean, the reason it runs this big ball of savings that tends to roll around internally is because there isn't that much of a social safety net. There isn't that much of a social welfare state.
And so people tend to accumulate a lot of savings or maybe rely on their children. But given the one child policy that's been in effect for a long time until recently, that wasn't really viable. What if China just built a social safety net to reduce the excess savings? Would that go some way towards retooling the economy in such a way that you could have RMB internationalization?
Karthik: (16:50)
I mean, yeah, I think so. I mean, to my mind it would actually take care of two or three different issues. And one is the underlying growth model in and of itself, right? Because you've kind of, you know, all the low hanging fruit on investment, particularly real estate investment, they're gone.
And I've kind of tended to be an optimist about China because I think you kind of need two things. One is a kind of demonstrated capacity for technological convergence and income convergence for the rest of the world, which they've shown. But the other thing you really need is internal convergence between kind of the coast and the interior.
Tracy: (17:33)
More middle income in the middle kingdom. That's my dad joke.
Karthik: (17:38)
I like that. And you know, you kind of look at works about what rural China is like. There's a huge incentive both socially and economically to do that. I think the other thing that lower precautionary savings would achieve is there would be a contribution to ending this kind of really horrible nexus of excess savings, no place to put them and underfunded mandates for local governments, which then end up having to sell real estate to developers in order to, you know, to get the money to provide the services the central government won't. So there's this really nasty nexus right there that a larger social safety net would also help with. It'd help with financial stability, I think.
Tracy: (18:33)
Joe, this is something that I've never really understood about China, that it's ostensibly a socialist country, but it actually doesn't have that big of a social net.
Joe: (18:41)
Not much of a safety net, I think they’re anti-unions. And weren't there like stories like they didn't want kids reading Marx and stuff like that? I think I read something. Anyway, I don't want to speculate on things that I don’t know.
Karthik: (18:53)
Well, you know, the Chinese road to socialism is the Leninist road to capitalism, is kind of how you could think of it.
Joe: (19:00)
There you go. Going back to the US real quickly. So you pointed out that Japan decided in the end it didn't want to make the trade-offs that would've [been] required for the yen to be a big international currency and maybe China will not anytime soon choose to make those trade-offs.
But that of course brings [us] back to another sort of like other debate that people have. And again, Klein-Pettis and some of these others, it's like, well, is the dollar strength a burden? And should we reverse, basically, should we try at some level at least at the margins try to de-internationalize the US dollar? I'm curious where you stand on that question.
Karthik: (19:39)
My personal view is that the, my response to the burden discourse is check your exorbitant privilege. Because you know, I've been around EM long enough that I think that if you think being able to print dollars to pay your debt is a problem, try owing dollars without having any, right? So that's, you know, that's extreme.
But I guess more substantively, I would say that there are lots of reasons I don't think the dollar is a burden. It certainly is a burden for certain sectors of the US economy that are very exchange-rate sensitive and very exposed to kind of catch up growth in other countries, you know, and those regions also fall basically along America's political fulcrum, which is the upper Midwest and Western Pennsylvania, you know, so I think that adds a political urgency to this debate. That said, you know, the US in total, I think is a much more interest rate sensitive economy than it is an exchange rate sensitive economy. It's basically a much more closed economy than either China or Europe.
And if you think that the flip side of dollar centrality leading to dollar strength, which I'm also not convinced is always true, is lower interest rates than otherwise, then you have to ask the question, why are we not doing more with that windfall from low interest rates? Why did we sink it all in countertops as opposed to doing things like, you know, improving LaGuardia 15 years ago or building a better BQE. I've only been here five years, so all my analogies are still East Coast analog analogies.
But you know, I think finally we're moving that direction of having a more activist government that uses that potential windfall from issuing currency to do something more in terms of building out essential infrastructure rather than being, “Oh, the government always do stupid things, let's give it to the household.” So, you know, then you end up with what happened before 2008.
But that said, the evidence that dollar centrality — which has been true basically since 1945 in one form and since 1971 in another — always leads to dollar strength, I think is not really true because in the 50 years since 1971 and Bretton Woods essentially ended, the dollar, you know, I'm an FX guy, the dollar has appreciated for 55% of that time and depreciated for 45% of that time.
The period of maximum current account deficits by the US is between 2002 and 2008. We were running a current account deficit of close to 6% of GDP in 2006. The US current account deficit was the largest in terms of rest of the world GDP back then and close to 2.5%. And no one wanted to hold dollars. I remember that. I remember, you know, that was when Giselle wanted euros. So this idea that you have an excessive demand for the safety of US assets that leads to dollar strength is not true. It's not true in the 1970s. It's not true between 2002 and 2008.
People want to hold dollars when US interest rates are rising — when you have terms of trade shock like shale, when you have a perceived technological productivity miracle like the internet boom between 1995 and 2002. Those are strong dollar moments, but the dollar goes up and down all the time it's been central. And I think that's not appreciated enough in the “burden” discourse.
Tracy: (23:24)
So what about ex-US and you know, I take the point about maybe that dollar centrality doesn't always lead to dollar benefits necessarily, but one argument that has been made, and I think it came up in the episode with Paul, is that the dollar can be a problem for the rest of the world at various points in time.
And, you know, we've had Hyun Song Shin on the show talking about this idea that the stronger dollar basically acts as an economic drag on other economies because of its role in the world and in trade and business activity. Is there an argument to be made that maybe it would make sense from a financial stability perspective, for instance, to have alternatives to the US currency?
Karthik: (24:11)
Absolutely. I am a 100% multi-polatarian on that front, right? And the reason is this idea, you know, like I was saying earlier, if you think about the global real economy organized around some hubs and there are spokes, right? And, you know, if you think about Germany or kind of Germany, France being a hub, what the EU has done and what the Eurozone has done and the extended EU has done, has created a financial cycle that kind of parallels the real cycle in the hub, right?
Because if you're borrowing in euros and you're highly exposed to what's happening in Germany or the broader core European economies, when that economy slows, the euro will go down, the ECB will cut rates — unless it's doing something really stupid, which it does periodically. That cannot be excluded.
But still, that kind of coincidence of real and financial cycles is really important. And a world in which the dollar is the only currency and the most important cross border liability currency, which is something also I keep harping on [about], is that the big role is as a liability denomination, not as reserves, not as invoices, none of this stuff. And that's where the financial stability issues come from. If you are indebted in a currency that tends to strengthen every time the global economy slows, it's bad news for everybody. And that's consumption spark.
Joe: (25:55)
This is also like, not to diverge, but this is also what the Bitcoiners never get — the liability aspect because, sure, some people may like the idea of getting paid in Bitcoin, but no one really wants to take Bitcoin-denominated debt. And I don't want to have a big crypto or Bitcoin tangent, but it really is the liability side that's crucial and you have to ask yourself, are you willing to take on debt denominated in this currency? And I don't think many people would say “yes.”
Karthik: (26:32)
No. But I think the other thing is also, I think the liability side is also really important to the broader discourse about this, because you see all this excitement about “Oh my God, they're going to do their trade in dollars.”
And yeah, it's interesting because this is your classic economic comparison, right? One of the ways you end an argument with an economist is “you're confusing stocks and flows.” But I think that's exactly what's at issue here. People are focused on the invoicing, which is a flow. But the stock of debt is a multiple both of reserves and of trade flows.
Tracy: (27:12)
So okay, classic stock versus flow thing going on there. But one of the things you do hear from China every once in a while is, you know, it might talk about invoicing more stuff in renminbi, but it also talks about special drawing rights — so SDRs, which I have never quite understood exactly what these are But this idea of , I think it's basically a basket of currencies, like a super-currency that would involve a lot of currencies from different countries. How viable is that? Like maybe instead of trying to create a multipolar currency reserve system, maybe we should just move on to SDRs and use those?
Karthik: (27:58)
I mean, I think that's even less likely frankly. I mean China's big tantrum over SDRs was in 2009. And one of the reasons for that was the Fed did QE and you had a situation where the dollar had resumed weakening again after this huge dollar spike, you know, post-Lehman.
And what China was concerned about at the time was that it was holding all these dollars, the Fed was doing QE and commodity prices were rising again in good part because of Chinese stimulus, you know, post crisis stimulus. And also because of QE.
So at that junction China was like, “Oh my god, the Americans are doing things that's making the real value of our reserves go down.” It's kind of very similar to the Arab reaction in the 1970s, for instance. And I think that's one of the things that kicked off OPEC, was not just the yYom Kippur war and all this other stuff. It's like, “we're holding all these dollars and now they're worth less because the US is now floating.”
Tracy: (29:06)
This is the old Dick Bove argument that QE was actually like a currency war in disguise almost, right? That's what it's reminding me of.
Karthik: (29:15)
I mean, interestingly enough, I think to some extent, not so much currency war but more just a way to reflate to the US economy. And I think the Fed was kind of coy about that. The Fed had been, has been pretty coy about the dollar until 2014/2015, when it was finally like, “okay, we'll just come out, we'll just come out and say it.” And that's wonderful. The Fed’s been much more open about the way the dollar figures into its thinking. You know, the world needed reflation and it got it from US monetary policy and Chinese fiscal policy. And together, that's what did a good deal to pull the world out of its slump in 2008 — was this combination of US monetary policy, you know, Fed QE and Chinese fiscal policy. Huge investment boom.
Joe: (30:20)
I want to go back to Chinese domestic trade-offs and this idea, you know, I think we have some idea that the elites might lose out in China were there to be some domestic reorientation towards more robust household consumption, or maybe just from the question of Japan in terms of they didn't wanna make those trade-offs that would that would allow the yen to become more international.
What are we actually talking about in terms of the potential costs, either to the country as a whole or to a certain category, maybe the coastal elites within China, and what kind of like hit, loss or meaningful shift? Because it's hard to like, okay, yeah, there's gonna be some domestic shift that happens everywhere. What are we really talking about in terms of how significant that would be?
Karthik: (31:01)
I'm honestly not sure to be frank, and this is probably a question for, you know Tom Orlik or Mike Pettis. You know I’m not a deep expert in China to the same extent I pretend to be an FX expert, or anything else like that. But one thing you do know about China is that the leadership sets a fair amount of store in kind of output legitimacy, right? In that, you know, “we're doing things that make people's lives better,” which is a very significant difference from the Soviet Union, you know, where the big calling card was, “We won the war, what do you want from us? We won World War II” and increasingly that kind of became, you know, this is all we have to show.
The Chinese leadership is not like that. It's had real gains I think it can point to, and presumably it makes sense for them to want that to continue. Now the question is, can the leadership deliver on those things? And to what extent are the forces or powers-that-be within China that are not the leadership — this kind of intermediate level — to what extent are they against that? The one thing I can actually think of, which seems to be a concrete issue, is changing hukuo registration requirements affects the relatively privileged status of people who have that and the ability to live in cities.
Tracy: (32:25)
This is allowing people from the country to move more freely into cities and vice versa, although no one ever really does the versa part.
Karthik: (32:32)
And then the other one, which is more obvious, is issuing some kind of tax on residential real estate so that you kind of increase the cost of carry on housing, which is otherwise basically considered a pure appreciation asset. I can see those two being concrete disincentives to people that I can distinctly identify.
But as to why China doesn't have a larger healthcare [program], a better social provision of healthcare, for instance. They only spend I think 6% of GDP on healthcare, one third of the United States. And France is kind of the sweet spot at 12%, according to me. I don't really see where the actual, maybe I don't have enough granular understanding of the social structures, as to why people might be opposed to that.
Tracy: (33:23)
Well, I mean, I guess in the US we have the same argument all the time about, “Well, why don't we just reform the healthcare industry?” It's so easy and clearly there are major issues with doing that.
But Karthik, just to go back to the, the original premise of this conversation, I don't expect you necessarily to come up with a 10 steppe-Genghis Kahn style plan on the fly, but what would be the steps or the prerequisites that you would look out for in order for the renminbi to achieve some degree of internationalization?
Karthik: (33:59)
I think the most logical place to look for a given capital controls and so on is slow incremental renmibi-ization of Bridge and Road lending. That's the most logical place to look for it, because you have all these other issues. Capital Controls. Just the structure and nature of Chinese financial markets, that makes it much harder to achieve more on that front.
But Bridge and Road lending in particular seems to be a place where, you know, you have a very large stock of debt owed to China. Almost all of it is in dollars, not in renminbi. Which is interesting in and of itself. And the question is why is that? It's because they're just long a ton of dollars. Some of it is because of shadow, kind of shadow intervention by other entities that then pass those dollar along.
Now what you're doing in many of these instances is opening up exactly those kinds of kind of real financial cycle mismatches, stock-flow mismatches that I talked about more broadly. So could there be a way to change that stock of dollar denominated debt in BRI that's basically owed to Chinese development banks? Is there a way change that gradually into renminbi? I’m assuming that seems like the most immediate likely prospect right now.
And one interesting thing here is this idea that, you know, Argentina is going to denominate all its trade with China in renminbi, and obviously, you know, that trade is small. Argentina's problem is that it has I think $200 billion of debt, $120 billion of which are owed in dollars. But there's a very interesting thing from Brad Setser and Daniel McDonald this morning, talking about how this is really about how Argentina really wants to hang onto its dollars.
So what they're doing is changing the invoicing of their trade with China into renminbi but over a very, very long time. What this allows is a replacement of a stock of dollar debt owed to the rest of the world with owing renminbi to China because the swap line, they run a deficit with China. So you're gradually changing liability structure, but at an incredibly slow pace. My joke is, you know, this is like the Ron Paul “it's happening GIF” only you play it at the slowest possible speed you can find.
Joe: (36:40)
Just imagining that like a very slow … so it's happening?
Karthik: (36:45)
Yeah. You know, how do you replace a stock with flows? Very, very slowly. And it may happen, you know, they'll probably end up having a restructuring before then. I mean, the other places people have talked about with this are Laos and Cambodia, which gives me an opportunity to say, you know, Cambodia might find a new Nominal Angkor?
Tracy: (37:07)
Anchor of Wat? Oh, sorry.
Karthik: (37:09)
<Laughing> Oh, that's, good.
Tracy: (37:09)
Thank. Sorry, I can I just ask what one quick follow-up question, which is why didn't China denominate Belt & Road loans in in RMB?
Karthik: (37:24)
That's a complete mystery to me, and someone who knows immeasurably more about this, Brad [Setser], I've asked him and he's not really sure about it either. I think it's just because they had a ton of dollars.
And one of the things that we're seeing around the world, this reminds me of the conversation with Paul on this Economist story, is that as reserve accumulation goes up, the countries find, you know, if you are above precautionary reserves, you can find other things to do with those excess reserves for a set of political geopolitical gains or influence, right? And that's not just China doing that by BRI, it's what the GCC is doing with Turkey and Egypt for instance.
Joe: (38:12)
And so in your view, in a world in which Brazil maybe were doing renminbi-denominated debt or Cambodia or someone else, some of these countries that have a lot of dollars, and we talked about this with Paul, that maybe have some political tension with the US and Saudi Arabia comes to mind as a country that accumulates tons of dollars. And, you know, depending on the administration at any given point, the political tension ebbs and flows, may want to acquire Brazilian issued RMB-denominated debt as a way to diversify its money, its portfolio?
Karthik: (38:50)
I mean it's certainly possible. And I would argue, I mean for me the argument to do that is that if what you know about the way the global financial cycle works is that countries with dollar-denominated debt that are commodity exporters get into a lot of trouble. And this happens to them repeatedly, then it might make sense for you to look at buying their debt in a currency that more closely corresponds to their real cycle.
It's like asking from a financial stability point of view: “Would you rather buy Polish debt in zloty, in euros, or in dollar? And I would put it precisely in that order. I'd buy it in zloty first, then in euros, then in dollars.
Joe: (39:37)
Right, because every once in a while you hear those stories about like how in some European country people have mortgage, everyone got it in Swiss francs or something like that. And then it's cheaper until one day then they can't print them domestically and there's a huge shock. And so it's like a macro version of that story that you hear about from time to time.
Karthik: (39:56)
Yeah, I think dollar centrality, I'm kind of mixed on that. For the US in particular, one thing I do want to mention about dollar centrality as an advantage to the US. I have no faith in these kind of beliefs that, you know, the loss of dollar centrality will lead to a crash in the US economy and nobody will want Treasuries. I mean that's crap, right? Because I mean, you know, the UK, Australia, and New Zealand, you have all these countries that kind of print their own currency, currencies go up and down. Investors hold them.
The more concrete benefit to the US is the US has much lower inflation pass through. When the currency weakens, basically what ends up happening is that the combination of invoice currency affects, there’s inertia there. And the sheer size of the US economy means that when the dollar weakens prices are slow to change. And wanting access to the US market, which is the biggest market in the world, means that exporters to the US will mostly just eat it in their margins.
And that's something that Gita Gopinath, she was the ex-Chief Economist now First Deputy MD at the IMF, she's written a lot about. So that's kind of a very concrete benefit, which kind of brings us to another point, which is China is the world's largest manufacturing exporter. They're paying their workers in renminbi. There's got to be someone somewhere who wants these renminbi. It can't be, you know, even taking into account the peculiarities of its financial system.
But I think this is where something, the people who are buying the most from China are the US right? Because that's the largest bilateral trade deficit. And there's no way that the US is going to redenominate its trade with China into renminbi, which kind of means that this idea that, you know, being the world's largest exporter means someone is going to want your currency, I think that runs into a problem.
Joe: (41:54)
Karthik Sankaran, this was such a great conversation. I feel like in like that span of time, so many of these longstanding things were tied up and several light bulbs went off. So really appreciate you coming on Odd Lots for the first time. It's been too long, but definitely won't be the last time.
Karthik: (42:11)
Great. I really love being here. Thanks very much.
Tracy: (42:14)
Thank you so much, Karthik.
Joe: (42:15)
That was a lot of fun.
Tracy: (42:17)
That was great. Thank you.
Joe: (42:19)
The Anchor Wat was a beautiful moment of like...
Karthik: (42:22)
It’s contagious.
Joe: (42:24)
Two great wordplay afficionados making magic live on air.
Joe: (42:43)
Tracy, I love talking to Karthik. And the thing that, like when I said at the end, the lightbulb moment for me was not even actually like the questions about the future of the renminbi. But this idea that it would like solve some of these problems that we talked about with Hyun Song Shin all these times. That there’s like the economic cycle and the dollar cycle. And we know that like that's a big problem all around the world. And so maybe the story’s like in a more multipolar currency world, you just have fewer those mismatches.
Tracy: (43:11)
Right, and you have less pro-cyclicality in the system. I mean, I thought his point about “is this actually possible?” it feels like we're converging, I guess getting to a consensus where, you know, we've switched from ‘never going to happen’ to ‘it might happen, but it'll take some time.’ But I think Karthik laid out the reasons for that really clearly, which is the whole stock versus flow argument. It takes time to actually replace all those liabilities with something other than dollars.
Joe: (43:46)
Right, so you can have these announcements like he talked about the recent announcement with Argentina. You can have these announcements where you just improve the flow a little bit, or you could have like a big change in stock. But if we're just going to do it through like these sort of bilateral announcements, “we're going to denominate this in renminbi, we’re gonna denominate that in renminbi.” It'll happen. Just really slowly...
Tracy: (44:08)
It’ll just take a really long time.
Joe: (44:08)
… As opposed to something sort of big, which is like, okay, China decides we're going to start making all these loans in renminbi, which is really interesting. Kind of makes me feel good that like even Brad Setser doesn't know the answer to that one.
Tracy: (44:20)
Yeah, well, that was the big question for me, because it would make sense in a lot of different ways. But the other thing about that episode is I think it's another one that's just gonna lead to further episodes, because now we’ve to get Brad Setser on to ask…
Joe: (44:33)
Gita Gopinath?
Tracy: (44:34)
Yes! And I know we've had Michael Pettis before, but I feel like we should maybe dive in a little bit more to the China social safety net question?
Joe: (44:42)
Yes, absolutely.
Tracy: (44:43)
Which he and Matt Klein have written about in various ways. So we need to do that.
Joe: (44:47)
Many follow ups to come.
Tracy: (44:49)
All right. Shall we leave it there for now?
Joe: (44:50)
Let's leave it there.
You can follow Karthik Sankaran on Twitter at @rajakorman .