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Thursday September 18, 2008 - 16:42:09 GMT
Larry Greenberg -

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FRS Swap Lines: Some History and Some Thoughts on Their Newest Use

Swap lines between the Federal Reserve Bank and other central banks are temporary credit lines that enable the Fed to draw foreign exchange and the other monetary authorities simultaneously to acquire dollars.  The FRS swap network has been around since 1962, when the post-world war II system of fixed dollar exchange rates and dollar/gold convertibility still existed.  The purpose of the swap lines both initially and after the dollar floated in March 1973 was to generate resources that central banks could then use to finance foreign exchange intervention.  Swap lines drawings are intended to be paid up within three months, although outstanding swap debt can be rolled over if that is not possible.  The predominant user of swap lines was the Fed.  Whereas other governments routinely hold dollar reserves that can be used for intervention, it has been U.S. policy to keep none or very few holdings of foreign currency.  So while most countries intervened with assets they owned, the United States historically used borrowed assets to fund its intervention.  This created two unique distinctions for U.S. intervention.  If the U.S. wanted to support the dollar by selling marks, for example, U.S. officials would need to contact their counterparts in Germany to discuss why they wanted to draw on their reciprocal swap line and negotiate parameters over how much could be drawn down without requiring further consultation.  The other factor of importance is that intervention funded with swap drawings generate foreign exchange risk if the dollar is at a different level when the drawing is repaid.  When I did my first tour at the New York Fed intervention desk in 1975, the United States was still paying back swap loans, which had been converted to longer-term facilities, dating back to the week to August 13, 1971.  That was the final week before President Nixon severed dollar/gold convertibility, temporarily suspended fixed dollar parities, and imposed wage-price controls.  The U.S. had run up huge losses, borrowing and then selling foreign currency in a vain effort to defend unsupportable dollar parities, and it cost considerably more to buy those dollars back in 1975.

The first swap line with France was only $50 million.  The swap network rose to $11.7 billion by January 1973, $20.2 billion by January 1978, $30.1 billion in mid-1982, and $67 billion prior to today’s $180 billion additional increase to $247 billion.  The 5.7-fold advance from January 1973 through yesterday or even the 21.1-fold increase to today’s higher level falls well short of the expansion rate of foreign exchange turnover.  U.S. turnover amounted to roughly  $1 billion per day in early 1974 but rose to $5 billion daily three years later and $129 billion over another ten years.  Global FX turnover, which was still less than $1 trillion in April 1992, increased to $3.2 trillion per day when last measured in April 2007. 

If the purpose of this latest increase in swap lines had been to defend the dollar in intervention, the resources would be inadequate.  However, officials were quick to assert that intervention is not their intent.  Rather, the swap lines are going to put dollars in the hands of central banks and from their into their respective money markets in hopes of cutting the draconian risk premia on money market lending.  Even for this alternative plan of use for these swap lines, it is suspect how effective this last innovation will be.  Many actions over the past 13 months worked for a while yet did not prevent the crisis from roaring back in an even more dangerous form.  The problem is not that global liquidity is too scarce.  Funds are not getting to the places that need them the most, so the problem is one of distribution, which is malfunctioning amid confusion, uncertainty, and raw fear. Those flaws are not removed by flooding markets with even more dollars.   Meanwhile, the Fed will have to be careful about what it does with the foreign exchange it receives for swapped dollars.  If a run occurs on the U.S. currency as a new venting of this crisis and if the Fed then intervenes, a big loss will be incurred unless the dollar is protected successfully.  Taxpayers are already deeply in hoc for actions forced upon U.S. authorities that nobody wanted to take.  The crisis in part reflects fear that each new action by officials might be digging the hole too deeply to climb out.


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