Forex Blog - Low Risk FX Swaps No End to Fed...Barron's: Europe's Growing Crisis Puts the Fed at Risk
Risk FX Swaps No End to Fed...Barron's: Europe's Growing Crisis Puts the Fed at
I am as
interested in the next shoe dropping on the global financial system as the next
person. But raising currency swaps between the Fed and ECB (and other
foreign central banks) as the latest FWMD (financial weapon of mass
destruction) is absurd.
Fed arranged vastly larger FX swap lines with the worldâ€™s central banks in 2008
it was not signing away vast sums of US dollars into a black hole of bank
insolvency as one might conclude from reading the Barronâ€™s article this weekend
(attached below). First of all the Fed got euros for USD in the swaps
from the ECB (and GBP from BOE, SEK from Riksbank, and NOK from Norges Bank,
and DKR from Danmarks National Bank and CHF from SNB, and CAD from BOC, and JPY
from BOJâ€¦). The article describes the facility as a loan from the
Fed to European banks via central banks. But the swap is also a loan of
euros to the Fed by the ECB. I would view even large FX swaps among G20
central banks as about as risk free as any financial arrangement and would not
consider it a loan. The swap lines were put into place to relieve a
shortage of USD in the global banking system as banks moved to hoard dollars in
light of a loss of confidence in the bank systemâ€™s solvency. Before the
swaps were arranged, banks were buying USD in the open market and driving the
greenback sharply higher (interbank swap and forward market shut for anything
beyond one-week money).
foreign central banks take on risk when they lend these dollars to local banks
â€“ they may not get repaid. However, the notion of banks not repaying
central banks for liquidity is as much a risk for the ECB as it is for the Fed
and we are now in a world where too big to fail is the operating instruction
guiding liquidity provisions to the banking system. No bank will be
allowed to default to other banks, bond holders and central banks.
is also noteworthy to view foreign central banks as having USD reserves which
could be used to swap back with the Fed for local currencies in the event the
local banking systems froze and failed to repay dollars borrowed from central
banks across the planet.
article also confuses an FX swap (no currency risk as exchange rate is fixed)
with spot exchange (comes with FX risk).
article seems to be based on the assumption that any move by a major central
bank to print money (the ECB for instance in the event of not receiving dollars
back from banks could use unsterilized intervention to buy dollars for euros to
repay the Fed on swap line plus or minus the difference between the FX rate of
the swap) is the end of a currency and bond market. Monetization is no
panacea for bank solvency and deflation. Moreover it is not a guarantee
of hyperinflation and currency devaluations assuming it ends quickly and is
just as quickly reversed.
European banks are way behind in writing down assets (MTM accounting) and are
considerably more leveraged than US banks. But this future adjustment and
dislocation is hardly the basis for expecting the Fed to take huge hits on
currency swaps with foreign central banks.
would euro/dollar be without Fed swap lines? We may never know, but I
suspect these swap lines were very effective shadow currency intervention (not
its main purpose â€“ liquidity was) and the Barronâ€™s article is off the mark by
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