In the Reykjavik roundtable on global economic challenges, September 1-2, 2022, arranged by Robert McCauley, Robert Aliber, Gylfi Zoega, and Mar Gudmundsson, I overviewed my research on bilateral swap lines with Hiro Ito and Gurnain Pasricha in the context of past and future challenges.
The Covid-19 crisis ended up being another test of the effectiveness of the dollar supremacy sometimes when the U.S., EU and China have actually converged to a similar international GDP share of about 20%, PPP changed. Dealing with acute stress in the overseas dollar financing markets throughout the COVID-19 crisis, the Fed offered United States dollar liquidity to the global economy by boosting or reactivating swap plans with other central banks; and establishing a new repo facility, FIMA, for financial authorities and financial institutions. The FIMA Repo Facility permits FIMA central banks and other international financial authorities with accounts at the New York FED to participate in repurchase agreements with the FED. Approved FIMA account holders might temporarily exchange their U.S. Treasury securities held with the FED for U.S. dollars, that can then be offered to institutions in their jurisdictions. This facility offers, at a backstop rate, an alternative momentary source of U.S. dollars for foreign official holders of Treasury securities aside from the sales of securities outdoors market.
Studying the effect of these centers suggests that access to Fed liquidity was driven by close monetary and trade ties with the US. An economys share in US trade and a military alliance with the United States are favorable aspects associated with access to a Fed swap agreement. An economy with high levels of banking and monetary direct exposure to US, and more powerful trade ties with the United States tended to have greater access to Fed liquidity, through swap lines or FIMA. Economies with a big share of international trade, despite whether they are major trading partners of the US, also had higher access to US dollar liquidity via the Fed. Economies that faced gratitude pressures versus the United States dollar and whose local currency exchange rate ended up being more volatile were most likely to auction greater amounts of United States dollars in their domestic market. Swap-related statements resulted in the gratitude of currencies versus the US dollar and lowered these currencies variances from CIP.
The auctions by the 4 significant central banks– ECB, BOJ, SNB, and BOE– peaked in mid-March at about 112 billion United States dollars per day and were the orders of magnitude bigger than those by all other central banks (Figure 1). The effect of significant main bank auctions was similar for economies with various monetary and trade links with the US, and for economies with different balance sheet currency and foreign financial obligation exposures.
Figure 1: Many advanced and emerging-market central banks auctioned US dollars throughout the COVID-19 crisis.
Notably, under the FIMA repo facility, the Fed provides overnight US dollar liquidity in exchange for existing US Treasuries held by these institutions, and the deal can be rolled over. The Fed facilities appear to have been effective in restricting the sale of United States Treasuries– economies with access to Fed centers on average saw smaller percentage declines in holdings of US treasuries in between February and April 2020 (Figure 2). The figure plots the portion change in the holding of US treasury securities in between end-april and end-february 2020, for economies with or without access to Fed facilities as of the end of June 2020.
Will the closer alliance between the US and the EU make it through beyond the Biden administration? Throughout the GFC and the Covid crisis the ecb and the fed worked together by conjuring up comparable policy position, offering positive spillovers. The possible return of a future United States administration that will apply “America First” isolationist policies might raise concerns on the trustworthiness and the depth of United States FED backstop Dollar policies.
Will the deepening of sovereign EUR bonds and the higher ECB and EU dedication to backstop these bonds, alleviate $ dominance? These trends might enhance the EUR international position by increasing the size, liquidity and the safe sanctuary status of sovereign EUR bonds provided by Euro Zone states.
Will weaponizing the $ dominance, and the higher geopolitical tension in between the West (OECD countries) and the East (China, Russia and their allies) induce growing fragmentation of trade and regional barter and credit plans, reducing overtime the $ supremacy?
Will the exit from QE and low interest policies set off by unfavorable stagflationay shocks, constrain the future application of BSLs and destabilize the $ supremacy?
Are we heading from the period of misleading supporting permanent globalization into a fragmentation duration that would rhyme with the first half of the 20thcentury, this time with the damaging abilities of contemporary technologies, modern worldwide warming and climate volatility, and more than doubled global population?
Hence, chances are that the dollar requirement would be evaluated again in more tough environment, where FED policies would possibly be less successful
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Selective References:.
Aizenman, J. (2022 ). The Feds swap lines: Narrow circle, broad impact?.
Aizenman, J., Ito, H., & & Pasricha, G. K. (2022 ). Central bank swap arrangements in the covid-19 crisis Journal of International Money and Finance.
Bordo, M. D., O/ F. Humpage, and J. Schwartz. “The advancement of the Federal Reserve swap lines considering that 1962.” IMF Economic Review 63.2 (2015 ): 353-372.
Diamond, Douglas W., and Philip H. Dybvig. “Bank runs, deposit insurance coverage, and liquidity.” Journal of political economy 91.3 (1983 ): 401-419.
Goldberg, L. S., Lerman, R., & & Reichgott, D. (2022 ). The US Dollars Global Roles: Revisiting Where Things Stand ( No. 20220705a). Federal Reserve Bank of New York.
Gourinchas, P. O. and H. Rey (2007) From World Banker to World Venture Capitalist: United States External Adjustment and the Exorbitant Privilege, in R. H. Clarida (ed.), G7 Current Account Imbalances: Sustainability and Adjustment, Chicago: University of Chicago Press.
Liao, G., & & Zhang, T. 2020. The hedging channel of currency exchange rate decision. FRB International Finance Discussion Paper (1283 ).
McCauley, R.N. and Schenk, C.R. (2020 ). Reserve bank swaps then and now: swaps and dollar liquidity in the 1960s.
Obstfeld, M., Shambaugh, J. C., & & Taylor, A. M. (2009 ). Financial instability, reserves, and reserve bank swap lines in the panic of 2008. American Economic Review, 99( 2 ), 480-86
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Today, we are pleased to provide a visitor contribution written by Joshua Aizenman (University of Southern California).
This post composed by Joshua Aizenman.
Figure 2. Economies with access to Fed liquidity lines saw smaller decline in United States treasury holdings between February and April 2020
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The above outcomes validate the Narrow circle, broad effect of US FED swap lines throughout the GFC and the Covid-19 crisis. A resilient interpretation of the FEDs experience with bilateral swap lines and FIMA is mission accomplished– the FED acted successfully in stabilizing the international financial system, by offering flexible supply of liquidity to systemic financial centers and to close US allies, at backstop rates, motivating them to provide dollar liquidity to their systemic institutions. The timing and magnitude of these innervations was appropriate, set off by the heightened international instability and flight to the security of the dollar. These actions strengthened the concept that the FED is committed to defend the international stability of the USD network, in line with Gourinchas and Rey (2007 ). The department of backstop services show a balancing act: FED emergency line of credit to foreign central banks offered the international backstop that prevented the panic balance caused by the efforts to liquidate dollar exposure in fire sales, where the flight to safety in the abases of the lender of last hope ends with a self-fulfilling monetary crisis (Diamond and Dybvig (1983 )). The foreign main banks functioned as the lending institution of last hope in their jurisdiction.
One may hope that by now the FED developed credibility of its policies, and the blueprint of emergency situation BSLs will be enacted in the future at times of heightened instability setting off global risk-off and flight to quality. Yet, there is no reason to presume that the future will resemble the past. Future difficulties to the United States dollar standard might dilute the effectiveness or willingness of the FED to provide the global backstop services. We close with open questions about future advancements, the answer to which would determine the toughness of the US dollar supremacy, and the performance of the worldwide monetary system in times of dangers:.
Dealing with intense stress in the overseas dollar funding markets throughout the COVID-19 crisis, the Fed supplied United States dollar liquidity to the worldwide economy by reactivating or enhancing swap plans with other central banks; and developing a new repo facility, FIMA, for monetary authorities and monetary organizations. An economy with high levels of banking and financial exposure to United States, and stronger trade ties with the United States tended to have higher access to Fed liquidity, via swap lines or FIMA. Significantly, under the FIMA repo facility, the Fed supplies over night United States dollar liquidity in exchange for existing United States Treasuries held by these organizations, and the deal can be rolled over. The Fed centers appear to have actually been effective in restricting the sale of United States Treasuries– economies with access to Fed centers on average saw smaller sized portion declines in holdings of US treasuries in between February and April 2020 (Figure 2). The possible return of a future US administration that will apply “America First” isolationist policies might raise questions on the trustworthiness and the depth of United States FED backstop Dollar policies.
