When Jay Powell, president of the United States Federal Reserve, was roasted in Congress this week, the focus was on how the central bank helped American businesses and consumers during the pandemic. Senators should also have asked – but did not – what the Fed has done recently to help dollar markets off the coast of the United States.
It was a big oversight. When future financial historians study the Covid-19 shock, they will conclude that Fed intervention in the offshore dollar markets through swaps with other central banks has been one of its main policies. Not only has the Fed’s action calmed the markets, but it has strengthened the hegemony of the global dollar-based financial system for years to come.
To understand all this, a little history is necessary. The concept of central bank swaps, in which two institutions exchange currency, is not new. This cooperation with the central bank had a “lasting prehistory from 1962 to 1998”, according to a document from the Bank for International Settlements. But their use waned at the start of the 21st century, with the Fed focusing on the onshore dollar markets and the US economy.
This changed abruptly during the 2008 crisis. Historian Adam Tooze notes that policymakers suddenly realized that non-US financial companies, particularly in the eurozone, had accumulated massive and unbalanced dollar exposures. They owed money to investors but could not get enough foreign exchange on the private markets, causing panic.
In the absence of a large stock of US currency, the European Central Bank could not help. The Fed therefore created swap lines that allowed the ECB and central banks of four other countries – Switzerland, the United Kingdom, Japan and Canada – to supply dollars to their local markets. “The Fed has effectively transformed the other central banks into branches to extend its reach to the offshore USD segment,” write economists Steffen Murau, Joe Rini and Armin Haas.
Since the crisis, there has been little public discussion on whether the Fed should leave these “emergency” measures in place and on the vital question of the Fed’s responsibility to the offshore dollar markets. The Covid-19 shock unexpectedly clarified this.
In mid-March, panic broke out again in the offshore dollar markets. The Fed reacted and even doubled. First, it reactivated the swaps with the five original central banks. Then he added nine players, including Mexico and Brazil. Finally, it offered a new “buy-back” facility allowing entities outside the 14-member club to exchange assets such as treasury bills for dollars.
This expanded safety net is not complete. Emerging countries without large treasury holdings, like Turkey, are left in the cold. And using the repo program is expensive, so few have done so. But 10 of the 14 swap club members seized $ 446 billion at the last count. In addition, “the program has been incredibly successful” to appease the markets, says Zoltan Pozsar, an analyst at Credit Suisse. In mid-March, borrowers based on the euro and the yen had to pay an additional 200 basis points and 250 basis points respectively to borrow in dollars; at the end of April, the difference was only 30 bp and 50 bp.
This is good news for non-US financial players. It also comes with a new and striking geographic touch.
Since 2008, major imbalances in the offshore dollar markets have migrated from the eurozone to Japan, while Japanese savers, banks and life insurance companies have plunged into the dollar markets to seek higher returns. high. Norinchukin, the agricultural bank, has thus become the world’s largest holder of guaranteed dollar loan bonds. Smaller banks, like Shizuoka, have also entered. Meanwhile, Pozsar says “the needs of life insurers in the currency swap market for US dollars exceed $ 1 billion.”
Before the pandemic, these imbalances began to worry certain Japanese regulators. The Fed’s intervention has allayed fears. At the last count, the Bank of Japan had taken $ 224 billion from the Fed, much more than the $ 143 billion from the ECB, and had probably passed them on to Japanese entities hungry for dollars. Clearly, a safety net is now in place.
Will this be kept after Covid-19? Almost certainly: Fed and Treasury officials are increasingly finding it necessary to prevent excessive tragedy in the offshore dollar markets to avoid shocks in the onshore dollar markets and the very important bond sector. Treasure.
Call it a new manifestation of American interest; or simply the inevitable consequence of financial globalization. In any case, the crucial point is this: even if the US global leadership weakens in many areas, the Fed’s support for the hegemony of the dollar is not. This could further consolidate the use of the dollar after the Covid-19 shock, even if countries like China hate it.
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