Does it matter if you lose track of $80 billion? It’s a question global regulators need to think about urgently, according to the Bank for International Settlements.
BIS economists recently delved into the bowels of the bank’s foreign exchange survey to track the trend of dollar swaps – derivative agreements that allow investors to exchange dollars for other currencies, for a specific period, before trading them again.
A layman might assume that this is a transparent corner of finance, given that the dollar underpins much of the world’s industry and these swaps are used by most major corporations and groups. of investment.
Not so. As the BIS’s latest quarterly report notes, dollar term payment obligations “do not appear on balance sheets and are missing from standard debt statistics” because they are not classified as a “loan” in accounting systems. They are off-balance – in other words, a black hole.
And this hole is surprisingly large. Detective work from the BIS suggests that there are “more than $80 billion” of obligations outstanding to pay US dollars in foreign exchange swaps – or forwards – and currency swaps. This has doubled over the past decade, with a turnover of $5 billion per day.
Some $39,000,000 of that amount involves non-US banks, and another $26,000,000,000 from non-US non-bank entities such as hedge funds and insurance companies. Moreover, the non-bank category has grown rapidly, eclipsing balance sheet risks, and is often associated with maturity mismatches.
Fortunately, there are no signs of current stress. But history shows that FX swap markets are “vulnerable to funding restrictions”, the BIS notes. This is because when shocks hit, investors worry about how to repay those dollar bonds, creating wild price swings.
And while the Federal Reserve has quelled panic in the past by letting other central banks supply dollars, the black hole means the dollar swap market was “supported in 2008 and 2020 by central banks acting on little information about who owed the debt”. The BIS is now (very sensibly) pleading with central bankers to close the data gap.
I hope the Fed and others will answer the call. Regulators have already created a data hub for global systemic banks, which tracks some of these feeds. But policy makers should not stop there. A dirty secret in global finance is that this $80 billion black hole is far from the only place we need more sunlight.
The sphere of private credit is also surprisingly murky. The same goes for the behavior of the Chinese credit cycle; as a new document from the Fed’s notes. This is important because Chinese credit conditions have significant implications for global asset markets, including the dollar-based one.
But another area of surprising data fog is treasury bills which (like dollar swaps) underpin much of the financial system. During the dramatic market turmoil of 2020, it became clear that secondary market trading structures have great vulnerabilities that were not previously understood – or reported. And while the Securities and Exchange Commission and the US Treasury are trying to address this issue, progress has been slow.
The primary market, meanwhile, has its own transparency issues, as economists Alexandra M. Tabova and Francis E. Warnock have recently argued. Public data shows aggregate bids in bond auctions and broad trends in foreign buying. But that doesn’t reveal which buyers are buying which bonds, or their price sensitivity.
This is significant, they argue, given the negative position of the US government’s external assets of $18 billion. He needs to know “which investors will step in and buy Treasuries” against the looming specter of higher Treasury yields as the Federal Reserve at the same time shrinks its holdings of Treasuries.
Tabova and Warnock scoured private data sources and concluded that while non-Americans hold about half of all Treasuries, their behavior is poorly understood. To cite an example: while official statistics claim that foreign private investors bought $3.5 billion more each year than foreign governments between 2005 and 2019, they believe that the latter actually bought $1 billion in more than the first. This is important, given that foreign government purchases have slowed recently and have acted surprisingly “price inelastic” before, with much shorter portfolio durations than private investors.
The good news is that digitizing private data makes this kind of detective work easier than ever. Better still, after the global financial crisis of 2008, the US Treasury created the Office of Financial Research, supposed to have a holistic view of the markets.
But the bad news is that the OFR has been called upon to cut its budget and it cannot hope to obtain better data on dollar exchanges or treasury bills without the help of central banks.
So let’s hope that the US government (among others) treats the revelations about this $80 billion black hole as a wake-up call. After all, if there was ever a time when central bankers needed to understand the real vulnerabilities arising from dollar-linked debt, it was when the world faced geopolitical risks, economic difficulties and political challenges to dollar supremacy. This is precisely what 2023 could bring.