Thursday, October 30, 2008

The King $US prolongs the global credit crisis; Fed opens at least $600 b in currency swaps

The U.S. dollar ($US) continues to gain ground, approaching its 2002 peak level against major currencies and on a broader basis. This hurts global economies that rely on $US to finance portfolio holdings, as well as U.S. exporters.

When dollar funding runs dry with tight interbank lending, firms and central banks go to the open market to buy up the difference; that is very expensive right now. In order to alleviate the pressures on demand for $US, the Fed continues to open up currency swap lines, effectively fanning out a supply of $US around the world. Hopefully, these swap lines will continue to stabilize the global credit crunch and also the value of the $US.

A timeline of recent swap lines in addition to the $67 billion already in place. If you want a nice discussion of what is a swap line, visit the macroblog here:
  • $180 billion September 18: Swap lines announced with major central banks: The Bank of Canada, the Bank of England, the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank
  • $30 billion on September 24: Swap lines announced with the Federal Reserve, the Reserve Bank of Australia, the Danmarks Nationalbank, the Norges Bank, and the Sveriges Riksbank.
  • $13 billion on September 26: Extending already-in-place lines with the Bank of England, the European Central Bank (ECB), and the Swiss National Bank.
  • $330 billion on September 29: Extended swap lines available to key central banks (developed World).
  • $Unlimited on October 13: Swap lines enough to “meet demand” with the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank
  • $15 billion on October 28: Swap line opened with the Bank of New Zealand
  • $120 billion on October 29: Swap lines opened with emerging economies: the Banco Central do Brasil, the Banco de Mexico, the Bank of Korea, and the Monetary Authority of Singapore.
Total: At least $688 billion.

Although the Swap lines are simply “lines of $US credit,” foreign central banks are drawing on these lines. As of October 22, the Fed had issued roughly $520 billion in $US to foreign central banks. Although these lines of credit are helping to heal international credit markets, the value of the $US is still at record levels. As the credit crisis filters into emerging markets, the developing world seeks $US funding.

Brad Sester was rather prescient to the Fed’s actions on October 29. He reported – on October 18 - on the emerging economies’ envy of the Fed’s unlimited $US funding with developed foreign central banks. Emerging economies can access $US through the IMF, but with economic strings attached. An excerpt from Brad Sester’s post:

“There is another key difference between European banks’ need for dollars and many emerging markets’ need for dollars. European banks need dollars to finance their holdings of US mortgages and other US securities. If they didn’t have access to dollar financing, they would either have to borrow euros and buy dollars – pushing the dollar up (and hurting US exporters) or they would have to dump their US assets (hurting US banks holding similar assets). By lending to European central banks who then lent to their own banks, the US kept some European banks from being forced sellers of risky US assets – and in the process putting pressure on US banks. The US wasn’t acting entirely altruistically.

Emerging market banking systems by contrast often need dollar financing not to support their portfolios of US assets but to support their domestic dollar lending.

And it is now clear that a broad range of emerging economies do need access to the international banking system to continue the kind of breakneck growth that they have experienced recently — and have been caught up in the recent “deleveraging” of the global financial system. The FT’s Garnham again:

Analysts said emerging market currencies were being hit as foreign investors pulled money out of developing regions, driven by liquidity pressures from the credit crisis. “There seems little now that the authorities can do to reverse the process of deleveraging that is taking place with financial institutions all contracting their balance sheets at the same time,” said Derek Halpenny, at Bank of Tokyo-Mitsubishi.”

Obviously, the swap lines have not stabilized the $US, but have helped (slightly) to calm credit markets. But the $US strength cripples US exports. In the second quarter of this year (third quarter to be released today), export spending contributed 1.5% to the 2.8% of recorded economic growth, and with domestic consumption sliding, export strength is needed to keep the U.S. afloat. Thus, the $US strength hurts the American economy as well as global economies.

The fact that the Fed continues to open up currency swap lines re-iterates the severity of the financial crisis that is both global and ongoing. One can only hope that these measures – with economic costs that are yet to be determined – will calm global capital markets enough to allow each economy to heal on its own accord.

Rebecca Wilder


  1. The Sester post is a wonderful read - worth seeing the whole thing. It is a good explaination of the globality of the currency problem. One questions: he mentions the G-7 (G10). What is the G10? I probably have seen it but don't remember the additional 3. Thanks, aj

  2. Hi Janie,

    The G10 is the IMF's designated group of 10 for a supplementary borrowing program in case IMF resources run too low.

    Member countries are: Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, U.K., and U.S.A.

    More information here:

    Thanks, as always, for your wonderful comments.