Why The Dollar Poses A Global Headache 5: Crisis Lending
Everyone’s need for Dollars, coupled with their inability to increase its supply when needed, is what led former US Treasury Secretary John Connally to refer to the USD as “our currency, but your problem”.
Which is why the Fed’s establishment of FIMA is such an important step.
It is an acknowledgement by someone/someones within the American establishment that the USD, and the provision of its liquidity, is a double edged sword for the rest of the world.
Prior to FIMA, the Fed would open ad hoc swap lines in times of crisis in order to conduct repo transactions with selected foreign central banks. This allowed those lucky enough to have access to these swap lines the ability to borrow USDs directly from the Fed by using their USTs (foreign reserves) as collateral.
More importantly, the swap lines also allowed foreign central banks to hold on to their USTs instead of selling them in the open market to raise Dollars. This is extremely helpful because central banks can only sell their Treasuries once.
If the amount that they raise doesn’t prove to be enough to cover their needs in the near future, then they will have to sell more.
Should they run out of USTs to sell, then they would have to seek help from external parties (likes the IMF), try to restructure their debt, or default.
However, if they can avoid selling their USTs, and instead use them as collateral, they have more options.
Firstly, they can roll over their repo transactions with the Fed until they can repay the Dollars they borrowed.
Secondly, after repaying a loan, they can use the same USTs as collateral to borrow from the Fed again (by entering into another repo agreement). As such, foreign central banks gain much more flexibility if they have access to the Fed’s swap lines.
FIMA is simply the permanent version of these swap lines, with a daily cap of $60 billion per counterparty. While $60 billion per counterparty does not sound like a lot, and given the extreme unpredictability and volatility that exists during Dollar funding crises might not be a lot, it is a good start.
Unfortunately, as with the SRF, FIMA doesn’t actually solve the underlying problems which cause Dollar funding markets to seize up. The main one being private sector risk aversion.
That is, the refusal of banks to extend USD lending to the rest of the financial system. But, can anyone really blame banks for not wanting to lend Dollars in such an environment?
Here’s a thought exercise:
If you owned a bank, would you want to lend Dollars in a global environment where you cannot be certain that your debtors will repay you?’
Considering that you need those Dollars yourself to ensure that your bank can fulfill its own USD obligations, and that you also cannot be certain that you can borrow Dollars from the marketplace – probably not.
To be concluded…
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