Why The Dollar Poses A Global Headache 6: Recurring Crises
The unwillingness on the part of USD lenders to actually lend Dollars during a crisis is a crucial part of the problem.
Since money is created by the private sector and not central banks, the Fed cannot coerce banks into lending USDs globally.
They simply do not have the mandate to do so, and probably aren’t willing to do so, given the public and private uproar such coercion will generate.
All the Fed can do is provide USD bank reserves as temporary Dollar liquidity.
The objective of which is to prevent financial contagion and the negative feedback loop of bankruptcies that follows in the broader economy.
However, bank reserves being what they are, they cannot be lent out and thus do not do anything to boost domestic lending, much less international USD lending.
Another major issue that FIMA does not solve is the “Connally Conundrum” – the fact that the Dollar is America’s currency, but everyone else’s problem. Remember that not all foreign central banks have access to FIMA,most notably the People’s Bank of China (PBoC).
China also happens to own the largest pile of USD foreign reserves in the world ($3.2 trillion at time of writing). This staggering amount illustrates how dependent the country is on Dollar inflows, even though it is one of the largest economies on the planet.
Its size ensures that the state of its economy affects the rest of the world, both in good times and bad, yet they don’t have access to FIMA, along with most other central banks in the world.
However, we can’t really expect the Fed to open swap lines with every central bank on the planet, which further underscores the problem of having the Dollar, or any other currency, as the global reserve currency.
Ultimately this is a systemic problem that FIMA definitely cannot solve, and should not be expected to solve.
From this perspective, FIMA is a band aid that buys time while the international banking system sorts itself out and regains enough confidence to start lending Dollars again, not a solution to a systemic problem.
As long as the world is reliant on a reserve currency that is distributed via lending by private sector banks, global Dollar funding crises will keep occurring.
They may not all be of the same magnitude and scale as those experienced in 2008 and 2020. But, every Dollar funding crisis, even those confined to small geographic regions, will still wreak economic havoc.
Moreover, each new crisis has the potential to spread across the globe, which is an outcome everyone wants to avoid.
That being said, FIMA, and the Fed’s swap lines before it, are very important band-aids, which have proven to be helpful in the past.
Although it is a pity that the Fed, by instituting FIMA, only gives global policymakers a bigger excuse to avoid having to sit down and work together on solving the real problem – our urgent need for a systemic overhaul of the global financial system.
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