By separating you from me These are the terms. We can swap, swap, swap it out Oh, swappin’ out will only change your life. But it’s worth it, the sacrifice.
Justin Beiber
Sometimes what appears to be a big story in its own right offers a glimpse of or an angle on an even bigger story. A friend directed me to a recent Reuters story which included the following;
“some European forums where participants assess potential risks to the financial system, these officials have discussed scenarios under which the U.S. government might pressure the Fed to suspend the dollar backstops. Some officials have been gaming out whether they can find alternatives to the U.S. central bank, the two sources said. In times of market stress, the Fed has provided the European Central Bank and other major counterparts with access to dollar funding. The takeaway from these discussions: there is no good substitute to the Fed, said the six sources, who include senior ECB and European Union banking supervisory staff with first-hand knowledge of the conversations.”
That’s a big story – as I’ll shortly demostrate. But the bigger storyis the potential undermining of international financial institutions – such as the IMF. The Fed’s dollar backstops will become a subplot the dollar will manage, though at a cost to the global financial sector. In the short term we can expect such a move to reinforce the dollar through pre-emptive demand internationally. A withdrawal from the IMF is altogether more complex, though not without its benefits.
How important are Fed central bank swap lines (for that is what the story is about)? Take a look at the following chart from FRED. Yes, the Fed provided nearly half a trillion dollars to foreign central banks in both 2009 and again in 2020. You can view the original chart here: https://fred.stlouisfed.org/graph/?g=1FIF3
In times of crisis, the Fed has been relied upon to provide dollars to stabilise the international financial system, whose banking systems cannot be relied upon to run a net balance in dollars in all jurisdications. During the GFC it was Europe that was particularly short of dollars. At other times, it is other places. For its generosity (and wisdom) during the GFC, the Fed was widely criticised by (mostly) Republican Senators and others. What are the alternatives?
A substitute for the Fed would indeed be challenging, though there are a few possibilities. In sensible times, the inability to borrow foreign reserves was a prima facie reason for going to the IMF.
But the IMF may soon no longer be in a position to assist if the Trump administration makes good on the following from the Mandate for Leadership (aka Project 2025):
“The U.S.… should withdraw from both the World Bank and the IMF and terminate its financial contribution to both institutions.”
The sentiment is echoed in websites like this: Tracking DOGE
If the US withdraws from the IMF and the Fed is constrained in provision of dollar swaps, then in times of need, dollars will have to be mobilised from other pools of liquidity, mostly outside the United States. The largest of these would be from foreign exchange reserves of Japan, China, the Gulf States and Saudi Arabia.