Zimbabwe Ben Can't Give It Away

ZB spoke Thursday in The Federal Reserve's Balance Sheet: An Update:

Like depository institutions in the United States, foreign banks with large dollar-funding needs have also experienced powerful liquidity pressures over the course of the crisis. This unmet demand from foreign institutions for dollars was spilling over into U.S. funding markets, including the federal funds market, leading to increased volatility and liquidity concerns. As part of its program to stabilize short-term dollar-funding markets, the Federal Reserve worked with foreign central banks--14 in all--to establish what are known as reciprocal currency arrangements, or liquidity swap lines. In exchange for foreign currency, the Federal Reserve provides dollars to foreign central banks that they, in turn, lend to financial institutions in their jurisdictions. This lending by foreign central banks has been helpful in reducing spreads and volatility in a number of dollar-funding markets and in other closely related markets, like the foreign exchange swap market. Once again, the Federal Reserve's credit risk is minimal, as the foreign central bank is the Federal Reserve's counterparty and is responsible for repayment, rather than the institutions that ultimately receive the funds; in addition, as I noted, the Federal Reserve receives foreign currency from its central bank partner of equal value to the dollars swapped. Because the loan to the foreign central bank, as well as the repayment of principal and interest, are set in advance in dollar terms, the Federal Reserve also bears no exchange rate risk in these transactions. Slide 2 shows the current value of outstanding swap lines at $57 billion, down from $554 billion at the end of last year, reflecting the marked improvement in dollar-funding markets across the globe.

Happily shoveling buckets upon buckets of the stuff to foreign investors.

A sterile, entirely uncomplicated central bank tactic, right?

Why did the Fed shovel out $554 billion in dollars to other central banks by December of 2008? Because they're nice like that? Because the normal channels were not functioning correctly?

In simpler terms:

Anecdotal evidence shows that around 80 per cent of currency failures follow a pattern: a large country borrows cheap (other countries invest in the US bonds) and loads up debt by importing much more than it produces.

The other (emerging) markets benefit to begin with until the borrowing country gets overburdened and trade retreats causing deflation which erases the wealth of creditors as less dollars are available externally. The amount of dollars available is dependent on the trade deficit and creates a problem for those countries trying to trade in dollar denominated assets. In fact, 2008 would have been catastrophic had the US Federal Reserve not agreed bail out the system by inducting dollars in currency. Is the world satisfied with these developments? The answer is no, as can be seen by relentless noises being made by the oil producers, Russia and China. China is the largest subscriber to Fed treasuries (with forex reserves of over $ 2 trillion).

China has already flexed its muscle by setting up currency swaps with several countries like Argentina, Belarus and Indonesia and by letting institutions in Hong Kong issue bonds denominated in the Chinese currency, renminbi. Brazil and China are now working towards using their own currencies rather than the US dollar.

Around the World in 80 Days in Ben Bernanke's Helicopter? I guess we'll find out. Sounds like it is running out of gas.

Jr Deputy Accountant

Some say he’s half man half fish, others say he’s more of a seventy/thirty split. Either way he’s a fishy bastard.