Bob McCauley is a non-resident senior fellow at Boston College’s International Growth Coverage Heart and affiliate of the school of historical past on the College of Oxford.
Kindleberger’s Lure is the hazard {that a} fading hegemon lacks the power however the ascendant one lacks the need to produce the world economic system with very important public items — similar to a reserve forex. Within the Nineteen Thirties, the Financial institution of England lacked the power to proceed to function worldwide lender of final resort, and the ascendant Federal Reserve lacked the need to take action.
Because of this, disaster unfold from Austria to Germany and Britain and in the end reached the US, turning the post-1929 hunch into an era-defining financial collapse. The Kindleberger Lure led to “the world in depression”, as Charles Kindleberger titled his seminal e-book.
Because of this worries over whether or not the Federal Reserve will proceed to produce {dollars} to abroad central banks at instances of economic strife are such an enormous deal. As Reuters reported final month:
Some European central banking and supervisory officers are questioning whether or not they can nonetheless depend on the U.S. Federal Reserve to supply greenback funding in instances of market stress, six individuals acquainted with the matter mentioned, casting some doubt over what has been a bedrock of economic stability.
The sources advised Reuters they think about it extremely unlikely the Fed wouldn’t honour its funding backstops — and the U.S. central financial institution itself has given no indicators to recommend that.
However the European officers have held casual discussions about this risk — which Reuters is reporting for the primary time — as a result of their belief in america authorities has been shaken by a few of the Trump administration’s insurance policies.
These considerations are warranted, each in mild of the Trump administration’s distaste for America’s conventional alliances and the centrality of the Fed’s swap strains to international monetary stability.
As Deutsche Financial institution’s chief FX strategist George Saravelos highlighted in a current report on the subject, doubts over the Fed’s willingness or capacity to step up when wanted on is a “nuclear button” for the greenback’s future:
Finally, a withdrawal of the Fed because the worldwide lender of final resort is equal to a suspension of the greenback’s function because the most secure of world currencies. Doubts a few dedication from the Fed to take care of greenback liquidity — particularly in opposition to main allies — would speed up efforts by different nations to cut back their dependence on the US monetary system. It could in the end result in decrease overseas possession of US property and a broad-based weakening of the greenback’s function within the international monetary system.
Within the 2008 and 2020 greenback panics, the Fed properly advised 14 central banks that the buck begins right here. By official swap strains the Fed may lengthen its credit score to every central financial institution in opposition to home forex as collateral. Every central financial institution may in flip lend the {dollars} to banks in its market in opposition to home collateral.
Reaching outstandings as excessive as $598bn in 2008 and $449bn in 2020, the swaps succeeded in stabilising international greenback markets. The quantities weren’t small, however offshore greenback lending — each on- and off-balance sheet — is measured within the tens of trillions of {dollars}. Thus, with pennies on the greenback lent and repaid with curiosity, co-operating central banks calmed these probably damaging greenback panics.
The US additionally received from the Fed’s worldwide provision of {dollars}. Crucially, the swaps reversed market-driven rate of interest hikes on Libor-priced US company loans and mortgages, which in flip would have hammered US jobs and consumption. As Saravelos identified:
Had the Fed not stepped in in the course of the 2008/9 monetary disaster and Covid pandemic, the reserves of overseas central banks and worldwide lenders just like the IMF would unlikely have been enough to satisfy international greenback demand, resulting in a good better surge in greenback borrowing prices than occurred on the time, defaults, and probably systemic implications for the worldwide monetary system.
What if a disaster like 2008 or 2020 occurs and the Fed doesn’t swap {dollars}? Central bankers wouldn’t be doing their jobs in the event that they weren’t asking this query.
If it got here to such a situation of “politicise[d] . . . recourse to the dollar swap lines,“ the Fed would have the ability but not the will, as in 1931. Any other single central bank might have the will but not the ability.
However, central bankers could form a dollar coalition of the willing.
The central fact is that the 14 central banks that had standing and temporary Fed swaps in 2008 and 2020 collectively hold lots of dollars. Their collective holdings of US safe assets amounted to an estimated $1.9tn at the end of 2021. (Their total foreign exchange reserves at the end of 2024 were about double that sum.) That $1.9tn is big money. It’s triple the previous maximum drawing on the Fed swap lines in 2008, and four times larger than the peak 2020 usage.
Leadership could arise among the Fed’s standing swap partners, the European Central Bank, Bank of Japan, Swiss National Bank, Bank of England, and Bank of Canada. The ECB and BoJ were the largest users of the Fed swap lines in 2008 and 2020, respectively. During the 2023 run on Credit Suisse, the SNB acquired unique experience in tapping the New York Fed for $60bn against US Treasury collateral under the FIMA (foreign and international monetary authorities) repo facility.
The coalition could enlist the Bank for International Settlements for technical support as agent as European central banks did in 1973-95. Or the BIS could serve as intermediary, as it did when the New York Fed lent dollars through the BIS to offshore banks in the 1960s to prevent funding crunches.
However, there is a major wrinkle: the $1.9tn is invested, and a crisis calls for cash dollars. In a world where the Federal Reserve refuses to allow access to its swap lines, would the New York Fed continue to provide same-day FIMA repo funding against Treasuries held in custody?
If it did, the coalition could arrange to access hundreds of billions of dollars in same-day funds. If the Fed did not, then it would end up providing ad hoc funding.
Without the FIMA backstop, heavy central bank sales of US Treasuries would rock the US bond market. Such selling could prod the Fed into the market as buyer of last resort — as in March 2020, before the FIMA repo was introduced.
Without the FIMA backstop, the Fed similarly would have to cap market repo rates if central banks sought to repo Treasuries for cash in size. However, the recent benchmark rate shift from dollar Libor to repo-based Sofer means that the Fed’s own domestic monetary transmission requires well-behaved repo rates.
One way or another, the coalition would need to work with the Fed to manage any “dash for cash.” Even a big pool of greenback reserves wouldn’t stack as much as “whatever it takes” Fed swaps. Limits excite. It might be, as Eurosystem sources grimly famous to Reuters, that “there is no good substitute to the Fed.”
Nonetheless, a greenback coalition of the keen may pool trillions of {dollars} to backstop international greenback funding with not more than self-interested Fed assist. An inferior lender of final resort beats no lender of final resort.
