It was the sort of man-to-man appeal no political official wants to make, especially for someone in a position of great authority during exceptionally trying times. Jean-Claude Trichet was the head of the European Central Bank and after having survived, arguably, the worst monetary panic since the Great Depression, here he was not very long afterward facing so much the same problems with nowhere else to turn.
So desperate, Federal Reserve Chairman Ben Bernanke would characterize this conversation with Trichet as a “personal appeal.”
It wasn’t the only one Mr. Bernanke would get. The Bank of England’s Mervyn King pleaded with the Chairman, too, when during the discussion between those two men Bernanke recalled, “I got very much some of the same tone” as from Trichet.
Though less urgent, a third phone call had also come in from the Bank of Japan’s leader at the time, Masaaki Shirakawa.
While playing it cool in public, in private authorities were downright scared, and why wouldn’t they have been? This was early May 2010, barely a year since the Global “Financial” Crisis was declared at an end, solved, at least according to these authorities, by a pile of QEs and zero interest rates.
To see all the same breakdowns and symptoms of systemic illiquidity – in dollars – come roaring back all over again was like some nightmare, as if they were stuck in a second-rate horror flick facing off against the same slasher villain everyone thought had been killed off at the climax of the previous movie.
“MR. SACK. I think that, at this point, unsecured dollar funding in European markets has essentially collapsed to overnight lending, or at least to very short-term lending, particularly over the past couple of days. So term funding is either very expensive or simply not available. You see this in some measures, such as a rise in LIBOR, but LIBOR doesn’t really capture the rate at which these institutions are borrowing. You see it more strongly in other measures, such as implied dollar funding rates through FX swaps—of course, a lot of these institutions borrow in euros and swap into dollars.”
While the affair would be called the European Sovereign Debt Crisis, it was a fair bit of gaslighting and revisionist history. As Mr. Sack had admitted, “for now, this is a story of European institutions’ ability to fund themselves in dollars.”
Not quite the same, is it?
What most people might remember, if anything, about this point in the eurodollar timeline was three days before these conversations had taken place on Mother’s Day, a Sunday, May 9. On May 6, Wall Street was struck by the infamous “flash crash” which was a 36-minute roller coaster across US equities when stocks crashed in a matter of minutes and then almost as quickly recovered.
Later blamed on, what else, computer trading, such monumental financial instability was, quite purposefully, never linked to the real “story of European institutions’ ability to fund themselves in dollars.”
In other words, global dollar shortage.
If 2008 had proven anything, at least outside the corruption of Economics, politics, and central banking, the appearance of global dollar shortage to any significant degree is first associated with major financial instability before, in a matter of time, leading to gross economic decline and more often than not severe and permanent economic damage.
But what to do about it? Policymakers had assured everyone they had taken care of it with QE1. So much so, the Fed’s chief critics were far more concerned about too much “money” having been “printed” collapsing the dollar leading to hyperinflation. Yet, mere weeks after that first QE had terminated, the world’s major central banks were one by one telephoning Mr. Bernanke, hat in hand, pleading for some kind of rescue.
Dollar rescue.
And one of a very specific kind. Indeed, several of the FOMC members on this emergency Sunday conference call questioned why the only option those other central bankers said they’d consider, pleading with Bernanke to only consider, was Fed dollar swaps.
Shouldn’t these European countries (or Japan) do what they’re “supposed” to and mobilize their national US$ reserves? No need for the ECB or the Fed. And as Mr. Sack reminded the group, half of those were being held at FRBNY anyway on Europe’s collective behalf.
“MR. LOCKHART. When we put the swap lines in place last year or the year before, there were questions at that time about what the status of the dollar reserves was in the ECB countries, and why would they not use those reserves. As I recall, the answer was that they simply wanted a supplemental capability and that they were protective of their reserve positions.”
The truth kept out of the standard Economics textbook, the one written after badly misreading the 1998 Asian experience, is that selling reserves or using them in any way entails other risks and potential problems. It sounds easy and straightforward yet rarely ever is.
This is why drawing down foreign reserves is seen as a last last resort measure. For one, most reserves take the form of US Treasury securities which happen to be the best repo collateral. Some local banks, particularly those in Europe, might need a standby source of collateral to borrow upon (collateral-for-collateral swap) from the ECB meaning National Central Banks (NCBs) holding them if the actual problem (spoiler: in May 2010 it was) is collateral shortage not cash shortage.
Selling the USTs off to provide some cash financing doesn’t solve the issue at hand. And should the NCB decide instead to borrow cash in repo using those USTs in its possession, they would essentially be competing with their own desperate banks for both collateral and cash in the very place where harmful discretion is taking hold.
To that end, the word “functioning” Mr. Sack uses seems to have a different meaning in this context:
“MR. SACK. On the repo side, repo markets are still functioning, but we are seeing a large degree of tiering across both the types of collateral and types of counterparties, and, in general, I think the investor pullback from financing European institutions has become wider.”
In this way, using UST reserves in any fashion including potential FX interventions might make things worse.
From the official perspective, however, the real issue was, as usual, psychology. Quite simply, if NCBs were to intervene using their own dollar reserves in whatever fashion hardly anyone would know. There would be no widespread media reports, no widely-quoted central bank press releases filled with reassuring language, the unambiguous public display of “support.”
“CHAIRMAN BERNANKE. Moreover, everybody I’ve talked to about this in the central banking world thinks that at least as important as the direct effect on the dollar funding problems would be the psychological effects of an international coordinated effort in size that supplements the main actions...”
Though some of his voting membership were quizzical, even skeptical, the dollar swaps of course won out.
The following week, starting May 10, about $9.2 billion were drawn by banks bidding in US$ auctions largely in Europe, though a few hundred million taken over at the Bank of Japan.
For the time being, that was it – at least for the Fed when it came to these useless gestures. Two weeks after the lines had been reauthorized and reopened on that Sunday, bidding was largely gone. The balance popped down to $1.2 billion from the $9.2 billion, up to $6.6 billion for one week, the last in May, but then right back to $1.2 billion again.
Meanwhile, broad eurodollar conditions (unsecured, repo, and FX) for European banks in US$ funding did not materially improve. LIBOR, for example, which had surged from as far back as mid-March peaked at the end of May yet stuck at the same high level for two more months. Fed dollar swaps? No impact.
In repo, the 4-week US T-bill yield had plunged (price shooting up for this global collateral squeeze) on, get this, May 6, the flash crash, then would come back shortly thereafter before display the telltale markings of another collateral run beginning at the end of May and lasting all the way until the end of June.
The US$ exchange value abruptly surged, too, an equally unsettling reflection (and doubly confusing to all those Fed-printed-too-much-money critics) of the FX portion of these US$ difficulties.
Meanwhile, gross financial instability worsened before the economy began showing signs of degradation at one of the most inopportune times in economic history being so soon after the end of the Great “Recession.” Twenty-ten was supposed to be the year of full, complete, and unmistakable recovery, ending up plagued by eurodollar, eurodollar, eurodollar.
Needless to say, by the end of August 2010 chastened Chairman Bernanke escaped to Jackson Hole if only to reluctantly preannounce a second round of quantitative easing even though the results of the first round had roundly dismissed any idea of it having been either quantitative or easing. It would be officially approved in early November.
Not that it did any good, because as bad as 2010 had been in eurodollars and interrupted economic recovery, 2011 proved even worse – including use of the Fed’s dollar swaps by year’s end.
No one should’ve been relieved by how banks had behaved using those swap lines at any point. That usage nearly disappeared and did so quickly had meant absolutely nothing, apart from the technical vagaries of how these foreign central bank US$ liquidity auctions really function (not the way you think, a topic I’ve covered ad nauseum in other venues).
In October 2022, as discussed last week, the Bank of Switzerland suddenly found unexpected bids at its regular weekly US$ auctions (these Fed swaps were eventually reauthorized to never expire). The balance taken from them was never more than modest, last week a high of $11 billion. Though that was more than May 2010, it has since disappeared, too.
As of this week, zero. Are you relieved? Many in the media are.
Yet, at the same time, just this week, Chinese commercial banks were doing exactly what European nations hadn’t wanted to over a decade ago. On behalf of the PBOC, China’s big banks were “selling dollars” to prop up the beleaguered yuan which had plummeted to as low as 7.30 to the dollar.
While these things are couched in the terminology of traders (selling dollars), unlike the media or Economists you really need to think about them from a purely monetary perspective (supplying dollars). The PBOC has no standing dollar swap line with the Fed, though you have to wonder if Yi Gang (who is on his way out the door, apparently, according to Xi Jinping’s approved political lists) might’ve picked up the phone or even shot Jay Powell his own desperately imploring DM.
Not that it would matter anyway. As I write this, CNY is on its way right back down again even if in Switzerland no one showed up there this week.
Even if he would answer Yi’s plea, assuming there might have been one, the current Federal Reserve Chairman is in no position to do anything about it. Powell simply cannot admit there’s another global dollar problem, let alone betray the psychology of doing something about it critics will all say adds more to inflation.
After all, Powell already U-turned and has spent nearly this entire year positioning the Fed for that not deflationary risk.
Like 2010, however, the choice is not his to make. The eurodollar has already made it for him, as Bernanke. There will of course be yet another QE in the not-too-distant future. All the signs and developments are lining up in exactly the same way; from T-bill rates, to the US$ (my god!), and, yep, LIBOR spreads, too. Even the short-term up then down in Fed dollar swaps right now focused, for a short time, in Switzerland.
All the curves are hugely inverted (they hadn’t had the chance in 2010), merely waiting for these inevitabilities. First, the negative influence of so much widespread eurodollar disruption, beyond the gross financial instability we’ve already experienced, before the economic consequences that inexorably lead to yet another parade of QEs.
It really is like another sequel to a bad horror movie nobody wanted, except the slasher in it, the main villain, isn’t actually “financial” disruption. That’s the, ahem, twist (if you catch my drift). You think it is all these bad loans or debts (first it was subprime, then it was PIIGS, if you remember back in 2010), you’re made to believe our problems are “financial”, but they’re not.
QE. Dollar swaps. Psychology.
The real antagonists all along are those who keep doing the same things over and over and over while assuring, persuading the public all is fine. All is well. Meanwhile, behind the scenes, the acting plays out very differently.
