*****Fed Using Currency Swaps To Boost The Dollar*****

Currency swaps are of reciprocal currency agreements (swap facilities) between central banks. The officially purpose of such agreements are explicitly of short term and are intended to finance short-term capital flows believed to be seasonal or temporary in nature. Swap agreements are also misused to facilitate large interventions in foreign exchange markets, which is what is occurring with the dollar today.

How currency swaps work

The easiest way to understand currency swaps is to think of them as two separate zero-interest loans. For example, let's say the fed and the ECB arrange a 80 billion euros ($107 billion) swap. The ECB then lends the 80 billion euros to the US, and the US loans $107 billion dollars to the ECB. Later, at an agreed date, the currency swap is reversed: the ECB returns the $107 billion dollars to the fed, and the fed pays back 80 billion euros.

How central banks use currency swaps

Central banks use the foreign currency from swap agreements to prop up their domestic currency by:

A) Providing the foreign currency to domestic financial institutions. (If those institutions were forced to go to the exchange markets for funding, it would drive down the value of the domestic currency.)
B) Using the foreign currency to directly intervene in exchange markets.

Why currency swaps are so popular

Currency swaps allow central banks to borrow foreign currencies without revealing that their country's banking system or currency is in trouble. In other words, since both central banks involved in a currency swap borrow foreign currencies at the same time, it is difficult to tell which central bank needed them the most. It is this lack of transparency which makes currency swaps so attractive to central banks.

The dangers of currency swap agreements

Currency swaps are temporary measures that need to be unwound. If the central banks involved in currency swaps were responsible in their use of the foreign credit (ie: financing seasonal short-term capital flows), then unwinding the swap agreement is a simple matter. However, if a central bank uses a currency swap to recklessly intervene in exchange markets (ie: desperately prop up a failing currency), then unwinding swap agreement becomes problematic.

Remember that currency swap agreements are essentially two loans. When a central bank misuses a currency swap to prop up its failing currency, it will not have the foreign currency on hand when it comes time to repay the swap drawings. As a result, that central bank will then be forced to issue bonds in foreign currencies to secure the funds to unwind its half of the swap agreement.

The true danger of currency swap agreements is that they allow irresponsible central banks to temporarily prop up their currencies by racking up large amounts of foreign debt. When the swap agreements are later unwound, not only does the domestic currency's value fall, but the nation is left with large amounts of foreign denominated debt.

The US has a history of misusing currency swap agreements

Through the treasury's Exchange Stabilization Fund and the Federal Reserve's System Open Market Account, the United States has twice used swap agreements in failed attempts to prop up the dollar. On both those occasions, the treasury was subsequently forced to issue foreign currency-denominated debt (Roosa bonds and Carter bonds) to repay swap drawings. Evidence of this repeated misuse of currency swaps can be seen on The United States Treasury Department's website.

(emphasis mine)

Intervention Operations

Treasury policy during 1961-71 period focused on deterring capital outflows from the United States and giving major foreign central banks an incentive to hold dollar reserves rather than demand gold from the U.S. gold stock. The ESF resumed intervention operations in the foreign exchange market in March of 1961 (for the first time since the mid-1930s), but it soon became apparent that the resources of the ESF alone were too small to sustain transactions of the magnitude necessary. At the invitation of the Treasury, the Federal Reserve joined in foreign exchange operations in February 1962. The Federal Reserve entered into a network of swap agreements with other central banks in order to obtain foreign currencies for short-term periods for use in absorbing forward sales of dollars by foreign central banks hedging exchange risk on their dollar holdings. To provide foreign currency to repay the Fed's swap drawings, the Treasury during the 1960s issued non-marketable foreign currency-denominated medium-term securities (Roosa bonds) and sold the proceeds to the Fed.
...
Later in the 1970s, the US monetary authorities built up foreign currency reserves substantially. For this purpose, the ESF entered in a $1 billion swap agreement with the Bundesbank in January 1978 (which has since been allowed to expire). In connection with the dollar support program announced in November 1978, the Treasury issued foreign currency-denominated securities (Carter bonds) in the Swiss and German capital markets to acquire additional foreign currencies needed for sale in the market through the ESF. The United States also drew its reserve position in the IMF.

Given the US's repeated abuse of currency swaps, it is very disturbing that the fed is once again engaging in an enormous amounts of such agreements. Just last week, Bloomberg reported that the fed has agreed to more swap lines to access euros, yen, and pounds.

Fed Agrees on Swap Lines to Access Euros, Yen, Pounds
By Craig Torres

April 6 (Bloomberg) -- The Federal Reserve and four other central banks announced a currency swap arrangement that will give the U.S. central bank access to as much as $285 billion in euros, yen, British pounds and Swiss francs.

"Should the need arise, euro, yen, sterling and Swiss francs would be provided to the Federal Reserve via these additional swap arrangements with the relevant central banks," the Fed said in a statement today. "Central banks continue to work together and are taking steps as appropriate to foster stability in global financial markets."

The plan, if used, "would enable the provision of foreign currency liquidity" by the Fed to U.S. financial institutions, the U.S. central bank said.

The currency swaps have been authorized through Oct. 30 by the Federal Open Market Committee and are not yet implemented, a sign that central bankers may see no urgent need for the currency lines at the moment. What's more, the Fed hasn't described how it would distribute the currency. One option would be to loan it through the discount window.

"In a regime of greater international cooperation among central banks, it makes sense" for the Fed to have open lines for foreign currency, said Brian Sack, vice president at Macroeconomic Advisers LLC in Washington and a former Fed Board economist. "I don't think it is an irrational response for investors to ask if the central bank is worried about something."

Yen, Euros

If drawn upon, the arrangements would let the Fed provide as much as 30 billion pounds ($44 billion), 80 billion euros ($107 billion), 10 trillion yen ($99 billion) and 40 billion Swiss francs ($35 billion), the statement said.
...
Dollar Swap Lines

Today's announcement mirrors the dollar swap lines the Fed has established with 14 other central banks, ranging from the Reserve Bank of Australia, the Monetary Authority of Singapore, and the Norges Bank, to provide U.S. currency to foreign markets.
...
Central bank currency swaps don't carry exchange-rate risk because the reversal, which could be as long as three months later, uses the same rates, the Fed says. All told, the Fed's balance sheet reported $308.8 billion in central bank liquidity swaps April 1.

My reaction: The news that the fed has secured more of currency swaps has some very disturbing implications:

1) There would be no need to secure these new agreements if the fed hadn't already used most of its existing $308.8 billion in central bank liquidity swaps.

2) This implies that unwinding the Federal Reserves existing swaps would leave the US with close to 300 billion in foreign denominated debt.

3) This development also implies that much of the dollar's recent rally has been artificially created by the Federal Reserve's 300 billion currency swap intervention.

4) To date, the fed's currency swaps have been presented as motivated by shortfalls in USD funding in foreign institutions. While this might have been true initially, it is now obviously false.

5) Considering that the fed is planning 15-fold increase in us monetary base, 300 billion in foreign debt could quickly turn into 3 trillion or more.


Conclusion:
The fed's use of currency swaps to boost the dollar shouldn't surprise anyone. After all, this is the same fed which has let
US Banks operate without reserve requirements, caused the housing bubble with low interest rates, and failed to regulate subprime mortgages. Opening credit lines which could help American banks finance a foreign capital flight falls right into place with the fed's other actions undermining the US financial system.

The dollar bubble is reaching its final stages

Soon food prices will begin rising, as the world is headed for a
Catastrophic Fall in 2009 Global Food Production. Weather and credit conditions are causing falling production around the globe, and the world's three biggest grain producers are all headed for big shortfalls. In India, torrential rains have devastated wheat crops, while in the US drought and freeze have damaged winter wheat. Meanwhile, Northern China was hit by worst drought in 50 years, and Chinese authorities have ordered three-month, nationwide audit of grain stocks as they are obviously very worried about whether China's grain reserves actually exist.

Inflation in food commodities will push up gold demand cause manipulation efforts to break down. Already, the NYSE has runs out of 1 kg gold bars, and default on COMEX gold contracts is a month or two away. The collapse of paper gold (futures, unallocated gold, GLD, etc...) would destroy what is left of confidence in the US financial system, starting a panic out of the dollar.

Lesson learned from the financial crisis

The truth of this world is that those, who, through stupidity, greed, and fraud, dig themselves into a hole, will keep digging deeper until they hit bedrock and run out of options. This is what happened with Bernard Madoff: he must have known for years his ponzi scheme was doomed to collapse, but he kept it going until he was down to his last 140 million. The United States, like Bernard Madoff, has for years been digging itself into a hole, and the fed's use of currency swaps to boost the dollar is the final part of this process. Unfortunately, the US, like Madoff, is about to hit bedrock.

This entry was posted in Background_Info, Bailouts, Currency_Collapse, Federal_Reserve, Financial_Wizardry, Wall_Street_Meltdown. Bookmark the permalink.

26 Responses to *****Fed Using Currency Swaps To Boost The Dollar*****

  1. Anonymous says:

    Thanks Eric. I had asked for an article related to this awhile back. Excellent job on explaining the swaps.

    How do the 300 billion dollar swaps translate into 3 trillion dollars of debt?

  2. Anonymous said...
    How do the 300 billion dollar swaps translate into 3 trillion dollars of debt?

    If the dollar loses nine tenth's of its value against other foreign currencies, then the dollar amount of foreign debt will increase.

    For example, lets say the US owes 80 billion euros to the ECB. 80 billion euros today is worth around $107 billion dollars. Now if the dollar then loses nine tenth's of its value against the euro, that 80 billion euros could become worth 1 trillion. The dollar amount of the US's foreign debt would have increased 10 times.

  3. Hugo says:

    Excelent post.

    Great explanation of the currency swaps.

  4. Anonymous says:

    Gold, and especially silver have been going down rapidly for the last few days. Are good days coming and financial crisis over? Or, gold and silver still good savings vehicle?

    Thanks.

  5. Anonymous said...
    Gold, and especially silver have been going down rapidly for the last few days. Are good days coming and financial crisis over?Stocks will go up, but it will be a false prosperity. (food and gold prices will go up much faster than stocks)

    Or, gold and silver still good savings vehicle?gold and silver are still good savings vehicle. In fact this pullback is a great opportunity to get in if you missed the rally up to 1000. Food shortage will jumpstart inflation which will send gold higher.

  6. Bowtie says:

    I am a gold bug, but -

    "India and China may press for the sale of the entire gold reserves of the International Monetary Fund (IMF) to raise money for the least developed countries"

    http://www.kitco.com/ind/nadler/apr172009A.html

  7. Hugo says:

    I am a gold bug, but -

    "India and China may press for the sale of the entire gold reserves of the International Monetary Fund (IMF) to raise money for the least developed countries"

    http://www.kitco.com/ind/nadler/apr172009A.htmlChina wants the IMF gold, but the IMF doesnt want to sell. Thats why they are preasuring the IMF.

  8. Hugo says:

    I am a gold bug, but -

    "India and China may press for the sale of the entire gold reserves of the International Monetary Fund (IMF) to raise money for the least developed countries"

    http://www.kitco.com/ind/nadler/apr172009A.htmlChina wants the IMF gold, but the IMF doesnt want to sell. Thats why they are preasuring the IMF.

  9. Bowtie says:

    Yea I am not exactly sure what it means - if the IMF sells the gold logically you would think increased supply of gold decreased prices.

    However, if China and India governments are the purchasers paying in dollars, then the gold is still frozen in the government vaults but the USD is flowing.

  10. EPC says:

    Eric, I had some comments to make on what you wrote about commodity prices and Bernard Madoff, but because what I had to say was rather long and I did not want to treat your comments section like a chatroom, I have posted them on my own blog, at http://antonkleutgen.blogspot.com/. In essence, I write that the food shortage situation stands to become even _worse_ than your sources have indicated, and that the Madoff case may not be quite what it seems to be.

  11. Anonymous says:

    I doubt that the IMF would dump all their gold into the market at once even if they wanted to sell it. They would get much more money for it if they piece-mealed it in. Better yet, they would woud do better to negotiate with a central bank or two in the world to sell it directly to them. If I were China, this would be almost too good to be true - an opportunity to dump some USD holdings for IMF gold!

  12. Anonymous says:

    Eric - great synthesis of your prior work into one article. Makes the bigger picture seem so clear now. I need to go buy some more gold...

  13. Anonymous says:

    Eric,

    Thanks for another excellent post.

    As for the IMF gold sales, anything with "Nadler" in it is suspect IMHO!
    Check history, after the last IMF gold dump and Britain's great sale.. what happened to prices?

    For those who are interested in some exceptional reading material on the big picture, take a peek at what this guy has to say:
    http://www.scribd.com/kzuur58
    Especially these : http://www.scribd.com/doc/14268132/Financial-Panics-Political-Change and http://www.scribd.com/doc/14227076/Behind-the-Curtain4909

    Here's hoping everyone stays safe in the challenging times ahead.

    BB.

  14. Anonymous says:

    Hello Eric,
    Your article offers a great explanation of what is happening in the currency markets.
    I am not so sure that your call on a breakdown of the Comex in a month or so will come true. Up to now the powers that be found a way to buy time on several occasions; you reported one of them on your blog. The European Central Bank sold the gold right on time for delivery to save Comex once more. Next time there might show up a seller of gold out of nowhere again or the buyers get forced to settle in cash or whatever trick they can pull.
    For the actual financial system a relatively low paper-gold price is essential, since a high gold price indicates inflation or loss of confidence in the system. In this case the bond yields are absurdly low, an increase in yield to reflect the newly recognized inflation means the debt game is up and it ends in hyperinflation or bankruptcy. To me the link between bond yield and the price of gold is in the long run obvious because both are driven by inflation, even if this relation is not currently observable. From 1971 to 2000 this correlation was observable with gold leading at turning points. Why is it different now??
    Gunther

  15. Anonymous says:

    That is the most easy way to print money, no deposit, no bonds, no debts... Just creat money from none. Swaps will never be unwinded. More swaps are to come till the end of USD, definitely. USD will be booted up in the next weave of tsunami. Some day not far away, USD will eclared its sudden death as an A-bomb.

  16. Anonymous says:

    But strong the $ is quite strong today. The Euro lost 5 cents from yesterday. Only because what Trichet said?!?!

    Strange times...

  17. Robert says:

    I don't believe for a second that there's any threat to gold and silver from this at the moment, but I just discovered this very interesting article on wikipedia;

    http://en.wikipedia.org/wiki/Synthesis_of_noble_metals

    It's about transmuting metals. Real alchemy! I expect we'll see these processes improve over the next decade with the general ramp up in nuclear related technology.

    It seems that reactor waste is already a viable source of some rare metals (although obviously the amounts we're talking about are tiny).

  18. Shin says:

    hey robert, thanks for the article.
    one thing im wondering after reading the article is... how much of synthesis gold can it be produced? enough to stabilize the price?

  19. stibot says:

    I do not underestand purpose well: why FED should be propping dollar at the moment?

    Why all this effort if devaluation of the dollar will cause debt to evaporate? It was also written that currency devaluation had enabled healing some economies in the past much faster.

    Or do they think the US is able to continue in Greatest Ponzi scheme forever and that's the target?

  20. Anonymous says:

    To keep the biggest ponzi sch. running:
    1. Europe----swaps US to save the banks because most CDS were valued in USD.
    2. US----swaps ERU & Pound in return, but no use for USA. So, it sells all the swapped EUR into FX markets and to short the paper gold. Results in boosting the USD.
    3. USD was boosted to make people believe that USD is still a strong currency.
    4. trillions of USD were created from none, even need not to issue any Treasury bonds!
    5. Swaps will never be rewinded because they can just swap the due bills(borrow receipts) some years later.
    6. US will never make money by hard working(real money) to pay back the loans owed to the world. How could US pay back in thousands of trillions of product value to the world? The only way is to devaluate the USD to zero.

  21. Anonymous says:

    so I guess the central banks run the world, or at least the financial world since this leads to currency manipulation, and higher risk down the road. Obviously, the governments of the world are complicit. Do they not question the motives of the central banks? Do they not know what we know?

    Is this a deliberate set-up to, at some point in time, destroy the USD and what's left of the US economy.

    does anyone know when Bernanke is scheduled to leave? Any thoughts on replacement? Geithner?

    We know how the SHTF when one of these guys move on...Paulson comes to mind.

    Its unbelievable that these unsound practices continue, in light of the fact that there are hundreds of economics that are speaking out against the soundness of our economic policy.

    eric - do you support abolishing the federal reserves and central banks??

  22. Anonymous says:

    Word is that gold is going to take a beat down in the coming years.China might be forced to sell gold onto the markets they are currently stockpiling.

  23. Numonic says:

    "stibot said...
    I do not underestand purpose well: why FED should be propping dollar at the moment?

    Why all this effort if devaluation of the dollar will cause debt to evaporate? It was also written that currency devaluation had enabled healing some economies in the past much faster.

    Or do they think the US is able to continue in Greatest Ponzi scheme forever and that's the target?"

    Printing federal reserve notes now is not equivalent with devaluing the US dollar. In the situation we are in now with this credit contraction, printing Fed Notes makes the dollar stronger. The Fed and govt. wants to keep the dollar strong. They are not trying to destroy the US dollar, they are trying to save it.

    Read more of my previous replys.

  24. Numonic says:

    "Anonymous said...
    Word is that gold is going to take a beat down in the coming years.China might be forced to sell gold onto the markets they are currently stockpiling."

    The only way gold would take a beating in the coming years is if hundreds of billions of ounces of new gold just appeared above ground on earth without anyone having to lift a finger to get it or if superman appeared and flew around the world in the opposite direction of it's spin fast enough to bring spin the planet in reverse and bring us back to the time when we had less debt than we have today.

    I'm going to go out on a limb and predict neither of those things will happen.

  25. Pantera says:

    Hello.he European Central Bank sold the gold right on time for delivery to save Comex once more. Next time there might show up a seller of gold out of nowhere again or the buyers get forced to settle in cash or whatever trick they can pull.
    For the actual financial system a relatively low paper-gold price is essential, since a high gold price indicates inflation or loss of confidence in the system. In this case the bond yields are absurdly low, an increase in yield to reflect the newly recognized inflation means the debt game is up and it ends in hyperinflation or bankruptcy.Thank you for site

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