Swap lines pulled us back from the brink in 2008. But as this pandemic spreads, a great power rivalry threatens to bring the global financial system tumbling downby Adam Tooze / March 18, 2020 / Leave a comment
As the coronavirus crisis has intensified, the turmoil in financial markets has awakened memories of 2008. At the weekend, along with announcing an interest rate cut and expansion of bond-buying, the US Federal Reserve led a group of major central banks in announcing changes to make it easier to borrow on the so-called liquidity swap lines. These are the hidden bits of wiring in the global financial system which (as I explained in my history of the financial crisis, Crashed) played a huge if under-appreciated part in pulling the world back from the brink just over a decade ago.
Swap arrangements allow the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan and the National Bank of Switzerland to borrow unlimited quantities of dollars from the Fed in exchange for credits in their own currency. After a pre-agreed period, and after the payment of interest on both sides, the currencies are swapped back. Since it is the other central banks that need dollars, the interest payments give the Fed a small margin in its favour.
When they were first used in the 1960s, the purpose of the swap lines was to funnel scarce currencies between central banks to give them firepower in managing and maintaining the fixed exchange rates, which the big economies were all committed to uphold under the post-war Bretton Woods system.
Two generations have passed since then, but much more recently—in 2007—the Fed brought swap lines back, to serve a different purpose. Today the central banks need swaps not so much as managers of national currencies, but rather in their role as conduits: they channel the dollars they receive from the Fed to banks in the financial centres of the City of London, Zurich and Tokyo. Through the swap lines, the Fed thereby acts as a de facto lender of last resort not just to America’s banks, or to foreign banks with branches in Wall Street, but to all the major banks in countries around the world that are covered by swap arrangements, wherever those banks may be located.
Though America’s global influence may be on the wane and though the coronavirus crisis is a further demonstration of how decrepit are America’s domestic institutions, the fact…