Brad Setser

Brad Setser: Follow the Money

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Financial de-globalization, illustrated

by Brad Setser
March 23, 2009

The financial world has changed — even if the scale of the change isn’t obvious in the financial sector’s 2008 bonuses.

Here is one indication of the scale of the change: the US government was — according to the latest US balance of payments data – a large net lender to the world. Yes, a net lender, not a net borrower. Foreign central banks are no longer providing the US with much new credit. Indeed, they withdrew $13.6 billion of credit from the US in the fourth quarter, as central banks’ agency sales ($96b) and the fall in their deposits in US banks (bank CDs fell by $80 billion) produced a net outflow despite record purchases of US treasuries ($179b, all short-term bills). And the US — through the Fed’s swap lines — provided a rather large sum of credit ($268 billion) to the rest of the world. For the year as a whole, the BEA data indicates the US government lent $534 billion to the rest of the world while foreign governments lent “only” $421 billion to the US.

Judging from the data on net flows, Bretton Woods II has in some sense come to an end. The world’s central banks are no longer building up reserves and thus are no longer a net source of financing to the US. It just didn’t end in the way the critics of Bretton Woods II expected — on this, Dooley and Garber are right. The fall in official flows* was offset by a rise in (net) private inflows.

Then again, Bretton Woods II also didn’t anchor a stable international financial system in the way Dooley and Garber suggested either. Both private and official demand for US financial assets has collapsed. Gross inflows are close to zero.

How then can the US still run a large current account deficit if the rest of the world isn’t buying its financial assets? There is only one answer: Americans have pulled funds from the rest of the world (call it deleveraging, call it a reversal of the carry trade or call it a flight to safety) faster than foreigners have pulled funds from the US market. Words cannot really capture the sheer violence of the swings in private capital flows that somehow produced a a rise (net) private demand for US financial assets. The modest change in net flows reflects an enormous contraction in gross flows. Look at the quarterly data — not a rolling four quarter sum — scaled to US GDP.**

To put in in plain terms, Lehman’s collapse had a bigger impact on cross-border flows than 9.11. Compare q4 2008 to q3 2001.

The enormous withdraw of private US lending to the world was offset, in part, by a surge in US official lending to the world. It was just the Fed, not the Treasury, that did all the heavy lifting.

For now, Dan Drezner doesn’t need to worry too much about the United States’ ability to be the world’s lender of last resort. A crisis may come when the US government cannot play a similar stabilizing role. But that crisis would be marked by a run out of the dollar — not a global scramble for dollars. The current crisis has constrained the United States’ ability to be the world’s importer of last resort, but not its ability to be the world’s lender of last resort. Not so long as the the world is scrambling to find dollars, the one currency the Fed can create. Here, my earlier concerns haven’t been born out.

Still, it is hard to look at these charts and conclude all is well in the world. Cross-border financial flows rose to crazy heights during the credit boom. Thank the shadow financial system. Over the past year those flows have collapsed with stunning speed.

Had the collapse in inflows and outflows not offset, there would now be talk of a sudden stop in capital flows to the US. But so long as the fall in demand for US assets is matched by a fall in US demand for foreign assets, a collapse in gross flows need not to lead to a collapse in net inflows. To date, the United States “sudden stop’ has manifest itself as a credit crisis not a currency crisis.

The “great contraction” in private capital flows actually started in the summer of 2007. The pressure that led to Lehman’s failure — and the near-failure of a host of other financial institutions, not the least AIG — had been building for a while.

And it is also striking, at least to me, that financial globalization collapsed of its own weight, not because of any political decision to throw sand into its gears. That may yet happen. The political reaction to the financial excesses of the past few years is just beginning. But the fall in financial flows to date largely reflects the unwinding of a a host of leveraged bets made by the City and the Street — not demands from Whitehall or Washington.

Indeed, without government intervention, the collapse in cross-border flows would have been far larger. If the government hadn’t stepped in, a host of financial institutions would have collapsed, leading to an even sharper contraction in capital flows. That is something that often seems to be lost in the debate over financial protectionism.

The data for the charts can be found here.

* The BEA data understates official flows from mid 2007 to mid 2008, as it hasn’t been revised to reflect the results of the survey data. Even the revised BEA data understates the impact of central banks and sovereign funds as it doesn’t capture those funds that have been handed over to private fund managers, or the purchases of US securities by European banks with a large dollar balance sheet as a result of large central bank deposits. This isn’t an issue for the tail end of 2008 though. The fall off in official demand is real. Central banks were in aggregate selling off there reserves — as the IMF’s forthcoming COFER data will show.
** A negative outflow is functionally the same as an inflow; a current account deficit can be financed by borrowing from the world (an inflow), selling equity to the world (an inflow) or by reducing your lending to the world (a negative outflow, and since outflows have a negative sign of the balance of payments data, a negative outflow generates a positive flow) and/ or selling your existing stock of foreign investments (a negative outflow).


  • Posted by Rajesh

    It is not surprising that the U.S. government is such a big lender. Countries such as South Korea and Russia are replacing private dollar denominated debt with local currency debt by running down their reserves (and in South Korea’s case borrowing directly from the Federal Reserve.) In addition, European banks are no longer able to fund their dollar assets using inter-bank lending and instead are getting their dollars directly from the central bank (again as a consequence of the swap lines with the Fed.)

    Apparently, all that time we were worried about foreigners stopping their lending to the U.S., we forgot to take into account the amounts of money that the U.S was lending to the rest of the world. As befits a bubble currency, the U.S. was a net lender in the short term market and a net borrower in the medium and long term market. When private short term lending disappeared, the Federal Reserve had to step in to bridge the gap.

  • Posted by jonathan

    It looks more and more like the villains are a) lack of information and b) lack of regulation. “Thank the shadow financial system” indeed! And it further looks like these villains are enabled by short-term compensation schemes.

    Charlemagne says the Europeans are worried that Britain will try to back off financial reform and they fear the US will back Britain. Trying to preserve the City’s big secrecy edge. I don’t see how that can happen; the cost has proven too high. Either Britain changes its “light touch” rules or the countries that deal with London will regulate the way their institutions operate there – which would be worse for the City because it would then be pushed to the fringes of respectability. (Hard to imagine?)

    You noted how AIG concentrated systemic risk and no one knew. Again, derivatives can be wonderful things but not if you don’t know what’s happening with them, who holds them, where the risks are concentrated.

    Better disclosure, better information capture, less secrecy and compensation set so traders aren’t rewarded for making deals that look good in the short run. That’s what it looks like we need going forward.

  • Posted by WStroupe

    An obvious question here – what happens when U.S. investors are largely finished repatriating their wealth back into the dollar? With foreign official and private demand for dollar-denominated assets gone, with Bretton Woods II hibernating or dead, who’s going to finance the U.S. Treasury? U.S. investors alone, along with the Fed, which is buying Treasuries? Does this whole situation portend that the Fed will have to step up and buy a lot more than the $300 billion they announced last week? With the dollar weakening, if I was a foreign holder of anything dollar-denominated, I’d try to sell it for something else, some hard asset, not any financial asset. Does this also portend that a run on the dollar impends?

  • Posted by RebelEconomist

    I would be surprised if the Fed’s swap lines were recorded as net US lending to the rest of the world. The dollar loans from the Fed to foreign central banks are supposed to be collateralised by an initially equal value of foreign currency loaned to the Fed – ie they are swaps (although it has to be said that the central banks have not been open about how the swaps actually work). The net change should be the reduction in private sector (eg money market funds) lending to overseas vehicles holding longer term dollar assets like CDOs.

  • Posted by DJC.

    The Federal Reserve also swapped $120 billion in US Dollars with the ECB and the Japan Central bank which supports the US Dollar.

    Where will the US obtain FDI inflows in the coming year? The China PBoC will have alot less surplus dollars simply because that nation’s trade surplus is collapsing along with world trade.

  • Posted by yoda

    is Geithner’s plan endorsed by Obama essentially Geithner and Obama Shadow Toxic Waste Monetization Plan.

    expect taxpayer be hook on toxic waste at more than 85c on dollar. that 85c will be used as loss buffer to monetize toxic waste.

  • Posted by b

    Brad have you seen this?

    Zhou xiaochuan, China’s central banker held a major speech today:

    Reform the International Monetary System

    He calls for IMF special drawing rights to replace U.S. dollars as reserve currency.

    The other BRIC countries support such a move and it will be proposed at the G20 meeting.

    The U.S. would lose its “extraordinary privilege” of borrowing in its own currency and later paying back in devalued dollars.

  • Posted by greg

    On the other hand, head of SAFE also said:

    “Investing in American Treasuries, as an important part of our foreign exchange reserve management, will continue.”

    “We may start studies and discussions about a multi-currency regime, but realistically we should focus more on enhancing supervision of the dollar-led currency system, particularly the financial and economic situation of major reserve-currency countries,” she said, alluding primarily to the United States.

    See the report from Reuters.

  • Posted by Mark

    I guess you respond to your latest posts. Quick question for you…

    US does not need to draw on its reserves because it sells dollar denominated bonds. How does China do it? I infer that they use their current account surplus to fund their fiscal deficit. Is this correct? A little confused…

  • Posted by Matt

    There has been no delivery of collateral for the Fed swap credit to the ECB and other central banks. These arrangements are “swaps” in name only; they are really loans. That’s why you see a $265 billion outflow in line 46 of BEA balance of payments Table 1: “U.S. government assets, other than official reserve assets” and also on line 49.

  • Posted by gillies

    i bought $150 ( in my irish bank – exchanging for euros plus a small transaction fee.) four years ago (late 2003).
    you all said ( contributors to brad’s site ) that the dollar was toast. i bought my few dollars for a bet with myself that the dollar was not quite on the cliff edge, as reported . . .

    four years later, (early 2009) my daughter was invited by a (u s resident) relation, to disneyland, florida. i gave her the $150 and it was worth, in euros, almost the same as the original purchase plus transaction cost.

    so i sent my dollars back into the u s economy. (fair enough – i remember with gratitude the marshall plan !) my original reason for confidence in the dollar was that in the event of serious crisis (and we all got that bit right) money would be going home all over the world. a lot of that homing money would be dollars.

    so i was vindicated.

    so, you ask – ‘what do you predict now ?’

    i don’t need to predict anything. i am out of dollars. perhaps that’s a prediction of massive black swan potential, upside and downside.

    incidentally, though the amounts involved are small – i am in land, buildings, cattle, sheep, and cash. the cash is spread across three different types of institution ( bank, credit union, post office )

    no dependents, no mortgage, no credit card, no car, no lawn, no television, no central heating, no medicines, no fridge.

    farm organic, no machinery, no agrochemicals.

    small vegetable garden.

    if all of this sounds off topic, it may make sense in a while. money is not the bottom line. money may be the bottom of the ship – but it is not the floor of the ocean.

    the dangers are touted now as inflation, and deflation.

    the real danger may be disillusion. the deflation of trust. it is not that people expect fed policies to result in money buying more (deflation), or buying less (inflation) – it is just that violent policy adjustments are demonstrating repeatedly that the rules are arbitrary. people accept wealth as a reward for effort or for luck. but they cannot accept arbitrary enrichment.

    china (zhou xiachuan) may be signalling the limits to arbitrary self enrichment. he may actually be defending capitalism !

    g20 may turn out to be g19 against g1. the outcome is so fraught with possibilities that only a fool would be either long or short the dollar !

    meanwhile i predict that food will be scarce and farming will continue.

  • Posted by gillies

    all of this thread is (to me) very instructive, and so was the last one. brilliant.

    * * *

    all of the pretty graphs above show inflows and outflows.

    - but the level line of net flows tends to hide the violent change from massive flows to tiny trickles. the great contraction continues with a great contraction in flows – contraction in transactions. the helicopter droppers have to boost not just the amount of money in circulation, but the amount of circulation of money.

    but trust is contracting too. credit without credibility. can it be done, ben and tim ?

    or will the new world order be the zhou world order ?

  • Posted by bsetser

    rebel — the rise in the fed’s foreign assets is recorded in the data as a rise on US claims on the rest of the world, or an outflow. that is one leg of the swap. if foreign central banks held the dollars they received from the swap, that would show up as a rise in their claims on the us, and as an inflow. but the central banks lent out the $ to their banks, which either bought treasuries (an inflow) or repaid their US debts (a fall in US lending to the world/ us claims on the world, or a negative outflow or an inflow)

    re: zhou — i am in favor of broadening the currencies in the sdr basket, and in broadening the set of reserve currencies. if china drops its capital controls, the yuan could/ should be a reserve currency. of course, being a reserve currency means accepting inflows, which china has generally resisted. a somewhat less dollar based global financial architecture — if the transition happens gradually — wouldn’t be a bad thing. but ultimately china’s decision about what it pegs to — and what types of reserve assets it buys — matters more than any rhetoric.

  • Posted by don

    “but ultimately china’s decision about what it pegs to — and what types of reserve assets it buys — matters more than any rhetoric.”
    And the fact that they continue to peg well below market may lead to more than rhetoric, as well.

  • Posted by don

    DCJ: “Where will the US obtain FDI inflows in the coming year? The China PBoC will have alot less surplus dollars simply because that nation’s trade surplus is collapsing along with world trade.”
    Inherent in this comment is a question that I have raised before. Which is fixed by policy in china, the amnount of intervention (and hence the current account balance), or the value of the yuan? I think it is the former, and I think we will see in the fairly near future which view is more accurate.

  • Posted by internationalist

    The G20 meeting is one of the most important meetings in U.S. history.

    Both the U.S. and UK must agree to a new financial order, with the introduction of a new global reserve (basket of currencies weighted by GDP of nations) to avoid global imbalances from reaching unsustainable limits.

    The failure of UK/US to not come to “basic” terms and agreement for a new global reserve under a new international monetary system could cause havoc in months going forward.

    A run on the dollar is almost imminent if the traditional west fails to acknowledge emerging players, who need a larger influence under a New Financial Order.

  • Posted by internationalist

    China, Most of Europe, Russia, and perhaps South America all agree on the call for a new global reserve.

    I am well aware that the transition and change is a difficult one for the United States.

    The United States is in extreme difficult spot to agree with this new financial order.
    The past privilege of U.S. Dollar global reserve allowed the U.S. to maintain a greater standard of living in the world we live….A move to a new order, would surely readjust certain previous privilege we endured for many decades.

    The G20 meeting in April is full of suspense. Depending on the outcome, Markets could be extremely volitile on:

    April 6, 2009.

  • Posted by don

    Internationalist: “A run on the dollar is almost imminent”
    That would be great for the U.S. current account and employment. But a run to where? Officials in China and Japan would not tolerate the current account pain and would so would not allow their currencies to appreciate substantially. And the euro would be as likely to crash shortly after any such run, as the results for their economies would be catastrophic. Though we might see a run to commodities (inflation).

  • Posted by internationalist

    @ don, you nailed it. the potential for an upcoming currency crisis would lead developing and emerging players in a rush toward commodity and agric related investments.

    Oil, Copper, Sugar, Aluminum and other such precious metal/agriculture related products will enter hyperinflation in terms of dollar-relationship.

    If this were to happen, oil would certainly and quickly go +$200, gold +$2000 and your gallon of OJ would cost you the price of what you now pay for a 12 pack of Guiness.

    Bad Nightmare? Yes! Realistic, unfortunately so.

  • Posted by jl

    my belief, part of the new international system will be larger role for the IMF.

    the structure should be outlined in detail after the G20 meeting in a few weeks. Basic bullet points will be outlined and my estimate is YES, a new global reserve is in the cards.

    Weighted on nations GDP, where all G20 players have a share of the new currency. The composite will be weighed and reshuffled every 5-10 years based on the cumulative GDP average for X number of years. This new currency may also have the mobility to be valued by the X’s and Y’s of certain commodities.

    This solution is perfect as it seeks and will help readjust the world’s global imbalances.

    Brad & Sebastian can probably better explain the +/-’s of this new global reserve.

    I’m sure Mr. Mallaby has much greater input on the data and vision than most…..

  • Posted by jl

    and all thoughts/comments in previous message are expressed of my opinion only. a new international system maybe all “talk”, but my thoughts differ…..

  • Posted by JKH

    Rebel, re collateral on the swaps:

    The Fed and the foreign central bank exchange currencies at the outset.

    The Fed puts foreign currency on deposit with the foreign central bank.

    The Fed has also entered into a forward exchange contract with the foreign central bank – to reverse the currency swap at an agreed rate.

    The net effect is that the Fed has a foreign currency deposit fully hedged into US dollars, which is recorded as a US dollar asset on the Fed’s books, even though the underlying deposit is foreign currency.

    Accordingly, the foreign currency collateral is not an inflow. It’s not a loan to the Fed. It’s actually the underlying (ex the currency hedge) for the outflow.

    The result is a net official outflow in terms of NIIP, etc.

    At the other end, the foreign central bank has a dollar loan to a foreign commercial bank. But it’s hedged the currency risk with the Fed. So the loan probably shows up on its books as an asset in the home currency.

    Then Brad’s explanation follows regarding the nature of the return dollar flow to the US, without contradiction.

  • Posted by EthanJ


    I’m back again to play the same old song:

    Net Investment Income is still positive in the TIC data, at about $30bn/qtr. Given the scale of US sales of bonds to foreigners over the last five years, that was a pretty unexpected outcome. I recall that two years ago, you were predicting it would have to turn negative because interest for financing the US current account and fiscal deficits would swamp any valuation or capital gains for US assets held abroad.

    But what if we assumed that the income would stay positive – and small. Would we gain any predictive insight into the financial crisis?

    Dark Matter speculation seems to have fallen by the wayside during the current financial crises. But maybe this is a sign that the idea of an US Income identity needs more examination…

  • Posted by bsetser

    JHK’s description of the swaps //s my understanding of the swaps.

    as for dark matter, the income balance has benefited from two things:

    a) the fall in US rates, which helps the US (as a net borrower in dollars)
    b) the fall in returns on foreign direct investment in the US linked to the recession/ strong $ (for most of 08).

    my early forecasts were based on the assumption that rates across the debt stock would rise to 5% or so and the gap between the US lending rate and the borrowing rate would disappear, so net interest payments would rise sharply. that isn’t happening. rates are falling.

    next year tho i would expect US FDI income abroad will fall sharply.

  • Posted by RebelEconomist

    JKH, Brad

    Thanks for the explanation, but I am sceptical. Since it is a swap, the accounting treatment of either side should be identical – your argument applies equally to the foreign central bank, and both central banks should not have a net official outflow that is not recorded by the recipient – so the swap per se should not generate any significant net capital flow. If the “swap” is recorded as an official outflow, that is presumably because the US official statisticians are (rightly in my view) recognising that these are really unsecured loans made by the Fed (ie collateral in the form of a foreign currency deposit that is the liability of the issuer of that currency does not really constitute “security”). Perhaps they are presented as swaps because the Fed does not have the vires to lend unsecured?

  • Posted by JKH


    We’ve been discussing this for a while, so I decided to work it through in more detail, at least for my own satisfaction.

    A currency swap is the combination of a spot FX transaction and a reversing forward FX transaction.

    A deposit that is created with the spot proceeds of a currency swap, where the maturity of the deposit matches the maturity of the outstanding forward leg of the swap, is referred to as a (fully hedged) swapped deposit.

    The Fed effectively has a swapped deposit with a foreign central bank. The Fed has sold dollars, bought foreign currency, deposited foreign currency with the foreign central bank, and arranged to swap foreign currency back to dollars with a forward currency contract at maturity of the deposit.

    The foreign central bank has the corresponding liability, and a dollar loan to a local commercial bank.

    The dollars loaned out by the foreign central bank circulate back to the Fed via international clearing banks, resulting initially in an increase in clearing account reserve balances at the Fed. That completes the circle as far as the Fed is concerned, and is consistent with Brad Setser’s example in terms of the broader system flows.

    The weekly Fed balance sheet includes “Central bank liquidity swaps” under assets. This terminology is unfortunate in that it is misleading with respect to the accounting for the constituent parts of the transaction.

    The Fed sources foreign currency from the currency swap. It puts those funds on deposit with the foreign central bank. The deposit is the balance sheet position. The currency swap is not the balance sheet position. The currency swap is a transaction, not an asset.

    Alternatively, the balance sheet position may be viewed as the deposit in combination with the forward part of the swap. The spot part of the swap has created the deposit. The forward part of the swap is still outstanding. The deposit together with the forward contract amounts to a swapped deposit, as defined above. The “central bank liquidity swap” terminology is closest to the swapped deposit interpretation. But it really doesn’t matter. The foreign currency deposit is the underlying substance of the asset.

    The Fed leaves foreign currency sourced from the currency swap on deposit with a foreign central bank. For a brief time, the foreign central bank similarly may have dollars on deposit with the Fed.

    But the central bank asset symmetry ends there. The foreign central bank lends its dollars to commercial banks. So there’s no remaining foreign central bank asset with the Fed. (The forward contract is still outstanding, but is an off balance sheet item.) The result is an official capital outflow in the case of the US, but not in the case of the foreign central bank. The official US outflow is offset ultimately by some other inflow, as in Brad’s example.

    Symmetry of central bank positions does remain in the case of the forward leg of the currency swap. Central bank counterparties to forward contracts have mirror obligations for the life of the swap. But forward transactions are off balance sheet, and don’t affect capital flows per se until settled in cash at maturity of the forward contract.

    The Fed recorded “Central bank liquidity swaps” of $ 329 billion on March 18, 2009.

    “The dollar value of foreign currency held under these agreements is valued at the exchange rate to be used when the foreign currency is returned to the foreign central bank. This exchange rate equals the market exchange rate used when the foreign currency was acquired from the foreign central bank.”

    The “foreign currency held” is in the form of a deposit with the foreign central bank, as described above. And the forward currency rate has been fixed, or hedged.


    The aggregate forward contract position itself is disclosed in the report on the US international reserve position. Presumably the forward position is disclosed there specifically because Treasury is responsible for the foreign exchange value of the dollar, and it’s an outstanding contract.

    Treasury recorded “short positions” in foreign exchange of $ 330 billion on March 13, 2009. This was under section II, “Predetermined short-term net drains on foreign currency assets (nominal value)”. The sub-section is titled, “Aggregate short and long positions in forwards and futures in foreign currencies vis-à-vis the domestic currency (including the forward leg of currency swaps)”.


    “The short positions reflect foreign exchange acquired under reciprocal currency arrangements with certain foreign central banks. The foreign exchange acquired is not included in Section I, “official reserve assets and other foreign currency assets,” of the template for reporting international reserves. However, it is included in the broader balance of payments presentation as “U.S. Government assets, other than official reserve assets/U.S. foreign currency holdings and U.S. short-term assets.”

    Thus, the Fed’s foreign currency deposit is not treated as part of official reserves, because of the reversing forward contract. It is included as an official outflow in the international balance of payments.


    Finally, there’s a good reason why the Fed transaction is structured using a currency swap and deposit rather than a US dollar loan. The possibility exists (however remote) that the foreign central bank (FCB) would not be able to source dollars to repay a Fed dollar loan. So there’s a risk. For exactly the same reason, in the case of an actual swap, it’s possible that the FCB could fail on its forward contract obligation to repay in dollars, if it’s unable to source dollars. But the FCB can always produce its own currency – with printing if necessary. Therefore, from a nominal currency risk perspective, leaving aside the derivative risk of currency depreciation, a foreign currency deposit with an FCB is a better credit risk than a dollar loan. And compared to alternative foreign currency instruments, a deposit with a foreign central bank is as good as notes issued by the bank, and better than the same deposit with a commercial bank (but arguably not as good as gold). So a deposit with the foreign central bank constitutes as good collateral as anything else in that currency, in terms of credit risk in that currency. No additional credit comfort would be gained by holding a security as collateral, for example. All of this is why the Fed uses foreign currency swaps and deposits for these transactions rather than US dollar loans, and why the swapped foreign currency is considered to be collateral for the dollars swapped to the foreign central bank.

  • Posted by babar

    thanks jkh

  • Posted by RebelEconomist


    Thanks for going to this effort; it all makes sense, although it already did make sense to me anyway (I do have a little experience of fx swaps). I am merely making the pedantic point that the swap agreements per se do not generate a net capital flow. What creates the capital flow is the dollar lending by the foreign central bank to their commercial bank. Since the dollars in their account at the Fed from all sources are fungible, this lending should be regarded as separate from the swap.

    My pedantry is partly driven by irritation at the lack of explanation given about these swaps. For example, it has not, as far as I know, been made clear how these swaps are priced. Given that they are so huge, the P/L implications are of the order of billions of dollars, which I used to think was a lot of money! I expect that it is all OK, but it should be possible to check. Another issue is why countries like Japan and Korea need swaps at all. Why don’t they obtain dollars from the Fed by pledging some of their treasuries to the Fed (instead of a deposit of their own currency)?

    However, I do disagree with you about the security provided to the Fed by a foreign currency deposit held at the foreign central bank issuer of that currency. If the foreign central bank cannot obtain dollars to repay the Fed by selling their own currency for dollars, what use is that currency to the Fed? And if it is a question of the will of that central bank to repay the Fed, what is the value of holding any liability of that central bank? The security is largely cosmetic.

  • Posted by JKH


    It’s a difficult subject to communicate, given the delicacy of the terminology and the various moving pieces.

    Writing this out was a good exercise in any case. In doing so, I was responding to what I interpreted was your earlier point, that accounting for the central banks should be the same. In fact it’s different because the two central banks end up with different positions with respect to each other.

    The other point was that foreign central banks wouldn’t be coming to the Fed unless they needed dollars. Otherwise they would sell dollar assets. Pledging collateral in dollars therefore doesn’t make much sense, given their net demand for dollars. Domestic currency seems the most natural alternative for such collateral. The only question remaining is whether the Fed is better off with un-uncollateralized dollar loan or a collateralized dollar swap.

  • Posted by RebelEconomist


    Sorry if I misled you about what I was trying to say; hopefully we now concur about the swaps. It is the fact that the foreign central bank lends out its dollars while the Fed does not lend its foreign currency that creates a net official capital flow.

    As to why the central banks with large dollar reserves are not selling dollar securities or even using them as collateral when borrowing dollars from the Fed, it raises some interesting questions. Countries like Japan are not actively using their holdings of treasuries for other purposes at the moment. Presumably the US would not welcome foreign central banks selling treasuries right now, but I would have thought that the Fed would have appreciated the better security provided by taking treasuries as collateral – ie a dollar asset in the Fed’s own custody. Perhaps the foreign central banks wish to avoid giving any impression that the present crisis requires them to run down or even encumber their reserves, but if they will not use their reserves at times like this, in what circumstances would they use them? Questions that are more for Brad perhaps.

  • Posted by JKH


    Good points. Every layer of the onion begets another.

    Apart from any disadvantages of foreign banks selling US reserve assets and the considerations you point out, the Fed mechanism was quick, systematic, and relatively smooth – attractive in the circumstances that precipitated the requirement for dollars.

    As to why dollar assets that might have been available as collateral weren’t used as collateral, your guess is as good as mine. That said, foreign central banks in drawing on Fed lines before using their own reserves would retain additional firing power for any further dollar contingencies (whatever that might mean) in what was a truly frightening systemic breakdown.

    But I agree that had dollar assets been used as collateral, they would have been superior to central bank deposits in foreign currency.

  • Posted by RebelEconomist

    Thanks for the discussion, JKH, although no-one else chipped in. If you think we are peeling off so many layers of the onion that our discussion could bring tears to the eyes of the other readers, feel free to use my email instead.

  • Posted by Иван Павлюченко

    Прикольный пост, очень интересно было почитать

  • Posted by BaLaM

    Видел что-то наподобие в англоязычных блогах, в Русскоязычном интернете про такие вещи как-то не особо часто сообщения увидишь.

  • Posted by Денис Лебедев

    Занимательная тема, продолжайте. Иногда нахожу ответы, которые получить самому просто реально не хватает времени. Премного благодарен!

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