On Sunday the six central banks renewed the swap line package. These arrangements have helped to ease strains in financial markets and mitigate their effects on economic conditions. The swap lines support financial stability and serve as a prudent liquidity backstop.
Two aspects are new: The penalty rate dropped, and funding can be accessed not only for 7 days but also for 84 days.
Fed has entered into agreements to establish central bank liquidity swap lines with a number of foreign central banks.
The swap lines worked during the 2008 GFC and prevented a complete worldwide financial meltdown. Similarly, during the COVID-19 Crisis. The real-side effects now ripple into the financial system, while the money market dislocations during the GFC and Pandemic rippled into the real economy.
Two types of swap lines were established: dollar liquidity lines and foreign-currency liquidity lines. The swap lines are designed to improve liquidity conditions in dollar funding markets in US and abroad by providing foreign central banks with the capacity to deliver U.S. dollar funding to institutions in their jurisdictions during times of market stress.
Likewise, the swap lines provide Fed with the capacity to offer liquidity in foreign currencies to U.S. financial institutions should Fed judge that such actions are appropriate.
Implications :
a) USD continues to reign Supreme:
1. With one brilliant move, it has divided the world up into allies and non-allies of the U.S. But this is just the tip of the iceberg. Currently, just 14 central banks have been approved. Few want to be shut out, and around eighty-five nations have applied for U.S. swap lines.
2. Over time, these critically important swap lines to be increased and more nations to be slowly added. They’ll be subject to the terms set by U.S. govt — both financially and geopolitically — but they’ll accede.
3. As monetary and fiscal policy are blending into one, it’s just a matter of time before President uses swap lines as a big geopolitical leverage hammer. Swap lines are that important, and they will dictate global alliances and policy. They will have an impact on companies, investments, and ultimately, the very fabric of our world.
4. They are, literally, lifelines. And they are also debts. All those dollars borrowed must be paid back in US dollars, with interest, also requiring US dollars. It’s ingenious because demand for the U.S. Dollar breeds further demand. And this will be proven to be even more true during a global power realignment like what’s happening right now.
b) Liquidity impact
There is a misconception that these swap lines are forcing the Fed to create new liquidity. Whereas QE and creation of new resultant liquidity is stimulative, this instrument should be seen as financial system stabilizer to ensure dollar funding is not disrupted and its more akin to being seen as a Discount window for the global central banks.