Poop back and forth, forever
Remember that scene from Me, You, and Everyone We Know where the little boy says
I want to poop back and forth. Like, I'll poop into her butt hole... and then she'll poop it back... into my butt hole.
And then we'll just keep doing it back and forth... with the same poop.I’ve been trying to figure out what swap lines are and I’m pretty sure it’s just that.
How’d I get to swap lines?
One of my favorite capitalists is Zoltan Poszar. He’s kind of like a ruling class finance clergyman, an analyst at Credit Suisse who advises the Treasury Department and predicted the repo market crisis last year. He also described the pandemic crisis earlier and more clearly than anyone I saw at the time. He also looks like a vampire.
Every month or so he writes essays for Credit Suisse. His most recent Research Note last month was all about swap lines, and why the US Federal Reserve needs to open up dollar swap lines to way more central banks than it has in the past.
He wrote that on March 17. Two days later the Fed did it, opening lines to 20 foreign central banks, which has never happened before.
The other thing that got me thinking about the swap lines is inflation. Will there be inflation after the US government prints all this money and puts it into circulation to bailout out the mode of production? We’d expect yes.
But since dollars are the world’s currency standard since 1971 (instead of gold), dollar inflation is an international currency issue. I thought the swap lines might have something to do with the situation.
Maybe it does, maybe it doesn’t. I’m still learning. In any case, I wanted to know about these swap lines. What are they?
Dollars everywhere
Every time I found a definition, there was another term I didn’t understand. When I looked up swap lines I got:
Central bank liquidity swap is a type of currency swap used by a country’s central bank to provide liquidity of its currency to another country’s central bank.[1][2] A liquidity swap is an offer by a central bank to lend its local currency to another central bank, taking the latter’s currency as collateral for the loan. The lender uses its currency to purchase the borrower’s currency at the market exchange rate, and agrees to sell it back at a rate that reflects the interest accrued on the loan.
Okay, so it’s when a central bank lends its own currency to another country’s central bank. The lender says “give me some of your money and I’ll give you some of mine, and I’ll give you your money back later with interest.”
After more definitions, technically the currency swap is an interest rate derivative, which is a contract deriving its value from an underlying interest rate.
So the dollar swap line between central banks uses the exchange rate of the currencies (basically the interest rate in the currency market between the two currencies) as the underlying entity.
The other thing about a swap is that it ‘unwinds’, or ends after a certain period of time. The Fed’s dollar swaps with the 20 banks ends in three months. At that point, the other central banks give back their dollars and the Fed pays them back at the original exchange rate.
Right. But these are central banks. They actually just sustain private banks in certain regions. So these are private banks all over the world that are getting infusions of dollars.
Basically, the US is flooding other countries’ private banks with dollars. Why?
All about liquidity
The Fed has a nice little FAQ page for their move. The swap lines are supposed to reduce “risks to U.S. financial markets caused by financial stresses abroad” because “such difficulties can add materially to pressures in funding and credit markets in the United States and abroad.”
It’s as much about protecting US lending—funding and credit markets—as it is about protecting international finance.
It doesn’t say anything about inflation, just various ‘stresses’ in foreign markets that come to bare on the US economy. I guess I’m still wondering: are the swap lines a protection against inflation? The more I read, probably not.
It’s more about liquidity. Pozsar says in his March 17th note that:
The Fed’s liquidity injections appear not to be working. All segments of funding markets – secured, unsecured and FX swaps – continue to show growing signs of stress. The Fed may have to do more still. In the U.S., we watched, but didn’t feel the funding impact of large banks in other countries being asked to help their economies. Now that U.S. banks are asked to do the same, dollar funding markets are starting to feel the impact. As U.S. banks increase their lending to the real economy as corporations draw on credit lines and banks lend more to households and firms, lending will consume more balance sheet and risk capital and that will leave less room for market making and arbitrage.
The problem is that there’ll be more debt than money to pay it off, and shoring up other countries’ central banks (becoming a lender of last resort for the world) will help that. So the swap lines actually add to the potential issue of inflation rather than try to address it. I think?
In any case, I can say this much: the swap lines are the the Fed passing its poop back and forth to the buttholes of other central banks, forever.