Fed’s dollar swaps should grow as policy tool, paper

It is hard to imagine an issue that could get a self-proclaimed socialist, uber-laissez-faire libertarian and a corporatista-statist interventionist to agree among one another. Yet, central bank liquidity swaps, or popularly known as Fed’s foreign government bailout loans, has indeed united Sen. Bernie Sanders, Ron Paul and “Any-war-is-US-national-interest” Sen. Lindsey Graham… and not just them.

In a recent Working Paper with the Fed, three prominent economists, some more so then the other, say that these liquidity swaps are a good thing for America and they will continue and should continue to be part of the monetary policy toolkit.

“They continue to signal central-bank cooperation, but whereas in the past, that collaboration focused on protecting the U.S. gold stock or on frustrating speculative sales of foreign currencies, it now aims primarily at extending a lender-of-last-resort function across national borders. The global integration of financial markets may demand such a function. We speculate that this new swap mechanism could remain a key instrument of central bank operations going forward,” write Anna Schwartz, Michael Bordo and Owen Humpage, listed in order of their fame.

Never explicit in their endorsement of Fed’s foreign bailout cash, Schwartz et.al are meticulous to point that the bailout “were collateralized”, that foreign central banks “assumed all counter-party risk”, that foreign central banks paid interest on the dollars received as though the Fed deposited them in a bank, that the Fed “sterilized” these swaps by shrinking the money supply by the swap amount… and that all these prudent banking measures were done in order to ease financial strains, something we all wanted anyway.

Of course, to folks who follow all this, not much is new in this paper, except that prominent names in economics are endorsing Fed’s cash pumping operations since 2007.

Schwartz is of Milton Friedman fame and a figure of worship in some, mostly conservative circles, as is Bordo, but of little less fame and Humpage who is still pursuing it.

Their reason for endorsing swap lines is rather clear:

“Even though many of these swap arrangements are scheduled to expire at their maturity. The precedent of using swaps for the emergency provision of liquidity denominated in key currencies now seems fairly well established. The dollar lines clearly enhance the currency’s role as the key international reserve currency and may be necessary if that role is to continue. These swap arrangement are likely to persist.” (emphasis mine typo theirs.)

In other words, Sanders, Paul and particularly Graham ought to celebrate the swap bailout because it enhances the power of the dollar and if they don’t well… these economists have a lot more intelligence in their portfolio.

In a rather bland paper, with some typos, designed to be an Epilogue to their upcoming book, the authors offer perhaps the lone tidbit of incisive insight when discussing China’s sterilization as sole counteraction to reserve accumulation saying that sterilization is “necessary, but not sufficient, for explaining the renminbi’s peg or its limited nominal appreciation” hence the inflationary bias there.

“In defense of the peg or to limit appreciation, the Peoples Bank of China must buy foreign exchange and must issue sufficient renminbi base money to meet that excess demand. Effectively, this requires non-sterilized intervention—an expansion of the money supply—to prevent a renminbi appreciation,” say authors.

Paper available here.