Central Bank to the World: Supplying Dollars in the COVID Crisis

In his comments at Jackson Hole last year, then-Bank of England Governor Mark Carney highlighted the continuing dominance of the U.S. dollar: it accounts for one-half of global trade invoicing; two thirds of emerging market external debt, official foreign exchange reserves, and global securities issuance; and nearly 90 percent of (one leg of) foreign exchange transactions.

It also is the basis for the Global Dollar system (see our earlier post). The BIS reports that short-term U.S. dollar liabilities of non-U.S. banks total $15 trillion. Foreign exchange forward contracts and swaps—with a gross notional value of more than $75 trillion—add substantially further to U.S. dollar exposures (see here). And, the U.S. Treasury reports that foreigners hold more than $7 trillion of U.S. Treasury securities. To put these numbers into perspective, total assets of U.S. depository institutions are currently $20 trillion. In other words, the U.S. dollar financial system outside of the United States is larger than the American banking system.

Like it or not, the Federal Reserve is the dollar lender of last resort not just for the United States, but for the entire world. The Fed’s role is not altruistic. Instead, it reflects the near-certainty that, in a world of massive cross-border capital flows, dollar funding shortages anywhere in the world will spill back into the United States through fire sales of dollar assets, a surge in the value of the dollar, increased domestic funding costs, or all three.

The Fed’s extraordinary efforts to counter the COVID-19 crisis include aggressive actions to counter dollar shortages outside the United States. In this post, we explore those actions, including the supply of dollar liquidity swaps to 14 central banks (“friends of the Fed”) and—to limit sales that might disrupt the Treasury market—the introduction of a repo facility to provide dollars to the others. We also note the challenges facing countries outside the small inner circle that do not have immediate access to the Fed’s swap lines….

Libra's dramatic call to regulatory action

Facebook’s June 18 announcement that it has created a Geneva-based entity with plans to issue a currency called Libra is sending shock waves through the financial world. The stated objectives of creating Libra are to improve the efficiency of payments and to ease financial access. While these are laudable goals, it is essential that we achieve them without facilitating criminal exploitation of the payments system or reducing the ability of authorities to monitor and mitigate systemic risk. In addition, any broad-based financial innovation should ease the stabilization of consumption.

On all of these criteria, we see Libra as doing more harm than good. And, for the countries whose currencies are excluded from the Libra portfolio, it will diminish seignorage, while enabling capital outflows and, in periods of stress, accelerating capital flight.

Like Bank of England Governor Carney, we have an open mind, and believe that increased competition, coupled with the introduction of new technologies, will eventually lower stubbornly high transactions costs, improving the quality of financial services globally. But in this case, we urge a closed door….

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Money, Banking, and Financial Markets