The Banking System: How the US Dollar Swap Lines Saved the World Economy

Given the status of the US dollar as the world’s main reserve currency and its use in pricing most commodities and trade transactions, a sudden spike in its value compared to other currencies can have dramatic consequences.

In March 2020, when the world went into a near synchronised lockdown, panic erupted on all the financial markets. Stock markets dived faster and further than at any time in history, future oil prices became negative and the demand for the Greenback surged sending its exchange rate through the roof. The stress that this created in the debt markets worldwide would, if left unchecked have led to a cascade of bankruptcies, bank failures and economic chaos of a greater magnitude than during a war.

What is a US Dollar Swap Line?

This cataclysmic scenario was averted by one vital decision of the US Federal Reserve (FED): its reactivation of the swap lines established with other central banks during the 2007-2009 financial crisis. In the example of the Bank of England (BoE), this emergency measure allowed the BoE to swap an unlimited amount of GBP in exchange for USD. This enabled the BoE to supply as many USD’s as required to the British banking system without drawing on its limited USD reserves. The British commercial banks were then in a position to satisfy the surging demand for USD from their corporate clients which therefore did not default on their USD payments, thus avoiding the cascade of bankruptcies of creditors throughout the supply chain.

Other government and central bank emergency measures surely helped, but none could have had such an efficient and immediate effect in calming the currency markets. This is because swap lines are uniquely able to stem speculative bets against the currencies enjoying this unlimited dollar funding and keeping speculators and short sellers at bay is essential to bringing back stability to the exchange rate.

What countries can call upon a US Dollar Swap Line?

However, not all central banks enjoyed the privilege of establishing swap lines with the FED; only five have unlimited and permanent access to the USD: the BoE, the European Central Bank (ECB), the Bank of Japan (BoJ), the Bank of Canada (BoC) and the Swiss National Bank (SNB). In March 2020 a further nine countries were granted limited access to USD swap lines in order to stabilise their currencies: Australia, Brazil, South Korea, Mexico, Singapore, Sweden, Norway, Denmark and New Zealand. All are key US military allies and trading partners.

The Economic Impact of US Dollar Swap Lines

So, what does this means for investors? Very simply that investing in the 14 currencies protected by USD swap lines is a lot safer. To prove it you just need to look at the Turkish lira (TRY) which has lost more than 20% of its value against the USD since March. Turkey’s request to be granted a USD swap line was rejected by the FED on the basis that its central bank is not sufficiently independent from its government. The result is high inflation, ongoing currency speculation and stress in all corners of the Turkish economy. This is in contrast to the relative stability of the 14 currencies granted USD swap lines with all the economic benefits that this entails.

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