Currency Swaps, the Dollar, and a Tilted Playing Field

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21

may be there is one more thing to the puzzle… AFAIR there was a very good graph on zerohedge that show very good correlation between the current stock market rally and the 300B monetizing by the Fed (they have 10B left).
So my thinking that main reason for the drop in the dollar is this monetizing. May be it is in some way interwinded with the swaps.

And also the point (B) says that they may use the money to manipulate Forex !! May be Chris may extrapolate abit.

One additional fact is also (I think I read it on Karl Denninger site) that just before the crisis of 2008, the Fed withdrew around 100B $. (and probably caused the crash!?), so it has to be in the timeframe before the $ jumped.

Speculation what happens if they withdraw 100B and then make a swap for 100B ?

22

interesting story but in my opinion you have got the causality backwards. The swaps were put in place becuase of the USD strength, they didn’t create the strength in the USD. There was a massive short squeeze in the USD during last autumn whereby European banks were playing the famous carry trade (much like right now) that had to be unwound very quickly. Banks all over the world were scrambling to get hold of USD, therefore the FED arranged these swap lines to facilitate enough USD for European banks.
In effect, the FED actually tried to offset the strength in the USD through these swap lines, not the opposite. And of course the mad scramble by the banks to get USD pushed the Libor through the stratosphere…which was another reason for these swaps.

By the way, I was reading your report “the five horsemen” and I agree with you until no. 4;

I can’t see why the USD would lose its value now, after the credit bubble has imploded. The USD has already lost most of its value in the last century through the rapid credit and monetary expansion. Now that the money supply and credit is shrinking, this will increase the dollars value. Deflation is coming, not inflation. The only way that the USD would fall in value if if the FED would through its actions would be able to re-ignite credit growth, but as you can see by the rapidly contracting money supply and credit, they are failing despite the 1.2tr QE program.

The only thing that disturbs me (in my belief of a stronger USD) is the rapid expasion of government debt but I think this problem will solve itself, the public outrage (elections in 2010 wiil be an exellent outlet for this) and probably eventually rising interest rates will reverse this course.

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[quote=pistolpete]
I can’t see why the USD would lose its value now, after the credit bubble has imploded. The USD has already lost most of its value in the last century through the rapid credit and monetary expansion. Now that the money supply and credit is shrinking, this will increase the dollars value. Deflation is coming, not inflation. The only way that the USD would fall in value if if the FED would through its actions would be able to re-ignite credit growth, but as you can see by the rapidly contracting money supply and credit, they are failing despite the 1.2tr QE program.

The only thing that disturbs me (in my belief of a stronger USD) is the rapid expasion of government debt but I think this problem will solve itself, the public outrage (elections in 2010 wiil be an exellent outlet for this) and probably eventually rising interest rates will reverse this course.

[/quote]Hello PistolPete: I’d be interested in hearing CM’s views. My own are in-line with what you are saying BUT and it is a big BUT, our federal debt and obligations AREN’T being destroyed. They aren’t payable. We take in 2 trillion and p away 4 trillion, a LOT of that 2 trillion isn’t being borrowed in the bond market it is being printed. That 2 trillion is ready to go up. If it wasn’t for this BUT I’d be a “deflation” camper. I think what will happen is that where credit is destroyed there will be asset prices that tank up until the dollar becomes toast.

I also feel that we are not alone. I think the slide of almost every currency is masking the severity of this. 

While crude and elementary and not precise: the gold to what you can buy from now back to 2002 is for me a barometer or chart of where we have been and where we are.

Just my 2 cents, take care 

24

Walter, Raptor and PistolPete,
Regarding the currency impact of the swaps, you are only looking at it from one direction.  To turn your example around, what if the US used it’s hoard of swapped Euros to sell into the Forex markets while the Europeans used theirs to provide to institutions that had debts with US dollar claims against them?

In this circumstance, the US dollars are being ‘extinguished’ in the service of debts, so no increase in USD supply, and no consequent upwards pressure on the dollar.

Meanwhile there are lots of Euros now flooding the market and so the USD would rise, especially against the Euro and that fits the data from that period perfectly. 

One way or the other, the correlation between the swaps and the USD index is there, I am only trying to understand why and what it might mean.

At the time of the surprise dollar strengthening, Paulson, et al., were on record saying that the high price of oil wasn’t helping anything and they were deeply concerned about deteriorating conditions in the largest banks.  A quick move in the dollar would have accomplished much; it would help repair the balance sheets of many a large bank who were happily positioned in long dollar/short commodity trades (against their hated competitors, the hedge funds), drive down the price of oil at a critical time for consumers, keep US interest rates low and demand for US Treasury paper high. 

All at a critical time.   This is precisely what happened.

While this could have all been a gigantic series of happy, free-market coincidences, I absolutely do not think this is the case. 

Remember, in the fall of 2008 things were very close to ripping apart, so from a policy maker’s standpoint, anything was justifiable.

Here, straight from the horse’s mouth:

King Says British Banks Got Within Hours of Collapse

Sept. 24 (Bloomberg) -- Bank of England Governor Mervyn King said two British banks got within hours of a liquidity shortfall on Oct. 6, 2008, and the day after as the U.K. financial system came to the brink of collapse.

“Two of our major banks which had had difficulty in obtaining funding could raise money only for one week then only for one day, and then on that Monday and Tuesday it was not possible even for those two banks really to be confident they could get to the end of the day,” the BBC cited King as saying in an interview to be broadcast later today.

Edward Lazear, chairman of George W. Bush’s Council of Economic Advisers at the time, told the program: “We literally thought that we were on the verge of the Great Depression, and looking back I think we probably were.”
King said that allowing the banks to fail would have brought the economy to a halt, the BBC said.

“Individuals would not have had access to the money in that bank,” he was cited as saying. “Their deposits would have been frozen. The accounts would have not been there for salaries to be paid in to, so many people would not have been paid their salary.

“In turn, they wouldn’t have been able to pay bills to businesses so the businesses would have found that their flow of payments would have come to an end,” King said, according to the BBC.

Let me put it another way; under those circumstances described by Mervyn King, what do you propose the odds are that the world's central banks would have allowed free-market forces to operate unhindered?

I say the odds of that are pretty close to zero, so examining the past evidence and data become more of a forensic exercise than a business school case study in free-market behaviors and explanations.

 

 

[Note: In October of 2008, based on my “forensic reading” of the markets I was advising people in the strongest of terms to ready themselves for a possible banking holiday.  I am somewhat gratified to discover how close to the mark I was, although disturbed by that very same prospect for obvious reasons.  

In these sorts of fast-moving, make-up-new-rules-as-we-go, times I happen to believe that an adherence to how markets used to (or are supposed to) work is a liability.  We are in uncharted territory.  The captain(s) are making it up as they go while keeping a brave face for the crew.  My service to my readers and subscribers is to use my ability to decipher the Captain’s actions (not words or posturing) and translate those into actionable thoughts and risk mitigation strategies.

This means I regularly spend time trying to think of alternative and quite often uncommon explanations from the mainstream views.  There is value in that, at least if my own portfolio and the unsolicited testimonials I receive are any indication.

As always, I relish any opportunity to engage in thoughtful discussions or debate that can help to bring greater focus to a subject or illuminate the future.]

25

Dr.M,
So your proposing that the Fed’s currency swap(s) is the primary reason that the USD appreciated last year? 

Does this imply that you reject the widely held perspective that the strength in the dollar was caused by debt deflation?

Thanks…Jeff

 

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Hi Mr. Martenson,

Should that say downwards?  If not, could you explore your thinking behind this idea?

Thanks for all your excellent work.  Cheers

27

hi pistolpete,
I read a hypothesis on itulip (which seems feasible to me) that even if you are in deflationary environment you can get inflation, even if the money printed&borrowed  are not enough to counteract the the deflating amount of money.

If you look at the the whole thing as a credit card, the printed&borrowed money can just be used to pay the monthly charges not the whole debt. Of course this can’t go forever but can ignite the inflation. And also future additional printing is just a matter of policy desicion.

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emhswm:
(Edit: Oh, it looks like Mike Pilat beat me to the punch here. And as a “student as Jefferson”, he did a very good job at that.)

Congress “seizing” the power to print money? I may be a little foggy on my understanding of the US constitution, but I believe that it states that it is the power of Congress to print (“coin”) money!

Check out section 8 of the Constitution: http://www.usconstitution.net/const.html#A1Sec8    . A few lines down it says the congress shall have to power “to coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures”

If I recall correctly what experts on the US Constitution have said, the founding fathers intentionally gave Congress the duty of guarding the purse strings of this nation, believing that the goverance of a nation’s monetary and fiscal policies was far too important to entrust to any other less democratic institution. In other words, if legislators pursued unwise fiscal and monetary policy, they could simply be voted out.

(Of course, we can digress and talk about how democratic the Congress really is anymore, with the exorbitant costs of running for office, the advantages of incumbency, and the disturbing degree to which it is penetrated by corporate interests. For a brief read on these topics, I recommend Tom Englehart “dispatches” here:    http://www.tomdispatch.com/post/175119/arundhati_roy_is_democracy_melting_               http://www.tomdispatch.com/post/175114/andy_kroll_the_washington_influence_machine      )

Setting aside “rubber stamp” Congress’s well known flaws, what other institution would you have run our nation’s printing presses? Yes, it’s scary to think about Nancy Pelosi wielding that power, but considering somebody is gonna be doing it, wouldn’t you rather know who? You can’t vote the Fed’s bureaucrats out of office, 'cuz you never voted the damn rascals in in the first place!

 

 

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Chris,
While I completely agree with you that Fed, Treasury and other CB’s are rigging, or at least intensely try to rig the markets whenever they feel it suits their purposes, I still think you’re on the wrong trail re the swaps. Suppose the CB’s indeed intended to initiate a dollar spike and tried to do so using swaps, then -assuming they would try to do so as efficiently as possible- logic would dictate their order of action would have been 1) establish the swap 2) have the Fed flood the market with the swapped euros to ignite the dollar 3) have the ECB +withhold+ its swapped dollars from the market to push the dollar even higher. But that doesn’t square with the actual chain of events: the swaps were established +after+ the rise in the dollar had started, and the ECB instead of withholding their swapdollars lent those out almost indiscriminately.

Also, it seems to me it’s not the dollars that were extinguished by servicing the debt, it’s the +debt+ that was extinguished. After those dollars (coming from the ECB) were paid against those dollar debts/interest in Europe, (part of) those debts had been cleared - but the dollars used to do so were still circulating. They didn’t disappear at all. (Perhaps they were repatriated to the US in the act of paying off debt, but that doesn’t make them vanish!)

I fully agree with you the spike was too much of a coincidence and I do think the CB’s did start it - but in some other way than through these swaps. I have no theory or insight on how they did start the spike, but I do think they they badly needed the swap to +stop+ the spike. That would make sense in a context when their intended nice ‘little spikie’ to their own horror kept feeding on itself (or more in particular on the huge short dollar positions at the time) and went for a complete blowout. (Well, that’s what you get when you manipulate the markets: unforseen & unintended consequences…). But the absolute last thing the Fed wanted, with the US debt running in trillions, was a +truly+ strong dollar, of course. They had to stop it and the swap would have been instrumental in doing so.

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[quote=WalterW]
 After those dollars (coming from the ECB) were paid against those dollar debts/interest in Europe, (part of) those debts had been cleared - but the dollars used to do so were still circulating. They didn’t disappear at all. (Perhaps they were repatriated to the US in the act of paying off debt, but that doesn’t make them vanish!)[/quote]
Hi Walter,
If the dollars were repatriated, would that mean the dollars were not sold into the currency market.  If dollars are not sold ino the currency market but euros, yen, etc are, would not the dollar exchange rate strengthen?

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double post

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@lookma
Yes those (swap)dollars were definitely sold in the currency market - by the ECB! To parties that needed and indeed used those dollars to pay off dollar debts in Europe. Some of those parties may have been US banks or companies operating in Europe who subsequently repatriated those dollars back to the US - though I’m merely speculating here about that last part: what happened to those dollars after they had payed off those debts no-one knows. My point was that those dollars did +not+ disappear from circulation by/after having been used to pay off debt, as Chris wrote.  

33
Also, it seems to me it's not the dollars that were extinguished by servicing the debt, it's the +debt+ that was extinguished. After those dollars (coming from the ECB) were paid against those dollar debts/interest in Europe, (part of) those debts had been cleared - but the dollars used to do so were still circulating. They didn't disappear at all. (Perhaps they were repatriated to the US in the act of paying off debt, but that doesn't make them vanish!)
Walter, paying off a debt to a bank does make dollars vanish.  That's how it works.

If you agree that dollars are created when a credit/debit combination is issued, then you (hopefully) must agree that dollars vanish when the credit/debit combo is extinguished.  This is just banking mechanics 101.

Now it’s possible that the dollars were not used to extinguish debts, but merely to service them, in which case the dollars most definitely do not disappear.  The interest payments flow to the top line of the debt holders.

Perhaps your informaiton is better than mine, but what I read was that USD dollars were needed to pay off debts denominated in dollars.

 

34

Chris,
You are absolutely right and I was wrong. I kind of thought we were talking common sense (i.e. when you pay someone back money you’ve borrowed, he/she will either keep or spend that money…). But instead, of course, we were talking fractional banking here, which is quite a different ballgame (…unless that someone happens to be a bank, in which case the money does indeed disappear - probably into the same nowhere it originally came from.)

However, I don’t think my error in any way impairs the point I was trying to make, which was that the swaps effectively put downward pressure on the dollar, not upward. You wrote:

> In this circumstance, the [swapped, WW] US dollars [in Europe, WW] are being ‘extinguished’ in the 

> service of debts, so no increase in USD supply, and no consequent upwards pressure on the dollar.

> [I suppose, just like Lookma pointed out in an earlier post, you meant ‘downward pressure’ here? - WW]

But there +was+ an increase in USD supply albeit only temporarily: before those swapped dollars could be extinguished through paying off debts, they first were created by the swaps (=USD supply increase) and then sold by the ECB into the market (=lowering the USD rate). So even though those dollars were subsequently extinguished, in their very short existence they did actually have a downward pressure effect on (the price of) the dollar.

Also, consider the alternative situation in which the swaps would not have taken place. In that case the demand for dollars (in Europe) to pay off those debts would still have been the same, but there would have been +no+ increase in dollar supply (in Europe) - not even temporarily. I.e. the dollar would have become more expensive without those swaps.

Then again, one could also argue that without the swaps the Fed of course could not have sold any swapped euro’s in the US (assuming they in fact did do so when the swaps were in place, as you contended) and hence without the swaps there would have been less upward pressure (in the US) on the dollar. However, there was no particular extreme demand for euros in the US at the time, but there was extreme demand for dollars in Euroland - and in fact worldwide. I think it’s reasonable to assume that would have resulted in a net demand for dollars, which again would have led to a higher dollar without the swaps in place.

 

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