What the Fed is doing about the dollar shortage

What toilet paper is for consumers is the dollar for large investors. For fear of the corona crisis, they have been stocking up with the US currency for weeks. Because, like gold, the dollar is a kind of safe haven. Companies are also increasingly hoarding greenbacks: They want to ensure that they can still pay their loans even if they no longer earn dollars due to a lack of sales. They need the US currency because many companies around the world have borrowed in dollars instead of their own national currency – this applies particularly to groups from China. In recent years, this foreign debt has increased again significantly: Non-banks have loans outside the USA of 12, $ 1 trillion – 2008 this sum was still just half the size. Demand for the US currency is now correspondingly strong.

The United States can theoretically print unlimited amounts. In practice, however, the high demand affects the course. For one euro, for example, you currently only get $ 1 09, at times it was only $ 1 06 – as little as since three years no more. And the development looks similar to other currencies.

The US Federal Reserve has now reacted to this and has taken unusual steps to continue supplying the financial markets with dollars. Without much fanfare, she launched a new program. Foreign central banks can now use this to obtain dollars if they deposit US government bonds in return with the Fed: They temporarily exchange US bonds that they already own for dollars.

This is how new liquidity comes into the market

This special type of security transfer with a buyback agreement is also known as a “repo transaction”. However, this is usually reserved for commercial banks. Similar to how consumers have an account with the bank, banks themselves have an account with the central bank: If a commercial bank now sells government bonds to the central bank, their credit on the reserve account increases. What is new is that central banks of other countries can also stock up with the Fed in Washington in this way. They can then pass this liquidity on to commercial banks in their countries.

The Financial Times describes this new instrument from the US Federal Reserve as an experiment that can at best calm the financial markets. Recently, many investors have not only sold shares but also lots of government bonds, although they are actually considered safe. But rising government spending and the resulting increase in debt scared many.

What happens if China wants to participate?

However, there are still some unanswered questions about the Fed's new program: For example, it is unclear what happens if the Chinese central bank wants to use the instrument to stock up on dollars. Unlike with allies like Japan or Europe, the White House might have something against it. The central bank is independent of politics – but does that still apply if your actions suddenly have an impact on diplomatic relations with another country?

That the US Federal Reserve is even following this new path is because their previous instruments have brought little. It has previously expanded its credit lines in two steps, similar to the financial crisis: other central banks can use so-called swaps to exchange their local currencies for dollars at low cost. After three months, the sums are automatically exchanged. In this way, for example, the ECB receives dollars without taking an exchange rate risk. Initially, this was possible for the Eurozone and Japan, and for two weeks now also for emerging countries such as Brazil and Mexico. In the end, however, that was no longer enough to meet the demand for dollars. The “Financial Times” sees it as a good sign that the US Federal Reserve quickly recognized this and reacted to it. The Fed acts “proactively, ingenuously, quickly and with determination” – something that is missing in American politics.