I’ve never understood the myth of central bank dollar swaps. They are automatically placed in the category of QE or IOER, perhaps because very few seem to understand what was really happening with them (as well as outside of them). The Fed expands its balance sheet which everyone assumes is the same as expanding either base money or something like it. It’s a false equivalency, and one that is demonstrably so.
They make their first crisis appearance in December 2007; seven, not eight. On December 6 that year, the FOMC gathered telephonically for one of those emergency policy calls that were becoming more frequent, the level of discussion more urgent.
MR. DUDLEY. The upward pressure in term funding markets and the uncertainty about forward LIBOR rates have caused impairment of the foreign exchange swap market—a market used by many European banks to obtain dollar funding. In this market, bid asked spreads have widened, transaction sizes have dropped, and some dealers have stopped making markets.
To address these problems, the FOMC voted in favor of a Term Auction Facility via the Federal Reserve and also dollar swaps to be transacted with each respective central bank. Dr. Nathan Sheets, FOMC senior staff economist, stated on the call the swap line was at the request of the European Central Bank, an important detail.
MR. SHEETS. This temporary arrangement with the ECB is proposed to allow dollar funding problems now faced by European banks, particularly at terms longer than overnight, to be addressed more directly by their home central bank. Improved conditions in European dollar trading would guard against the spillover of volatility in such trading to New York trading and could help reduce term funding pressures in U.S. markets. In addition, these measures may help address the difficulties in the foreign exchange swap market, which Bill [Dudley] has discussed.
Over the next year, however, dollar swaps would only expand in volume as well as capacity. An actually effective program would see the opposite, where dwindling volume would accompany an end to the liquidity issue (international or not).
