The Fed has reinstated dollar swaps with Europe and Canada because European commercial banks are struggling to get hold of dollars. This problem comes up every time strain mounts on the global financial system – the dollar is the world’s reserve currency and only the Fed can provide it. The BOJ is meeting as I write to agree the same.
The policy is necessary to deal with a rise in short-term dollar interbank rates:
But as we saw in 2007-2008, providing an alternative source of liquidity to interbank loans is just a palliative, and the private funding markets won’t improve if people still fear that banks may be bust. What needs calming is fear of defaults on eurozone sovereign debt (the chart is 5-year CDS on Portuguese debt to last Friday – I don’t have access to current pricing):
That means that the eurozone/ECB package is an order of magnitude more important than the dollar swaps. Viewed from Tokyo it looks pretty impressive but I’m not close enough to judge whether it will work. Just as with the deployment of TARP after Lehman went under, the crucial question will be whether the eurozone truly does socialise the risk of sovereign default – or at least buys enough time for fiscal consolidation in southern Europe – such that people are no longer concerned about bank balance sheets.
We should find out pretty quickly when Europe wakes up…
