Currency swaps – the beginning of a ‘solution’?

By far the most important event of the week was the joint announcement by the world’s leading central banks that they were extending existing US dollar swap agreements and lowering the swap rate. Furthermore, these dollar swaps will be extended to secondary swaps between individual central banks in non-dollar currencies as required.

The stated purpose of this action, according to the Bank of England, is to ease strains in financial markets to ensure credit continues to be available to households and businesses, and so foster economic activity. Forget the PR spin, it is simply about saving the banks and that is why markets jumped, fuelled by a massive bear squeeze ahead of and after the announcement.

Market reactions aside, the plans for resolving the West’s financial and economic difficulties are becoming clear. There are two different elements to this crisis, which should not be confused: the problems faced by the banks as their balance sheets continue to contract, and Euroland sovereign debt. The agreement to extend currency swaps is designed to help the banks, and measures to address sovereign debt will probably be announced shortly.

The obvious way to deal with sovereign debt will be through the International Monetary Fund, perhaps issuing SDRs (Special Drawing Rights). The SDR was created by the IMF in 1969 to support the Bretton Woods system of fixed exchange rates, a function that was swept away by events. According to the IMF, the SDR is not a currency, but a claim on “the freely used currencies of IMF members”. So if an SDR facility is extended to Italy, for example, the SDR can be cashed in for the underlying currencies and converted into euros. The facility is sitting there unused.

If the SDR route is taken, governments such as Italy would become net buyers of euros, generating a bear-squeeze in both the euro and government bonds bringing yields down smartly. Market-aware central planners love this sort of thing, because they can force the switch in market sentiment from extreme pessimism to do much of their work for them.

So far, so good; but to anyone with a grasp of the economics of sound money, the encashment of SDRs is raw monetary inflation. But with the economic establishment and the general public happy to accept quantitative easing as a responsible economic policy, despite its ultra-thin cover for monetary inflation, it is unlikely the inflationary aspects of SDRs will be understood. Instead, the media will praise the benefits of international co-operation to resolve the sovereign debt problem, selling the concept as a way to counteract contracting bank credit to prevent deflation.

Whether or not the short-term fix for the sovereign debt problem is by activating SDRs, the underlying truth is that a way will be found and it will involve monetary inflation. The alternative is a transfer of real wealth to governments in trouble through taxation of one form or another, and that is not going to happen. So we will end up with two solutions to the current crisis, both of which will accelerate the expansion of money supply everywhere. This is confirmation of a trend firmly established and from which there is no politically acceptable escape.

Money-creation that cannot be stopped has only one logical outcome: the complete debasement of the currency. This is good for gold and silver. Furthermore the first two days’ delivery notices on Comex for the December gold contract total a massive 50 tonnes, indicating the futures market is also set up for a bear squeeze from lack of physical.

This article was previously published at

More from Alasdair Macleod
Gold reentering the monetary system
Early in 2011, the London Bullion Market Association began to push for...
Read More
2 replies on “Currency swaps – the beginning of a ‘solution’?”
  1. says: Tim Lucas

    The decline in yields within the Eurozone periphery following the establishment of these swap-lines really is incredible.

    It is evidence that the principle liquidity problem that the banks European banks were experiencing was dollar shortage, rather than that of Euros.

    This would tie into the idea that European banks were responsable for the biggest increase in lending to the US consumer during the great moderation.

    It would also explain why it was that despite significant ECB support prior to these actions, peripheral Eurozone yields stayed stubbornly high – private lenders of US dollars had cut their funding of European banks following the botched Greek bailout in which the ECB was not required to participate in any haircut and the CDS contracts did not pay out as the Greek default was not defined as a “credit event”. Just imagine what signal this sent to any private buyers of Eurozone bonds/lenders of US$ to those banks. They all cut their funding lines. The Eurozone banks are the biggest holders of the Eurozone sovereign bonds and the political priority within the Eurozone is to save the banks. Should the European banks come under stress due to a shortage of dollars, then naturally no one would want to hold anything held in size by the banks as the banks either become forced sellers of these boncs or else they are favoured by the authorities over non-Eurozone holders in any default situation.

    Finally, the idea that the European banks became short of dollars would explain why it was that the dollar rallies so hard whenever the Eurozone comes under pressure.

  2. says: Tim Lucas

    Clarification of the comment above:

    10 year Italian bond yields have declined from 7.2% to 5.7% and 1 year Spanish bond yields from 6.6% to 5.1% in just 1 week.

Comments are closed.