WASHINGTON • The United States Federal Reserve is acting as central banker to the world by seeking to provide the global financial system with the dollar liquidity it needs to avoid seizing up.
In its latest measure to combat the economic fallout from the coronavirus pandemic, the Fed said on Tuesday that it was establishing a temporary repurchase agreement (repo) facility to allow foreign central banks to swap any Treasury securities they hold for cash. This is yet another step beyond the actions it took in the 2008 financial crisis.
"To the Fed's credit, it is playing the role of central banker to the world rather than denying it and trying to ward it off," said Mr Ted Truman, a senior fellow at the Peterson Institute for International Economics in Washington and a former Fed official.
The Fed is trying to prevent a liquidity squeeze amid a worldwide rush into dollars, as the virus wreaks havoc on a global economy that is heavily dependent on the greenback as its linchpin.
"A lot of borrowing and commerce and investing is done in dollars," said Ms Julia Coronado, founding partner of MacroPolicy Perspectives in New York.
"When you have a dollar crunch, it can turn a recession or contraction in activity into a financial crisis very quickly because the dollar shortage can trigger defaults and deleveraging."
Emerging-market borrowers are especially at risk. Encouraged by low US interest rates, they have loaded up on dollar-denominated debt in recent years. They now face a squeeze as their exports plummet due to economic shutdowns worldwide to combat the coronavirus pandemic.
A significantly stronger dollar can also hurt the US by tightening financial conditions and making American exports more expensive on world markets.
Investors rushed for the currency last month, pushing the premium paid to swap funding exposure from euros into the dollar to multi-year highs.
While the shortage of dollars has since eased, strains remain in emerging markets.
Unlike the currency swap lines the Fed already has in place with selected central banks, the new repo facility will be open to most foreign central banks and foreign monetary authorities with an account at the New York Fed.
"Almost every country that holds dollars has an account at the Fed," Mr Truman said. "My guess is that US$5 trillion (S$7.2 trillion) is held there."
The New York Fed says it has over 200 account holders, with the vast majority held by foreign central banks and monetary authorities.
The new facility does lack something the currency swaps provide. While it allows foreign central banks to liquefy their holdings of Treasuries and obtain dollars, it does not add to their reserves. Rather, it just changes their composition.
Mr Krishna Guha, head of central bank strategy at Evercore ISI, said the repo programme should help smaller emerging markets that need to raise dollars to intervene to prevent free-falls in their currencies.
The Fed is having to take on the mantle of world central banker because of the dollar's dominant role in the world economy and the critical importance of the Treasury debt market to the global financial system.
Total dollar credit extended to borrowers, excluding banks, climbed to a record US$12.1 trillion by last September, Bank for International Settlements' data show. That is more than double the level from a decade ago. It amounted to almost 14 per cent of global gross domestic product; the ratio back in 2009 was under 10 per cent.
Having the dollar as the world's reserve currency is often described as an "exorbitant privilege" for the US because it allows the world's largest economy to raise money on international capital markets at lower interest rates than otherwise.
But it has its downsides as well, because it tends to push up the value of the greenback, hurting the competitiveness of US exports.
"We are responsible for the dollar - for better, for worse," Mr Truman said. "The dollar is the dominant liquidity of the global financial system."
BLOOMBERG
