Bob Macquarie is a non-resident senior fellow at the Center for Global Development Policy at Boston University and is an associate meeting of the Faculty of History at Oxford University.
The Kindleberger trap is a risk that the decline in hegemon is lacking in capacity, but ascendant tensions lack the will to supply the world economy with important public goods such as reserve currency. In the 1930s, the Bank of England lacked the ability to continue serving as an international lender for last resort, and the dominant Federal Reserve lacked the will to do so.
As a result, the crisis spread from Austria to Germany and Britain, eventually reaching the US, turning the slump after 1929 into an era-defined economic collapse. The Kindleberger Trap led to the “world of depression,” as Charles Kindleberger entitled his original book.
This is why we worry about whether the Federal Reserve will continue to supply dollars to overseas central banks during financial struggles. As Reuters reported last month:
Some European Central Banks and Supervisors have questioned whether they can rely on the US Federal Reserve in times of market stress, and six people familiar with the issue have raised some questions about what is the bedrock of financial stability.
Sources told Reuters that they believe it is very unlikely that the Fed will not respect the behind-the-scenes side of its funding. And the US Central Bank itself has not given a signal to suggest that.
But European authorities have been holding informal debates about this possibility — a first-ever Reuters report — as their trust in the US government has been shaken by some of the Trump administration’s policies.
These concerns are guaranteed in light of both the Trump administration’s dislike for traditional American alliances and the centrality of the Fed’s exchange line with global financial stability.
As George Saravelos, chief strategist at Deutsche Bank, highlighted in a recent report on the topic, the federal reserve’s willingness or ability to step up when necessary is the “nuclear button” of the dollar’s future.
Ultimately, the Fed’s withdrawal as an international lender for last resort is equivalent to a suspension of the dollar’s role as the safest role of the world currency. Questions about the Fed’s commitment to maintain dollar liquidity, particularly to key allies, will accelerate efforts by other countries to reduce their reliance on the US financial system. Ultimately, it leads to a decline in foreign ownership of US assets and a widespread weakening of the dollar’s role in the global financial system.
With dollar panic in 2008 and 2020, the Fed wisely told 14 central banks that the money would start here. Through the official swap line, the Fed can extend credits to each central bank for its domestic currency as collateral. Each central bank can lend dollars to market banks for domestic collateral.
With $598 million in 2008 and $449 million in 2020, the swap managed to stabilize the global dollar market. The amount was not small, but offshore dollar loans (both out-of-balance and off-balance sheets) are measured in tens of trillion dollars. Therefore, the central banks working together to lend the dollars and pay them off with interest have calmed these potentially destructive dollar panic.
The US also won from the Fed’s international dollar regulations. Importantly, the swap would have reversed the market-driven interest rate hike for LIBOR-price US corporate and mortgages, which would have hindered US work and consumption. As Saravelus pointed out:
If the Fed did not intervene during the 2008/9 financial crisis and the Covid pandemic, the reserves of foreign central banks and international lenders like the IMF would not be sufficient to meet global dollar demand, and would likely lead to an even greater surge in dollar borrowing costs than the then default, potentially systematic implications for the global financial system.
What happens if a crisis like 2008 or 2020 occurs and the Fed doesn’t exchange dollars? Central bankers are not at work if they weren’t asking this question.
If the situation arises “Politicize(d)… a scenario like asking for the DollarSwap line,” the Fed has the ability, not will, as in 1931.
However, central bankers are happy to form a coalition of dollars.
The central fact is that 14 central banks, which had temporary Fed swaps standing in 2008 and 2020, collectively own a large dollar. Their collective holdings of US safe assets amounted to an estimated $1.9tn at the end of 2021 (total foreign exchange at the end of 2024 totaled about twice as much). This is the triple of the maximum drawing before the 2008 FRB swapline, four times greater than peak 2020 usage.
©Deutsche Bank
Leadership can occur between the Fed’s standing swap partners, the European Central Bank, the Bank of Japan, the Swiss National Bank, the Bank of England and the Bank of Canada. ECB and BOJ were the biggest users of the Fed swapline in 2008 and 2020, respectively. During its 2023 run in Credit Suisse, SNB gained unique experience tapping the New York Fed for $600 billion against US Treasury collateral under the FIMA (foreign and international monetary authorities) report facility.
The Union was able to enlist in the bank for international reconciliation as an agent, as the European Central Bank did in 1973-95. Alternatively, the BIS could act as an intermediary, just as the New York Fed Fed was able to lend dollars to offshore banks through the BIS in the 1960s, preventing crunching of fundraising.
However, there are large wrinkles. $1.9tn has been invested and the crisis is seeking cash dollars. In a world where the Federal Reserve refuses to grant access to swaplines, will the New York Fed continue to provide funding for the same-day FIMA report to detained Treasury Department?
If so, the coalition could arrange to access hundreds of millions of dollars in same-day funds. Otherwise, the Fed would provide ad hoc funding.
Without FIMA’s backstop, sales of the heavy central bank of the US Treasury would shake the US bond market. Such sales allowed the Fed to market as a last resort buyer, as in March 2020, before the FIMA repository was introduced.
Without a FIMA backstop, the Fed would like to similarly curb market repo rates if the central bank attempts to report the Treasury’s report for cash of scale. However, the recent benchmark rate means shifting from Dollar Libor to a repo-based sofa. This means that the Fed itself needs a behavioural report for domestic financial transmissions.
In any case, the coalition will need to work with the Fed to manage the “dash for cash.” Even the massive dollar reserves could not be stacked up to the “anything” of Fed Swaps. Excitation limit. It may be that, as Eurosystem sources pointed out badly to Reuters, “there is no substitute for the Fed.”
Nevertheless, we were able to pool trillions of dollars to backstop trillions of dollars into global dollar funding without the help of the self-interested Fed. The inferior lender of last resort will not beat the lender of last resort.
