Back to Quack Off
Europe Borrow Dollars from the Fed?
by John Carney
New York, NY -- The Federal Reserve and other banks
that they were engaging in a coordinated action to
provide liquidity to Europe's credit markets.
essentially happened is that the Fed cut the interest rate it charges the
European Central Bank to borrow dollars.
European Central Bank wants the dollars so it can lend them out to European
banks, which have been having trouble borrowing dollars at affordable rates
due to fears about their financial health.
worth taking a moment to see what actually happens with these swap
facilities because they can create the illusion we’re sending boatloads of
dollars overseas and the ECB is sending us boatloads full of euros.
Would-be pirates will be disappointed that no currency flotillas cross back
and forth on the Atlantic.
really takes place, for the most part, is down on Maiden Lane in Manhattan’s
financial district. That’s where the headquarters of the Federal Reserve
Bank of New York is located.
most interbank transfers these days, everything is done electronically.
the ECB wants dollars, it gives notice to the New York Fed. The notice
contains how many dollars the ECB wants, when it wants them, what the
exchange rate is at the time, when it will pay back the dollars, and what
the interest rate will be.
today, the interest rate was one percent plus something called the US dollar
Overnight Indexed Swap Rate. Today's announcement cut the spread in half, so
that the ECB now borrows at just half a percent over the OIS. (It’s very
telling that only the ECB has to pay interest. There’s no price for the Fed
getting to hold euros.)
Next—and this is important—nothing happens. Not really, that is.
Nothing moves anywhere. No currency flotillas leave for the high seas.
that happens is that an account at the NY Fed that the ECB has designated as
its swap account gets credited with the dollars. This account is really just
a line on a spreadsheet in a computer in that Fed building on Maiden Lane.
Crediting the account just means that someone enters numbers into a
same time, the ECB enters numbers onto a spreadsheet housed in a computer in
Frankfurt, Germany, where the ECB is headquartered.
numbers represent Euros that are now “in” an account for the NY Fed.
Neither the dollars nor the Euros come from anywhere. They aren’t moved or
debited from anywhere. They are invented right on the spot with a few taps
on the key pad. And that’s all. There’s no printing press fired up to make
new dollars or euros.
is sometimes called “fiat money.” But that makes it sound as if some command
from a sovereign created the money. It’s really closer to “keyboard money,”
since it is created by data entry in a computer.
the swap is outstanding, the ECB can lend the dollars in its account to
European banks. It does this simply by telling the NY Fed that it wants to
credit the account of a European bank and debit its account. This all
happens, again, by someone typing the data into a computer.
forward to the maturity date—the date when the swap is supposed to be
unwound. On that day, the Fed simply zeros out the ECB’s account. This means
there are no dollars left in it to be lent out to banks, although that’s
really just a metaphor. What it really means is that the Fed will not credit
the accounts European banks if asked to do so out of the zero’d out account.
ECB’s account on the maturity date has the right amount in it, then the swap
is closed off. If there’s a shortfall, then a new swap is created to
represent this amount. This means that it’s pretty much impossible for the
ECB to default on this loan, since any shortfall is just rolled over into a
might there be a shortfall? Remember, the ECB is borrowing dollars so that
it can lend them out to European banks. If those banks haven’t repaid those
loans, it must “purchase” the dollars from elsewhere—most likely other
more, the ECB must pay interest on the swap—which means that it must always
purchase a few dollars more than it borrowed or collect those dollars in
interest from the banks it lent to. If it doesn’t purchase the dollars or
get those interest payments, you get a shortfall.
way, there’s nothing in the swap agreement about what happens if the Fed
doesn’t have the euros to refund the ECB. That’s because it is impossible
for the Fed not to “have” those euros. You see, the ECB created the euros
“held” as collateral for the loan by entering data on a spreadsheet. As far
as I can tell, there is no provision at all for the Fed to “draw” from the
“account” in which the euros are held.
just “sit” there—although, again, since its just numbers on a spreadsheet,
nothing is physically sitting anywhere.
honest, I don’t think there is an economic point to the existence of the Fed
account with the ECB. What do we care if there is a spreadsheet in Frankfurt
that represents the conceptual Fed possession of a bunch of euros?
suspect the reason for this is entirely legal and optical. It’s good for all
the central bankers to be able to tell the world that these loans are fully
collateralized. Depending on how you read the regulations, the Fed may even
be required to be able to claim it has collateral for the loans—even if that
collateral is just a line entry on a spreadsheet in a computer housed in the
very central bank that is borrowing dollars.
not even 100 percent confident that anyone in Frankfurt does enter the
numbers into a spreadsheet. Why would they? There’s no point at all to
having them entered and automatically erased at the end of the swap.
since the Fed doesn’t use those euros during the period of the swap, there’s
no need to keep track of how many are in the account. If you’re a Frankfurt
central banking clerk, why not just take a smoke break instead of opening
the computer file that has this totally made up account in it?
– FM Duck
back to top...