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Swapmania

Currency swaps between central banks are quickly emerging as a key feature of the international monetary system.
Par Christophe Destais
Billet du 9 décembre 2013


On October 30st 2013, five central banks, the European Central Bank, the Bank of England, the Bank of Japan, the Bank of Canada and the Swiss National Bank, together with the US Fed, posted a communiqué on their websites. The latter informed the press and the public that these banks have decided to make permanent the temporary swap lines they had between themselves and, chiefly, between the five of them and the Fed. This news was hardly noticed. The new facilities bear no conditionality. Their stated aim is to foster financial stability.

The creation of these facilities is reminiscent of the de facto role of global lender of last resort that the Fed played during the recent crisis. Between December 2007, and October 2008, it authorized temporary dollar liquidity swap arrangements with 14 foreign central banks [1]. These arrangements, which bore no conditionality, expired on February 1, 2010. It was the first time that the FED intervened to prevent a liquidity crisis on the “Eurodollar” market (the dollar that is traded among non-US residents) or to mitigate its effects.

In May 2010, the dollar liquidity swap lines between the FED and five foreign central banks, the ones with whom it recently institutionalized permanent facilities, were reactivated in response to the re-emergence of strains in short-term dollar funding markets.
Other foreign exchange swaps, not involving the Fed, have taken place, but they remained modest.

Local currency swap agreements between central banks are also a tool that is widely used by the Chinese central bank, the People’s Bank of China (PBOC), to foster the internationalization of its currency, the Renminbi.

So far, the PBOC has 23 active local currency swap agreements amounting to a total of RMB 2.56 trillion or USD 420bn. The last in the row was announced on October 10th, 2013. It links the PBOC and the ECB and amounts to RMB 350bn (Euros 45bn or roughly USD 60bn), a non trivial amount. On June 22nd, 2013, the PBOC and the Bank of England had signed an agreement to establish a reciprocal 3 year, sterling/RMB currency swap line for a maximum amount of RMB 200bn (Euros 26bn, USD 41bn).

Commentators often refer to the Renminbi swaps between the PBOC and other central banks as a rather symbolic step. It is sometimes said that these swaps have no actual monetary or financial consequences and that they just exist as a way to lay the ground for future more substantial monetary relations. Such an interpretation is supported by the often minimal communication on these swaps with only their amount, the maturity of the agreement and fuzzy justifications being made public.

However certain central banks have recently been more open on this subject. The ECB press release which made public the swap agreement with the PBOC explicitly stated "From the perspective of the Eurosystem, the swap arrangement is intended to serve as a backstop liquidity facility and to reassure euro area banks of the continuous provision of Chinese Yuan."  A similar statement had been made earlier by the Bank o f England, the Monetary Authority of Singapore or the Reserve Bank of Australia.

Currency swaps between central banks on a large scale are recent. To our knowledge, prior to the recent financial crisis, they were solely used in Asia. The modest 1977 Asean Swap Agreement was included in 2000 in the Chiang Mai Initiative (CMI) which also included a network of bilateral swap arrangements (BSAs) among the ASEAN+3 countries. In December 2009, the BSAs were consolidated into a single swap contract and a regional surveillance unit, the Macroeconomic Research Office, was created. However, the CMI has remained a US dollar reserves pooling system. It is not a tool to exchange currencies that the central banks parties to the agreement are empowered to create.

The other existing or previous regional financial agreements, such as the modest Arab Monetary Fund, the equally modest Latin American Reserve fund, the Anti-Crisis fund between Russia and some former USSR countries are based on loans or credit lines (Rhee 2013). The current arrangements in Europe also include limited possibilities to intervene  on the secondary debt market. The closer instrument to the current swaps is maybe the large foreign exchange intervention mechanism that took place within the European Monetary System (EMS) in the 80s. These interventions were financed by mutual credit lines between central banks (Giavazzi, 1988).

Until recently, the development of swaps between central banks might have appeared to be the result of exceptional and temporary circumstances, in the case of the Fed, or with limited purpose, in the case of the PBOC.

With the recent extension of PBOC’s swaps to major non-Asian central banks and the setting up of permanent swap facilities between major western (including Japan) central banks, it seems that a new permanent feature of what is coined the “international monetary system” is emerging: a decentralized network of freely agreed and revocable contracts among international currency issuers and between the latter and other central banks.

References:

Rhee (Changyong), Lea Sumulong and Shahin Vallée “Global and regional safety nets: lessons from Europe and Asia” Bruegel Working Paper 2013/06, November 2013

Giavazzi (Francesco), Stefano Micossi and Marcus H. Miller “The European Monetary System” Cambridge University Press 1988
 

[1] In addition to the ECB, the central banks of Australia, Brazil, Canada, Denmark, the Bank of England, Japan, Korea, Mexico, New Zealand, Norway, Singapore, Sweden and Switzerland.

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