The Dollar System and Central Bank Swaps

The dollar system is a global system - "Our Dollar, Your Problem".

While the Fed has historically denied responsibility for off-shore dollars, in Dec 07, it capitulated when it set up central bank liquidity swaps.

A 🧵 about central bank swaps, the eurodollar, and Switzerland

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

The dollar system that collapsed in the GFC was a global system - the so-called "eurodollar".

In Aug 07, BNP Paribas announced the global crisis had arrived when it blocked withdrawals on some funds, citing "The complete evaporation of liquidity" in US markets due to subprime

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

The evaporation of liquidity is a *deflationary* event. The '07/'08 collapse was a mega monetary deflation. Liquidity in the eurodollar system dried up as risk shot up and money dealers backed out.

The system has never really recovered.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

Over the fall of 07, the Fed started to take action, and in December, they announced swap lines with the European and Swiss central banks.

Over time, they'd expand the amounts and the counterparties. pic.twitter.com/Pn2j67BuRw

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

The swap lines basically offer a short term USD loan collateralized by the other central bank's currency.

So the Swiss National Bank (SNB) puts up some amount of CHF for a short term USD loan from the Fed at a fixed fx rate. At the end of the term, they unwind. Hence, a swap.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

But who are the dollars for? It's not so much for the SNB as it is for the commercial banks in Switzerland.

Swiss banks bid for dollars in an auction with the SNB, who then gets the USD from the Fed by swapping its own currency (CHF) for a fixed short term and rate.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

The need for the swap is a signal of deflationary money.

True, the Fed expands its balance sheet to loan the foreign central bank USD, but only because foreign banks are so desperate. It's a sign of USD shortage. And then the swap unwinds and the new USD are destroyed

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

As we saw in the announcement, SNB's limit started at $4B. But demand from Swiss banks far outstripped this

Here's the SNB data: https://t.co/kCiwDvEQws

1st column is repayment date, 3rd last is # of banks bidding, last 2 columns are total bids & amount allocated (Ms): pic.twitter.com/kDo1MjrpcL

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

So 10-20 Swiss banks were bidding for ~10B USD, but could only get 4B. You can see in '08 the limit was upped to 6B. A few months later it was upped more.

For most of '08, every 2 weeks, the Swiss banks were bidding for ~10B USD worth of 4 week swaps.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

After Lehman collapsed, they're bidding for ~10B worth of 1 day swaps *every day*

This goes on for weeks. pic.twitter.com/0Z55yGzNvj

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

Things start to calm a bit by the end of the year, and by April '09 use of the swaps in Switzerland is down to 0.

And it mostly stayed at 0.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

There's a small blip during the Euro sovereign debt crisis, when the SNB swapped a few hundred M USD a few times. Still, nothing in comparison to the '08 activity.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

So things were mostly quiet for the SNB on the USD swap line front.

Then COVID hits. Bam. Back to ~1B in swaps *every day*, now for 7 day or 84 day terms: pic.twitter.com/iN7bcNr0Of

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

By Sept 2020, the frequency drops to weekly, and the amounts start to tail off again.

For most of 2021, use of the swaps by the SNB is 0. An occasional 1B or 2B USD blip.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

Then something strange happens in October 22.

A sudden surge in usage of the dollar swaps - up to 11B! pic.twitter.com/wjsratMreC

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

While the Fed is going on about inflation, 10+ Swiss banks are bidding for billions in USD again, a sign of some kind of USD shortage in Switzerland.

What might have been going on in Switzerland in October to cause this?

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

Switzerland is a major eurodollar hub. Swiss banks play a key role in enabling dollars to flow all around the world.

In October, it looks like something seized up, and the Swiss banks suddenly needed a ton of dollars from the Fed.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

Of course, this past Sunday, Credit Suisse was gobbled up by its old rival UBS in a shocking emergency deal.

And the Central Banks announced they are upping the swap line operations to daily again.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

Does Credit Suisse's reporting have anything to say about October 2022? Sure does. From their Q3 report: pic.twitter.com/ghjk1iOA4v

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

Let's have a look at their balance sheet. Their Q3 2022 numbers are similar to their year end 2021. But year end 2022 shows major balance sheet shrinkage: pic.twitter.com/RpITTMseUe

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

150B in deposit outflows in the last quarter of 2022!

But also note the drop in "Central bank funds sold, securities purchased under resale agreements and securities borrowing transactions" - from >100B to <60B. This is Credit Suisse repo lending - collapsing.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

That's a sudden ~40B drop in money market lending. Perhaps this is what led to the ~10B run on the SNB's dollar swap?@JeffSnider_AIP is suggestive in a recent Eurodollar University episode.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

But who can really say? Swap line activity was quickly back to 0 after this. Though we did see it tick up again this week ...

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

Surely more and more folks will be watching the swap lines.

For more great writing on the topic, see @NathanTankus, eg. https://t.co/VDydFJkdLk

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

This thread has only talked about Switzerland, but other central banks are swapping too. You can see the Fed's daily data here: https://t.co/Vp5CVn9B3n

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

There's lots of routine swaps for say up to 100M, that seem uninteresting.

But the occasional 1B+ swap signifies who-knows-what shenanigans deep in the offshore dollar markets.

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

Things went completely crazy during COVID when we start seeing 30B USD 1 week swaps (!) and 70B+ USD 3 month swaps: pic.twitter.com/W1qPbPvbsV

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023

We'll see what kind of activity lies ahead.

The global monetary system is a deep dark forest, where no one really knows what's going on. Clues show up in various places, from usage of fed facilities to bank financial reports to yield curves, interest rate spreads, and so on

— Ethan Buchman (🐝,🦇) (@buchmanster) March 23, 2023