But a note from Deutsche Bank today has me seeing new ways that that dollar dominance could erode, if not collapse. They call it a nuclear button for the US dollar and it's the FX swap line system.
It comes after Reuters reported that some European Central Bank officials are questioning whether they can rely on US dollar swap lines in times of market stress.
"The immediate question is whether Fed liquidity support is withheld at a time of immediate stress. The consequences would be grave," DB writes.
The fear is that if foreign banks needed USD liquidity in a crisis, the US might demand something in exchange.
At the same time, it's hard to even fathom the size of the swap and forward market. The BIS estimated it was nearly $100 trillion in 2022 or the equivalent of 100% of global GDP, more than double the size of the US equity market.
The problem is that times of stress -- and I wrote about this extensively during covid -- bank swap lines are pulled because of counter-party risk and degrossing. Instead, banks must sell collateral and at the time, it led to a brief fire sale in Treasuries that reversed when the Fed announced unlimited QE.
DB underscores that these agreements are with the supposedly-independent Fed but there are court cases ongoing around the FCC right now that raise questions about the independence of agencies like the Fed.
Now if these lines were pulled in the heat of the moment, the effects would boomerang back into the US and lead to a firesale in Treasuries and MBS, who argues that "the bar for withdrawing support at a time of systemic financial stress would seem exceptionally high."
That led to this incredible paragraph from Deutsche Bank:
Doubts about a commitment from the Fed to maintain dollar liquidity – especially against major allies - would accelerate efforts by other countries to reduce their dependence on the US financial system. It would ultimately lead to lower foreign ownership of US assets and a broad-based weakening of the dollar’s role in the global financial system. It is instructive that large economic rivals to the United States like China and Russia do not enjoy swap lines with the Fed and have shored up their financial systems either by significant official reserve accumulation or by de-dollarising. Ultimately, where such concerns to spill over to US allies, it would likely in our view create the most significant impetus to global dollar de-dollarisation since the creation of the post-war global financial architecture.Not coincidentally: Gold hit a record high today and it's gone parabolic since Trump moved ahead of Biden in polls at this time last year.
This article was written by Adam Button at www.forexlive.com. Read More Details
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