In today's newsletter we talk about the Federal Reserve's last stand and swap lines.
The buck stops at the Federal Reserve
It’s inevitable now. Coronavirus will push businesses to the brink. It will disrupt trade channels. It will crack open supply chains and leave ‘em for dead. It will force governments to expend significant resources in a bid to halt its march and the global economy in all likelihood will eventually run into a protracted slowdown. But against all odds, the Federal Reserve (US Central Bank) is trying it’s best to delay the inevitable.
For instance, the US Federal Reserve cut interest rates to 0% yesterday. Meaning big banks in the US can now borrow at no interest whatsoever. On top of this, they are also giving away money to banks for free (sort of) through a complicated procedure called quantitative easing and ensuring banks are flush with cash at all times. The idea here is to keep the money supply flowing through multiple channels 24/7.
But why? Why would they delay the inevitable if they know a storm is due?
Well, because if they don’t do everything in their powers to halt the pace at which the global economy is unravelling, the momentum will take it into oblivion. You delay the inevitable in the hope of saving as many businesses as you can. Travel, Tourism, FMCG, you name it. They all need money to keep their shutters open and in times like these, when you don’t have customers walking in your door like they used to, bank credit goes a long way.
And the hope is that, when the threat from the virus does abate, you don’t have to rebuild the economy from scratch.
Swap Lines to the Rescue
When the future looks dubious, investors look for safe havens i.e. assets that retain their value and can well be sold with ease. And one of the most popular assets in the market right now happens to be the US Dollar. Yes, we are talking about the actual currency. It’s an amazing store of value and it is the de facto global currency especially when it comes to trade. If you are in India and buying oil from a Middle Eastern country, they’ll most likely ask to be paid in dollars. If you are in China looking to sell plastic chairs in Venezuela, they’ll want dollars too.
Unfortunately, when people aggressively buy dollars, it leads to a bit of a supply crunch and this has far-reaching repercussions. Not just for global trade, but for businesses and banks in general. So now, the U.S. Federal Reserve and 5 other central banks have announced that they will be supplying more dollars to banks, investors and businesses alike through swap lines.
Take, for instance, a swap line between the Fed and the Bank of Japan (BOJ). In this case, the US Federal Reserve offers dollars to the BOJ in exchange for Yen at the going exchange rate. They agree that after a specific time period, they will buy back their respective currencies at the initial rate. The Fed charges the BOJ interest on the dollars, and the BOJ gets to lend the dollars to commercial banks in Japan. This way, both countries can ensure there’s always a steady supply of dollars and everyone’s happy
Why would the US be so altruistic, you ask? Well, because a downturn in global trade will have devastating consequences for everyone, including the USA. So if there was any way they could prevent this from happening they would work out a deal with anyone willing to fix this. And for now, they are coordinating with central banks the world over to turn the tide.
Our Time is Now
This is our time to act — with love and courage, with empathy and compassion. I know we’ve been told the virus is (more or less) harmless if we are young and without pre-existing medical conditions. And that much is indisputable. However, it’s imperative that we act with prudence to ensure we break the transmission chain before it becomes a systemic problem, before our national healthcare system is overburdened, before we have a chance to spread it to more people around us — those who are most vulnerable to the disease.
So stay at home whenever you can. Avoid unnecessary travel. Practice social distancing, anything you can to avoid places where large groups meet and gather. Most importantly, let us not be selfish for it is our moral obligation to friends and strangers alike.
As Giuseppe Conte, the Italian prime minister, said this week: “Let’s distance ourselves from each other today so that we can embrace each other more warmly […] tomorrow.”
Until then fellow reader… you stay safe.