Troubled History For Depending On The Fed To Save The ‘Dollar’

Submitted by Jeffrey Snider  –  Alhambra Investment Partners

The relevant part about eurodollars these days is that the term itself is a misnomer, or at the very least not a comprehensive description. “Eurodollar” itself is not necessarily a dollar (or even “dollar”) that originates from Europe, though it has been European banks that have formed the backbone participation for decades. The word is shorthand for any “dollar” that lives wholesale offshore of the US, as a creature of bank balance sheet mechanics. The root “euro” was given in its infancy because of the concentration around London.

The fact of the global “dollar short” is that there is likely every bit an Asian eurodollar as those emanating from Europe. Given that European banks are themselves withdrawing significant wholesale resources (in native euro wholesale too) it may have been inevitable that the marginal eurodollar would turn East across the Pacific. It was, after all, Japanese banks that were the second largest group of dollar swap users during the panic in 2008 and then again even in late 2011. That history is actually long, as there was evenwholesale “dollar” disruption surrounding Japan’s banks into the worst parts of the Asian flu in 1997 and 1998.

It seems simply assumed that any Asian eurodollar branch is still exclusively Japanese, which is becoming clear as a big mistake. The PBOC’s experience with the “dollar” run of late is being confirmed more by the day, with yesterday’s nod toward reserve requirements for banks “trading” forex is, in my view, nothing but a veiled cover forexpected “dollar” liability shortages.

That all would seem to suggest an already-in use solution that could, in theory, have avoided some or all of this mess. As noted yesterday, the Federal Reserve still maintains an open and unlimited dollar swap with several central banks, including the Bank of Japan, but nobody has yet asked why the PBOC wasn’t included or at least added in early August when all the real trouble started to break open (across the world; LIBOR, repo rates and other “dollar” indications were surging before the PBOC “devaluation”).

The answer to that from the media perspective is obvious, just as it was in October and November 2008 when these swaps were met with stunned dismissal even though rising to somewhere around $600 billion; convention still regards the dollar as some kind of 1950’s version of finance. The Federal Reserve, for its part, isn’t that much more evolved in its thinking, which is why it waited until after the panic to turn to swaps as something more than an offhand nuisance. Starting in December 2007, the Fed took little notice of foreign “need” for “dollars” and first instituted the swap lines almost as pure courtesy at counterpart central bank request. In other words, they regarded the dollar as if it were purely onshore for consideration and that the eurodollar piece wasn’t a distinction worth investigating (another huge mistake).

This isn’t just interpretation on my part, as at any number of junctures in the now-disclosed passages of transcripts from that period more than demonstrate an almost open contempt for any central bank not within the “developed” clique. In one of the most arrogant and disqualifying dialogues, the FOMC on the day after Lehman failed somehow took to ridicule the PBOC as if the Fed were by comparison some standard of excellence. The timing of this is disgusting in at least how little self-awareness these people conduct utterly grave affairs of global importance:

NATHAN SHEETS, Staff Economist, “Yes. Yesterday the PBOC cut its main policy rate 27 basis points. I guess they felt that 26 would not have been enough and 28 would have been too much. [Laughter] And 27 was just the right number. I’d say a couple of thoughts were there.”
RICHARD FISHER, “Thank you.”
CHAIRMAN BERNANKE, “Three is a lucky number in China. Don was going to tell you that 3 cubed is 27.” [Laughter].
DONALD KOHN, “He was also going to wonder, Mr. Chairman, whether we needed to harness the mystical powers.” [Laughter]

CHAIRMAN BERNANKE, “I think we have good feng shui here.”
MR. SHEETS, “The science of monetary policy.”

Yes, the PBOC did what it did while the geniuses in DC sat inside their “science” of monetarism and watched the whole thing crash exactly where they said it was all getting better and was never possible given their collective brilliance.

The “science” of monetary policy, indeed. While mocking the Chinese, Mr. Sheets had just finished his presentation, along with staff economist Dave Stockton, in which the Fed’s best monetary “scientist” economists were predicting only a modest impact on GDP from the mess in which they had a heavy hand in creating. Blundering about through crisis was, to them, the epitome of sophistication.

What that shows is not just how incompetent the FOMC was (and remains, nothing has changed) during the worst of it, but also how they treat the dollar’s financial affairs as if it were exclusively an internal matter for their consideration alone. The great failure of 2008, run in the exact same fashion as that which started in August 2007 for crying out loud, was the geographical divide separating NYC and London eurodollars – which is why they eventually under a detestable cloud of total confusion removed all restrictions upon the dollar swaps but only too late.

Any such realization in that manner is right away against orthodox economics that still, somehow, treats financial and monetary conditions as if they were purely closed systems with only minor spillovers or direct links; the dollar is the affair of the dollar, the euro the euro and yuan unto itself. That is demonstrably false, just as it was in August 2007, but recognizing that fact would obliterate a great deal of orthodox economic theory as well as completely upset their view of the global monetary order. Thus, they thought they could belittle the Chinese on September 16, 2008, as if they were some small and unrelated inconvenience when they should have been recognizing the deep, chaotic and unifying wholesale connection.

Despite the $600 billion in eventual eurodollar needs (which included, again, Japanese banks under just as sizable and desperate of a “short squeeze”) the Fed still considers only the closed system; even after a rerun in 2010 and more so in 2011 that reopened the swap lines left to expire on February 1, 2010.

The fact that the “dollar” seems to have taken aim squarely upon Asia in 2015 is just evolution, but the Fed and monetarists are always behind the curve. Whereas the Bank of Korea and even the central bank for New Zealand were included in the “unexpected” May 2010 swap line restart (which shows you yet again all you need to know about how the Fed responds to “dollar” trouble; they end swaps on February 1, 2010, only to restart them once more in limited fashion just weeks later), only the Bank of Japan remains in the open and existing format declared finally in October 2013 – they are looking at the past without considering how the system may have changed, or may be still evolving.

To add the PBOC to the swap lines in August 2015 would be declaration yet again of how the Fed gets it all wrong. The nightly news declares, as does every media outlet, that China’s problems are her own and nothing to do with Fed policy, dollars or anything of America; all echoing what comes out as regular FOMC wisdom and expertise. To move against that, even in necessary remediation, is too far and too damaging to the core enterprise as they still see it.

Further, it shows not simply ignorance but just how unreliable central banks truly are and can be as a general rule. Depending on a central bank for salvation is a deeply dangerous appeal because of all the assumptions it contains; that a central bank actually knows what is wrong, what to do and how to do it – and then has the standing means, rather than ad hoc and unruly, to carry it all out. The evidence is repeatedly dispositive in the negative on all those counts.

The importance of the Asian eurodollar I don’t think should be understated both as a factor in current condition and also as reminder about how dynamic the world, finance especially, can be. Central banks are the antithesis of dynamism for so very many reasons, but not the least of which is orthodox rigidity that really plays out as a lack of respect and discipline where needed the most. The appalling lack of humility given in all these repeated and still repeatable circumstances should be more widely disconcerting, not the least of which in the days before and after August 11.

This is not to say that political and national divisions might not be playing a role, but we won’t know for another 5 years what the Fed might be discussing in that direction. Given its outward projection in the five plus years since that which I quoted above, I would bet squarely upon continued, dangerous indignity. I think that “dollar” markets already have.