In the editorial accompanying the March 27 Daily, I highlighted a media report which suggested senior officials and supervisory staff at the ECB “informally” discussed a scenario wherein a politicized (or commandeered) Fed was unwilling (or unable) to provide foreign central banks with access to dollar liquidity through the swap lines.

Such a scenario is, I hope, far-fetched, and as such I wasn’t going to harp on it. But upon reflection, I want to highlight it more prominently.

The story itself was published by Reuters on March 22. The gist of it says the Trump administration’s willingness to break with decades of transatlantic precedent on matters of the utmost importance (e.g., collective security) prompted European officials whose remit is financial stability to ask if the White House “might pressure the Fed to suspend the dollar backstops.”

I should note that Reuters’s sources were clear that neither the Fed nor the ECB “leadership” (which I assume just means top policymakers on the Governing Council) gave any indication there’s cause for concern in this regard, but the very fact that staff think it’s a tail risk speaks volumes about just how much trust was indeed lost over the past three months.

Those liquidity swaps are among the first lines of defense in a real crisis. On March 15, 2020, when Jerome Powell announced a raft of measures to backstop the global financial system in the face of the pandemic, the swap lines played a key role. The inauguration of the backstops during the GFC was crucial to the crisis-fighting effort.

The chart gives you a visual sense of the extent to which these are life lines when things take a turn for the absolute worst.

Importantly, this liquidity support serves a purpose even when the world’s not ending. That is, the swap lines play a key role in lesser crises too. For example, following Credit Suisse’s weekend shotgun wedding to UBS in March of 2023, the Fed announced (on a Sunday) that all parties to the standing swap arrangements (the BoC, the BoE, the BoJ, the ECB and the SNB) were increasing the frequency of their dollar liquidity operations to daily from weekly.

What would happen in the event the Fed refused to allow foreign central banks, and particularly major DM central banks, to tap dollar liquidity through the swap lines in a real crisis? The short answer’s that, assuming the crisis were existential in nature (i.e., like the GFC or COVID), the dominos would fall very quickly, because foreign central banks may not be able to meet the dollar liquidity needs of the institutions in their respective jurisdictions.

It’s very difficult to game this out because it effectively posits a Fed beholden entirely to a vindictive White House. In such a scenario, it’s reasonable to assume Treasury, as an even more politically beholden institution, would be engaged in a simultaneous effort to prevent reserve managers and foreign banks in locales on the outs with Trump from raising dollars by selling or repoing their Treasurys.

Certainly, an administration that won’t let the Fed open the swap lines to Europe won’t let Treasury lend against UST collateral, and it’s not unreasonable to suggest that in such a scenario, the White House might ban dealers in Manhattan from facilitating trades (e.g., UST repos or sales) which allow counterparties from “unfriendly” jurisdictions to raise dollars. If foreign monetary authorities can’t raise dollars and neither can large foreign banks, then all the smaller financial institutions which rely on them, to say nothing of foreign corporates, would be unable to meet their dollar liquidity needs.

As Deutsche Bank’s George Saravelos wrote, in a note citing the same Reuters reporting, crises invariably strain the offshore dollar-funding ecosystem, where non-US counterparties use swaps to access the dollars they need. In a scenario where those swaps can’t be rolled (i.e., where no one’s willing to lend dollars) and foreign central banks are unable to provide sufficient dollar liquidity to ease the crunch because the Fed’s not picking up the phone, you don’t have a dollar crunch, you have a dollar drought and in very short order (where in this case “short order” means hours, not days or weeks) you have a total meltdown.

The world needs dollars all day, every day. Without dollars, the whole thing — all of it — simply stops. Everybody from banks to corporates has dollar obligations to meet all around the world. The Fed has a responsibility to make sure that even if no one else — e.g., US banks — is willing or able to lend dollars, they will.

I should be as clear as possible. There’s no ambiguity about what happens in the event a US president decides to weaponize the dollar in this particular way during a real crisis: It’ll be the end of the world, almost literally because… well, just imagine what the consequences would be if there aren’t enough dollars available to the rest of the world to service, meet and otherwise satisfy the constellation of outstanding obligations which in some way, shape or form, reference the dollar.

After an obligatory nod to the notion that “the responsibility for extending dollar swap lines with foreign central banks lies with the Fed,” not with Trump, Deutsche’s Saravelos addressed the question directly. “What if the Trump administration was to step back from the US commitment to maintain dollar liquidity at a time of immediate stress?” he wondered. Here’s his answer:

The consequences would be grave. Had the Fed not stepped in during the 2008/9 financial crisis and COVID pandemic, the reserves of foreign central banks and international lenders like the IMF would unlikely have been sufficient to meet global dollar demand, leading to an even greater surge in dollar borrowing costs than occurred at the time, defaults and potentially systemic implications for the global financial system.

I’d omit “potentially.” A Fed that cuts off the swap lines under orders from a capricious US president is a Fed that would absolutely (not “potentially”) trigger a systemic crisis for the global financial system because… well, because the Fed is the global financial system.

The Reuters piece went on to say that for now, European banking officials view “the possibility the Fed would ever curtail its financing lines… as only a very remote possibility” given that “such a move would have profound ramifications for global markets, financial stability and the economy.”

Far-fetched or not, one of the sources for the report said “the question of whether Europe can rely on the Fed’s backstops is expected to come up in more formal discussions soon” in light of recent events, which raise questions about “the potential for less international cooperation on the part of American authorities.”