The Economist USA 03.21.2020

The EconomistMarch 21st 2020 Finance & economics 63

2 provision for bad loans as the probability of
default rises, rather than waiting until
counterparties start missing payments be-
fore booking losses.
The second problem banks have is their
own scramble for cash. As lenders make
loans, their balance-sheets grow. But bal-
ance-sheet is a scarce resource, especially
in the current climate. In order to issue
more loans banks must either shrink other
assets, or find extra capital and funding.
They are doing both. Banks have pulled
back from market-making activity, as evi-
denced by the stubbornly high interest
rates in the “repo” market, where firms and
banks can swap cash overnight in ex-
change for posting Treasuries as collateral.
Ordinarily banks might jump at the oppor-
tunity to arbitrage the difference away by
hoovering up Treasuries. Yet intermediat-
ing in the repo market is something they
can ill afford at present. Banks are also re-
taining more of their profits in order to
build up capital. On March 15th America’s
six largest banks announced they were
halting share buybacks for three months.
Their backstop is the Federal Reserve,
America’s lender of last resort. It has gone
out of its way to ease the blockages in the fi-
nancial system by encouraging banks to
lend. It started on March 12th when the
New York Fed, a branch of the central bank,
made $1.5trn (an ocean of cash) available
for repo operations. In addition to cutting
interest rates on March 15th the Fed an-
nounced it would buy up $500bn-worth of
Treasuries and $200bn-worth of mortgage-
backed securities. By taking assets off the
banks’ hands, it enables them to expand
lending. It cut the rate on the “discount
window”, a tool for banks to borrow from
the Fed, and encouraged them to use it free-
ly. It suggested that banks could dip into
their capital buffers, worth $1.9trn, and
their liquidity buffers, another $2.7trn, to
lend to firms and households, which
helped ease their regulatory constraints.
Then, on March 18th, the Fed announced it
would start buying short-dated commer-
cial paper, to provide direct support for big

companies. It also relaunched a facility to

lend directly to “primary dealers”, a group

of financial firms that do not have direct ac-

cess to typical Fed lending channels.

These steps are the right ones. Other

central banks are taking similar steps. For

banks that promise to lend cash the Euro-

pean Central Bank has cut the rate at which

banks can borrow from the central bank be-

low the rate at which they are compensated

for deposits. It says it will also expand its

bond-buying programme by a whopping

€750bn ($818bn). The Bank of Japan, mean-

while, is buying up company shares di-

rectly, too.

The scramble for cash will continue. If

enough liquidity is created quickly, the

long-term damage to the real economy will

be minimised, though. And if firms know

that they can get cash whenever they need

it, they might not need quite so much in the

first place. Rather like loo paper. 7

Junk funk

ICE BofAML US high-yield corporate-bond

spread over Treasuries, percentage points

Source:FederalReserveBankofStLouis

25

20

15

10

5

0

2017151311092007

A

merica’s currencywas not always as

coveted as it is in today’s troubled

times. In the 1960s European central banks

had more dollars than they felt comfort-

able holding. To discourage them from

converting their greenbacks into gold, the

Federal Reserve introduced its first “swap

line” in 1962, allowing foreign central

banks to obtain dollars in exchange for

their own currency, then swap them back at

a later date. Combined with the Fed’s pur-

chases of dollars, the swaps helped protect

nervous foreign central banks from the

dangers of a dollar devaluation.

The world now faces the opposite pro-

blem: a dollar in high demand, prone to

dangerous appreciation. It has, unsurpris-

ingly, strengthened against the currencies

of emerging markets, which have suffered

brutal capital outflows since late January

(see chart). But the dollar has, more sur-

prisingly, also strengthened against safe-

haven currencies such as the yen and the

Swiss franc, and pushed currencies like the

pound and the Norwegian krone to their

weakest level in decades. On March 18th

Bloomberg’s dollar spot index, which mea-

sures the greenback against a basket of cur-

rencies, hit an all-time high, its seventh

consecutive rise. Anyone seeking to swap

their yen, francs or euros for dollars (and

then swap them back again after a few

months) must pay a premium, known as

the cross-currency basis, which is deduct-

ed from any interest they earn. That pre-

mium has risen sharply on several occa-

sions in the past two weeks.

One reason for this scarcity may be the

dollar’s global role. Zoltan Pozsar and

James Sweeney of Credit Suisse, a bank,

have pointed out that supply chains are

payment chains in reverse. When the flow

of parts, components and assembly is in-

terrupted, so is the flow of payments in the

other direction. In East Asia, where the

pandemic began, these payments are often

made in dollars.

Some hospitals overwhelmed by co-

vid-19 cases have reported a lull before the

storm, a period when emergency rooms

fall quiet, because people with other ail-

ments are staying away, but the people who

cannot breathe have yet to arrive en masse.

Something similar befell the dollar fund-

ing markets in February. China’s shutdown

reduced the need for trade finance, point

out Mr Pozsar and Mr Sweeney, removing

one source of demand for dollar lending.

But as companies’ dollar earnings have

dried up, more of them have turned to their

banks for help. Companies with pre-ar-

ranged credit lines have drawn them down.

Large firms that are accustomed to obtain-

ing money directly from the capital mar-

kets, through bonds or commercial paper,

have also turned to the banks instead.

The banks themselves can turn to the

Fed, which can lend them dollars they can-

not obtain on their own. But the Fed is less

able to help banks that lack a presencein

America. Last year non-American banks

HONG KONG

The Fed is, but does not want to be, the world’s central bank

The surging dollar

Multi-coloured swap shop

First line of retreat

Cumulative non-resident portfolio flows to

emerging markets during global shocks, $bn

Source:InstituteofInternationalFinance

20

0

-20

-40

-60

-80

0 10 20 30 40 50 60 70 80 90

Days since indicated date

China scare

26 Jul 2015

Covid-19

21 Jan 2020

American

quantitative-

easing scare

17 May 2013

Global financial

crisis 8 Sep 2008

1