What Are Currency Swaps?

I got interested in the headlines this morning that talked about the Federal Reserve injecting $600bn into the Global markets this morning.  The $600bn number did happen to grab my attention because, if I recall correctly, this was roughly the number that was being voted on in the Bailout…er..”rescue” bill.  When I checked, I realized the difference between the Bailout and SWAPS was only $100bn  (what’s a hundred billion dollars between friends…not what it used to be and that’s for sure.)

• In any event - back to the SWAPS - Essentially these swaps are an agreement between two central banks.  The USA agrees to swap $100bn USD in return for 100bn EURO, based on the exchange rate on the date of the swap agrement.  It’s basically a wager.  The USA is obligated to return 100bn EURO to the ECB at a specific date and time.  The hope is that the USD will appreciate against the EURO so that it will cost the USA less (in US dollars) money when they exchange USD’s for EURO’s on the day of the repayment.

• Foreign banks have been under stress as they have seen their overnight borrowing costs escalate.  It is for this reason that they are less willing to lend money.  There is also a fear of default in the credit marketplace.  Their unwillingness to lend is based on both cost and a credit issues for the Foreign Banks.    The high borrowing costs are reflected in the LIBOR rate.  The USA, by injecting $’s via the SWAP lines is hoping to bring down the LIBOR rate.

• The one question, that I’m not clear on is whether or not the derivatives show up as a liability on the balance sheet of the Fed.    I found and interesting article on the Federal Reserve Bank of Atlanta’s website dealing with Currency Swaps

• I think that this could be inflationary as the supply of both currencies are being increased.  The inflationary pressures could show up in the cost of commodities.  In this situation you have more units of currency versus 1 bbl of crude oil.  The cost of a bbl of crude oil would have to rise.

I’d be interested in any comments or light that any readers could add or share on Currency Swaps and whether or not the Fed is inflating their balance sheet with these SWAPS.

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Comment by B. Baker

2008-10-04 13:09:39

Foreign Exchange Swaps
New England Economic Review, Second Quarter 2002
By Leonardo Bartolini
Vice President, Federal Reserve Bank of New York.
leo.bartolini@ny.frb.org

Article:
http://www.bos.frb.org/economic/neer/neer2002/neer202b.pdf

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