All bank failures can be quickly papered over, except those that involve foreign currency. The authorities are well equipped to deal with domestic currency bank failures, where even the failure of a GSIB can be resolved and forgotten in a week. But the authorities cannot print foreign currency, and there are several trillion in uninsured dollar deposits abroad. A loss of confidence in regional U.S. banks raised the awareness of bank credit risk, and led to a shift out of smaller banks and into safer investments. This is a scenario that could also play out when dollar depositors in foreign banks realize that only U.S. banks enjoy the full support of the dollar printer. This post reviews the recent flight to safety, sketches out the global dollar banking system and suggests it is a point of vulnerability.
Flight to Safety
The failure of a few regional banks appears to have shaken the confidence of some depositors in small banks. Although the authorities protected all deposits in the failed banks, the data shows sizable outflows out of small banks and inflows into large banks and money market funds. Note that First Republic and Silicon Valley Bank are categorized as large banks. This suggests that some depositors did not feel secure with their small bank despite strong actions by the authorities. These depositors may have felt safer in a money market fund or a GSIB. This is not a crisis, but it illustrates how fragile confidence in banks can be.
Outside Dollars
Dollar deposits in U.S. banks are now de facto fully protected by the U.S. government, but that protection does not extend to the trillions of dollar deposits in foreign banks. The dollar is unique in that there is an extensive network of foreign banks that offer dollar banking services throughout the world. These banks take dollar deposits and make dollar loans, but are outside the purview and protection of U.S. regulators. They are supervised by their home country regulators, who usually do not and cannot offer insurance on dollar deposits. Note that even the U.S. branches of foreign banks tend to be uninsured by the FDIC.
Foreign banks can meet withdraws of dollar deposits with their liquid dollar assets or by drawing on official sector support. Collectively, foreign banks hold $1.3t in cash at the Fed. If that is not enough, they can also borrow from their own central bank or the Fed. Some foreign countries hold tremendous amounts of dollar reserves to support the dollar needs of their banks. Other countries rely on emergency borrowings from the Fed, who has become the global dollar lender of last resort through its FX swap lines and FIMA Repo Facility.
Fed facilities are a powerful life line, but that they are not without limit. The FIMA Repo Facility has a trivial limit of $60b. Fed FX swap lines are “unlimited” for the closest allies of the U.S., and limited to $30b or $60b for a few others. The swap facilities have been drawn on significantly the in the past, and successful in calming dollar squeezes. But they are ultimately subject to political concerns and not actually without limit.
Un-Paperable
There is little indication of a dollar run, but that is a possibility in a world where awareness of bank credit risk is rising. A confidential draw on the FIMA Repo Facility suggests some need for dollars by a central bank. The failure of Credit Suisse appears to be shaking confidence in European banks, especially Deutsche Bank. Most European countries hold small amounts of foreign reserves and are completely reliant on the Fed.
Although granular deposit data is not publicly available, aggregate data indicates European banks have $3t in dollar liabilities booked in Europe and about the same amount outside of Europe. Off-shore dollar depositors tend to be institutional and corporate accounts that can exhibit high degrees of risk aversion. The failure of a regional U.S. bank showed some depositors that small banks may not be safe. Concerns over large foreign banks could easily spark a realization that dollars can only be safe within the U.S. That would be a crisis that could not be easily papered over.
19 comments On Ameridollars
Dear Wang
You specifically talk about euro-dollar market.
> Concerns over large foreign banks could easily spark a realization that dollars can only be safe within the U.S. That would be a crisis that could not be easily papered over.
Certainly. This means the end of global reserve status.
All prudential reserve banking systems have heretofore “come a cropper”.
Dr. Franz Pick:
(1)”government bonds are certificates of guaranteed confiscation.”
(2)“The fact is that the destiny of every currency is devaluation and expropriation.”
(3)“The difficulty with a debt that doubles every ten years is that the interest compounds to the point that it can no longer be paid out of the current revenues. Once the interest itself is debt financed, the compounding accelerates.
That’s why folks subscribed to Dr. Franz Picks’ “Pick’s Currency Report”, a monthly newsletter, and “Pick’s Currency Yearbook” (90 currencies each year).
I recall attending a Gold conference he sponsored in the early 80’s at the Plaza Hotel in New York City.
He saw the writing on the wall many years ago!
How big of a scale the ripple effect will this be? have we reached peak yet or worse still to come?
As far as the implication that flows into money funds drains deposits at small banks, are you implying a net reduction in total deposits or just a shift from small to large banks? If the former, doesn’t flows to MMMFs just transfer deposits since those funds are invested and spent, so never leave the system unless kept at the ON RRP facility?
MMMFs can alsp invest in primary issuances of government and bank debt too, both of which will drain deposits out if the system.
But the Treasury eventually spends those funds, thus they eventually end up back in the banking system
The DFIs are credit creators. The NBFIs are credit transmitters. The NBFIs are the DFI’s customers. Savings flowing through the shadow banks never leaves the payment’s system.
Thank you, Mr. Wang. This is an eye-opening and important article for many readers.
Effective diversification has always been an accepted and rational risk mitigator. Decades of undisciplined global debt, deficit spending, coupled with pathetic CB and various gov’t agency supervision and regulation enforcement are some of the major reasons the global markets and global savers are in this mess. The US reserve currency hedges trillions of non USD risk. Unfortunately, this adds another reason to diversify away from the USD and will give traction to the Chinese yuan or perhaps a BRIC CBDC backed by commodities as growing alternative to USD.
You’re reaching Mr JC
The Yuan, or any other BRICS commodity-based currency, have two -irreconciliable?- challenges to feasibly become a threat to the USD:
1) Their sketchy legal frames: capital controls, obscure reporting/auditing, questionable democracies (if at all), etc. Would you trust your life savings to a bank under the direct control Putin or Xi, or would you feel safer if deposited in JPMorgan?
2) Infant bond market with very limited liquidity and the appropriate tools. What do you do with your excess of Yuan, or BRICS currency, if you want to get a yield on it?
I definitely see a fragmented, multipolar, Cold World 2.0 type of world in our near future… but none of those currencies will dethrone the USD.
Seems like in most advanced econ, dollar deposits are protected by deposit insurance – https://documents1.worldbank.org/curated/en/593131468330040612/pdf/wps36280rev.pdf&ved=2ahUKEwjqkrKf4YD-AhWNUKQEHcLCCBYQFnoECDEQAQ&usg=AOvVaw3Q5szCWEi_TyC20SWwb_A0
I know you have earlier concluded that CBDC are unnecessary for the Amerian System, but does not this situation make you think twice? 🙂
A fed CBDC would probably accelerate a decline in dollar use in foreign transactions because of the restrictions the US would put on its use to support US foreign policy.
Dear Joseph,
Sorry this is not actually a comment but a request.
I first came across your name through Robert Armstrong’s article at FT.com. I am interested to learn more about the Fed. I found out that you have a Central Bank 101 book and would like to suggest my local library to purchase. Much to my surprise they refused. Here’s the answer: “We are sorry to inform you that we will not be purchasing the item you suggested because there is no independent/authoritative third party review. ”
Could you help me counter that argument?
Thanks for your support – I appreciate it. This is a hard question because in macroeconomics there are disagreements, the field evolves over time, and some things that are widely taught are very obviously not true. My work is supported by tons of footnote citations, as well as my experience actually working in a central bank. There are many macro economists who support and agree with my descriptions, and there may be some who do not. The same could be said for any number of text books. I would suggest that in the social sciences there is no absolute truth like the physical sciences, so there are no authoritative experts. In such a case, a range of perspectives on topics is most helpful to the reader.
Thanks for those explanations. Press seem to overhype this bank crisis.