Central bank swaps then and now: swaps and dollar liquidity in the 1960s

Focus

How can the Federal Reserve manage a global dollar money market that opens for business while US markets are closed? Many accounts of central bank cooperation assume that this question was first posed during the Great Financial Crisis in 2007-08. Then, the Fed offered foreign exchange swaps to selected European central banks to allow them to lend dollars to banks in their own markets before New York opened. Was this the first time that the Fed had tried to stabilise the offshore dollar market in this way?

Contribution

We profile the Federal Reserve's swap lines since 1962. We consult not only Fed sources, but also Bank of England, Swiss National Bank and Bank for International Settlements archives. We provide the first systematic analysis of the Fed's eurodollar operations in the 1960s through swap lines. The BIS served the Fed as an operating arm, taking credit risk as it placed eurodollar deposits to stabilise offshore dollar yields in advance of year- or quarter-end window-dressing. While short-lived, these operations have a very modern ring.

Findings

We draw out four themes. First, swaps had a sustained pre-history from 1962 to 1998, surviving the transition from fixed to floating exchange rates. Second, the Fed wove its swaps into a wider net of central bank swap lines. Third, the Fed's eurodollar operations contradict the view that swaps in the 1960s solely managed exchange rates and not Libor. Fourth, this earlier cooperation underscores the Fed's use of swaps to keep eurodollar strains from blocking the transmission of its domestic monetary policy. In all likelihood, the US interest in the eurodollar market, and thus the Fed's self-interest in central bank cooperation, will not end even when Libor ceases to benchmark costs for US loans and mortgages.

Abstract

This paper explores the record of central bank swaps to draw out four themes. First, this recent device of central bank cooperation had a sustained pre-history from 1962-1998, surviving the transition from fixed to floating exchange rates. Second, Federal Reserve swap facilities have generally formed a part of a wider network of central bank swap lines. Third, we take issue with the view of swaps as previously used only to manage exchange rates and only more recently to manage offshore funding liquidity and yields. In particular, we spotlight how in the 1960s the Federal Reserve, working in conjunction with the BIS and European central banks, repeatedly used swaps to manage eurodollar funding liquidity and Libor yields. BIS, Bank of England and Swiss National Bank archives show an intention to offset seasonal disturbances to funding liquidity in order to prevent eurodollar yield spikes. Fourth, this earlier cooperation underscores the Federal Reserve's use of swaps to prevent eurodollar shortages from interfering with the transmission of its domestic monetary policy. The US interest in the eurodollar market, and thus its self interest in central bank cooperation, is unlikely to end even when Libor is replaced as the benchmark for US floating-rate loans and mortgages.

JEL classification: E52, E58, F33, G15

Keywords: central bank swaps, international lender of last resort, central bank cooperation, eurodollar market, financial crises, Federal Reserve, Bank for International Settlements