Friday, January 29, 2010

The USD/Euro Currency Swap Unwind

A reader has asked me to comment on the announced unwinding of the $500 billion in currency swaps that were implemented by the Fed between the U.S. and the British, Japanese, EU and Swiss National Banks.  It's a really good question and given that Bernanke issued a statement, under oath in front of Congress, that he doesn't know how that money has been used or the specifics of where it went, then we have to assume that even Bernanke can't answer that question.  Let me make it clear that I believe Bernanke lied under oath.

The problem in analyzing the answer to this question is that, notwithstanding Bernanke's feigned ignorance, it would be impossible to know exactly how the money was used in the first place, so it is impossible to form judgements about what the unwinding of these swaps will look like.

I really want to avoid making educated guesses about this topic, because the bottom line is that it would just be guessing.  Perhaps our brilliant Senators should have forced Bernanke to disclose all of the details about these transactions before they voted on his reappointment. But given the trillions being printed by Bernanke and spent by Congress, what's a mere $500 billion among friends?  Having said that, I do suspect (and again we can never prove this) that the swaps conducted with the Bank of England were employed to help fund U.S. Treasury bond auctions during the past year.  And I am completely fascinated to watch how the Fed/Treasury is going to finance the $2+ trillion in new Treasury issuance that is coming this year ($2.2 trillion debt ceiling = $300 billion raise at Christmas + $1.9 trillion just approved by the Senate). 

What all this points to is the growing Orwellian nature of our Government and Central Banking system - AND the growing unwillingness of Congress, the Executive Office (that's you Obama) and the Judicial Branch, to reverse the process of the Government becoming MORE secretive (as opposed to LESS secretive, which Obama promised to do to coax votes and has failed miserably in doing).  All this is to say that I have no idea what the currency swap unwind will look like and I have yet to see anyone else offer a credible explanation.  Maybe if Congress held the Fed and Wall Street more accountable, we wouldn't even be having this discussion...


  1. Dave how smart is the Japanese finance minister?! THey have billions in US treasuires but yet they still continue with debt financing. Where is the logic in that?! Me thinks the end game will have them cornered and no choice but to be the first to shout fire in the us treasury market. Rest assured the crazy sitting in N Korea will then start lobing missiles over Japan, to keep them in line for the US government.

  2. LOL. Japan has had a fascist system longer than we have. They've been printing loads of money to keep the banks solvent since their stock bubble popped. Look at a really long term chart fo the yen, you'll see what I mean. If you strip out last years decline in gold against the yen, just eyeballing it, gold went up more vs. the yen the past decade than against any other currency.

    Japan is starting to align itself with China. The best indication of this was when they announced that they were pulling their only military support of U.S. operations in Afghanistan when they announced they would withdraw their refueling support unit.

  3. "what's a mere $500 billion among friends?"

    Um...Dave, this money wasn't spent, it was a swap! The foreign central banks swapped their respective currencies in exchange for dollars. The unwinding of these swaps means that the dollars are coming home to the Fed.

  4. Ya, eventually dollars will be coming home. But it's unclear what effect this will have on the markets, if any.

    If those dollars were given to subsidiary member banks to make dollar payments required on toxic assets, those banks have to go into the market and buy back dollars to return them. Maybe that's the source of the dollar rally over the past month or so.

  5. Yes, that would be correct. The dollar swap were arranged between the central banks, but each and every central bank chose their own method of distributing those dollars. The European Central Bank distributed these funds via dollar auctions. The information has all been documented and is available on the BIS website, working paper nr. 285.

    I have been following the dollar swaps for at least months now since it seemed interesting and important. And it was. But to claim that the current dollar rally is due to member banks buying dollar in exchange for euros, yen, francs and what have you doesn't really carry any weight because the amount of swaps left on the table is just too small. If you are interested in the swap numbers, I'll send you an excel spreadsheet. I've got 'em all lined up. But just for reference: at the height of the swap lines, they totaled $582 B. During last year, when more than $200 B worth of swaps were closed, the dollar actually plummeted. When the dollar rally started, the swaps were standing at around $25 B. So I would imagine that the swaps aren't that big of a market mover. The arrangement of those swaps was, however, because they were arranged due to a huge dollar shortage. This is getting too long for a comment...maybe I'll write a blog post and then send you guys the link?

  6. Interesting Kristjan. Thanks for the color. I never claimed the dollar could be attributed to the unwinding of the swaps, I said there might be some correlation to the extent that banks had to unwind the swaps and return dollars but the original swap dollars were used to pay toxic asset payment obligations, which would have left them short dollars. The fact is we don't know how the money was used by the counterparty CB's, as per Bernanke's testimony.

    But you have some great data there and please do write a blog post and send me the link.

  7. I'll do that tomorrow and I'll send you the link. It's getting pretty late in this part of the world (GMT+2).

  8. whoa Kristjan! Midnite on should be out chasing women!! LOL

    Look forward to reading your post.

  9. Too complicated for me! Chasing women sounds good, go long TNA!
    It must be Friday!

  10. It's all because of the recession, you know. I've been investing and saving money more than ever before all the while my income has been dropping. This means I can't go out that often. But saving and investing will pay off and then I'll be partyin', knowing I can afford anything. I've got some elaborate plans ;)

  11. The post is up at
    Just follow the link to scribd to read the whole story. I'd love to know what you guys think about the report. Let me know!

  12. Thanks. I'm going to read it later tonight (Sat) or in the morning. Looks like you put a lot of work into it.

  13. Kris,
    I will check it out in the morning and looking forward to it. Thanks for the info.

  14. Kristjan an interesting analysis I think the most significant points of extrapolation are:

    1. The resetting of ARM 2 this year going into June is going to set off a another deleveraging round worse than the last one and could cause PM's and particularly shares in PM's to collapse. The only way this could be prevented is if the gold price reacts to physical buying and the credit squeeze is so large that the hedge funds get broken on their ratio spreads.

    2. The banks are again preparing for this new wave of bankruptcies by proprietary hoarding huge of amounts of cash just look at the deleveraging of main street published everywhere in the loan reduction numbers.

    This time though the analysis is overlaid with the news last week that S&P had downgraded the structural credit of London’s banking system from a 2 to 3. This is the biggest news in the last four hundred years and you don’t find it on any web site or discussion group that I have seen. You hear about them maybe down grading sovereign debt to double A but last week they downgraded the structural risk of the whole London banking system to 3.

    The long term implications of this down grade are much greater than the implications of a sovereign down grade as it impacts the trading ability of the markets. A rating of 3 is the same as Greece or Turkey and you simply would not put serious trading capital into these systems. It means the long term future of the LME and the other trading markets is nonexistent.

    The people I talk to in London are saying they are preparing for another full-scale crisis in June and this time banks are going to go. The one that gets talked about most is JP Morgan doing a Bear Stearns on the US side with a collapse/break up of HSBC on the UK side. Barclays can’t repay its £50 b and could go. This time there is going to be real blood on the carpet hence the down grade.

    This would coincide with what Jim Wylie is saying. We can only hope that Jim Wylie is right and the precious metals squeeze will come before the general credit squeeze. The only player that can make that happen is China. God help us all.

    What are you hearing in the US?

  15. It took me quite a bit of time to write this as this is not what I do for a living. I'm actually a student and I have no education in the field. Everything that I know has been self taught which also explains why I might have a few errors there. If you see anything that is off then let me know.

  16. Dave,

    Jim Sinclair has written an article saying these swaps cannot be unwound.

    If JPM and HSBC go down so do the large Gold/Silver short positions and this shoud put Silver in the hundreds of dollars range.

    Joe M.

  17. Kristjan: That is a very well-written/documented article and excellent analysis. I have a couple comments:

    1) Regarding the suspension of mark to market accounting: I knew that was the mechanism banks were using to write-up toxic asssets and recognize paper gains/profits, and that's been the primary source of "profitability" for U.S. banks, but I had not contemplated that it was also a mechanism by which banks "boltered" their position as a counter-party in the swaps market. Your article brings that to light.

    2) It is true that the huge swaps initiated by the U.S. Fed indeed created dollar liquidity which allowed the financial markets to "unfreeze" and function. BUT, all that did was treat the symptoms of the problems and not problems. The economic/financial system which underlies the asset side of every big bank continues to rot and deteriorate. At some point this will again cause a cash flow problem, and the assets have been marked up in a way which has created a false sense of stability in the sytem.

    3) Given #2, I'm wondering if the recent rally in the dollar might have something to do with foreign banks starting to hoard dollars ahead of an inevitable crisis hitting, to which I'm sensing the system is edging closer.

    4) Given #3, I surmise that this time around we may well see gold being used as a true flight to safety vehicle.

    Thanks for posting that blog.

  18. Joe, I'm wondering if you are referring to credit default swaps, which for sure can't be unwound. They have to be monetized, which is what has bailed out Wall far, anyway.

    The Fed-induced fx-currency swaps can be unwound. But, as Sinclair points out, they will soon be put back in place and my guess is in greater size.

  19. It is beginning UBS is the largest derivative player outside of the US, now it’s faced with collapse.

    AFP) – 10 hours ago

    GENEVA — Switzerland's justice minister warned in an interview on Sunday that top bank UBS could collapse if sensitive talks with the United States over a high-profile tax fraud investigation fall through.

    "The actions of UBS in the United States are very problematic. Not just because they are punishable but also because they threaten all of the bank's activities," Eveline Widmer-Schlumpf told Le Matin Dimanche newspaper.

    "The Swiss economy and the job market would suffer on a major scale if UBS fails as a result of its licence being revoked in the United States," she said.

    Switzerland and the United States have negotiated an agreement under which UBS would hand over information on some 4,500 account holders to US tax police.”

    And look what the response to the latest warning has been.

    Jan. 29 (Bloomberg) — Rich individuals from Europe and the Middle East are moving money from Switzerland to Asia, said Renato de Guzman, who heads private banking at Oversea-Chinese Banking Corp. after it acquired Asian assets of ING Groep NV.

    “It’s a favorable trend,” Guzman said in an interview on Jan. 27. He takes the helm at the Singapore-based bank’s unit today after having been ING’s Asia private banking head since 2000. “Having a Singapore bank with no ties to Switzerland is an attractive proposition for a lot of them.”

    UBS Chief Executive Officer Oswald Gruebel said this month in a note to staff that it’s “imperative” Switzerland’s biggest bank halt withdrawals. Net redemptions by wealthy clients at UBS accelerated in the third quarter, bringing the total to 182.9 billion francs ($179 billion) over 18 months and undermining profit at the bank’s biggest division.

    Ëither way the net result for UBS is the same; give up the 4,500 names and you get a bank run as the depositors flee from you or lose the banking licence in the US and watch the bank run as the depositors flee from you.

  20. Dave, thanks for reading it. I agree that the FX swaps were just a temporary liquidity measure done to ease the pressure. I don't think solved any real problems, because the real problems are derivatives and the shadow banking system. I'll have add a few lines about that into the report, I'll do that in a few days.