Currency

The Central Banks Are Doing What?

Federal Reserve Chairman Ben Bernanke and European Central Bank President Mario Draghi.

Federal Reserve Chairman Ben Bernanke and European Central Bank President Mario Draghi. Brendan Smialowski/Getty Images hide caption

itoggle caption Brendan Smialowski/Getty Images

This morning the Fed along with the central banks of Canada, England, Japan, Europe and Switzerland rang the dinner bell and basically said to banks around the world, "You need money? Come and get it!" Of course, the central bankers themselves were a little more reserved in their press release. They described it as "coordinated actions to enhance their capacity to provide liquidity support to the global financial system."

Okay, that's a scary sentence so let's break it down:

"Coordinated actions" - We're going to work together. Why these central banks and no others? The Fed says "these five currencies are used globally and account for the bulk of the foreign currency funding of U.S. financial institutions." Really this is about two key players — the U.S. and Europe. No one believes that the financial crisis in Europe is really that they don't have enough Canadian dollars (Loonies to the rescue!) No, this is mostly about getting dollars to Europe.

"To enhance their capacity" - This is a polite way to describe the flood of money that is about to be made available to European banks.

"To provide liquidity support" - Bingo. It's all about liquidity. Basically, the banks in Europe are having trouble getting loans from other European banks. They need these loans to open their doors every morning. So "liquidity support" means the Fed will loan other central banks (the ECB) as many dollars as they want. Then each central bank (the ECB) can lend those dollars to the banks in their country that need them. These agreements are called "swap lines" because the country that lends their currency gets some of the other country's currency in return.

"To the global financial system" - Europe. Don't let them fool you — this is all about helping European banks. Nobody else needs this kind of help right now. Banks in Europe are having trouble getting people to lend them dollars. Why? Lenders are afraid that Europe's banking system is in trouble because a lot of the banks there are holding a lot of bad debt. Why do European banks need dollars? Because they lend money to people in the U.S. and because they have borrowed money from the U.S. and they need to pay these loans back in dollars.

Why is this making headlines?

These swap lines have been in place since 2008, but what the Fed announced today is that it is making it cheaper for other central banks (the ECB) to borrow dollars. In Fed speak, they are lowering "the pricing on the existing temporary U.S. dollar liquidity swap arrangements by 50 basis points." They also extended their promise to do this until February 2013. The Fed is making dollars cheaper in hopes that the ECB will borrow more of them. If the ECB likes this deal, Benjamin Franklin is about to show his face in a lot of European vaults over the next few weeks.

Could the Fed lose this money if European banks go bust?

No, the Fed lends only to the ECB — not directly to individual European banks. Also, these are called "swap lines" because that's exactly what they are swaps. If the Fed sends dollars to Europe, the ECB sends an equivalent amount of euros over here. So unless the Euro goes bust, the Federal Reserve won't lose money on this deal.

What does this mean?

It means the Fed and other central banks around the world are really freaked out about Europe. They are worried that European banks can't get access to the money that they need and that could spell disaster for the global economy. The Fed is lending to the ECB on very favorable terms because they know Europe desperately needs dollars.

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