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Liquidity Swaps Presage Battle for Currency Supremacy

Friday, May 22, 2009

Since the eruption of the global financial crisis last fall, the world's three largest economies -- the United States, Japan, and China -- have become very generous toward countries in need of cash, opening up a bevy of new bilateral currency swap arrangements. At first glance, this may seem to be a positive example of great-power cooperation in the face of a collective threat: The world's economic powers are working together to provide liquidity to a global economy dying of thirst. A closer look, however, reveals that the intentions of the parties in question may be far more self-interested than they initially appear.

Bilateral currency swap arrangements have become an increasingly important tool in international finance. The primary purpose of these schemes is to give central banks facing liquidity shortfalls direct access to the hard currency held by the American, Japanese, or Chinese central banks, by "swapping" domestic tender for dollars, yen, or yuan. The latter can then be funneled into domestic banks that need to fund liabilities denominated in those currencies. ...

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