Why is the Fed lending dollars unsecured to the ECB… again

By Warren Mosler

It remains my position that Congress should not allow the Fed to lend unsecured to foreign central banks without specific Congressional approval. But the Fed does currently have that authority and they are again using it to keep $ LIBOR from rising. And that lending must be in unlimited quantities to insure $ LIBOR is capped at the Fed’s target rate.

The Fed doesn’t want $ LIBOR to go up because many US domestic loans are indexed to $ LIBOR, including adjustable rate mortgages. That’s why I’ve been proposing the Fed not let its member banks index loans to $ LIBOR, but instead let them index to the fed funds rate, or some other rate controlled by the Fed. That would return direct control of US $ interest to the Fed, obviating the need to use unsecured (and unlimited) $US lending to foreign central banks.

By the way, when testifying to Congress the Fed Chairman states the lending is secured, with the Fed getting euro deposits as collateral. And he believes that. However, the euro are on deposit at the European Central Bank, who is also the borrower of the $ from the Fed. So if he ECB defaults on the $ loans, the only way the Fed could use those euro is by instructing the ECB to transfer them to another’s account so the Fed can buy the dollars it wants.

So what are the odds of the ECB even taking the call from the Fed if they just defaulted on it’s dollar loans from the Fed? And what can the Fed do if the ECB doesn’t make payment and won’t let the Fed use its euro at the ECB to buy dollars?

It’s like lending your dollars to someone in a far away land who uses his watch for collateral. But he gets to keep wearing the watch, and he’s out of your legal jurisdiction.

This article originally appeared at the Center of the Universe blog.

  1. Grace Styles says

    ‘the good news may be short lived’ – according to economist Shaun Richards.
    He wrote about this possibility back in August:
    For equity markets in the short term this is likely to be initially taken as good news. Once investors have time for a more reflective response they are likely to focus more on the underlying causes of this which are not good and the consequences of liabilities once again moving from the private-sector to the taxpayer supported sector.

  2. David Lazarus says

    Well the Fed may not want the Libor rate to go up because so many loans are linked to it. It does have some advantages. Libor is a better way to assess the true cost of money. Fed funds are artificially low and do not represent the real cost of money. Loans rates should be higher, otherwise a new debt bubble will happen. There needs to be a floor to interest rates to stop such bubbles.

    1. TC says

      I’d argue that the advantage of “assess the true cost of money” cuts the effectiveness of monetary policy by 80%.

      Monetary policy is a rube goldberg style contraption that relies on so many effects of effect that it makes it nearly worthless.

      Here’s the monetary policy chain of effect:

      Fed lowers/raises interest rates>
      Banks make more/less money on loans>
      Banks change their policy in response>
      People get more/less borrowing
      People spend more/less

      For example, the fed could lower FF rates, but it might not cause them to change their lending policy a whit. The extra money from a .25% rate change doesn’t make much of a cash money difference to these banks.

      If personal, corporate, and real estate borrowing were linked directly to the FF rate, then it cuts out one hugely mushy area of bank policy.

      The federal reserve then is able to change a large majority of variable interest rates in the economy.

      Note – this is exactly what the federal reserve wants to do with monetary policy, but can’t do it now.

      1. David Lazarus says

        Yes but what it also does is create false markets in assets. US and UK real estate are still over valued because of false interest rates. This keeps asset prices far too high and impedes the entry of new competition. This increases the start up costs of new businesses. That does not help job creation. It also does not punish people for speculation in assets. This eliminates moral hazard in asset markets. If speculators do not fear getting wiped out because monetary policy will always save them. It also allows congress to abdicate responsibility for fiscal policy. As such the US has had no fiscal policy for years, and why its economy is so weak. The Europeans on the other hand have far better fiscal policy even if their banks are so weak. Without the banks on both sides of the atlantic the continental europeans have a far stronger economy than the US.

  3. roger erickson says

    People ask why the US Treasury, US Fed or ECB won’t implement the obvious. The answer was laid out clearly in a policy dispute ~150 years ago.

    You don’t think there are exceptionally mindless & hopelessly narrow lobbies at work? On top of all the simple confusion & mis-information?

    GG McGeer, BC Canada, 1935
    make a copy of this; even this text might disappear someday

    most recently re-invented by Warren Mosler (many other partial re-statements in between)
    Seven Deadly Frauds of Economic Policy (PDF Link)

    The basic message wasn’t always so hard to explain; it was actively suppressed.

    “It is equally clear from his message to Congress that Lincoln appreciated that by correlating the power of government to put money in circulation with its power to withdraw it from circulation by taxation, the evils of deflation and inflation could be avoided.” [McGeer, 1935]

    Contrast that with our own Fed’s reluctance to discuss the topic.
    Beardsley Ruml, NY Fed, 1946
    “Taxes for revenue are obsolete.” https://tinyurl.com/y3dkda3
    (hasn’t been mentioned since)

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