The SEC builds a safety net for the global dollar system. Will Trump dismantle it?

Although the Fed and other central banks describe them as neutral financial instruments, scholars including myself believe that these agreements have implicit political attributes because they can be consistent with national security and economic interests. The Trump administration may try to treat them purely as geopolitical tools.

However, withdrawing from the offshore dollar market would run counter to its core trade and economic goals. The Fed’s swap lines act as a safety valve, easing pressure for overseas hoarding of dollar assets—pressures that are precisely at odds with the government’s stated macroeconomic goals. The U.S. trade deficit (i.e., current account deficit) requires foreign capital inflows (i.e., capital account surplus) to finance it. Reducing the trade deficit is clearly a priority for the Trump administration, and current account interventions such as tariffs are being implemented to that end.

Many analysts believe that capital account interventions are also on the agenda. Key administration advisers such as Council of Economic Advisers Chairman Stephen Miran have discussed the possibility (although Miran later clarified that the idea was not current policy), and former U.S. Trade Representative Robert Lighthizer has also considered a similar idea. The logic of such proposals is that reducing the financing of the US deficit is one way to reduce the deficit itself.

While such causal inferences are questionable, there is strong academic evidence to support the view that the accumulation of foreign dollar assets has contributed to the US trade deficit. Swap agreements may reduce the need for foreign governments and central banks to hold dollar reserves by providing an alternative dollar insurance mechanism.

Asian economies learned this lesson during the

The view that excess reserve accumulation is exacerbating harmful global imbalances is not new, with economic journalist Matthew C. Klein and Peking University finance professor Michael Pettis

A recent study by Princeton University scholar Haillie Lee and Stanford University professor Phillip Lipscy shows that East Asia (the home of huge surpluses and reserve holders) has been The reserve accumulation that began in the late 1990s was driven more by self-insurance motives than mercantilist trade policies. This is consistent with my private conversations with central bankers who were hit hard by the Asian financial crisis. Although they did not like the centrality of the US dollar, they had to face reality and believed that the International Monetary Fund (IMF) would not help (or the conditions were too harsh), and they did not expect to obtain swap lines from the Federal Reserve. Therefore, they concluded that they had to hoard US dollar assets individually or in conjunction with Southeast Asian countries.

If they could not obtain

Solutions may include strengthening the role of the IMF in the global financial safety net (which may be opposed by the Trump administration), expanding the scale of swap agreements (which is also not Trump's favorite), or replacing the dollar's status as a reserve currency (which is even more undesirable to Trump), which can be called the "Trump trilemma."

Expanding the Fed's swap agreement network will help ease foreign demand for the dollar, but it is not a panacea. Michael Bordo style="font-family:Songti SC Regular" )points out that, since the 2008 crisis, foreign official holdings of US dollar assets have accounted for only a small part of the financing of the US current account deficit. Central bank swap agreements can only alleviate the demand for US dollar assets by official holders (central banks, sovereign wealth funds and other reserve management institutions). Although data tracking is difficult, the increase in US Treasury bonds held by foreign private individuals in the past decade has accounted for the majority of the total increase in foreign holdings (there is a similar trend in institutional bonds). Swap agreements can do nothing about this.

In addition, the assumption that foreign official investors have unlimited demand for US dollar assets is being challenged. Recent reports indicate that one of the world’s largest official reserve managers, China’s State Administration of Foreign Exchange, plans to reduce its holdings of U.S. dollar assets, consistent with the long-term decline in the dollar’s ​​share of global reserves. Nevertheless, foreign official reserve managers remain significant marginal buyers of dollar assets, accounting for about one-fifth of total U.S. long-term securities holdings last year. Maintaining the availability of Fed swap lines is consistent with the Trump administration’s objectives as long as they reduce the pressure on reserve managers to accumulate dollar assets. Refusing to offer swap lines while reducing foreign official holdings of U.S. Treasuries would weaken the United States’ position as a global supplier of safe assets.

If Washington really wants to give up its status as the issuer of the world's reserve currency, forcing the Fed to withdraw the swap agreement would be a step in that direction.