In Euro Crisis, Time for the Next Swap?

The euro-crisis is flaring up again, as we told you it would. And the crisis will be met with more currency swaps, as central bankers shift money around the table to mask the world's massive banking problems.

What's a currency swap? That's when central banks take some of their piles of reserve and make it easier to borrow so that various countries and financial entities can "swap" currencies and, basically, get the cheapest form of liquidity. Why is this important? Well currencies are a major source of liquidity for the funding of banks and financial institutions. And central banks can always print up more. The United States has done it several times -- and at an extreme scale -- since the 2008 financial crisis.

What's interesting is these things have occurred with regularity. They were put in place in 2008, of course, during the global financial crisis. Smaller onces were implemented in March 2011, after the Japanese tsunami, and in November 2011, after another bout of euro flu.

As reported last November 30, that month's major global coordinated easing appeared to be a big turning point in the markets.

Let's read what the Fed did here:

The Federal Open Market Committee has authorized an extension of the existing temporary U.S. dollar liquidity swap arrangements with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank through February 1, 2013. The rate on these swap arrangements has been reduced from the U.S. dollar OIS rate plus 100 basis points to the OIS rate plus 50 basis points. In addition, as a contingency measure, the Federal Open Market Committee has agreed to establish similar temporary swap arrangements with these five central banks to provide liquidity in any of their currencies if necessary. Further details on the revised arrangements will be available shortly.

This, in essence, made dollars cheaper so that other countries could borrow dollars to shore up their banking systems.

Another Day, Another Dollar

The Fed and other central banks have used currency swaps to relieve the rolling financial crises.
Are they getting close to doing it again?

Swaps were part of the tools used by central banks to fight the crisis in 2008 and again in 2011.

Why do I think the central banks are ready to do more? Because that's the way Ben Bernanke and the European Central Bank have chosen to dealt with the problem in the past. When the markets became problematic -- that is, when yields on dangerous European bonds such as those from Spain and Italy were spiking and most markets tanking -- the central banks have chosen to act.

What's interesting is that though these currency swaps have been one of the major features of the many "bailouts" and "rescues," they are actually not paid much attention to. In fact, as the chart above shows, these dollar swaps have been key inflection points in the markets -- especially the intervention last November. After new swap lines were extended by the United States, the ECB proceeded with the now-infamous LTRO, and markets received a respite.

Think of the doctor who is frustrated by a patient's bad condition. He's not sure how to cure the patient for the long term, but he knows that there are certain medications he can adminster that can help the patient in the short term. It may be time for another round of morphine.