How the Swap Lines Protected US Interests

Swaps were also quite effective. As indicated above, the United States considered swap lines to be an added line of defense against the joint threats of a speculative attack on the dollar and the gold drain. In the event of a speculative flight from the dollar, the Fed could draw on the swap lines and use the currency it acquired to intervene in the foreign exchange market to support the dollar.[1] By buying and selling foreign currencies, the central bank could subdue and even deter speculative movements that were harmful to the dollar by making such movements less profitable and hence riskier. As Roosa put it, "The central bank can ... by varying the extent of its own intervention in the forward market, allow the cost of [a] speculative hedge to go as high or as low as it wishes.” Roosa added, regarding the purposes of the swaps, "While these swaps have, to be sure, been drawn upon to meet various kinds of short-run swings in reserve needs, their usefulness as a backstop to forward transactions has been crucial for the fulfillment of operations that successfully thwarted the cumulative development of speculative pressures against the dollar.”[2] Regarding the gold drain threat, the United States could tap a swap line when a foreign central bank had accumulated more dollars than it wanted to hold. If, for example, the German central bank was flush with dollar reserves, the United States could activate its swap with the Deutsche Bundesbank and use the borrowed marks to buy the superfluous dollars. This would effectively give the German central bank "cover against the risk of a dollar devaluation for the duration of the credit.”[3] On its face, this may seem contradictory since the swap activation has the effect of increasing Bundesbank’s dollar holdings. Even if the United States were to use its acquired marks to buy $250 million in dollars back from the Germans, Bundesbank would still have an additional $250 million dollars it acquired in the swap. This is true. However, what made the deal work was the fact that the dollars acquired in the swap were guaranteed to be exchanged at the initial exchange rate when the swap is reversed. So in this example, Bundesbank is swapping dollars that are at risk to a potential devaluation for dollars that are protected. And, once protected against devaluation, much of the motivation behind converting those dollars into gold is eliminated.[4]

  • [1] Rainoni 1973.
  • [2] Roosa 1965, pp. 30-32.
  • [3] Odell 1982, p. 103.
  • [4] However, there was no provision in the swap agreements that would prevent a partnercentral bank from taking the dollars acquired in the swap and demanding gold. C. DouglassDillion and Roosa explained to a concerned President Kennedy that this would not happenas "we don’t make a swap with anybody if we don’t already know what their practice is withrespect to the holding of dollars” (Naftali 2001, p. 501).
 
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