THE FUTURE OF THE UNITED STATES AS AN ILLR

Is the United States likely to continue acting as an ILLR in the event of future international financial crises? The 2008 financial crisis, the relative economic decline of the United States, and the recent debt crisis in Europe have led some to question the United States’ ability and willingness to stabilize the global financial system in the face of future crises.[1] One very prominent scholar of international relations, G. John Ikenberry, noted in a recent book that

in previous postwar economic crises, the United States played a role—directly or indirectly—in stabilizing global markets. The most recent financial crisis was unique in that the United States was the source of the instability. Whether it can return to the position of global economic leader remains uncertain.[2]

Ikenberry is correct that the United States was the source of instability. Yet he ignores the fact that the Fed also played the role of international stabilizer by providing unprecedented global liquidity via its swap program. Ikenberry’s concern about the future ofthe United States as a global "economic leader,” however, is echoed frequently in the post-2008 public sphere. For example, another prominent scholar of international relations recently wrote, "The hegemon is supposed to be the lender of last resort in the international economy. The United States, however, has become the borrower of first resort—the world’s largest debtor.”[3] One newspaper columnist raised similar questions about US ILLR capabilities post-2008:

In 1995, the U.S. Treasury single-handedly rescued Mexico when its peso and economy collapsed. Two years later, acting through the International Monetary Fund, Washington played a crucial role in stabilizing the Asian financial crisis. And as late as the spring of 2009, a freshly inaugurated Obama arrived at a summit in London like a white knight, marshaling support for a synchronized international stimulus to avert a global meltdown . . . . In one international crisis after another, the U.S. has long been front and center in leading the way out. But not this time. As countries with economies as small as Australia’s stepped up Thursday to pledge money for Europe’s bailout fund, President Obama made no such commitment.[4]

Such comments are representative of a decline narrative as it relates to US ILLR capabilities. The economic decline of the United States, the narrative says, limits the ability and saps the willingness of US officials to provide global public goods like international liquidity in times of crisis. As it relates to Europe’s debt woes, the assertion is that if the United States still had the ability, surely it would have bailed out Europe when it was in the darkest days of the debt crisis.[5] The apparent lack of a US response is interpreted as evidence of the country’s declining economic capabilities. How accurate is this position? Is the United States no longer able to provide international liquidity in times of crisis? And, if so, does this not run counter to my contention that, by virtue of the dollar’s key role in the global financial system, the United States will retain its ILLR capacity for many years to come?

On at least two counts, the decline narrative is wrong. First, although the United States has not contributed to Europe’s new "bailout” funds, it provided ample financial assistance to Europe via new unlimited currency swap lines with the Federal Reserve. While the Fed’s swap program was allowed to expire in February 2010, the US monetary authority reopened "precautionary” swap lines with the European Central Bank (ECB) on May 9, 2010. The Fed also reopened swap lines with Canada, Japan, Switzerland, and the United Kingdom. It was around this time that the earliest signs of debt troubles in Europe were appearing. Indeed, the events leading up to the reopening of the swap lines looked eerily similar to the events in the summer of2007. The dollar Libor rate was rising daily,

Table 8.1 FED SWAP LINE TIMELINE, 2010-2012

  • 05/09/
  • 2011
  • 12/21/
  • 2010
  • 06/90/
  • 2011
  • 11/30/
  • 2011
  • 12/13/
  • 2012
  • 10/31/
  • 2013*

Bank of Canada

$30 bn

$30 bn

$30 bn

$30 bn

$30 bn

$30 bn

Bank of England

to

TO

TO

TO

TO

TO

Bank ofJapan

TO

TO

TO

TO

TO

TO

European Central Bank

TO

TO

TO

TO

TO

TO

Swiss National Bank

TO

TO

TO

TO

TO

TO

Swap lines effectively made permanent and reciprocal.

rates on commercial paper were increasing, and markets were getting worried. In practice, these swap lines work exactly the same as those open between December 2007 and February 2010, as discussed in chapter 6. Table 8.1 lists the partners and the size of the swaps (to = unlimited). Each column indicates the date on which the five lines were extended.[6] In October 2013, the swap lines were extended indefinitely, making them effectively permanent.

These new swap lines went largely unused until the winter of 2011 as global credit conditions began to worsen on fears ofthe exposure of major European banks to bad sovereign debt. At that time, the ECB—along with other partner central banks—ramped up their borrowing. Around that same time, fears began to increase that the IMF did not have enough resources to put out the European fire were it to spread from countries like Greece and Portugal to larger economies in the region. These fears emerged despite the fact that the Fund had substantially increased its resources in the years following the 2008 crisis. At the end of 2011, the IMF had roughly $400 billion at its disposal; however, $168 billion of that had already been committed to member countries—$66 billion to Greece, Ireland, and Portugal alone. If countries like Italy or Spain (economies roughly eight and five times the size of Greece, respectively) required IMF assistance, the institution’s capability to meet the needs of its members would have been called into question. Despite its increased financial war chest, global financial conditions were once again pointing to the problem of resource insufficiency. Moreover, if the crisis spread to the major economies of Europe, the US financial system would once again come face-to-face with the potential for a systemic crisis at home. It was within this context that European borrowing from the Fed began to pick

Figure 8.1

Federal Reserve Swap Line Credits, 2011-2012

up again. Figure 8.1 presents the weekly outstanding balance of the Fed’s swap program, plotting ECB borrowing as well as aggregate borrowing (including all five partners) from the US central bank. As the figure shows, borrowing from the Fed topped $100 billion in late 2011. Thus, the decline narrative ignores the fact that the United States did act as an ILLR during the European crisis in a substantial way.

Yet some may still suggest that had these events unfolded at the height of US economic might, the United States would have provided direct assistance to Greece. This hints at the second problem with the decline narrative: Waning US economic power does not explain the difference between the US reaction to the European crisis and its reactions to the major financial crises in the past. In fact, the narrative ignores another very important contrast between the Mexican and East Asian crises on one hand and the Greek crisis on the other: the degree to which the US financial system was threatened by the countries engulfed in crisis. When systemic risk is elevated, US officials should be most likely to respond to crises in countries where the US financial system is most exposed because intervening in these cases will have the greatest likelihood of preventing destabilizing spillovers. When the US Treasury put together a multibillion-dollar rescue package for Mexico in 1995, around 6 percent of major American banks’ foreign claims were concentrated in Mexico. Two years later, in 1997, when the Asian financial crisis erupted, US banks were exposed to South Korea and Indonesia to the tune of 5 percent of total foreign claims. By contrast, the degree to which US banks were exposed to Greece in 2011—the epicenter of the European crisis—was minuscule. For example, in the fourth quarter of 2011, claims against the

Greek financial system represent roughly one-quarter of 1 percent of total US bank foreign claims.

This helps explain why the United States aimed its assistance at the ECB rather than Greece directly. The United States has rarely, if ever, acted as an ILLR for charity’s sake. Its motives are self-interested: to protect the US financial system from serious instability that might spill over from financial crises abroad. A May 2010 Fed statement describing the swaps explained, "These facilities are designed to help improve liquidity conditions in US dollar funding markets and to prevent the spread of strains to other markets and financial centers.”[7] [8] On its own, the threat from Greece simply did not merit a direct response. Of course, if Greece were to have defaulted in a disorderly fashion, this could have caused significant losses to banks in France, Germany, and other major economies in the Eurozone. These are economies where US financial institutions had much larger exposures. Interbank lending, which was already tight in light of the European problem, would have likely been further squeezed. In short, systemic risk conditions would have been similar to those in the fall of 2008.11 In such an event, the Greek crisis could have become much more of a US problem. This is precisely what the Fed’s liquidity lines were put in place for. They were designed to provide dollars to European banks so that they could continue to meet their obligations to US financial institutions as dollar-funding markets tightened. As the Federal Reserve regional president Charles Plosser explained when the new lines were opened, the Fed was doing what was necessary to "protect our financial institutions.”[9] Similarly, Fed Chairman Ben Bernanke explained to congressional leaders that the situation in Europe "was basically a European problem but with ramifications ... [for] our banks and our banking system if there was no intervention.”[10] In other words, the US response to the European debt crisis was quite consistent with its past ILLR actions. It might be tempting to conclude that the United States is no longer a capable ILLR, but that conclusion would be wrong.

However, the United States’ ILLR capabilities are not immune to degradation. The most prominent threat does not come from a rising economic rival or the specter of US decline, however. It comes from Congress. The Federal Reserve’s foreign lending in 2008-2009 and again in 2010-2011 raised the ire of many on Capitol Hill. This is important because the Fed’s authority is derived from Congress. Thus, it must "maintain congressional support to protect itself from legislative challenges.”[11] In recent years, there have been a number of efforts to curtail the Fed’s political independence and impose increased transparency on the institution. As part of the Dodd-Frank financial overhaul law, for instance, the Fed’s ability to provide liquidity to specific banks in trouble was constrained.[12] Beginning in 2009, Ron Paul (R-TX) launched the most prominent effort to rein in the Fed’s powers with his "Audit the Fed” movement. Paul and his supporters sought to pass legislation that would curtail the Fed’s powers to provide liquidity during crises. For example, a report on the Federal Reserve Transparency Act of 2014 summarizes the movement’s intended reforms. Among other things, it would enable the Government Accountability Office (GAO) to audit "any of the Federal Reserve’s transactions involving a foreign central bank, the government of a foreign country, or a non-private international financing organization.”[13] The US House of Representatives passed this bill in September 2014. However, sister legislation did not pass in the Senate. Nonetheless, this is exemplary of the kind of action Congress may take if the political climate surrounding the Fed continues to worsen.

The possibility of such scrutiny, especially during times of crisis, could cause the Fed to think twice about providing assistance to foreign jurisdictions in crisis. Indeed, one need only look to the Treasury’s use of Exchange Stabilization Fund (ESF) funds for foreign rescues after Congress voted to increase scrutiny of that ILLR mechanism in 1995. Without question, the heightened political attention on US emergency foreign lending in the 1990s dampened the Clinton administration’s appetite for providing global liquidity. Increased political attention today could have a similar chilling effect on the Fed’s desire to act as an ILLR in the future. As I argued in chapter 2, a key reason the United States has been so well positioned to manage international financial crises over the last 60 years is because its ILLR mechanisms are independent of Congress. To be most effective, the lender of last resort must be able to act quickly and without reservation or fear of reprisal. The threat of increased political scrutiny and, perhaps, even curtailed powers is a far greater threat to the United States’ ILLR capability moving forward than relative economic decline.

  • [1] Such assertions are reminiscent of similar premature claims that were made about USdecline and ILLR capabilities by very prominent scholars in decades past. See Kindleberger1986, p. 9 and Eichengreen 1995, pp. 238-239. These arguments are discussed in moredetail in chapter 2.
  • [2] Ikenberry 2011, p. 299.
  • [3] Layne 2012, p. 210.
  • [4] Parsons and Lee 2011.
  • [5] For another column with a similar perspective, see Cooper (2011).
  • [6] For more information, see http://www.newyorkfed.org/markets/liquidity_swap.html.
  • [7] Federal Reserve Press Release, May 9, 2010, http://www.federalreserve.gov/newsev-ents/press/monetary/20100509a.htm.
  • [8] Indeed, in testimony before a House subcommittee, one Fed official explained thatthere was the possibility for a worst-case scenario where financial strains "could lead to areplay of the freezing up of financial markets that we witnessed in 2008” (Aversa 2010).
  • [9] Hilsenrath 2010.
  • [10] Quote is from Senator Richard Shelby of Alabama, paraphrasing what Bernanke toldthe Senate Banking panel after a closed-door meeting regarding the reopening of the swaplines. See Felsenthal and Somerville (2010).
  • [11] Broz 2015, p. 325.
  • [12] Harrison 2015.
  • [13] Congressional Budget Office 2014.
 
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