BIS paper by Robert N McCauley, and Patrick McGuire
This feature argues that a combination of factors caused the surprising US dollar appreciation in the second half of 2008. Both the global flight to safety into US Treasury bills and the reversal of carry trades amidst the crisis were sources of dollar strength. In addition, the surge in dollar funding costs in the interbank and FX swap markets provided price incentives for corporates to draw on non-dollar funding to pay down existing dollar debt. Finally, dollar asset writedowns left European banks and institutional investors outside the United States with overhedged dollar books. The squaring of their positions, which required dollar purchases, also boosted the currency.
It is worth noting that…
…at current US yields, carry trades and institutional investors’ hedges respond similarly to big changes in asset prices and volatility. In particular, when equities fall, risk appetite shrinks and volatility is increasing, dollars are bought by both types of investors, as in late 2008; with “risk on”, equity prices rising and declining volatility, dollars are sold by both, albeit perhaps at different frequencies.
Related:
Dollar
The US Dollar Shortage in Global Banking
The US Dollar Shortage in Global Banking and the International Policy Response
“The recent financial crisis led to homing in global bond markets, but also
to safe haven demand for US Treasury securities, especially bills (Table 1).
With the intensification of the crisis after the Lehman Brothers bankruptcy, US
investors sought to de-risk their portfolios by selling foreign bonds and stocks
in the latter half of 2008. For their part, private foreign investors turned to
selling US corporate bonds, including asset-backed securities, and accelerated
their sale of agency mortgage-backed bonds and debentures.
In contrast to this homing, however, was the flight to quality by private
foreign investors into Treasury securities. On these rainy days, the safe haven
of Treasuries gained in value as equities plunged and credit spreads widened
to record levels. While government bonds performed well in France, Germany,
Japan, the Netherlands, Switzerland and the United Kingdom, the attraction of
Treasury bills kept global investors from staging a general retreat from US
securities. To the extent that global investors sold other currencies against the
dollar to take refuge in Treasuries, safe haven flows strengthened the dollar.”
What’s important about this is that it’s a flight to liquidity and govt guarantees. I believe that the Govt Guarantees were the main attraction. If that’s true, then the only thing that can stop a panic and a debt-deflationary spiral is a govt guarantee. If that’s true, the Govt cannot help but offer guarantees in a panic. In fact, the sooner the better, since you hope the guarantees will stop the panic and allow an orderly unwinding of positions. Also, there will have to be a de facto LOLR in the future for a cross-national panic. In this case, it was the US Govt.
Given that there’s no way for the govt to avoid being a LOLR, I believe that only some form of Limited/Narrow/Utility Banking can act as a firewall against the govt getting involved. It can act as a backstop or LOLR in the beginning of a panic, and hopefully avert the govt and taxpayers getting involved. Only a govt has the believable resources to stop a panic, and only Narrow Banking offers a strong firewall that offers believability of banks not being necessarily involved in a panic.
well, not sure it was bank prop leverage, more like standard banking book leverage funded the traditional way (short term) and regulated in terms of capital ratios but, in theory, without a lender of last resort.
but now we know better, there is a lender of last resort, if you are part of a bunch of french and/or german tbtf banks, the ecb and the fed will “cooperate” and send the missing $ your way and if some u.s. tbtf banks was running short of euros, same trick would apply in reverse. vive la cooperation…
agreed that was the keystone, but it is hard to disentangle bank prop lev spec form the transformational lev spec on behalf of their erstwhile “clients”. The systemic issue of currency mis-match stems from a classic composition fallacy, no? – and this remains a regulatory no-man’s land.
the problem started with banks unable to fund dollar assets, the “others” lev players, cta/trend followers etc.. are pretty small fry in the scheme of things and if the fed and other c.b. did massive amounts of swaps to stop a dollar buying panic it is to save the banks. so perhaps what should addressed is the issue of banks carrying assets in a currency that their own c.b. can’t provide on its own.
oops – see Gallopin’ Gertie here: http://www.youtube.com/watch?v=j-zczJXSxnw
Seems like a thorough though rather obvious glimpse of the quite fascinating and large feedback loops at work here reinforced by all manner of leveraged specs, systematic macro, CTAs/trend-followers. “Wir, alle sind Macro Traders….” By extension, it also seems as if there are large systemic negative externalities in leveraged spec – both domestically and internationally – that need to be addressed else we find ourselves witnesses to a Financial Gallopin’ Gertie