‘Swaps, mops, fobs.’ These sardonic words of my first boss at the US Treasury came to mind after hearing stories of a possible swap between the US and United Arab Emirates.
The term ‘swap’ is a misnomer, but one endowed with a seeming mystical quality of being able to transform global currency relationships and the future monetary system. But a swap is nothing more than an asset exchange and tells one nothing about the purposes, terms and conditions of the loan – sorry, swap.
China has a vast swap line network, which is sometimes wistfully portrayed to be challenging dollar dominance and promoting renminbi internationalisation. The network, though, is highly opaque. Multiple rollovers suggest de facto bailouts. They sometimes act as trade finance or are connected with support for the Belt and Road Initiative. Interest rates can be steep. Swaps with Pakistan, Sri Lanka, Argentina and Egypt, among others, are hardly suggestive of shorter-term liquidity operations.
Even if China offers swaps, that doesn’t address fundamental obstacles to increased renminbi internationalisation – such as the lack of convertibility, capital controls, fledgling capital markets and questionable rule of law.
Fed swaps should not be about politics
Federal Reserve swaps are different. The dollar is the world’s dominant currency. Financial shocks impact the US economy and the Fed’s ability to achieve its dual mandate, as well as global stability. The 2008 financial crisis and Covid-19 pandemic provide ample evidence. In such cases, the Fed becomes a reluctant global lender of last resort.
The Fed’s emerging market swaps in 2008 and during the pandemic were short-term liquidity swaps, only for the highest-quality performers. The purpose was to impart confidence and avert sudden stops. It was not about shoring up political friends and allies. The countries sought swaps as a Fed seal of approval. Confining swaps to platinum performers meant that they were not intended as balance-of-payments support.
Global financial markets are not now facing systemic stress. Jerome Powell and Kevin Warsh, outgoing and incoming Fed chairs, both emphasise that Fed decision-making isn’t and shouldn’t be about politics. A Fed swap for the UAE would surely run afoul.
The UAE doesn’t need liquidity
Conditional BoP support is primarily the International Monetary Fund’s domain. The Fund, however, finally secured agreement to create a short-term liquidity line in 2020. The terms and conditions are far more akin to a Fed emerging market swap than Chinese swaps. It has had only one taker, Chile. There is little clamour for it.
The UAE might well qualify for an IMF swap line, but the UAE doesn’t want an IMF ‘halo effect’. It has plenty of financial resources and doesn’t need liquidity. Further, if it did, it could deposit instruments with the Fed for cash via the Foreign and International Monetary Authorities Repo Facility.
By all appearances, the UAE’s motivation is political in nature, aimed at securing a US signal of support as it faces Iranian attacks and difficult regional strains. That raises the question of the US Treasury’s Exchange Stabilization Fund and a possible ESF swap.
Decades ago, the ESF had a swap line with the Bundesbank, allowing it to draw Deutschemarks for use in intervention. The ESF historically engaged in credit stabilisation operations, serving predominantly as a short-term bridge to IMF loans. The ESF also has two framework agreements – a $9bn never drawn upon framework agreement with Mexico under the North American Framework Agreement and a $20bn framework accord with Argentina. Any drawing under a framework agreement needs to be negotiated.
Questions abound
There is no indication the Donald Trump administration intends to offer an ESF swap (or framework accord) to the UAE. But for the sake of argument, might it? Only Trump and Treasury Secretary Scott Bessent know.
Any such swap or framework would be politically motivated, not in line with the ESF’s predominantly economic and financial history. That said, at a time when economic statecraft and geoeconomics is ascendant, arguing such tools could bolster dollar dominance or counter China’s financial reach might hold some attraction – even if it is questionable.
Is it legal? The ESF statute affords the secretary of the Treasury wide latitude. It would not be taxing to develop a novel legal rationale to support such a proposition.
Would it be a stretch? Yes, and a big one. Obviously, the US wouldn’t use the ESF for unfriendly countries. But it has been used as an economic and financial tool. A UAE swap would be political. ESF entry into the political realm would place it in new terrain.
Would it be wise? The administration would need to think through possible consequences. If the UAE succeeded, countries with far weaker financial footing might quickly appear at the Treasury’s doorstep. The Treasury would be put in the awkward position of picking and choosing among friends, inevitably causing market volatility and political aggravation for those rejected. The ESF might have to assume significant heightened credit risk.
Does the ESF have the firepower? Its more immediate liquid resources are limited, but it can quickly mobilise its $200bn-plus balance sheet in extremis if needed.
The UAE doesn’t need a swap on economic and financial grounds. It wants one for political signalling. A Fed swap should be an absolute non-starter. An ESF swap would put the US Treasury into new terrain and entail a heightened political orientation. Despite the hoopla surrounding swaps, they come in many shapes and sizes and their impact may often be limited.
Mark Sobel is Vice Chair and Chief Economist at OMFIF.
Join OMFIF on 4 June for the chief economists’ briefing.
Interested in this topic? Subscribe to OMFIF’s newsletter for more.