Friday, August 24, 2007

. Federal Reserve: "Factors Affecting Reserve Balances", August 22

- Fed's Treasuries holdings: $780.9bn (-$14.7bn)
- Other central banks' Treasuries holdings: $1,218.8bn (-$25.3bn) (*)
- Other central banks' agency securities: $767.6 (+$6.7bn) (*)
- Mackinlay's Global Dollar Liquidity Measure: $2,767.3bn (-$33.1bn)

(*) Off-balance-sheet items

We all knew it: this week's Fed balance sheet was going to be an eventful one. But while we were expecting improved liquidity conditions (thanks in part to the rediscovered discount window), what we got instead came as a shock: the biggest weekly fall ever in our Global Dollar Liquidity measure. The $33 bn collapse came as a result of a double whammy: foreign CBs sold as much as $25bn in Treasuries, and the Fed itself turned restrictive (-$14.7bn). In the event, the net amount borrowed at the discount window came in at a modest $1.27bn.

What is going on? Given the extent of the damage, we cannot entirely rule out the possibility of a "1997-1998 style" global banking crisis. (I know, I know: I recently wrote that this was not Asia redux). Here's a possible transmission mechanism: somewhere in the world, Mr. X worries about the solvency of his bank. He wants physical euros and U.S. dollar notes, which he buys from his bank. The bank now turns to the central bank, which has to sell a portion of its custody holdings at the New York Fed. As a result (and assuming that Mr. X has many imitators worldwide), the Global Dollar Liquidity measure registers a sharp fall.

There you have it. This is roughly what happened in Asia-Rusia ten years ago. Could it happen in 2007, courtesy of the global sub-prime mess? That's not my central scenario. But I'll keep a vigilant eye on credit spreads and on the next weekly Fed balance sheet.


tmcgee said...

it seems that's just what happened, judging from russia and others. outflows = selling treasuries/agencies to keep those dirty pegs in place. which ironically means money was flowing back into the greenback. but judging from the dollar index the past week or so, that trend seems to have reversed as quickly as it began.

Agustin said...

Exactly! I was about to write a post on this very issue. Many thanks! Agustin