Ripples presaging a financial tsunami

Abstract:

Loss of confidence in the US dollar’s reserve currency status could trigger a collapse of the US Treasury market and international financial fragmentation. This column argues that hedging is a rational response to recent fluctuations in the US dollar, as investors look to insure against exchange rate risks. However, widespread hedging itself makes Treasuries less attractive, which further weakens confidence. The Federal Reserve has multiple tools to stabilise markets in the short term, including providing time-limited liquidity, activating dollar swap lines, supporting non-bank cash conduits, and lending to non-banks. These actions buy time but are not sufficient by themselves to restore long-term confidence.