Swap Lines Are Powerful Weapons for the Federal Reserve

Marin Katusa  |

Image: Marriner S. Eccles Federal Reserve Board Building. Source: traveler1116 / iStockphoto

Swap lines

Warren Buffett once famously stated that derivatives are financial weapons of mass destruction.

But swap lines are far more destructive to a nation when factoring in the politicization of sovereign reserves.

For those who think Putin will be able to break the U.S. Dollar's reign of global dominance, please pay attention.

  • Right now, the Federal Reserve satisfies the global demand for U.S. dollars while maintaining the USD’s title as the planet-wide currency king.

With one brilliant move, it has divided the world up into allies and non-allies of the U.S.

Today, everyone needs the stability of the USD in a world turned upside down with economic turmoil.

Granted, that stability may only be relative to other countries’ own currencies, but American allies have to deal with that reality.

They know it. And the Fed knows it.

  • That’s why the Fed has created a path to access U.S. Dollars for government-identified real allies of America.

And it has denied access to those identified as unfriendly.

It’s Critical That You Understand This

And when you do, you’ll be miles ahead of almost everyone else.

The U.S. has put a system in place where all but the most die-hard anti-American nations will want to be included among the friendlies. In fact, many will do anything to make the list.

How do they do this? Through swap lines.

Never heard of them? You’re not alone.

For the most part, whenever I bring up SWAP lines, I’ve found myself speaking in a vacuum.

I haven’t come across one person in a hundred that knows about them. And that includes business executives, politicians or even bigshots in the financial industry itself.

Most investors are not even cognizant of the program’s existence, much less aware of its significance.

But given how important swap lines are to the global economy, every investor should understand them and how they work.

What Are Swap Lines?

First things first, here’s how the Fed explains swap lines on its own website:

The Federal Reserve has entered into agreements to establish central bank liquidity swap lines with a number of foreign central banks. Two types of swap lines were established: dollar liquidity lines and foreign-currency liquidity lines. The swap lines are designed to improve liquidity conditions in dollar funding markets in the United States and abroad by providing foreign central banks with the capacity to deliver U.S. dollar funding to institutions in their jurisdictions during times of market stress. Likewise, the swap lines provide the Federal Reserve with the capacity to offer liquidity in foreign currencies to U.S. financial institutions should the Federal Reserve judge that such actions are appropriate. These arrangements have helped to ease strains in financial markets and mitigate their effects on economic conditions. The swap lines support financial stability and serve as a prudent liquidity backstop.

​Here's how I think of them:

  • If you have access to a US swap line, you are what I call a +Swap Line Nation.

  • If you don’t have access to a swap line, you are a -Swap Line Nation.

Swap Lines Are Financial Lifelines for Nations

In the wake of any global panic (the most recent example being the pandemic)…

Many central banks request that America provide financial assistance to at least alleviate the stress caused by a lack of U.S. Dollars.

Swap lines have provided that relief and will continue to do so.

They are, literally, lifelines. And they are also debts.

  • All those dollars borrowed must be paid back in US dollars, with interest, also requiring US dollars.

It’s ingenious because demand for the U.S. Dollar breeds further demand.

And this will be proven to be even more true during a global power realignment like what’s happening right now.

It will be paramount for nations grappling with inflation to enter the favored group capable of exercising swap lines.

Here’s a list of the nations that have access to U.S. Dollar SWAP lines (as of now):

Click to enlarge

Countries outside the group—the negative swap line (-Swap) nations—will struggle to access U.S. dollars.

Swap Lines are Important for Politicians and Investors

The result of how this program is set up is that countries receiving swap lines will follow any stipulations they are asked to follow. They’ll have no choice.

Suppose you want to be blessed with a swap line from the U.S…

In that case, you must be careful not to antagonize the hand that feeds you.

This means not aligning in any way with nations designated as non-friendly and agreeing to follow any restrictions, such as sanctions, that the U.S. government puts on.

The struggling nations that require emergency access to U.S. Dollars, and can’t get them…

  • Could engage in the expropriation of foreign-owned assets as the world recession deepens.

For example:

Last year Papua New Guinea revoked Barrick Gold’s ( GOLD) social license. Several months ago, Barrick gave the PNG government a 51% stake in the mine. Now the mine is back in production.

The PNG government is not the only nation flexing its muscles…

  • New left-wing President Boric of Chile starts his reign and Chile is amidst altering its tax code which could see miners be taxed up to 75%.

  • And just recently, Kyrgyzstan seized Centerra’s Kumtor gold mine.

It’s either that or face crippling depressions or revolutionary uprisings of their citizens (or both).

So, American businesses with operations in these places had better beware (and so should their investors).

Swap Lines Will Always Defend American Interests

As global unrest progresses, there may be more nations that will be granted swap lines. But don’t forget, swap lines will always defend American interests.

Make no mistake: this is big business and even bigger power…

The last time that foreign central banks took down that amount from U.S. swap lines was at the height of the COVID-19 Crisis in 2020.

The swap lines worked during the 2008 Global Financial Crisis and prevented a complete worldwide financial meltdown. Same thing during the COVID-19 Crisis.

But this is just the tip of the iceberg.

Few want to be shut out, and around eighty-five nations have applied for U.S. swap lines. Currently, just 14 central banks have been approved, with the E.U. technically representing 27 nations.

In fact, Indian Prime Minister Narendra Modi has publicly confessed to having “swap line envy.” To be approved, all those countries must solidify their positions as U.S. allies by falling into line with our policies.

Think they will? Yep, me too.

And with Russia’s military attack on Ukraine, the allies (with swap lines) and those that want access to swap lines of the U.S.A. will be tested.

More Nations Will be Added

Over time, I expect these critically important swap lines to be increased and more nations to be slowly added.

They’ll be subject to the terms set by the U.S. government — both financially and geopolitically — but they’ll accede.

As monetary and fiscal policy are blending into one, it’s just a matter of time before the President uses swap lines as a big geopolitical leverage hammer.

Swap lines are that important, and they will dictate global alliances and policy. So, pay attention to them.

Because I promise you, they will have an impact on companies, investments, and ultimately, the very fabric of our world.

  • If you have a producing asset in a Negative Swap Line (-SWAP) country, you MUST prepare for potential setbacks and for things to go wrong.

It’s about properly understanding and pricing in risk.

Something that has become overlooked in the resource sector.

Swap Lines and Your Portfolio

Key Points:

1. I believe nations who have existing swap lines won’t screw with foreign operating entities (American companies) to the same extent as the –Swap Line Nations will.

2. I still expect higher taxes in all countries as it’s the only thing politicians across the world have executed effectively throughout time.

This means mining assets in +Swap Line Nations won’t nationalize their gold mines, copper mines, etc. Those nations won’t screw with America.

3. Nations with existing U.S. Swap lines won’t put currency exchange restrictions on the foreign (American) companies operating there. –Swap Line Nations may do so, and many have already.

This will cause a decrease (and in some cases, a prevention) of those U.S. Dollars in –Swap Line Nations from being sent back home as dividends to the owners of the company.

Marin Katusa is the founder of Katusa Research, an independent investment research firm.

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Equities News Contributor: Marin Katusa

Source: Equities News

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