Return of the Dollar Cavalry

The world is in distress. The economic future looks bleak. Who can the citizens of our great planet turn to, to save them in this time of need?

The Federal Reserve, apparently.

In emergency meetings yesterday, the European Union and the Bank of Japan did just that. Both groups moved to re-open dollar swap lines with the Fed.

The dollar swaps were first implemented in the wake of the Lehman collapse in fall 2008. Governments found that many buyers who do business globally in dollars were having trouble getting access to the bucks they needed.

The strain in the dollar-denominated market was threatening to touch off a fresh round of credit problems.

So the Fed leant Europe, Canada and Japan all the dollars they needed. At the peak, more than $500 billion in swaps were issued. The receiving governments then re-leant these dollars to businesses.

As of a few months ago, these swaps had been unwound. All of the dollars were returned to the Fed, and everything seemed to be good again.

But apparently after last week's market squiggles, dollars are getting hard to find again. Both Japan and Europe are once again "turning on the dollar spigots", taking new loans from the Fed to help supply borrowers.

This is a major about-face on a program that looked like it was headed out to pasture. And also a sign that dollars are still the "go to" currency when times get rough. Lack of dollars in the markets means holders are hoarding and unwilling to sell. When the chips are down, it seems investors would rather hold greenbacks.

We'll see how much ends up being issued under the new swap lines (today's announcement of a $1 trillion bailout for Europe may alleviate some of the liquidity problems). And just how effective the dollar cavalry will be the second time around.

By. Dave Forest of Notela Resources