I have long brushed-aside talk of de-dollarization; around ideas like a BRICS currency, I’ve mocked it.

But a note from Deutsche Bank today has me seeing new ways that that dollar dominance could erode, if not collapse. They call it a nuclear button for the US dollar and it’s the FX swap line system.

It comes after Reuters reported that some European Central Bank officials are questioning whether they can rely on US dollar swap lines in times of market stress.

“The
immediate question is whether Fed liquidity support is withheld at a time of
immediate stress. The consequences would be grave,” DB writes.

The Trump administration has taken an increasingly hostile tone with Europe and the Atlantic leaks showed top officials calling them ‘pathetic’. It’s also increasingly turning to leverage — if not extortion — tactics in negotiations.

The fear is that if foreign banks needed USD liquidity in a crisis, the US might demand something in exchange.

The Swap Market is Huge

At the same time, it’s hard to even fathom the size of the swap and forward market. The BIS estimated it was nearly $100 trillion in 2022 or the equivalent of 100% of global GDP, more than double the size of the US equity market.

It’s dominated by the US dollar and largely facilitates borrowing against safe assets like Treasuries in order to facilitate cross-border flows, including foreign exchange.

The problem is that times of stress — and I wrote about this extensively during covid — bank swap lines are pulled because of counter-party risk and degrossing. Instead, banks must sell collateral and at the time, it led to a brief fire sale in Treasuries that reversed when the Fed announced unlimited QE.

It took the Fed announcing the most-drastic action in its history to put out the fire, along with unlimited FX swap lines directly from the Fed to global central banks. There are 14 central banks with these agreements in place with the Fed.

DB underscores that these agreements are with the supposedly-independent Fed but there are court cases ongoing around the FCC right now that raise questions about the independence of agencies like the Fed.

Now if these lines were pulled in the heat of the moment, the effects would boomerang back into the US and lead to a firesale in Treasuries and MBS, who argues that “the
bar for withdrawing support at a time of systemic financial stress would seem
exceptionally high.”

Still, the ECB is at least discussing it and that may lead to pre-emptive measures to cut reliance on the dollar swap system, which essentially means de-dollarizing in the medium term.

That led to this incredible paragraph from Deutsche Bank:

Doubts
about a commitment from the Fed to maintain dollar liquidity – especially
against major allies – would accelerate efforts by other countries to reduce
their dependence on the US financial system. It would ultimately lead to lower
foreign ownership of US assets and a broad-based weakening of the dollar’s role
in the global financial system. It is instructive that large economic rivals to
the United States like China and Russia do not enjoy swap lines with the Fed
and have shored up their financial systems either by significant official
reserve accumulation or by de-dollarising. Ultimately, where such concerns to
spill over to US allies, it would likely in our view create the most significant
impetus to global dollar de-dollarisation since the creation of the post-war
global financial architecture.

Not coincidentally: Gold hit a record high today and it’s gone parabolic since Trump moved ahead of Biden in polls at this time last year.