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THE UNITED STATES’ ILLR MECHANISMS

As the remaining chapters of this book will document, when the Fund’s unresponsiveness and resource insufficiency have threatened vital US economic interests, the United States has consistently chosen to act as the ILLR by providing credit to afflicted countries unilaterally. Historically, either the US Federal Reserve or the Treasury has been the source of these rescues. In this section, after briefly describing the process through which US bailouts are provided, I explain how these two ILLR mechanisms enable the United States to unilaterally respond more swiftly to crises and bring more resources to bear than the IMF.

The Mechanics of Currency Swaps

Both Fed and Treasury foreign rescues are orchestrated via what is known as a "currency swap.” Charles Coombs, a former vice president ofthe Federal Reserve Bank of New York, once explained that currency swaps create an increase in the international reserves of both central banks "out of thin air.”[1] When a swap is activated, each of the two parties to the agreement (the Fed or Treasury on the one side and a partnering foreign central bank on the other) agrees to exchange its currency for the currency of the other party, based on the market exchange rate at the time of the initial transaction. Typically, the parties agree to a prearranged limit on the amount that will be swapped as well as a specified period of time before the swap is to be reversed. A swap is reversed when the two parties swap back the same quantity of their currencies at the initial transaction’s exchange rate.[2] Consequently, both parties are insulated from the effects of exchange-rate volatility: the losses (or gains) that accompany fluctuations in the two currencies’ exchange rates.[3] During the swap term, the Fed or Treasury holds the foreign exchange it has acquired in a special account at the foreign central bank while the "borrower” uses its newly acquired dollars to address its financial needs. In short, while the mechanics might be a bit more complex, in practice currency swaps function as collateralized loans.

  • [1] Coombs 1976, p. 76.
  • [2] Edwards 1985, pp. 137-138.
  • [3] Of course, the transaction is not entirely risk-free. For instance, if the exchange ratechanges, one country loses in the sense that it could have acquired the foreign currency at amore favorable rate.
 
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