Yesterdayâs announcement about the Fedâs central bank swap lines sure caused a lot of confusion in the markets. For instance, Rick Santelli of CNBC said this all but guarantees QE3. Goldman Sachs said: âAlthough there is the obvious counter: why act now. Is there something lurking around the corner?â. Peter Schiff said it âmay be one of the most important economic events of the year.â What to make of this new intervention? First of all, the swap lines merely provide banks with access to dollar funding. This is nothing new so the fact that the program was touted as something new is very odd. The program has been in place since 2007 so the announcement is just an alternative form of something that was already in place. What they announced here was a reduction in the cost of the loans from OIS+100bps to OIS+50bps. The swaps were also extended to several other currencies though the USD is the primary focus. The goal is to keep short-term lending markets from seizing up like they did in 2008 after Lehman Bros went bankrupt. There had been signs in recent weeks of money market troubles and short-term loan troubles so this program should help to some degree. The Fed elaborates on the purpose of the swaps: âThese swap lines are being implemented as a contingency measure, so that central banks can offer liquidity in foreign currencies if market conditions warrant such actions. These lines provide the Federal Reserve with the same ability to provide foreign currency, should the need arise, as foreign central banks currently have through the existing dollar swap lines with the Federal Reserve to provide dollar liquidity in their jurisdictions.â So, will this destroy the dollar and generate high inflation? This is highly unlikely. As we can see below, demand for swaps has been muted in recent months and even the 2008 surge in swaps was not accompanied by a surge in inflation. In fact, there is a near inverse correlation between the rate of inflation and swaps demand. This makes sense since demand for swaps will coincide with credit seizure which will coincide with deflation risk. So, the loans will serve a protective role for banks who need access to dollar funding. Itâs not firing dollars out into the economy, but merely helping to avoid a potential deflationary collapse that would be accompanied by a credit crunch Interestingly, the biggest news surrounding the swaps is the dissenting vote by Jeffrey Lacker. He said the loans are equivalent to fiscal policy and do not fall under the jurisdiction of the Fed. I think thereâs an even bigger problem with this program though. The swaps expose the US government to potentially substantial foreign denominated debt. From an MMT position, this is an absolute no-no. The loans are essentially unsecured since theyâre denominated in a foreign currency so if the Euro vaporized tomorrow the Fed could be on the hook for the losses. This is an entirely irresponsible risk. Does this mean QE3 is on the table? This program has nothing to do with QE3 or the Fedâs open market operations. As of now, the Fed has been fairly clear that QE3 is off the table unless inflation pressures moderate. With core inflation still bumping up against the upper end of their 2% core inflation range itâs unlikely that the Fed can justify QE3 presently. Is there something lurking around the corner? There very well could be. But letâs not blow this out of proportion. The announced program is a change to current programs and not the unleashing of some new bazooka. On the other hand, itâs nice to see that central banks are being proactive to some degree. Unfortunately, this program does nothing to help solve budget woes in the periphery of Europe. So, it doesnât stop a Lehman 2.0, but merely cushions the downside should Lehman 2.0 occur. Ultimately, greater action is needed from the EMU leaders if they want to resolve the Euro crisis. December 9th is when weâre expected to hear more on this. If we donât get further action markets will not respond well and we might look back at the swap lines as a futile announcement as a credit crisis erupts across Europe. http://pragcap.com/swap-lines-not-a-panacea