During the outset of the Iraq War, the Oxford Union hosted a debate between its best and brightest on the topic of America’s foreign policy and whether it’s a force for good or evil for the world: this from the august society that famously declined in 1933 to “fight for its King and Country” in the face of Hitler’s threat to Europe.
The view of “Good America” prevailed, but the fact they thought it necessary to engage in such cogitation made me shudder.
I was reminded of this at a recent top advisor conference hosted by Curian Capital, the managed account arm of Jackson National Life.
“We’re now starting to hear rumbles that the Fed might somehow bail out Europe,” advisor Bruce Woods with Woods Investment and Insurance Services said during a roundtable discussion that touched on a recent spate of bad economic news.
If true, it would be similar to last December’s largely unnoticed “backdoor bailout,” as described at the time by former Dallas Fed Vice President Gerald O’Driscoll in the pages of The Wall Street Journal:
“The Fed is using what is termed a ‘temporary U.S. dollar liquidity swap arrangement’ with the European Central Bank. Simply put, the Fed trades or ‘swaps’ dollars for euros. The Fed is compensated by payment of an interest rate above the overnight index swap rate. The ECB, which guarantees to return the dollars at an exchange rate fixed at the time the original swap is made, then lends the dollars to European banks of its choosing.”
No matter the legalistic interpretation, O’Driscoll noted, “the Fed is working through the ECB, bailing out European banks and, indirectly, spendthrift European governments.”
If it were to happen again, “At that point, we’ll simply be a loan broker for China,” Woods wisely added during the Curian discussion.
Even so, with the Fed supposedly “out of bullets” in its desire to help our own economy, skyrocketing debt and deficits, worries over inflation and a devalued dollar, we’re still rushing to Europe’s aid (again). It’s dollars and cents rather than guns and ammo, but it’s foreign policy nonetheless.
There are many potential downsides to such moves. First, it’s unclear the Fed has the authority. Second, as O’Driscoll pointed out, these Federal Reserve swap arrangements “foster the moral hazards and distortions that government credit allocation entails.” Lastly, the secrecy of the swap arrangements certainly conflicts with the glasnost Fed chair Ben Bernanke recently promised.
All are legitimate objections that will probably be overcome, if only for the sake of our vested self-interest in Europe’s survival. But any debate on the subject probably won’t air in the mahogany and Corinthian leather atmosphere of Frewin Court.
So to the academic twits I simply say, “You’re welcome.”