The ability and willingness of central banks to be forces for global stability will be tested with frequency in coming decades. None is likely to be challenged as much as the Federal Reserve. Such is the burden of the US possessing the world’s primary reserve currency. But is it ready for a more contentious period of statecraft?
The first joint US-Japan intervention in 28 years to shore up the yen recently was a case in point and underscored the dollar’s pivotal role in global finance. That role derives in part from the Fed’s credibility and independence.
This new era is bound to bring encroachments from politicians looking to reward allies and spurn antagonists. Washington cannot be confident of supremacy, with China engaging in its own monetary diplomacy and the European Central Bank (ECB) aspiring to a bigger role for the euro.
The battlefields of the future are being drawn—economically, technologically and geopolitically—and central banks will have a large part to play. As lending, trade and technology become more entangled with geopolitics, authorities will be drawn into questions of security, sanctions, payment systems and the resilience of capital flows.
The US Treasury's support last year for Argentina, which has a history of default but whose leader shares President Donald Trump’s hard-right agenda, was an early signal of a more muscular posture.
For now, no other central bank can do what the Fed has done. At least twice this century, during the Global Financial Crisis (GFC) and in the worst days of the covid pandemic, the Fed extended dollar lifelines to key economies and financial centers.
These so-called currency swap lines allow foreign central banks to exchange their own currencies for dollars from the Fed, then lend those dollars to banks and businesses at home. The arrangements played a critical role in easing a cash crunch that might otherwise have made severe recessions worse. They also underscored the greenback's crucial role at the center of global commerce.
Andrew Hauser, a former Bank of England (BoE) executive who is now deputy governor of the Reserve Bank of Australia, called the facilities the most important component of the international safety net that almost nobody has heard of.
The countries that have standing swap lines—a permanent pipeline to the Fed’s supply of dollars for when markets run short of cash—either represent allies like the UK, the eurozone, Japan and Canada or, in the case of Switzerland, a partner.
Not everyone that has sought support has been successful. During the GFC, four emerging markets secured lines based on strict criteria, which were renewed during covid. Those that did not meet the test were encouraged to try elsewhere.
In 2020, some were encouraged to tap a new Fed programme that allowed them to use their holdings of Treasuries as collateral to access dollars rather than unload those assets, which might have pushed up long-term bond yields and set the American economy back.
The Trump administration is seeking to exploit a grey area as it flexes power. The Treasury has usually taken the lead on international economic policy while the Fed, in addition to pursuing price stability and maximum employment, worries about financial stability and the potential for turbulence to harm domestic growth.
Usually, the two agencies work in tandem, and any tensions are handled behind the scenes. Since the 1990s, the Treasury had been loath to be construed as giving the Fed instruction. Trump’s team isn’t so bound by convention.
The yen intervention illustrates this different approach. While past Treasury secretaries have carried out market forays with Group of Seven nations, with the Fed acting as its banker and sometimes deploying its own cash as well, the framing of the latest initiative was unmistakably geopolitical.
Trump “delivers for America's trusted partners,” Treasury Secretary Scott Bessent said. Japan, which has counted on US military backing since 1945, had been trying for months to entice Washington to join its currency defence, after fruitless solo efforts to stem the plunge.
Bessent went further and signalled his desire for the Fed to pour additional funds into the collateral facility, which Japan said it would tap. In doing so, he made clear that the new contours of diplomacy will draw more publicly on the central bank. Not only does Washington now appear intent on brandishing the greenback to secure political as well as economic goals, but it also does not mind pressuring the Fed.
While the Trump White House relishes norm busting, the temptation for future administrations, Democratic or Republican, to take the same route will be significant. That may result in further discomfort for the Fed, which has wrestled in the past with perceptions that the swaps drew them into judgments about the worthiness or otherwise of foreign governments.
For much of the past three decades, policymakers could focus largely on domestic mandates, leaving foreign relations to those elected. Detours into statecraft were occasional but pointed: providing vital cross-border liquidity after the collapse of Lehman Brothers in 2008 and, in the case of the ECB, salvaging the continent's common currency. Credible and influential economic custodians are a huge asset. Politicians need to nurture them and call upon their arsenals judiciously.
That kind of financial firepower is becoming a geopolitical prize. The United Arab Emirates, which has suffered attacks from Iran, has expressed interest in joining the exclusive circle that receives the firmest backing. The oil-rich nation is not in dire need of cash.
A permanent, or standing, swap line is more a signal that officials desire a degree of the access and level of trust accorded to the likes of the ECB and the BoE. An Emirati minister described it as an “elite matter.” For Washington, such an arrangement would counter China's push to bolster relationships in the Gulf.
The support for Argentine President Javier Milei was justified partly on the basis that such aggressive backing for a fellow conservative would constrain Beijing’s diplomatic and economic initiatives in Latin America. It is also consistent with Bessent’s objective of locking in greenback supremacy. He has also hinted it would not be left entirely to the Fed.
The dollar's dominance comes with responsibilities. But where does prudence end and politics begin? Some Fed decisions on support have been baffling. India reportedly sought a swap line and was rejected. The Reserve Bank of India has benefited from a lifeline extended by Japan. Paul Tucker, a former deputy governor of the BoE, recalled in a book being aghast at the refusal of a country that was clearly an ascendant economic power.
Beijing is stepping up efforts to embed the yuan in decisions around economic security. By the end of last year, China signed agreements to backstop more than two dozen countries. But it starts from a low base: The yuan makes up just a tiny fraction of global reserves. The greenback accounts for around 57% and the euro about 20%.
Given this kind of advantage, and China's desire to catch up, it’s tempting to look past the shortcomings of potential partners merely to thwart President Xi Jinping. Bessent—and Fed Chair Kevin Warsh—must get the balance right.
Central banks have a big role to play in the jostle for influence. In his second inaugural address, President Woodrow Wilson, who signed the Fed into law in 1913, girded the US for entry into the Great War. “We are provincials no longer,” he declared. The 21st century will belong to the central banks that recognize—and are comfortable with—their global role. ©Bloomberg
The author is a Bloomberg Opinion columnist covering Asian economies.