Consider this confusing sentence from the Baba/Ramaswamy paper:
“US banks’ need for European currencies is much smaller because US banks have leveraged their domestic operations with foreign assets much less.”
When you’re telling lies with statistics, it requires the use of complicated terminologies with clever twists in them as well. Such as, for instance, Brad Setser’s phrase “financing the US current account deficit”.
There is, in fact, no such thing as a European bank “leveraging domestic operations with foreign assets”. The more you think about this, the more confused you will be.The financial laws of gravity are simple. A global bank will source funds where interest rates are low; and lend where interest rates are high. Given that both short term and long term rates were much lower in the US, European banks borrowed in dollars and lent in local currencies.“Interbank market” is a euphemism for a bank HQ’ed, say, in Germany, borrowing USD from a local US bank. When this type of source is disrupted, the dollar funding can’t go on any more.Secondly, the existing USD loans weren’t rolled over.Which is why there had to be inter-central bank currency swaps.Apart from the US and the UK, I haven’t seen many reports of retail mortgage borrowers in any geography defaulting in large numbers. Of course, a liquidity crisis can transform into a solvency crisis rapidly.But the BIS papers are a clever attempt to confuse readers on the topic of “European banks’ need for dollar funding”. That ‘need’ developed as a result of lower US rates; and persisted due to non-rollover of existing dollar debt.
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