Exchange Stabilization Fund

The Exchange Stabilization Fund (ESF) is an emergency reserve fund of the United States Treasury Department, normally used for foreign exchange intervention.^[1] This arrangement (as opposed to having the central bank intervene directly) allows the US government to influence currency exchange rates without directly affecting domestic money supply.

As of December 2019, the fund held assets worth $94 billion, including $51 billion in special drawing rights (SDRs) from the International Monetary Fund (IMF).^[2]

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Narrator: In the last video we saw how everyone in country A got excited about investing in country B and so they wanted to convert their currency into country B's currency. Left to its own devices with this new demand for currency B, it would have made currency B more expensive, but instead of allowing that to happen the central bank of country B said no, no, no, no, no, I want to keep the exchange rates relatively stable, so I'm going to print B's and use those to buy up A's. So at the end of that video the central bank of country B ended up with foreign currency reserves. It ended up with some of A's currency on its balance sheet. What I want to do in this video is think about what if demand goes the other way and how could the central bank use its foreign currency reserves to prevent its currency from devaluing. Let's go to the next stage in our little hypothetical story here. Let's say people in A, all of this investment happened in country B, everyone was all excited. Probably a bubble was forming of some kind and then all of the sudden the investors in country A start to get a little bit scared. They start to hear reports of the bubble forming, they start to realize that conditions in country B weren't as good as they thought it might have been initially, so they start to panic. They start wanting to unwind their investments. Whatever they had in country B they want to sell it, they get B's currency for it and they want to convert that to their home currency. Now you have the reverse situation of what we saw in the last video. Everyone wants to sell their B's, so they had invested in country B maybe they had bought some real estate there, they're going to sell their real estate, they're going to get B's for it and then they're going to get out of that countries currency. They're going to want to convert that money back in to A's, but this is the opposite situation. Now everyone wants to run out of country B and there isn't a lot of supply of A's in return. No one's really looking to trade A's for B's now. Everyone is irked, the market is going completely in the opposite direction. If, once again, foreign exchange markets were allowed to float freely what would happen? In this situation all the demand is for the A's and all the supply is on the B's so you would have either more ... Let me write it this way, you would have fewer A's per B. (writing) Fewer A's per B ... or you could have more B's per A. These are the same statement. (writing) More B's per A. In general, A has now become more expensive in terms of B or B has become cheaper in terms of A. Let's say you're the central bank and you say well I don't like this either. Now all of a sudden, usually this unwinding, this panic happens much faster and in more dramatic fashion than the initial phase over here. You say, oh my God people in our country they might not be able to ... If this were to happen foreign imports would become so expensive people might not be able to even afford food that we have to import from other countries or essential supplies from other countries. So they say, no, we're going to intervene. We were able to accumulate some of these foreign currency reserves so we can use those now to try to stabilize our currency. In this situation what the central bank would do is say okay I've got some reserves of A what I'm going to do is I'm going to go into the open market. I'm going to go into the open market and also sell my reserves ... and sell my reserves of A and try to equalize the supply and the demand. So, once again, if they're able to sell these reserves, now all of the sudden their currency will not devalue or maybe not devalue as much. The one kink in the system here is that they only have a finite of reserves. This right over here is finite. In the previous video when we saw that they were printing their own currency to build reserves, they could do this all day, all night because they have the right to print as much of their own currency as they want. But now they are using reserves of someone elses currency to keep their own currency from being devalued, but they can't print someone else's currency. They're hoping that what they have on hand is enough to fight this ... what they're probably perceiving is a short term imbalance, but it could be scary. What happens if all of this currency runs out? Then they blow all of their currency reserves and if this kind of panic keeps occurring then you're going to go back to the free market forces and their currency will have to devalue. That's how central banks attempt to keep their currencies relatively stable. In future videos we'll go through real cases of when this happened and what exactly happened when the foreign currency reserves ran out and how speculators could use that knowledge to essentially make an easy speculative buck.

Background

The U.S. Exchange Stabilization Fund was established at the Treasury Department by a provision in the Gold Reserve Act of 1934.^[3] It was intended as a response to Britain's Exchange Equalisation Account.^[4] The fund began operations in April 1934, under director Archie Lochhead and financed by $2 billion of the $2.8 billion gold surplus the government had realized by devaluing the dollar. The act authorized the ESF to use its capital to deal in gold and foreign exchange to stabilize the exchange value of the dollar. The ESF as originally designed was part of the executive branch not subject to legislative oversight. The fund was originally authorized for two years, subject to extension by the President or Congress, and was made permanent under the Bretton Woods Agreement Act of 1945.

The Special Drawing Rights Act of 1968^[5] made the ESF the recipient of IMF special drawing rights (SDRs) acquired by the US government. The ESF can convert SDRs into dollars on its account by issuing certificates against them and selling the certificates to the Federal Reserve,^[6] and later repurchase them when it has surplus cash.^[7] The Federal Reserve uses the certificates as a portion of the collateral for Federal Reserve Notes.

Uses

The ESF was originally created to stabilize the international value of the dollar following the collapse of the gold standard. Under the Tripartite Agreement of 1936 the Treasury used the ESF to guarantee daily exchange rates under which it converted the dollar holdings of France and the United Kingdom to gold. Because the use of the fund was left at the broad discretion of the Secretary of the Treasury, it proved highly adaptable to changes in the international monetary situation. Over the course of decades, governments have repeatedly used it for urgent defense against dollar crises until long-term solutions could be found. The fund has also extended loans to foreign countries in the interests of the United States.^[8]

With the establishment of the Bretton Woods system, the ESF contributed the initial US share of capital to the IMF and retreated to a secondary role.^[8] During the first debt ceiling crisis in late 1953, the ESF used part of its gold reserves to buy back debt from the Federal Reserve and create additional borrowing space for the government.^[9] International concerns about John F. Kennedy's commitment to gold convertibility led to an outflow of gold from the United States in early 1961. In response the ESF returned to buying foreign currency long enough for the IMF to create a credit facility that allowed countries to settle payments through direct currency exchange instead of gold redemption. The new IMF facility did not fully resolve the problem of speculative attacks on the dollar. From 1962 onward the ESF intervened increasingly in currency markets, with the support of the Federal Reserve and special borrowings, to prevent drains on US gold. The termination of gold convertibility as part of the Nixon shock marked the ultimate failure of these efforts. Having no further need for gold, the ESF sold it at the statutory price to the Treasury, which then sold a portion at auction.^[8]

The U.S. government used the ESF to provide $20 billion in currency swaps and loan guarantees to Mexico following the 1994 economic crisis in Mexico. This was somewhat controversial at the time, because President Clinton had tried and failed to pass the Mexican Stabilization Act through Congress. Use of the ESF circumvented the need for approval of the legislative branch. In response, Congress passed and President Clinton signed the Mexican Debt Disclosure Act of 1995, which implicitly accepted the use of the ESF, but required reports to Congress every six months on the status of the loans.^[10] At the end of the crisis, the U.S. made a $500 million profit on the loans.^[11]

After the bankruptcy of Lehman Brothers in September 2008 triggered a run on money market funds, Treasury Secretary Henry Paulson offered to guarantee the funds using the ESF. Nearly all money market funds accepted the offer, helping to calm the market. The funds paid $1.2 billion in fees for use of the guarantee program and ultimately no guarantees were paid, but Congress prohibited the use of the fund to offer such guarantees in the future.^[12]

The CARES Act of 2020, which provided economic relief during the COVID-19 pandemic, temporarily removed the post-2008 restrictions on the ESF and made a spectacular appropriation of $500 billion. Of this amount up to $46 billion was available for loans or guarantees to air carriers and industries critical to national security, and the rest to support emergency credit facilities of the Federal Reserve. The ESF provided these facilities with contributions of equity to protect the Federal Reserve from losses on loans made under high-risk pandemic conditions. The CARES Act appropriation was temporary and accounted separately from the ESF's currency operation funds; the act required repayment of the appropriated funds by 2026, with any residual earnings paid to the Social Security Trust Fund.^[13] Outgoing Treasury secretary Steven Mnuchin withdrew equity from several facilities in November 2020, controversially and against the preference of Federal Reserve officials,^[14] and the Consolidated Appropriations Act, 2021 rescinded $479 billion in unused appropriations.^[15] At the end of 2022 the ESF owed $17 billion related to the CARES Act transactions.^[16] As of September 30, 2022, the ESF held total assets of $207.9 billion.^[17]

Following the collapse of Silicon Valley Bank in March 2023, the ESF contributed $25 billion as a backstop for the Bank Term Funding Program, an emergency Federal Reserve credit program allowing banks to borrow against bonds on special terms.^[18]

References

^ Gertrude Chavez-Dreyfuss (2019-08-07). "U.S. dollar - When will bulls turn to bears?". Reuters. Retrieved 2019-08-07.
^ Treasury Bulletin (Report). March 2020.
^ 31 U.S.C. § 5302
^ Anna J. Schwartz. "IMF's Origins as a Blueprint for Its Future".
^ 22 U.S.C. § 286o
^ "Exchange Stabilization Fund: Legislative Basis". Archived from the original on 2008-09-17.
^ "Exchange Stabilization Fund: Finances & Operation". Archived from the original on 2008-09-17.
^ ^a ^b ^c Schwartz, Anna J. (May 1997). "From Obscurity to Notoriety: A Biography of the Exchange Stabilization Fund". Journal of Money, Credit and Banking. 29 (2): 135–153.
^ Garbade, Kenneth R. (June 2016). The First Debt Ceiling Crisis (Report). Federal Reserve Bank of New York Staff Reports. No. 783.
^ Pub. L. 104–6, title IV, Apr. 10, 1995, 109 Stat. 89, 31 U.S.C. § 5302
^ Greenspan, Alan (2007). The Age of Turbulence. Penguin Press. ISBN 978-1-59420-131-8.
^ Treasury’s Exchange Stabilization Fund and COVID-19 (Report). In Focus. Congressional Research Service. April 10, 2020. IF11474.
^ "Coronavirus Aid, Relief, and Economic Security Act".
^ Crutsinger, Martin (December 1, 2020). "Mnuchin defends shut down of Fed emergency loan programs". AP. Retrieved 2023-03-01.
^ Audit of the Exchange Stabilization Fund’s Financial Statements for Fiscal Years 2021 and 2020 (PDF) (Report). Audit Report. Office of Inspector General, Department of the Treasury. March 9, 2022. OIG-22-029. Retrieved 2023-02-07.
^ Treasury Bulletin (Report). March 2023.
^ ESF Annual Report for Fiscal Year 2022
^ Cox, Jeff (March 12, 2023). "U.S. government steps in and says people with funds deposited at SVB will be able to access their money". CNBC. Retrieved 2023-03-13.

External links

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This page was last edited on 27 February 2024, at 15:53

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