When You Can’t Hear Yourself: The Other Reverse Repo

A lot of times, what becomes most frustrating about all of this eurodollar business is trying to get other people out of the conventional mindset to open up to the idea that there is something more going on. It’s the myth of the “maestro”, how there is just no way these Ivy League Economists could be missing something so big. After all, you’d figure even if they screwed up once (2008) it was absolutely assured they were going figure out how to fix (QE) what was wrong.

At other times, what’s most maddening is how officials say the very thing that’s wrong (chronic and global dollar shortage) and then don’t realize the magnitude or the implications of what they’ve just said.

Before getting to that, we have to back up and start with the Fed’s other reverse repo. Yes, there’s actually two of them. The first, the RRP, is really the second. This is the reverse repo rate the central bank pays domestic institutions so as to act as a floor underneath the federal funds rate. It’s not as big a joke as IOER, but T-bill yields are certainly laughing at it at the moment.

The original, this other one, goes back much further. New York City has been a global money center since before there was ever a Federal Reserve System to hang a branch from. Global trade demands global payment, and New York reserve city banks functioned as the transit point between US dollars and foreign currencies. Both were exchanged and netted as necessary.

As with any payment system, it required(s) correspondent balances to be kept up and maintained; a liquidity buffer, so to speak. A foreign central bank may wish to hold more dollars in New York if its own domestic agents (businesses and banks) are expecting more robust trade heading in their direction in the near future. This would necessitate the need for more dollars to pay for it.

They might also do so if they get the sense dollars are becoming scarce. Whether in anecdotes or in the prices of foreign exchange or foreign markets, if an overseas central bank worries dollars are going to be harder to come by then it would naturally, prudently build up that correspondent buffer. Make sure there are more than enough dollars on hand to keep the goods flowing with a lot to spare.

Once the Federal Reserve came along, more and more it took over the basis for a lot of global payments. As time went on, the system’s New York branch began to offer more services attached to this crucial function. There was custody and clearing products. And it would allow overseas entities maintaining these correspondent balances to invest the proceeds in risk-free ways.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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