A "squall in the fall" over dollars for Europe Always define every issue as just a technical problem. This was my father's advice for how the civil servant - in his case, a foreign service officer - should keep the bumbling political overseers at bay. If the presidential appointee should realise that there was a "policy" question that was being decided, disaster could ensue as they attempted to re-invent the wheel, or come up with some imaginative, unworkable scheme in the hope of getting face time at the White House. So it is with central bank liquidity swap lines. When capital in the form of foreign exchange is not sloshing peacefully across the markets, these allow central bank bureaucrats to make forex available to less popular financial institutions. At the height of the 2008 crisis, the Federal Reserve had some $600bn in swap lines outstanding with its counterparts, the largest of which was the European Central Bank. The idea behind swap lines is that the central banks are just exchanging currency at an agreed on rate for seven to 89 days, with the user of the swapped currency accepting any devaluation risk. They're not loans - no indeed! Just technical facilities to provide temporary liquidity in the event of one of those bureaucrat-beloved market failures. Nothing to see here. Basically, that's true. Unfortunately for the central bankers and their forex-needy friends in the commercial world, swap lines, otherwise known as cheap and easy loans to undeserving rich foreigners, are just too big and slow moving a target to avoid being made the subject of political debate. So on June 17, Mitt Romney announced on Face the Nation, a national CBS television talk show, that "We're not going to send cheques to Europe. We are not going to bail out the European banks. We're going to be poised here to support our economy. Regardless of what is happening in Europe, our banking system is able to weather the storm. That's a good one: it sounds decisive, brutal to foreigners, and means nothing in the world of reality. Federal Reserve swap lines, or comparable US Treasury facilities, don't require the president to write out cheques, and put them in the morning post for Europe. However, when even a sophisticated financial sector person such as Mitt Romney finds it useful to take such a shot, we could have a problem come the late fall. I've heard from both Democratic senators and senior House Republicans that if there is any large scale use of dollar swap lines at the time of the "fiscal cliff" budget negotiations, the reaction on Capitol Hill would be "volcanic." As one of them told me last week, "You can expect a lot of demagoguery." The problem is that while you can eventually explain to Senators and House members that a swap line is not a loan, and necessary to allow that weathering of the storm, political interference and delay could accelerate capital flight. This is made more likely by an unfortunate coincidence of budget and swap line calendars. The current framework arrangement for swap lines between the Fed and ECB is set to expire on February 1 2013. This is customary; the idea is to have swaps in place to offset any year-end balance sheet dressing across the Atlantic. However, it means that the renewal of the agreement will come at the same time that Congress is being asked to unwind otherwise automatic budget cuts and tax rises. My own thought has been that it would be a good idea to get the swap line framework extended as soon as possible, before the now-customary autumn euro area crisis. The central bankers, in particular the ECB, shy away from this idea. They tend to believe, as my father did, that last minute technical fixes are much better than opening a problem to public debate. They have a point, but the tail risks are much more serious than they were. Why take a chance? Also, it appears that the rest of the world is much shorter of dollars than it was even at the time of the 2008 crisis. The world has run up even more dollar-denominated debt in recent years, as private America deleveraged. So foreign private accounts are enormously short of dollars; two weeks ago Morgan Stanley estimates the dollar gap at about $2tn. Already, banks in peripheral Europe, which appears to start now at the Rhine, have had to cut down on voluntary dollar lending or new project finance that requires dollars. Spanish banks, for example, have tried to offset their dollar shortage by using their subsidiaries in the western hemisphere to channel funds home. That practice is up against the prudential, or regulatory, limits. Edwin Truman, a senior fellow at the Peterson Institute in Washington, a former Treasury official, and former director of the Division of International Finance of the Federal Reserve Board of Governors, says "I can't imagine they [the Fed] will be lucky enough that the Europeans won't want to continue [the swap lines], and that this will happen sometime before the end of the year. It will be a squall in the fall.