The aliens among us

How viruses shape the world

They don’t just cause pandemics

Humans think of themselves as the world’s apex predators. Hence the silence of sabre-tooth tigers, the absence of moas from New Zealand and the long list of endangered megafauna. But sars-cov-2 shows how people can also end up as prey.

Viruses have caused a litany of modern pandemics, from covid-19, to hiv/aids to the influenza outbreak in 1918-20, which killed many more people than the first world war. Before that, the colonisation of the Americas by Europeans was abetted—and perhaps made possible—by epidemics of smallpox, measles and influenza brought unwittingly by the invaders, which annihilated many of the original inhabitants.

The influence of viruses on life on Earth, though, goes far beyond the past and present tragedies of a single species, however pressing they seem. Though the study of viruses began as an investigation into what appeared to be a strange subset of pathogens, recent research puts them at the heart of an explanation of the strategies of genes, both selfish and otherwise.

Viruses are unimaginably varied and ubiquitous. And it is becoming clear just how much they have shaped the evolution of all organisms since the very beginnings of life. In this, they demonstrate the blind, pitiless power of natural selection at its most dramatic. And—for one group of brainy bipedal mammals that viruses helped create—they also present a heady mix of threat and opportunity.

As our essay in this week’s issue explains, viruses are best thought of as packages of genetic material that exploit another organism’s metabolism in order to reproduce. They are parasites of the purest kind: they borrow everything from the host except the genetic code that makes them what they are. They strip down life itself to the bare essentials of information and its replication. If the abundance of viruses is anything to go by, that is a very successful strategy indeed.

The world is teeming with them. One analysis of seawater found 200,000 different viral species, and it was not setting out to be comprehensive. Other research suggests that a single litre of seawater may contain more than 100bn virus particles, and a kilo of dried soil ten times that number.

Altogether, according to calculations on the back of a very big envelope, the world might contain 1031 of the things—that is ten followed by 31 zeros, far outnumbering all other forms of life on the planet.

As far as anyone can tell, viruses—often of many different sorts—have adapted to attack every organism that exists. One reason they are powerhouses of evolution is that they oversee a relentless and prodigious slaughter, mutating as they do so. This is particularly clear in the oceans, where a fifth of single-celled plankton are killed by viruses every day.

Ecologically, this promotes diversity by scything down abundant species, thus making room for rarer ones. The more common an organism, the more likely it is that a local plague of viruses specialised to attack it will develop, and so keep it in check.

This propensity to cause plagues is also a powerful evolutionary stimulus for prey to develop defences, and these defences sometimes have wider consequences. For example, one explanation for why a cell may deliberately destroy itself is if its sacrifice lowers the viral load on closely related cells nearby. That way, its genes, copied in neighbouring cells, are more likely to survive. It so happens that such altruistic suicide is a prerequisite for cells to come together and form complex organisms, such as pea plants, mushrooms and human beings.

The other reason viruses are engines of evolution is that they are transport mechanisms for genetic information. Some viral genomes end up integrated into the cells of their hosts, where they can be passed down to those organisms’ descendants. Between 8% and 25% of the human genome seems to have such viral origins.

But the viruses themselves can in turn be hijacked, and their genes turned to new uses. For example, the ability of mammals to bear live young is a consequence of a viral gene being modified to permit the formation of placentas. And even human brains may owe their development in part to the movement within them of virus-like elements that create genetic differences between neurons within a single organism.

Evolution’s most enthralling insight is that breathtaking complexity can emerge from the sustained, implacable and nihilistic competition within and between organisms. The fact that the blind watchmaker has equipped you with the capacity to read and understand these words is in part a response to the actions of swarms of tiny, attacking replicators that have been going on, probably, since life first emerged on Earth around 4bn years ago. It is a startling example of that principle in action—and viruses have not finished yet.

Humanity’s unique, virus-chiselled consciousness opens up new avenues to deal with the viral threat and to exploit it. This starts with the miracle of vaccination, which defends against a pathogenic attack before it is launched.

Thanks to vaccines, smallpox is no more, having taken some 300m lives in the 20th century.

Polio will one day surely follow. New research prompted by the covid-19 pandemic will enhance the power to examine the viral realm and the best responses to it that bodies can muster—taking the defence against viruses to a new level.

Another avenue for progress lies in the tools for manipulating organisms that will come from an understanding of viruses and the defences against them. Early versions of genetic engineering relied on restriction enzymes—molecular scissors with which bacteria cut up viral genes and which biotechnologists employ to move genes around.

The latest iteration of biotechnology, gene editing letter by letter, which is known as crispr, makes use of a more precise antiviral mechanism.

From the smallest beginnings

The natural world is not kind. A virus-free existence is an impossibility so deeply unachievable that its desirability is meaningless. In any case, the marvellous diversity of life rests on viruses which, as much as they are a source of death, are also a source of richness and of change.

Marvellous, too, is the prospect of a world where viruses become a source of new understanding for humans—and kill fewer of them than ever before.

Abandoning hope

Official economic forecasts for poor countries are too rosy

Over-optimism at the IMF and the World Bank can have serious consequences

Most people, when presented with bad news, tend to play it down. Even professional economic forecasters are not immune to the temptations of hope. In February more than 500m people in China were experiencing some form of lockdown, and covid-19 had spread to Italy.

Yet the IMF said that in its base-case forecast global GDP growth this year would be only 0.1 percentage points lower than previously expected. By April it had cut its forecast by 6.2 percentage points, to -3%. By June it had sawn off another 1.9 percentage points. Just a week later an informal poll of about 40 IMF staff found that two-thirds expected another downward revision in October.

By and large, economic forecasters are a sunny bunch. They rarely predict a downturn. Human nature, incentives and political pressure get in the way. Yet rosy forecasts by the IMF and the World Bank can have serious consequences. That is especially the case in poor countries today, where covid-19 is ravaging economies, and governments, international organisations and investors are using forecasts to guide their decisions.

IMF and World Bank projections can be very influential in some countries. They can affect governments’ spending and borrowing plans. Investors may lend more cheaply to countries expected to grow rapidly. And the forecasts determine whether the fund and the bank think a country’s debt is sustainable, which in turn determines whether it qualifies for a bail-out.

The fund tends to be optimistic. Its one-year-ahead growth forecasts for developing countries in 1990-2016 were, on average, 0.42 percentage points above subsequently published gdp figures.

Most of the optimism comes from failing to predict downturns. Even once a recession has begun, forecasters are still slow to accept the news (see chart).

Such errors can drastically change debt dynamics. Take a country expected to have public debt of 50% of GDP in 20 years’ time. If annual economic growth is 0.5 percentage points less than predicted, and nothing else changes, then the debt ratio could instead be 90% of GDP. In a recent study Paul Beaudry of the University of British Columbia and Tim Willems of the IMF even link over-optimism to future fiscal crises.

They find that overestimating average annual growth by a percentage point for the next three years, as the IMF does about 40% of the time, reduces growth three years later by a full percentage point. Governments and firms seem to celebrate good forecasts by racking up debt. Trouble sets in.

Predicting growth, and especially downturns, is fiendishly hard. Getting it right is not helped by forecasters having little incentive to spot clouds on the horizon. Analysts fear that gloom could become self-fulfilling. Standing out from the crowd and wrongly calling a recession damages a forecaster’s reputation more than failing to predict one along with everyone else.

Then there is “pushback from governments”, says Maurice Obstfeld, who was the fund’s chief economist in 2015-18.

Internal pressure to nudge up forecasts in order to justify a lending package is also “definitely an issue ”, says Mr Obstfeld. A paper by Giang Ho and Paolo Mauro of the fund in 2014 found that forecasts were especially optimistic when countries were just about to enter a programme.

The fund’s Independent Evaluation Office (IEO) acknowledges that forecasts tend to be rosy in high-profile bail-outs, but notes that these are usually corrected at the programme’s first review three months later. (By then, of course, the agreement has already been signed.)

Some economists at the fund are more optimistic than others, find Messrs Beaudry and Willems. In poor countries, less experienced economists tend to be less accurate. Although oil and mineral discoveries do not boost growth immediately, IMF forecasters consistently predict that they will, according to research in 2017 by James Cust of the World Bank and David Mihalyi of the Natural Resource Governance Institute, a think-tank.

The fund’s lack of consistency attracts criticism, too. Since the coronavirus pandemic began it has revised down growth in rich countries in 2020 by three percentage points more than that in developing ones. That is odd, argued Justin Sandefur of the Centre for Global Development, another think-tank, and Arvind Subramanian of Ashoka University, in June.

Lockdowns and social distancing are at least as severe in poor countries as in rich ones.

But fiscal responses have been much weaker, and, as the fund itself has argued, capital outflows and currency pressure are bigger threats. Perhaps, the authors speculate, the fund has been rosier about poorer countries this time in order to avoid having to provide support.

The IMF says that China’s success in containing the virus explains why its forecasts are more positive for developing countries and strongly denies lending influences its growth forecasts.

The other big official forecaster in poor countries is the World Bank. (Private firms, including The Economist’s sister organisation, the Economist Intelligence Unit, also publish forecasts.)

Over the past decade, the bank has produced more accurate forecasts for Africa and the Middle East than the fund, but done a worse job for Latin America (though differences are small). Overall, a comparison of the forecasts published by both institutions every January by Prakash Loungani of the IEO suggests that the fund is still better than the bank at predicting downturns in poor countries.

Perhaps people should simply expect less of forecasts, says Mr Obstfeld. They may represent an expectation of the most likely outcome, but the chance of them being bang-on is slim. “You are getting something that is useful,” he argues, but “in general, you are not getting high accuracy.”

Why banks’ declining reserves matter for the dollar

Last year’s repo mayhem underlined the importance of banks keeping a big cash pile at the Fed

Wenxin Du

The worst of the dollar funding crunch is over, for now. But as conditions improve in the financial system, the related decline in the total cash pile held by all banks at the US Federal Reserve should be carefully watched.

September’s blow-up in a key US short-term lending market was a stark reminder of the risks that a low level of bank reserves can pose to the global dollar funding market.

It is worth recounting how we got here. The coronavirus shock set off a dollar shortage around the world, as a significant contraction in lending denominated in the greenback by banks and non-banks failed to meet strong demand. The Fed acted quickly to rekindle swap lines with its overseas counterparts. And with the US economy contracting at a record pace, it pledged to provide an extraordinary level of support for the foreseeable future.

The medicine worked. The dollar and the cross-currency basis — a metric to gauge global dollar funding conditions — retraced back to their pre-pandemic levels, and the usage of central bank swap lines fell significantly.

However, over the past two months, banks’ total reserves at the Fed have declined from $3.3tn to $2.6tn as the central bank’s asset purchases slowed, usage of the swap lines declined, and the US Treasury’s cash pile increased. More cash for the Treasury means less cash for the overall banking system.

To put this $700bn reduction into context, during the period that the Fed actively reduced its asset holdings between October 2017 and September 2019, known as the Fed taper, bank reserves declined by the same amount, from $2.1tn to $1.4tn.

What happened after that? The US money market hit a liquidity pothole, with the interest rate charged on repurchase, or repo, agreements — a type of secured borrowing where cash is exchanged for collateral such as Treasuries — rising close to 10 per cent last September. The Fed was forced to inject cash to the banking system.

The $700bn reduction in bank reserves over the past two months is very different in nature, and the current level of $2.6tn is still high by historical standards. However, the past episode taught us a lesson: a seemingly high level of reserves might still be inadequate, so we should remain vigilant.

In a recent research paper written with Ricardo Correa and Gordon Liao, we took a deep dive into the daily balance sheets of large global banks and articulated why high levels of bank reserves are key to support the healthy functioning of dollar funding markets.

The first reason is that large global banks have relied on their own cash pile to provide additional lending in response to sudden surges in dollar funding demand in recent years. The alternative for banks would be to borrow additional bucks from cash-rich lenders in the economy, such as money market funds, in order to lend more to ultimate dollar borrowers. But the unpleasant consequences of this during a dollar shortage are higher external funding costs, a larger bank balance sheet and a more binding leverage ratio requirement.

Larger reserves are also important because a substantial portion of banks’ cash is set aside to comply with the regulatory requirements and risk management practices developed after the global financial crisis. Tapping banks’ own cash at the Fed to finance short-term dollar lending involves significant amounts of liquidity transfers across subsidiaries within a large bank. This is because depositary institutions hold reserves, but broker-dealers do most of the lending in the repo and FX swap markets. Therefore, any liquidity requirements at the bank subsidiary level would not only limit these internal flows but more broadly affect the dollar funding market.

This issue matters even more today, when demand fluctuations in the dollar funding markets are likely to be large. The dollar cash pile of the US Treasury at the central bank is at a record $1.8tn, compared with an average of $200bn over the past 10 years. Large fluctuations in this amount lead to swings in dollar funding conditions. An $83bn increase in the Treasury’s cash balance on September 16 last year was enough to set money markets in disarray.

In the Covid-19 fightback, the Treasury’s cash balance has become more volatile and uncertain, due to high levels of debt issuance, and uncertainty on the timing of fiscal payouts. This makes it even more vital that banks hold a lot of cash at the Fed.

The Fed can enable this by holding a large portfolio of securities, or by supplying additional funds to banks and non-banks through credit and liquidity facilities. To the extent that such facilities are meant to provide a backstop in times of stress, and as markets transition to a “new normal” of a post-virus world, the size of the Fed’s securities holdings will matter more and more for global dollar funding.

The writer is an associate professor of finance at the University of Chicago Booth School of Business.

Fed Headed for a Clash With Hedge Funds, Other Shadow Banks

By Rich Miller and Jesse Hamilton

- Global central banks push tougher oversight after March tumult

- Industry is mobilizing lobbyists to head-off new constraints

The Federal Reserve and other central banks are heading for a collision with shadow lenders -- the firms with a sinister nickname that are increasingly dominating global finance.

Even as policy makers struggle to reopen their economies in the midst of the coronavirous pandemic, they’ve launched a review of what went wrong with markets in March, when a worldwide dash for cash by investors nearly crashed the financial system and forced unprecedented rescue actions by central banks.

Their focus is on loosely regulated money market and hedge funds, mortgage originators and other entities. Already, some watchdogs have pointed to highly leveraged trades involving U.S. Treasuries as one source of the turmoil.

“In many cases they have reached systemic importance,” Bank for International Settlements General Manager Agustin Carstens said of the non-banks. He added that it’s time to move toward more regulation.

There’s a lot at stake should the scrutiny lead to tougher oversight. The alternative financiers are major providers of credit to households and companies, making their smooth functioning critical to the health of financial markets and the economy.

Non-banks are marshaling their lobbyists in Washington to argue that casting blame on the industry is misplaced. A point in their favor is that unlike Wall Street banks a decade ago, shadow lenders didn’t cause the recent meltdown. Instead, the financial-market stress was triggered by a health crisis.

No Smoking Gun

“Often you need an obvious smoking gun to make significant reforms, and it’s not at that threshold for the non-banks,” said Capital Alpha Partners analyst Ian Katz.
Much will depend on the results of the November U.S. election. A clean sweep by Democrats would increase the chances of far-reaching reforms, including the passage of legislation in the mode of the 2010 Dodd-Frank Act, which imposed new guardrails on banks but largely left shadow lenders unscathed.

“We need a new Dodd-Frank,” said former Fed Chair Janet Yellen, who cited leveraged hedge funds, high yield and other investment vehicles that buy less liquid assets, and money market funds as areas of concern.

The Brookings Institution fellow called for strengthening the Financial Stability Oversight Council -- an umbrella group of U.S. regulators led by the Treasury Secretary -- so that it can ride herd on the non-banks. Private equity firms also could be in the crosshairs if the Democrats win big in November. Led by Massachusetts Senator Elizabeth Warren, progressives argue that such firms damage workers and the economy.

‘Key Driver’

Global regulators contend that it’s shadow banks where the stresses showed up in March, with hedge funds dumping U.S. Treasury securities and bank loan funds and some money market funds hemorrhaging deposits. That led to wild swings in asset prices, forcing central banks to pump liquidity into markets.

In its annual economic report, the Bank for International Settlements said a rapid unwinding of so-called basis trades by hedge funds was “a key driver” of the turmoil -- something the funds dispute. The transactions involved buying Treasury securities using leverage via repurchase pacts while simultaneously selling futures contracts.

The tumult highlighted the vulnerabilities of non-banks, Fed Vice Chairman for Supervision Randal Quarles wrote in a July 14 letter to central bank chiefs and finance ministers of leading nations. As head of the Financial Stability Board, he’s promised to deliver a report on the mayhem to leaders of the Group of 20 nations by November.
Quarles’ aim is ambitious. He wants to develop an overall framework for regulation of non-traditional lenders, rather than focusing on piecemeal reforms. And he recognizes that template can’t simply be a replica of that already applied to banks.

Sufficient Liquidity

Whereas the thrust of the reform effort coming out of the 2008 financial crisis was on building bank capital, the emphasis this time may be on liquidity, to ensure that shadow banks have sufficient cash to ride out market squalls, rather than intensify them.

Whether the scrutiny of non-banks leads to new U.S. legislation -- as Yellen advises -- remains an open question. Regulators typically need lawmakers’ backing to stretch their oversight into new areas, but bills have been exceedingly difficult to get through a gridlocked Congress.

Dallas Fed President Robert Kaplan told Bloomberg Television and Radio on Monday that the market turbulence earlier this year merited further study.

“There was a substantial amount of leverage, whether people were leveraging Treasuries as part of risk parity trades or other strategies,” he said. “The Fed needs to be cognizant how financial stability concerns are sometimes hard to see.”

Michael Pedroni, an executive vice president at the Managed Funds Association, which represents hedge funds, said that the unwinding of basis trades was “dwarfed” by foreign central bank selling of Treasuries. He added that evidence indicates hedge funds continued providing liquidity, even as banks pulled back.

A July 16 study by analysts at the Treasury’s Office of Financial Research cast doubt on the argument that Treasury market illiquidity was amplified by the closing of basis trades, though it also said the high leverage involved in such deals remained “a cause for concern.”

‘Not Helpful’

The shakeout has also thrown a spotlight on prime money market funds, especially those catering to institutional investors, which suffered big outflows in March. In the wake of turmoil, Fidelity Investments announced plans to drop its two prime institutional money funds.

In a May 27 presentation to a Securities and Exchange Commission’s advisory committee, Investment Company Institute Chief Economist Sean Collins emphasized that many market participants were hit hard by coronavirus.

“The focus on a narrow aspect of the financial markets is not really helpful,” Collins, whose group represents mutual fund companies, said in an interview.

The U.S. concerns echo long-running fears in Europe that shadow banks are a threat to financial stability. European Central Bank officials have highlighted the issue for years in speeches and in their Financial Stability Reviews. Bank of England Deputy Governor Jon Cunliffe said in June that money market funds were a a source of “vulnerability” in the financial system at the height of the coronavirus crisis that demands closer scrutiny.

— With assistance by Michael McKee

China’s Great Wall of Water

With water levels rising and the Three Gorges Dam reservoir reaching capacity, China has assumed a war footing in preparation for a potentially catastrophic flooding crisis in the Yangtze River Basin. Though its flood-control systems most likely won't fail completely, the mere possibility that they could is a wake-up call.

Giulio Boccaletti

boccaletti6_XinhuaDu Huaju via Getty Images_threegorgesdamchinariver

LONDON – The East Asian monsoon is pummeling China this summer. As of late July, flood alerts had been issued for 433 rivers, thousands of homes and businesses had been destroyed, and millions of people were on the verge of becoming homeless. The water level of Poyang Lake, China’s largest freshwater lake, has risen to a record-breaking 22.6 meters (74 feet), prompting authorities in the eastern province of Jiangxi (population: 45 million) to issue “wartime” measures. Chinese citizens have not been threatened with devastation on this scale in more than 20 years, and this is likely just the beginning.

From Latin America’s lost decade in the 1980s to the more recent Greek crisis, there are plenty of painful reminders of what happens when countries cannot service their debts. A global debt crisis today would likely push millions of people into unemployment and fuel instability and violence around the world.

Destructive floods are not new to China, which has been reckoning with its powerful rivers for thousands of years. Historically, political stability has often depended on governments’ ability to tame them. The last time China was crippled by catastrophic floods, in 1998, more than 3,000 people died, 15 million were left homeless, and economic losses reached $24 billion.

Reflecting the floods’ political importance, the Chinese government rushed to implement new measures – from infrastructure investment to land-use reforms – to prevent such a disaster from recurring.

China has since emerged as the world’s second-largest economy, owing to its pursuit of modernization and advanced industrialization. One of the principal factors in its success has been its extraordinary stock of river infrastructure. Over the last 20 years, China’s river systems have been manipulated in unprecedented ways not only to avoid a repeat of 1998, but also to generate enough hydropower to sustain industrialization. As a result, water flowing in the Yangtze River today encounters a globally unprecedented cascade of dams and infrastructure.

The crown jewel of this system is the Three Gorges Dam – the largest in the world – which is designed precisely to smooth the impact of a peak flood. In 2010, an unusually strong La Niña cycle in the eastern Pacific subjected the newly commissioned dam to its first big test. In July of that year, its reservoir accommodated an onrush of 70,000 cubic meters of water per second. The reservoir’s water level rose by four meters, but it held, averting a disaster. The message was that China could now sleep soundly in the belief that the Yangtze had been tamed.

But water management is always provisional, because the risks are never eliminated. The reservoir behind the Three Gorges Dam is once again dangerously full, and the government has mobilized the military to reinforce levees that stand as the last line of defense for communities and businesses downstream. Although the Yangtze’s flood-control systems are unlikely to fail completely, Chinese officials are rightly worried. Beyond the immediate physical effects, a significant failure would have severe, far-reaching political consequences.

An edifying historical parallel to China’s current situation is the Great Mississippi Flood of 1927, the worst in US history. Following months of heavy rains that began in the summer of 1926, the Mississippi River’s tributaries had reached capacity, and the levees broke. Water inundated 27,000 square miles (70,000 square kilometers) of land, displacing 700,000 people.

The flood struck a country that, like China today, had developed an unshakeable faith in its ability to control nature.

Beyond the immediate devastation, the Great Mississippi Flood had three long-lasting effects. First, it demonstrated that river control is an illusion; rivers can be managed, but never totally controlled. Investments in expensive fixed assets like dams must be accompanied by a thoughtful approach to managing a live river system. Cement cannot be the only tool. Floodplains, insurance, and land-use policies also have an important role to play.

Second, successful flood management requires that all local stakeholders’ voices be heard. Almost a century after the Great Mississippi Flood, US officials still conduct boat trips and listening tours through communities on the lower Mississippi. In this exercise of real-time democracy, even the most powerful institutions are obligated by statute to hear, acknowledge, and consider local concerns.

Finally, the flood generated enormous political energy just when the global balance of power was shifting. The British Empire, the largest economy in the world, was in the throes of a fiscal crisis, whereas the United States had grown to become an economic powerhouse. America was increasingly becoming the world’s leading producer of grains, which meant that its farms and factories were at the root of its economic success.

The immediate response to the crisis was led by then-Secretary of Commerce Herbert Hoover, who enjoyed broad support (owing in no small measure to his own propaganda efforts). A year later, Hoover parlayed this support into clinching the Republican nomination for the presidency, which he went on to win.

But, in the meantime, fierce discontent among farmers in the lower Mississippi basin grew more intense following a drought in the Great Plains. This political ferment unleashed a wave of populism and protectionism that culminated in the infamous 1930 Smoot-Hawley Tariff Act, designed to shield US agricultural products.

The implementation of the tariff quickly spiraled into one of the most destructive trade wars of the twentieth century, deepening the Great Depression even further. The effects of the Mississippi flood were internationalized along the trade routes of the global economy.

It is far from clear how things will play out in China. As Chinese officials navigate the crisis, even a near-miss should prompt a reconsideration of their current approach to water-resources management. The lessons of the twentieth century are clear. Rivers can be managed, but they are not amenable to control, and they are sure to grow more unwieldy as a result of climate change.

The rest of the world should pay close attention to what is happening in the Yangtze River Basin. Riparian crises have a proven tendency to fuel social tensions and political instability. And the impact of a truly catastrophic flood in China would not affect that country alone.

Giulio Boccaletti is Chief Strategy Officer and Global Ambassador of Water at The Nature Conservancy.

Central banks scale back dollar lending operation as demand drops

Use of swap lines declines as financial system recovers from coronavirus panic

Martin Arnold in Frankfurt and Eva Szalay in London

An employee wearing protective gloves counts US banknotes at a currency exchange in Jakarta, Indonesia. Global demand for dollars has eased off.
Demand for US dollars has declined as strains in the global financial system have eased © Bloomberg

Four of the world’s leading central banks have further scaled back the US dollar liquidity they offer via emergency swap lines with the Federal Reserve, in the latest illustration of the global financial system’s recovery from the market panic caused by coronavirus earlier this year.

The European Central Bank, the Bank of England, the Bank of Japan and the Swiss National Bank said on Thursday that they would offer short-term dollar funding via the Fed’s swap lines only once a week, instead of three times, because of “continuing improvements in US dollar funding conditions and the low demand” at recent auctions.

This is the second time central banks have scaled back their efforts to channel dollars cheaply into their domestic economies. In June they cut back the auctions from every day to three times a week.

“The decision is a signal of the success of these operations,” said Kamakshya Trivedi, a currency strategist at Goldman Sachs in London.

The US central bank reinstated the swap lines in March for the first time since the financial crisis, after global demand for the greenback surged in the early stage of the pandemic and sent the currency’s exchange rate surging. To soothe the markets, the Fed provided overseas central banks with dollars directly in exchange for their local currency.

The intervention played an important role in slowing the surge in the dollar’s exchange rate and easing the sell-off in equity markets.

Line chart of Outstanding loans via US Federal Reserve dollar swap lines, $bn showing Demand for dollars has fallen

Since its peak in March the dollar has fallen about 12 per cent against a trade-weighted basket of currencies, according to Bloomberg, and it has slumped to its weakest level since 2018 against the euro.

“The mere existence of precautionary liquidity arrangements has a calming effect on investors,” said ECB executive directors Fabio Panetta and Isabel Schnabel in a blogpost earlier this week. “This measure eventually improved market sentiment, resulting in a considerable drop in the costs of US dollar funding.”

As the strains in the global financial system have eased, demand for US dollars has fallen. The total value of swap line loans outstanding from the Fed has dropped from a peak of $449bn in May to below $100bn — mostly lent to the Bank of Japan.

The ECB had no bidders for six of the nine short-term dollar liquidity operations it has conducted since the start of this month. The Bank of England has not had any outstanding loans from the Fed’s facility for almost a month.

Mr Trivedi said the cost of accessing short-term dollar funding had normalised in both emerging and developed economies, making it likely that the use of the facility would be tapered further in the coming months.

The central banks said they would continue with their weekly offers of US dollar liquidity with 84-day maturity. They added that they “stand ready to readjust the provision of US dollar liquidity as warranted by market conditions”.