Worried about the weaponization of "dollar swaps," European officials discuss preparing for the "worst-case scenario": building their own dollar reserve pool

European financial stability officials are discussing the possibility of reducing dependence on the U.S. financial system by pooling dollars held by non-U.S. central banks.

On November 13, according to media reports citing five informed sources, European financial stability officials are considering whether to establish a plan to integrate dollar reserves held by central banks outside the U.S. to create an alternative funding support mechanism to the Federal Reserve, in order to reduce reliance on the U.S. under the Trump administration.

The Federal Reserve's funding support mechanism refers to providing dollar loans to other central banks, acting as a lifeline during market pressures to ensure global financial stability.

Media reports citing interviews with a dozen officials from the European Central Bank and regulatory agencies indicate that they are concerned that these mechanisms could be weaponized by the Trump administration. Two of the individuals stated that concerns peaked in April of this year when tariff threats proposed by Trump shook the global financial system.

Wallstreetcn mentioned in June that although Fed officials like Powell vigorously defend the value of swap agreements, the real concern lies after Powell's departure in May next year.

At that time, will the new Federal Reserve Board tie financial tools deeply to geopolitical issues? It seems that the European Central Bank is still preparing for the "worst-case scenario."

Real Obstacles Facing the Dollar Funding Pool

According to media reports citing some sources, integrating dollar reserves will face practical difficulties and may not be feasible.

Nevertheless, reports indicate that discussions are still ongoing at the working level rather than among high-level decision-makers at the European Central Bank, involving central banks both within and outside the Eurozone. One official stated that some national central banks in the Eurozone are pushing for this plan.

European officials pointed out that while non-U.S. central banks collectively hold hundreds of billions of dollars in cash, this cannot be compared to the Federal Reserve, the issuer of the world's reserve currency, which has "almost bottomless pockets."

They stated that such a dollar reserve pool might be able to address localized, short-term liquidity tightness, but it would be difficult to play a decisive role in widespread market turmoil.

Additionally, any attempt to pool reserves will face dual challenges of logistics and politics.

A senior central bank official noted that even a hint that the Federal Reserve might interrupt swap lines would be enough to trigger significant pressure on the global financial system. In such a scenario, it would be difficult for any central bank to continue providing its dollar reserves to others.

Asian Experience and Other Alternatives

In exploring paths to reduce dependence, European officials are not without precedents to follow. Other countries and regions have attempted to pool resources to enhance financial resilience.

ASEAN, along with China, Hong Kong, Japan, and South Korea, established the "Chiang Mai Initiative," a multilateral currency swap arrangement aimed at providing assistance to member countries, which has grown to $240 billion.

Bank of Japan Governor Kazuo Ueda mentioned this initiative in July when asked about financial risks, emphasizing:

It will be very important to continue trying multi-layered approaches like swap lines In addition to the reserve pool plan, European officials are also considering other measures to enhance resilience, including strengthening scrutiny of lending institutions.

According to reports, two executives from the eurozone banking sector stated that enhancing scrutiny of banks requires them to develop plans for obtaining dollars in other markets such as Asia and the Middle East, and to stress test these plans.

The report cites an official involved in the discussions, stating that the issue of how to build resilience without relying on the United States is raised at every central bank meeting.

Secondary Concerns but Worst-Case Scenarios Must Be Considered

During periods of market pressure, demand for dollars often surges, and shortages can exacerbate problems. The Federal Reserve's tools not only help alleviate this issue but also serve broader U.S. interests.

Wallstreetcn previously mentioned that on March 27, a Deutsche Bank report pointed out that the Federal Reserve's dollar swap lines are a key tool for maintaining global financial stability, far more influential than tariffs. The dollar swap mechanism controls a foreign exchange swap market worth approximately $97 trillion, equivalent to the total global GDP.

By providing dollars, the Federal Reserve ensures that instability abroad does not escalate into a full-blown financial crisis that could affect the United States. The use of these tools peaked at $449 billion during the COVID-19 pandemic in 2020.

Reports indicate that during a meeting of the European Central Bank's Governing Council a few months ago, Klaas Knot, then President of the Dutch Central Bank and Chair of the Financial Stability Board (FSB), listed reliance on swap lines as one of a series of potential risks.

Although a European Central Bank supervisory official stated that losing swap lines is not a "primary concern," the debate about finding alternatives continues among the European Central Bank and several national central banks to ensure financial stability.

Reports indicate that European officials are genuinely concerned about what will happen after Powell's term ends in May next year, as Trump has indicated he may select the next Federal Reserve Chair by the end of this year.

The report cites another source summarizing that European officials "need to consider the worst-case scenario."