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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Who owns eurodollars?Who owns eurodollars? Eurodollar holders are persons, partnerships, and corporations who seek good interest rate returns in highly liquid investments in a strong currency, and appreciate the anonymity and, in many cases, the freedom from income taxes, available through dollar deposits in banks outside the United States. These can be U.S. banks foreign offices and agencies, oras in the greatest volume of depositsthey can be any other nationality of bank. What is the interest rate on eurodollars? Eurodollar interest rates, being rates on bank deposits, are naturally higher than U.S. Treasury bill rates. How much higher they are on any given day depends on how global investors see the two risks that together set eurodollar rates: (1) the risk for the value of the dollar itself as against key foreign currencies, and (2) the risk that a major global bank will be unable to meet demands for withdrawal of its eurodollar deposits. The Federal Reserve has great influence and control over U.S. Treasury bill rates, but the Fed has no direct influence or control over eurodollar rates. The global rate for eurodollar deposits is virtually set out of London each day when the London InterBank Offered Rate (LIBOR) is quotedthe rate set for large banks eurodollar deposits with one another. However, it trades widely around that rate when the market becomes unstable. In the past five years, the spread has ranged from a low of 20 basis points 0.2 percent) to a high of 120 basis points (1.2 percent). That yield spread is called the TED spread (T for Treasury bill, and ED for eurodollars). It was for decades one of the most important financial data in the world, as will be discussed shortly. Eurodollars started multiplying in their billions when the U.S. Current Account regularly went into deficit in the late 1960s. (The deficit became perpetual after 1981 and has risen steadily, except for the brief period during the Gulf War when the United States received huge subsidies from its allies.) Because the Current Account includes the balance of trade, including tourism, and the balance of short-term interest payments, it is the best measure of short-term capital flows. Why Did the Current Account Go into Deficit and Stay There? Initially, economists tended to blame it on the Vietnam War, which put extra inflationary pressures on the U.S. economy, making U.S. manufacturers less competitive. But the United States has run trade and Current Account deficits nearly full-time since the 1950s, though the outflow has been far more severe since the Vietnam War. Ironically, it was another war that gave the United States its only big Current Account surplus. During the Gulf War, Germany, Japan, and the Gulf states paid most of the costs. In effect, the U.S. military became modern Hessiansan army paid by foreigners. The real reason for the imbalance was the revival of Europe and Japan as formidable trade competitors, and a long decay in American industrial productivity. Americans acquired a liking for such foreign-produced products as Japanese cars and electronics, German cars and machinery, French wines and fashions, and Italian wines and clothing. When a German automobile manufacturer sold a car to an American, dollars flowed abroad. The German could cash them in at the bank for deutschemarks (and they would probably end up on the books of the Bundesbank), or use them to buy a factory in the United States, or hold them as U.S. cash in a eurodollar account. It was convenient for many of those exporters who acquired dollars to keep some of them, rather than trading them in at their bank for deutschemarks, francs, pounds, or yen. Eurodollar accounts were exempt from almost every kind of controland the biggest growth came in places with low or nonexistent income taxes, such as Switzerland, Hong Kong, the Cayman Islands, and the Channel Islands. For many decades after World War II, businesspeople in most countries faced exchange controls on using their own currencies abroad. Eurodollar accounts were useful caches to pay for international purchases, or corporate acquisitions, or just to have available to cover foreign travel for corporate executives. Eurodollars are the Rodney Dangerfield of financial economics. They get almost no respect from financial economists. Statistics on them have always been hard to obtain, and they remain elusive even when the global financial system depends on them for survival. Doing research for this book, one of the most comprehensive books on eurodollars we found was published by a very smart analyst, Jane Sneddon Little, a remarkable 28 years ago: Euro-dollars: The Money Market Gypsies (New York: Harper & Row, 1975). Her book begins well: A latter-day specter is haunting Europehaunting the entire world, in fact. That specter is the vision of $100 billion on the loose in the Eurodollar market, free to rush with next to no restraint from one nation to another, scattering well-ordered government policies and exchange-rate systems in its path. Not even the wealthiest nations in the world have been able to protect their economies from the meddling of this phantom. . . One reason that the Eurodollar market appears formidable to central bankers is its extraordinary freedom from regulation. As a market for dollar balance deposited outside of the United States, it is a truly international creature beyond the control of any single national authority. . . . It now reaches $100 billion and produces huge monetary waves, which can flood into national economies or drain them with a powerful undertow . . . Ms. Little deserves some sort of award for having analyzed the way eurodollars were changing the worlds financial markets while economists were still (and still mostly are) focusing only on monetary aggregates compiled by the Federal Reserve. Her prescience is impressive. Just add zeros to her data and youll have a useful analysis of the system in every year since she published her book. Today, eurodollars are measured in trillions. They are still, to use her term, gypsies. What made the eurodollar supply multiply exponentially from that $100 billion level was the sudden wealth of the oil-exporting nations after the two 1970s oil shocks. Countries such as Saudi Arabia, Iraq, Iran, and Abu Dhabi found themselves awash in dollars, because oil was dollardenominated. Their own Third World economies were unable to absorb and use most of this cornucopia, so, after buying planes, guns, palaces, baubles and bangles, the rulers invested it abroad. Few of them were financially sophisticated, so they bought obvious investments, such as government bonds and Treasury bills. But they also deposited tens of billions of dollars into global banks. Leading banks, such as Deutsche Bank, Chase Manhattan, and First National City Bank, found themselves with an embarrassment of riches, as they were deluged with a flood of what became known as petrodollars. Money supply growth in the industrial world was rapid in the 1970s far too rapid to slow the rise of inflation. That meant, however, that the banking system had enough domestically generated liquidity to meet loan demandmost of which was coming from the New Economy borrowers oil, gas, mining, forestry, and agriculture. By the late 1970s, eurodollars had become the most liquid and flexible liquidity source in the world. London became the center of the eurodollar market (and the new euromarket in other offshore currency deposits, including markets in all major currencies). By 1978 there already was insufficient demand from credit-worthy borrowers in the industrial world to absorb the inflow of petrodollars. Then came the fall of the shah of Iran, and a redoubling of oil prices. What had been a somewhat unmanageable flow of dollars into the banks became an unimaginable flow. Yes, the banks could have declined to take all the petrodollars offered, based on an inability to find clients to borrow such mind-boggling sums. Had they done that, the history of the world would have been very different. For one thing, there would have been no crash in 1987. Instead, bankers found a new class of borrowers with nearly unlimited demands for loans to balance their supplies from a new class of major depositors who were lavishing them with a nearly unlimited supply of funds. It seemed a stroke of genius: Since previously unimportant Third World countries were now the worlds biggest bank depositors, why not lend the funds to previously unimportant Third World borrowers? Some of these new borrowers were struggling democracies, but many (or most) were dictatorships and kleptocracies. Politics were irrelevant. Bankers fell over one another trying to get the nod to be lead bank in syndicates arranging massive deals for such sterling borrowers as the Congo, Sudan, and North Korea. Why were capitalist banks willing to bet their very existence by making hundreds of billions of dollars in loans to countries with primitive economic structures? A new theory had emerged to meet the new needs of new times. Citibanks Walter Wriston, the most publicized of the new breed of swashbuckling eurolenders, in explaining why country loans were a better deal for banks than corporate loans, announced a bankers epiphany: No country has ever gone bankrupt. On that rationale, banking syndicates made gigantic loans to countries previously notable in international trade mainly for sales of postage stamps and purchases of armaments. Lending to them was the kind of aggressive lending you had to do if you wanted to be in the big leagues. By the late 1970s, billions of petrodollars were being recycled (another splendidly convenient new term) to almost any nation or nationette that qualified for membership in the UN General Assembly, and many who didnt meet even that minimal test. Another colorful (but unpublicized) term emerged to cover the explosion of global banking syndications: the Secretary Loan. The Secretary Loan was the participation limit in a new banking syndicate loan offered over the Teleprinter that a secretary in a bank in places such as London, Zurich, Frankfurt, Geneva, Luxembourg, or Hong Kong could agree to while her boss was out having a three-martini lunch. (Yes, back then they actually did have three-martini lunches. Nowadays, we are given to understand, global financierslunch breaks involve workouts in the gym, followed by drinks of designer water.) When dealing with dictators, it wasnt considered smart to press them on what they would do with the petrodollars you were advancing. As an example of salutary neglect in asking tough questions, consider what happened after North Korea got a huge loan from a syndicate headed by a major Canadian bank. Canadian newspapers began carrying a series of full-page advertisements (usually in the business section, where ads cost most), in which North Koreas Stalinist leader published very long answers to long questions about Marxist theory raised by Communists abroad. This kind of dense intraparty dialogue had been filling pages in Pravda and its kind for decades. It was a first to have such long-winded Marxist musings published in expensive ads in capitalist newspapers financed by loans from capitalist banks. By 1980, Wriston and his colleagues were shockedshocked!to discover soaring default rates on their eurodollar loans to Third World borrowers. To make matters worse, critics were showing the insensitivity to question the way the borrowers had actually spent those hundreds of billions of dollars. In too many cases, the critics alleged, little or none of the money was used productively to help their struggling economies and impoverished citizens. This unpleasant turn of events came at an extremely inconvenient time for Walter Wriston, David Rockefeller, and other globetrotting petrodollar pushers. The Iranian revolution had once again sent oil prices skyrocketing, triggering a worldwide recession in the oil-consuming economies. And the determined Paul Volcker was sticking to his pledge to impose Friedmanesque monetarism on the U.S. financial system. This restraint was proving to be an ever-tightening tourniquet on the big banks with big portfolios of bad loans. Enter the TED spread. |
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