The History of the Eurodollar Market in the 1960s

Written by admin on May 18th, 2011

THE HISTORY OF THE EURODOLLAR MARKET IN THE 1960s

(A CHRONOLOGICAL ACCOUNT)

Introduction

The Euro-dollar market* was in fact, and is indeed today, an international wholesale market in money, involving Euro-sterling and other national currencies such as Swiss franc and to a lesser degree the other major European currencies. This paper will briefly outline in a chronological order how the Euro-dollar market developed during the first five years of the 1960s. As these markets had one thing in common, the fact that they existed in centres foreign to the natural habitat of the currency concerned. US restrictions, such as Regulation Q of the Federal Reserve System limited the rates that may be paid to depositors, whether domestic or overseas, primarily in order to protect the great number of small US banks that constituted the American banking system. Hence, a banking business developed, involving borrowing and lending and, the evolution of an investment medium, in currencies outside the territory in which the currency is ordinarily regarded as domestic currency. This tended to produce a wider spread between the rate paid to overseas depositors and the rate charged to overseas lenders than was the case in London and certain other major centres.

For the second Labour government from 1966-1970, Labour’s taxation policy was important both for economic management and political strategy. This paper will briefly outline in a chronological order how the Euro-dollar market progressed during the second era of the 1960s. The UK position in the late 1960s required increases in financial capital (namely the Euro-dollar market) along with the restraint of domestic consumption. Business organisations had to be given incentives to borrow on the Euro-dollar market. Both the actual incidence of business taxation and its political impact, were going to play a part in Labour’s tax strategy. The environment of this strategy was shaped by a number of factors. The mid-1960s saw fresh hopes for the second Labour government to ending the UK’s chronic deficit in its balance of payments, which looked to be almost in balance. However, the late sixties also saw large amounts of the country’s reserves, being spent in order to defend Sterling. Euro-dollars proved to be a solution. However, the other side was how vigorously the business interest was going to respond to taxes levied against it. In the late 1940s-50s, it was criticised for being too defensive in its posture: “the attitude of industry, when EPT (Excess Profits Tax) was raised to 100% had been weak. Industrialists previously appeared to be unwilling on political grounds to fight for what they knew to be right” . However, both the Labour government and private industry were to some extent uncertain in their analysis of tax questions, and some of the issues involved in developing long-term business taxation received legislative enactment under Harold Wilson’s first government in 1965 .

1961 – “Introducing” the Euro-dollar Market

One can only guess at the amount of Euro-dollars and Euro-sterling outstanding between lenders and borrowers and, though the guesses of financial journalists have varied considerably, all of them fall in the range of billion to billion. Due to this and other market reports, it was clear that before 1961, the Euro-dollar market was well established in that not only were there large number of buyers and sellers, but that large sums could be transferred easily and without big changes in rates. Turnover in this, as in all the Euro-currency markets, was probably very big. It was also suggested that Euro-dollars constituted 90% of all Euro-currency, Euro-sterling another 5%, and all other Euro-currencies combined the remaining 5%. It was not clear as to the amount of Euro-sterling outstanding, but its turnover in the Paris market in 1961 had been estimated to have reached £10m a day at times .

The rate of expansion in the Euro-dollar market was due to two main factors: Firstly, the continuing balance of payments deficit of the USA which had put into international circulation a steadily increasing volume of dollars seeking the most profitable form of use. Secondly, the banning by the German and Swiss authorities of the payment of interest on foreign-owned balances which had caused holders of marks and Swiss francs to hawk their balances around the international money places with a view to earning any interest that can be obtained there. (The French also, followed the German and Swiss example).

This situation led to the development that depositors were able to find centres which offered a higher return, than offered at home. Also, borrowers were able to raise funds in this currency more cheaply than they would be able to do by going to the country of origin of the currency concerned or in their own currency. It was natural enough that London banks – and merchant banks in particular – with their expertise and international connections, participated actively in this business; since London was thought to be the largest market in Euro-dollars. The total of London’s liabilities in all currencies to non-sterling was a depositors was around the £1 billion mark in 1961, and after allowing for double counting it was not unreasonable to suggest that London accounted for well over half of the real total . However what was significant was the number of banking institutions in London that have been most active in the Euro-dollar markets which have increased their business enormously since the end of 1958.

The Public Archives shows that four groups of banks increased their deposits by £884m or 80% between the end of December 1958 and the end of March 1961. At the same time their overseas lending increased by £479m and their loans to UK local authorities by £119m in each case nearly a three-fold increase. Euro-dollar transactions was also reflected in changes in the net spot position of UK Authorised Dealers (these was unpublished). A net liability here can be taken as an indication of the extent to which Dealers have switched Euro-dollars, and to a lesser extent other currencies, into sterling.

The movements of highly volatile Euro-currency must make for closer integration of the world’s main money markets. This must tend to make domestic money market rates in different centres more nearly equal than they would be in the absence of Euro-currency markets. Movements of Euro-currency was certainly a significant factor in the determination of forward rates. Differences in Euro-currency rates can induce big movements of short-term funds and have to be considered jointly with interest differentials on Treasury Bills as main determinants of the size and direction of the international flow of short-term capital. So far this did not seem to have had any significant effect on the balances of payments either of the UK or of the US. Euro-currency may be used in ways that monetary authorities regard as desirable. For example, it must have reduced the cost of financing foreign trade – this must have benefited Japan in particular – and it may even have increased trade. On the other hand, it could be used to exaggerate speculative movements of short-term capital and a system cannot be without dangers where funds which was liable to be withdrawn at very short notice was used to finance hire purchase finance companies and local authorities. There were two points that was worth taking into account:

The first considers the view that “short-term capital movements will be bigger than they would otherwise have been” . This statement was true in the sense that a greater number of transactions were taking place and the total of the flows in all directions was greater. The UK tended, however, to be most concerned about the flows into and out of the United Kingdom; it seemed that Euro-sterling transactions did not, in general, add to the influx or withdrawal of sterling. In other words, for example, the fact that transactions were going on in sterling between Frenchmen and Japanese did not exaggerate the large reduction of sterling holdings in the hands of non-sterling countries in the first seven months of this year. It was possible, of course, that the existence of the Euro-sterling market resulted in the lenders holding rather larger amounts of sterling than they would otherwise have done, so that the scope for a withdrawal from sterling may have been increased. On the other hand, the fact the Frenchmen could lend sterling profitably to the Japanese, and possibly for a rather extended period, may have added some element of stability to the Frenchmen’s holding of sterling. The fact was that there was no evidence, however, to confirm either of these hypotheses.

The effect of the UK authorised dealers’ transactions in Euro-dollars was not easy to expound clearly. The limits on the authorised dealers’ operations were that there was a limit on the spot convertible currency assets which any one dealer may hold against future liabilities and furthermore each authorised dealers’ spot and forward commitments must match. Perhaps it is easiest to think in terms of the net spot position of the authorised dealers, which became increasingly minus towards the end of 1960, stayed at about minus £100 million from January to May and later declined somewhat. This minus spot position reflects the switch of Euro-dollars – and other currencies – into sterling. There can be wide variations in the gross liabilities and assets of the authorised dealers, but only the net position affects the reserves, as, each transaction is self-liquidating. Nevertheless, the reserves, reflecting as they do the authorised dealers’ spot but not their forward position, will have

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