The History of the Eurodollar Market in the 1960s
Written by admin on May 18th, 2011benefited from the growing switching of Euro-dollars into sterling and will have suffered when this switching was unwound .
1962 – Developments for the demand of US dollars and other currencies
There were considerable statistical difficulties in estimating the size of foreign markets for dollars and other currencies. Hence, any estimate was little better than a guess. Given this qualification, Altman estimated that the market in Europe for dollars, sterling and other currencies as of June 1962 was more than billion. Leading to the assumption that a world total of dollars and other foreign currencies used in foreign markets would be of the order of to billion.
It was estimated that 85% of foreign market operations in foreign currencies during 1962 were conducted in US dollars. Continental European currencies, particularly Swiss francs and deutsche marks were held and used in larger amounts in 1962 than in 1961, but, since operations in dollars were also larger, they did not increase greatly in relative importance. Deposits of Euro-sterling continued to be relatively small. The greater use of continental currencies stems from the smaller forward premium on the dollar which made it possible to pay rates of interest on Swiss franc deposits which were closer to those paid on dollar deposits. This in turn made it possible to obtain and use more Swiss francs in foreign market operations.
Euro-money operations were conducted almost entirely by commercial banks although brokers had become an important mechanism for organising the market as the number of participants has increased. A large proportion of the dollars were dealt with in foreign markets, but a modest proportion of the other currencies, were directly or indirectly owned by central banks and other monetary authorities. Altman estimated that about two-thirds of all funds in European markets in the summer of 1962 were of this character. Official funds reached the money markets in three ways: Firstly, central banks and monetary authorities provide their respective commercial banks with dollar funds through swap operations, with a general or specific understanding that these dollars will be based to acquire foreign currency assets. (The Deutsche Bundesbank had swap transactions to carry out its monetary policy). Secondly, central banks deposit dollars in domestic commercial banks without requiring the surrender of the local currency equivalent (e.g. Italy). Thirdly, central banks in Europe, Latin America, the Middle and Far East deposit dollars with commercial banks in London, Paris, Canada and other money markets. The BIS had become an important intermediary between its members and the Euro-dollar markets .
The funds other than from official sources in the market represented deposits of commercial banks and business enterprises and individuals. Banks and other business enterprises used the major part of the dollars (etc.) in foreign markets, although governments and official agencies used significant amounts. Local authorities in the UK had been important borrowers in the London Euro-dollar market. Most of the funds, however, were used by the private sector. Interest rates on dollar deposits were determined on a highly competitive basis, arrangements being available for depositing any sum for any period up to 18 or 24 months. At any one time in the market there was a range of rates rather than any one unique rate. The effective floor to the rate on Euro-dollar was determined by rates paid by US banks on time deposits and by other comparable short-term investments in the United States. In 1961, the Euro-dollar rate in London averaged 3.58% compared with 2.35% on new issues of US Treasury Bills and 2.80% on prime bankers acceptances. In the first eight months of 1962, the Euro-dollar rate averaged 3.66% compared with 2.76% on new issues of US Treasury bills and 3.02% on bankers acceptances.
The demand for Euro-dollars was obviously determined by their profitable use. Pure interest arbitrage was a factor, though not the major one, in the demand for such funds. Rates on Euro-dollars had been consistently too high to permit covered interest arbitrage in UK Treasury Bills, though not too high for uncovered movements. During periods when confidence in sterling was high, it was possible that Euro-dollars were used to finance the purchase of Treasury Bills. Local authority and finance house deposits had been a profitable outlet for Euro-dollars. On average over the period 1961 and first eight months of 1962, the covered yield on deposits with local authorities, covered forward, was approximately the same as published rates on Euro-dollars. This follows, given that Euro-dollars was an important source of funds to the local authority market, and no arbitrage transactions would tend to even out disparities in rates. These averages, however, suggested that, smaller investment opportunities had in fact existed given the spread of rates on both Euro-dollars and local authority deposits.
For the blue chip industrial and commercial customers, the rates they have had to pay for borrowing funds from the market ranged between 5½ – 5. 7/8% (i.e. prime borrowing rate on the New York market). As the commercial banks were paying between 3½-4½% for three months dollar deposits, their gross interest margin would be in the region of 1-2½%. Euro-dollar operations, however, were not confined to channelling funds to those borrowers who may be entitled to the prime rate in New York with the result that the lending rate is often considerably higher than 5 7/8%. Thus with banks being able to work on margins of 1½ % upwards, the possibility of profitable business was great .
Rates of interest paid on deposits of sterling and other non-dollar currencies were closely related to those paid on Euro-dollars taking into account the cost of forward cover. This again illustrates the integrated form of the foreign currency markets, arbitrage transactions ironing out interest discrepancies. Most of the transactions in Euro-currencies was covered forward although banks may carry open positions for considerable periods. They have been known to carry short positions in particular currencies over a long string of weekends when they expected changes in exchange parities. Loans in dollars and other foreign currencies was listed or regulated in three ways: Firstly, that attempts have been made (e.g. Italy) to increase the rate of interest charged in loans in dollars etc. Secondly, agreements have been made in some countries (e.g. Germany) that loans in foreign currencies should only be made to the foreign trade sector. This, by making an artificial distinction between the domestic and foreign trade sectors in the economy results in a highly unstable situation. Thirdly, in many European countries (e.g. the UK) the competitive effect of foreign currency loans is restricted by exchange or capital control regulations.
The effect of the abandonment of interest ceilings on foreign deposits for US banks was not, it was thought, to have a considerable effect on the Euro-dollar market. It was not clear whether US commercial banks were prepared to raise interest rates selectively to any great extent, and even if they did and funds did flow out of the Euro-market, Euro-dollar rates would be adjusted accordingly.
The growth of the Euro-dollar market raised interesting problems of monetary management for the UK authorities. The short-term money markets of the major industrial countries had become considerably unified and internationalized with the emergence of this market. It was possible for the monetary authorities to use the market as an aid to domestic control by operating in the forward market for dollars, so facilitating commercial bank buying of foreign short-term assets. If it was felt that the domestic short-term market was too liquid, it was possible for the bank, by lowering the forward premium on dollars and pegging it for such transactions, to supply commercial banks with dollars for profitable use abroad and thus reduce their supply of sterling. The Deutsche Bundesbank had great use of the swap technique in its attempt to relieve pressure on the domestic market.
On the other hand, the Euro-dollar market imposed certain limitations on domestic policy. It was one thing to encourage banks to supplement their domestic assets with foreign assets, it was another to reverse the process. A tight money policy, by raising short-rates, attracts Euro-funds thus helping to defeat the object of control. Of course given exchange control in the UK arbitrage was not perfect but nevertheless there were considerable pressures which appeared when the UKs short-rates moved out of line with those prevailing in other centres. A very strong reason for the control of Local Authority short-term borrowing stems from the use by that market of Euro-dollars when domestic funds were in short supply. Apart from a fool-proof exchange control, the only way to regulate the flow of Euro-dollars into the UK was for the official authorities to have control over all significant short-term interest rates.
The Times on the 13/09/1962 quoted that: the bill to remove the ceiling on interest rates paid by US commercial banks on certain dollar deposits from abroad has now passed the House of Representatives. This is bound to raise fresh doubts about the future of the market in Euro-dollars . If passed by Congress, the Bill would remove the Federal Reserve Boards present ceiling, which ranges up to 4% according to the size of the deposit, on interest rates paid on time deposits of foreign governments, their central banks or other monetary authorities, and international institutions of which the US is a member.
Tags: 1960s, american banking, amount, attraction, bank, borrower, business organisations, business taxation, capital, chronological account, Concern, course, cover, deficit, Demand, deposit, dollar market, domestic consumption, domestic currency, euro dollar, euro dollar market history, Euro-deposits, Eurodollar, eurodollar market, eurodollar market history, eurodollar market history tax, european currencies, exchange, exchange rate, federal reserve system, finance, government, history, history eurodollar market federal reserve, house, how big is the eurodollar market, interest, inthe, investment medium, labour government, limit, logo, market, national currencies, need, origin of eurodollar market in london, place, political impact, resident, shell climate change usa, shell oil future, shell oil reserves, shell pension investment jobs, shell profits, shell recruitment accounting or commercial or finance or hr or management or pension or investment or procurement or supply or support, spot, sterling, swiss franc, tax strategy, taxation policy, the history of the eurodollar market in the 1960s, time, turn, uk position, wholesale market
