The History of the Eurodollar Market in the 1960s
Written by admin on May 18th, 2011This, in fact, covered a large part perhaps as much as 50-75% – of a total Euro-dollar market with an annual turnover now running in excess of ,000 million. While the US move would undoubtedly serve to relieve the strain on the US gold stock, it must, according to The Times newspaper, ultimately be expected to diminish the size of the market in Euro-dollars to some extent. However, dealers in the market recalled the almost negligible effect of the liberalisation of the American Regulation Q, which from 1962 permitted a modest increase in rates paid on foreign deposits. It was pointed out that liquidity among US commercial banks was already running at a high level and that they would probably not be very keen in these circumstances to raise their interest rates further. Therefore, it was felt that any decline in the size of the market in Euro-dollars was likely to be a slow process.
So during the era of 1962, there was a view prevalent in the City of doubts whether there was a long-term future for the Euro-dollar market. This argument for supposing that the Euro-dollar market was a purely temporary phenomenon followed from the view that the market originated because of rigidities in the structure of interest rates in the United States. It was therefore suggested that the Euro-dollar market was born out of the banking legislation limiting the rate of interest American banks pay on foreign deposits. Similarly with Euro-sterling, the interest rates paid by British banks were so low as to encourage foreign holders of sterling to lend it to other non-residents at the higher rates that prevail in the free market outside the UK.
Given this view, the revision to Regulation Q, enabling US banks to raise their rates on foreign deposits, was regarded as the beginning of a movement to allow interest rates to reach their natural levels, which would destroy the Euro-market. This, however, was to take a rather facile view of the workings of the Euro-market. The existence of Regulation Q (or its sterling equivalent) was only a subsidiary reason for the markets continued existence, and that market is likely to flourish so long as the American payments deficit continues to pump dollars into foreign hands. The Euro-dollar market was essentially an international money market and as such was a convenient source of credit for the borrower and a useful and profitable outlet for the lender. The market may well have been born out of interest rate rigidities, but given the apparatus of an international finance market with dealers willing to operate on small margins, the system would not be allowed to rust. As it was always useful to have a ready source of finance available.
Of the more immediate significance was the stimulus given to the market by the American operations in the forward exchange markets. During 1961, in Switzerland and Germany, the dollar stood at a substantial forward discount against Swiss francs and D. marks respectively. By contrasting to buy forward dollars against these currencies, the US authorities attempted (with some success) to lower the dollar discount. In this operation it was fairly certain that they had cleaned-up some loosely held Euro-dollars (mainly from European traders worried about the exchange risk). The effects of this operation was best considered by analysing two distinct positions. Firstly, when the dollar stood at a substantial discount, holders of Euro-dollars i.e. traders, would hardly sell them forward for say D. marks because of the cost involved unless they were really panic-stricken. However, when the US authorities managed to lower the forward discount, such holders would take advantage of this in getting out of dollars and to the extent that this happened there would be a gap in the Euro-dollar market. This outflow from the Euro-market would be more than balanced by inflows from the United States as Regulation Q continues to exist and because European holders of dollars realised, seeing that the US authorities stood ready to correct disorderly forward exchanges, they could convert their dollar holdings into other currencies without great cost. It was this factor which was presumably acting as a stimulus to the market in that Euro-dollar holders can have confidence in the future value of their holdings. Therefore, one of the main features of the American operations has been to encourage the continued holdings of dollars in non-official sectors. The Euro-dollar market was only dangerous to the American balance of payments to the extent that holders sell their dollars to their respective Central Banks who earmark these for gold.
1963 – The growing developments of the Euro-dollar Market
The Euro-dollar market as a whole by 1963, amounted to -5 billion and was tending to grow. At 31st March 1963, there were about billion outstanding in the UK market alone. A world total of dollars and other foreign currencies used in foreign markets was of the order of -6 billion . Euro-money operations were conducted almost entirely by commercial banks although brokers became an important mechanism for organising the markets as the number of participants increased. Central banks and other monetary authorities directly or indirectly owned a large proportion of the dollars dealt with in foreign markets. It had been established that about two-thirds of all funds in European markets was of this character.
The supply of dollars for the Euro-market came from American residents and non-residents. During 1963, it was the non-residents who supplied the vast majority of the dollars, generated by a continuing US balance of payments deficit on current and long-term capital account. The most important suppliers of funds by country were Canada, Western Germany, Italy, Switzerland and France, although other countries had contributed. American residents added to the market (and hence to the overall US payments deficit) by switching short-term funds to European banks in order to take advantage of higher interest rates than could be obtained domestically. In actual fact, most American resident funds reached the Euro-market via Canada, in which the residents switched short-term funds to Canadian banks, which had then placed them into European banks .
The process by which these dollars reached the Euro-market was as follows: As a result of the American deficit, foreigners build-up dollar deposits in American banks on current account. The foreigner could then invest the dollars in any number of ways, but assuming that they would lend the dollars to a European bank, as that bank would be willing to pay a higher interest rate than could be earned in the American short-term money market. The ownership of the deposit is then transferred, within the American bank, to the account of the European bank which is then able to use the funds to lend. When the new owner of the dollar deposit lends to a third party, the European banks account in the American bank is debited and the third partys credited. The whole process is essentially a transfer of the dollar deposits in the American banks between accounts, the deposit never actually leaving the American bank.
As stated previously, official authorities were the most important suppliers of dollars to the market. This was presumably because residents in many countries surrendered (voluntarily or otherwise) dollar earnings to their central authorities which then put the dollars back on to the market in three ways: Firstly, that central banks and monetary authorities provide their respective commercial banks with dollars through swap operations, with a general or specific understanding that these dollars will be used to acquire foreign currency assets. The Deutsche Bundesbank has over the past two years engaged in such operations. Also this operation had occurred in Italy. Secondly, central banks deposit dollars in domestic commercial banks without requiring the surrender of the local currency equivalent. In some cases this is because such deposits earn higher rates than in New York. In Italy, however, this operation was used to increase the liquidity of the banking system. 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. Members of the Bank for International Settlements deposit funds with it and the BIS has become an important intermediary between its members and the Euro-dollar market .
Although precise data was not available, Oscar Altman of the IMF estimates that the central monetary authorities of 20-25 countries have deposited dollars outside the United States . The non-official funds reaching the market represent the funds of commercial banks, largely in continental Europe, and funds of businesses and individuals in many countries including the United States. Corporations in the United States have made substantial time deposits in Canada and Europe in order to earn higher interest rates than can be earned domestically. The funds deposited in Canada were channelled into European banks, (particularly the UK) the Canadian banks acting as intermediaries for US dollars. Businesses and individuals in many other countries, e.g. Canada, Germany and Switzerland, can hold dollars and other foreign currencies without restriction as to time, amount or purpose. Some have themselves deposited funds in the Euro-market, or have placed them with domestic banks which have done so. In a number of industrial countries, where there is a residue of exchange control, as in France, business enterprises can hold dollars and other foreign currencies for limited periods of time through authorised banks.
The dollars emanating from the US current and long-term deficit remain deposited in
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