A True Horror Tale

It has long been recognized that a shift of deposits from a domestic banking system to the corresponding Euromarket (say from the United States to the Euro-dollar market) usually results in a net increase in bank liabilities worldwide. This occurs because reserves held against domestic bank liabilities are not diminished by such a transaction, and there are no reserve requirements on Eurodeposits. Hence, existing reserves support the same amount of domestic liabilities as before the transaction. However, new Euromarket liabilities have been created, and world credit availability has been expanded.

To some critics this observation is true but irrelevant, so long as the monetary authorities seek to reach their ultimate economic objectives by influencing the money supply that best represents money used in transactions (usually M1). On this reasoning, Euromarket expansion does not create money, because all Eurocurrency liabilities are time deposits although frequently of very short maturity. Thus, they must be treated exclusively as investments. They can serve the store of value function of money but cannot act as a medium of exchange. [emphasis added]

This right here was the whole movie, the error which set everything else in motion; it was everything which would dictate the course of the following decades. The eurodollar was declared as non-money, therefore no sense in spending any time or effort keeping track. And when they couldn’t even figure out a useful M1 anymore, then fed funds targets was substituted to “reach their ultimate objectives by influencing…”

But in moving past the geographical boundary, the actual offshore system hadn’t become less money-like, it had transformed the very idea of money itself. That, more than anything, had been the crucial error, the villain’s pathos spun in motion long before the events of our current story had begun. The very one which removed central banking from the central bank model which followed.

Eurodollar University’s Making Sense; Episode 32; Part 1: Oh, *Now* They’re Interested

And it was one that others at the time had warned authorities not to make (there’s always the hard-edged, wise character who appears and just spells it out for the central characters to laugh their way past only to regret in later scenes). In some places, like the paper from Dufey and Giddy I referenced last week, it was listed right out there for them in painful, gory detail.

Here’s the counterpoint made by Dufey and Giddy while they were actually cataloging the proliferation of products not all that long after it had occurred:

…the general principle is that the currency of denomination of an asset can be “converted” by contractually selling the future cashflows from that asset for another currency. Similarly, the currency denomination of a liability may be altered by contractually purchasing the foreign currency necessary to liquidate that obligation. The remarkable feature of this use of forward contracts in the Eurocurrency market, for example, is that it enables banks to offer deposits or loans in any currency for which there is a forward exchange market, even if no external money market exists in that currency. The result is that the Eurodollar is the only full-fledged external money in existence; other Eurocurrencies are often simply Eurodollars linked to forward exchange contracts.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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