Photo Credit: Tima Miroshnichenko

In this article, I want to share my initial exploration of the Eurodollar market. To achieve this goal, I want to start with a book edited by Paolo Savona and George Sutija. The title of the book is Eurodollars and International Banking.

The book was published in 1985, twenty-three years prior to the collapse of the housing market in 2008. Considering the date of publication, I leave judgment to the reader as to the relevance of the message of the book.

What I intend to do at this point is to impart the preliminary topics covered in the first paper. However, by doing this, I will not follow the outline given by the contributor, Rene P. Higonnet. Instead, I will restructure his content as I see fit. As such, in this post, I plan to cover the following subjects by using my typical strategy, that is, by asking questions:

• How did the Eurodollar market originate?
• What are the distinguishing characteristics of the Eurodollar market?
• How does Higonnet see the problem in the Eurodollar market?
• What is his proposed solution? In your own opinion, will such a solution really work?
• What lessons can we learn from the Eurodollar market that is relevant to cryptocurrency?

Introduction

Before we proceed to answer the first question, allow me to first provide the background that prompted me to study this subject and also give general information about the book and the paper that serves as the basis of this article.

Unlike economics, somehow, I gain familiarity with the concepts and terminology after more or less a decade of study. However, in the case of the Eurodollar market, this is actually my first attempt to explore this subject. If this disqualifies me to present credible information, again I just want to leave the final say to the reader.

2008 Housing Crisis as Blessing in Disguise

For more or less two to three months now, I have been intrigued by the idea that the monetary system adopted by cryptocurrency did not start after the collapse of the housing market in 2008. Yes, Bitcoin as commonly perceived has been introduced during that time due to widespread distrust among authorities, particularly government and rating agencies. They cannot be trusted when it comes to giving investors reliable investment instruments. At the end of the day, in the midst of all the economic and financial troubles they caused in the first place, all they can do is shift the blame to the free market and libertarianism and pass the financial burden to taxpayers.

Nevertheless, the idea remains that the kind of system adopted in the crypto space is something old that can be traced to 1957, twelve years after World War 2 as pioneered by the Eurodollar market. If this is the case, how come the majority of the people remain clueless about such a significant event that can influence the economic and financial situations of nations all over the world? If not for the 2008 Great Recession, we will remain in the dark about how this system works. Praise be to the Governor of human history that in His wisdom and providence, he allows such a crisis to bring to the attention of many the kind of system that has the power to liberate people from the control of national authorities.

Introducing the Book and the First Paper

If it is really accurate that such a system has been pioneered in the Eurodollar market, it is therefore very important to see how this system works in Eurocurrencies to provide us a background to better understand cryptocurrencies.

In Eurodollars and International Banking, the contributors explore the nature of this market. For the editors of the book, this “market represents the most astonishing phenomenon in the modern world of finance . . .” (p. 1). The volume confirms that the operation of the Eurocurrencies is really outside the jurisdictions of national governments.

The volume has a total of six papers. In these papers, we can see the insights of international bankers, “the experience of prominent central bank officials,” and the analytical tools presented by academic observers (ibid.). These experts examined “the historical evolution of Eurobanks and Eurodollars,” offered both an economic and policy analyses of the market, and discussed “the impact of international banking facilities” (pp. 1-2).

The focus of the first paper is on “the lending activities of Eurobanks” (p. 43). In order to explore this subject, Rene P. Higonnet adopted an eclectic historical approach to identify both past and present problems. His proposed solution is to come up with an international organization tasked to regulate and supervise the Eurodollar market.

Though Higonnet divided his paper into four parts, I only intend to cover the first two, plus some insights that I consider important.

Not a Banking System?

An initial observation I find interesting is the editors’ description of the Eurodollar market not as “a banking system,” “but rather as an extension” of the banking systems of major countries (ibid.). This is somewhat surprising for the same market has been named elsewhere as either “international banking” or “offshore banking.”

Importance of Eurodollar Market

The Eurodollar market plays a very important role in international finance. Instances of such importance include the size of the market, the financial innovations they created, and its impact “on domestic banking systems, on domestic monetary policies, . . . on inflation, interest rates and the distribution of credit” (ibid.). Due to its influence, the editors believe that “the Eurodollar market will undoubtedly continue to play a major part in the equilibrium and disequilibrium of the financial world in years to come” (ibid.).

Birth and Early Growth of the Eurodollar Market

Now, let us proceed to answer the first question about the origin of the Eurodollar market. Its origin was associated with a certain “Dregasovitch” (p. 27). It was either he himself or the people under him who invented it and he just later took all the credit.

The earlier names of the Eurodollar include “Embark dollars,” “Continental dollars,” or simply “foreign market dollars” (ibid.). “The first Eurodollar business was an $800, 000 loan issued on 28 February 1957 by Moscow Narodny Bank, through a London merchant bank” (ibid.). As such, in that year, “a new and original, international money market in short-term dollars and other currencies emerged in London” (p. 28).

Characteristics of the Eurodollar Market

After having such a rough overview of the origin of the Eurodollar market, let us now shift our attention to the characteristics of this market. I will just present them in bullet points and will provide a brief description of each character except those that are self-explanatory:

• “It is an interbank market with typically large transactions” (p. 30).

In short, “it is a wholesale market,” in which players include “commercial banks, central banks, other financial non-bank institutions, large firms especially transnational companies, and some very wealthy individuals” (ibid.).

• “The market is largely unregulated” (ibid.).

Reserve requirements are not strictly implemented. Consequently, this logically results in the expansion of loans. Transactions are secret and taxes are lax.

• Not a single new bank is involved in this market.

• “The deposits accepted by the Eurobanks are usually dated, although there are escape clauses, 24 hours, seven days, two months, etc.” (p. 31).

I struggle to simplify this character. The only two things that made sense to me have something to do with liability maturity and “time arbitrage” (ibid.). The latter is defined as “deliberate time intermediation . . . i.e. borrowing short and lending long” (ibid.).

• “The Eurodollar market receives funds from everywhere for the purpose of making loans to everywhere” (p. 32). And lastly,

• “Banks heavily involved in the Eurodollar market usually present it, in their publications, in the best possible light” (p. 33).

The Problem in the Eurodollar Market

After dealing with the first two questions, the problem in the Eurodollar market is described by Higonnet first generally and then specifically.

General Description

From the point of view of Higonnet, the Eurodollar market plays a big role in contributing to the current crisis in international finance. He identifies the nature of this problem in at least four ways:

• Lack of accurate information on Eurodollars
• Relaxation of strict banking practices
• Imprudent and unsound banking policies, and
• Evasion of responsibility on the part of central banks

Specific Description

An interesting but alarming admission from Higonnet himself that recognizes the nature of the current problem in international banking is the existence of a significant percentage of questionable assets (p. 16). This he describes as the outcome of nations being “forced to contract further loans” (pp. 16-17). In the mind of Higonnet, such a financial solution is actually like “sending good money after bad.” He is afraid that countries that contracted such loans have no capability or intention to “carry out the policy changes agreed upon” (p. 17).

Despite this situation, only a few of the larger banks both in the US and in the UK “have created substantial loan-loss reserves” (ibid.). What is alarming is that banks that are in fragile condition announce instead “hefty increases in profits and increase dividends” and “the larger the volume of non-performing loans which must be rescheduled,” “the higher the accounting profits” (ibid.).

What I find “fascinating” or perhaps the appropriate word is “disturbing” is that such a loss becomes a source of huge profit. Higonnet describes this situation in more detail:

. . . the more a bank manager must reschedule, the more he is found wanting, the more, however paradoxically, he appears as a financial genius who should remain in office. Whereas those bank managers who do not have to reschedule under duress should, by such standards, be dismissed for failure to bring in these "profits" (pp. 17-18).

For Higonnet, such spurious activities remain due to the absence of supervision. International banks are protected by bank secrecy laws that “prevent domestic banking supervisors from gaining access to complete information” (p. 18). Add to it the fact that policies differ from country to country which makes it difficult for “bank supervisors to monitor the affairs of a bank on a global basis” (ibid.). Still, another problem is that an increasing “number of banks operating in the international markets are headquartered in developing countries where supervisory standards are often laxer than in industrialized countries” (pp. 18-19).

Other details, which we cannot elaborate on further due to the limitation of this article include evasion and vagueness of “parental responsibility” (pp. 24-25), the tension between “legal appearance” and “economic reality” (p. 25), the “roll-over technique” (ibid.), and bailing out the banks (p. 27).

Two relevant quotes describe the nature of the “roll-over technique” and “bailout,” which the Eurodollar market has brought to international finance:

One of the characteristics of our time is that small firms in difficulty are abandoned to the harshness of the law and of the market, whereas large firms are bailed out, even when in much worse shape” (p. 24).

This roll-over technique was initially acclaimed as a path-breaking innovation, the ideal solution for both borrowers and lenders. New loans of this kind went from 5 billion dollars in 1970 to 133 billion dollars in 1981. Only recently has it been more generally perceived that the roll-over technique can be unsound banking (p. 25).

Proposed Solution

The foregoing details of the problem have changed the mind of Higonnet about the Eurodollar market and that is why in order to correct this kind of dangerous situation, he is calling for a stricter form of regulation and supervision of Euro banks. If this solution is not implemented sooner, he foresees “an international banking crisis, through the default of some Eurobanks” (p. 19).

Higonnet is appealing for “reform” in three areas:

• Better accounting practices
• Regulation of foreign lending, and
• Supervision of all offshore banking centers

For Higonnet, adopting his proposed reform does not necessarily mean starting from scratch. He argues that policies already exist, which are long overdue. All that the authorities have to do is to implement them. And he seems to suggest that the responsibility to implement the existing policies depends on an international committee of wise men selected from central bankers, commercial bankers, and economists (p. 43).

Nevertheless, authorities are divided as to the matter of regulation and supervision of the Eurodollar market. Though both camps recognize the important roles of the Eurodollar market in international finance, they disagree among themselves as to the need for an international body to oversee this market.

Conclusion: Lessons from the Eurodollar that is Relevant to Cryptocurrency

Finally, for our last question. What lessons can we learn from the Eurodollar market that is relevant to cryptocurrency? To expand it a little bit. How do you see the importance of cryptocurrency in international finance? In what way is it similar to the Eurodollar market. And in what way is it different?

First, we could say that the players in cryptocurrency who are outside of the jurisdiction of national governments share this character with the Eurodollar market. If such national control of the Eurodollar cannot be implemented after 65 years of its existence, how long do you think will it take for national governments to accomplish such a goal in cryptocurrency?

Second, if the Eurodollar market is really not a banking system, then the idea that is now popular in cryptocurrency that every individual is his own bank is something new and revolutionary.

Third, as to the criteria of the importance of the Eurodollar market in international finance, many if not almost all of them can also be found in cryptocurrency. Yes, in terms of the size of the crypto market, still we could not say that cryptocurrency is making a big impact. However, when it comes to financial innovation and distribution of credit, I think cryptocurrency also possesses these qualities. As to its impact on both national and international banking and monetary policies and inflation, we still have yet to see.

Still another important similarity and distinction that can be said about cryptocurrency in relation to the Eurodollar market is that, unlike the latter that brought stability and volatility to traditional finance, the explosive growth happening in cryptocurrency has the capability to destabilize the world of legacy finance in the short-term, but will bring abundance for many in the long-term.

Finally, the matter of regulation, which is also related to the first point is a hot topic in cryptocurrency now. Cryptocurrency can follow the same path just as the Eurodollar market did. National regulations don’t apply to it.

What I find funny is that even in the Eurodollar market, financial authorities are actually divided on the subject of regulation and supervision. In fact, pro-regulation is in the minority. They still could not impose such strict regulation in more or less a seven-decade market. And here the pro-regulators again come to the cryptocurrency expecting to win their fight. Yes, perhaps cryptocurrency doesn’t have powerful individuals just like what we see in the Eurodollar market, but I think we have the number, and it is growing as we blog.

Grace and peace!

Reference: Paolo Savona and George Sutija, editors. 1985. Eurodollars and International Banking, England: Macmillan Publishers Ltd.

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