What Happened To The Dollars?

I doubt very much that reversal had anything to do with conscious appreciation for convertibility, but deep within the mechanics of money and global liquidity it was certainly there. When I wrote yesterday about liquidity preferences under something like the eurodollar system, it was this that I had in mind; there is no defined mechanism for convertibility in a wholesale system that has banished hard money properties. As such, banking and monetary agents are forced to incorporate a different approach to liability management and prudence (modeled with and on volatility at its core).

It’s a very difficult concept to grasp largely because mainstream economics treats money as if it were still present; even if only as the Federal Reserve’s ability to create liabilities on its own balance sheet. This is the ancient world of the money multiplier.

There was something of that in the eurodollar system, but only in its earliest days where connections between onshore and offshore “dollars” were cumbersome and almost visceral. When Milton Friedman answered eurodollar confusion with some stark accounting in 1971, it was to define the basis of the money multiplication system then at its core. But even at that point, there were already signs that the eurodollar was something even more intangible and, frankly, incredible.

At the FOMC meeting on February 11, 1964, the members were briefed on a paper presented via the BIS about the relatively new (and wondrously unknown) eurodollar and euro-currency market that had really developed only about five or six years before seemingly out of nowhere. The paper overall was positive in tone about offshore currency and banking flung out beyond the discretionary borders of nationalistic central banks, to which several FOMC members voiced their displeasure in “challenging” the “favorable flavor” of the paper’s positive conclusions (the FOMC at the time considered eurodollars to be a part of the “capital outflows”, a primary monetary problem of that age for economists asserting a managerial economic doctrine; that which led, of course, to the Great Inflation not long thereafter).

However positive the BIS paper might have been, it did contain something of a warning, at least in the form of citation about the potential for eurodollars to explore new ground.

The Euro-dollar market is today a substantial source of international credit. It brings many lenders and borrowers together on more favorable terms to both, and therefore more efficiently than would otherwise be the case. Moreover, the impetus towards equalization of money rates which it has given has been useful, not only to individual lenders and borrowers, but in the broader context of international monetary equilibrium. Some observers have stressed certain adverse consequences which the market may have and it would seem that these observations have their element of truth. From the standpoint of official policy, however, it does not seem that the possible dangers of Euro-currency credit are of a different order from those of other movements of short-term funds. Maybe, because of its efficiency, the Euro-currency market has an exceptional potential for expansion which may create a special problem for monetary authorities in the future; but so far this does not seem to have been the case and on the whole it appears clear that the market has served a useful purpose. [emphasis added]

In a prior FOMC discussion, that of March 24, 1962, the Committee again considering the topic of eurodollars and outflows, it was noted that in conversations with dealer banks that London dollar markets were especially advantaged over NYC even when most traditional rate metrics suggested the opposite (in this specific case, the FOMC was discussing T-bill rates in comparison to the forward discount rate on sterling).

Actually, however, comparison based on Treasury bill rates can be misleading because the London money market offers higher rates on certain investments that are, rightly or wrongly, considered by some investors the equivalent of prime investments in New York, especially deposits with local authorities and with finance companies. On a covered basis, these rates still show an advantage of nearly one per cent over investments in the New York money market. Euro-dollar rates in London also are still quoted at 3-1/2 per cent, at least 1/2 per cent higher than returns on prime money market paper in New York.