Global Liquid TX Dynamics, Offshore Dollars - Rise of EuroDollars

By pjain      Published Aug. 29, 2019, 1:39 a.m. in blog Invest   

Dollar as Reserve Currency - Implications

Emerging World Fund Flows = Cycles of Ready access to Cheap Hard Capital - 2008-16, Crony Capitalism

Thanks to the dollar’s role as the international reserve currency, it can also be a boon for global growth, particularly.

For example in early 2020 at height of the Covid-19 Fear, companies around the world drew down credit lines in an effort to hoard dollars, boosting funding costs. The Federal Reserve responded by expanding existing swap lines with major central banks and opening new swap lines with others, while taking additional steps to meet dollar demand.

USD Denominated $11T of Debt is HEAVY and hard to manage

That $11 trillion in debt held outside the US just got an awful lot heavier. Foreign companies and governments who borrowed in dollars are refinancing at higher rates, in a stronger currency. In other words, it’s getting a lot harder.

Should they default on their dollar loans, the problem becomes worse for everybody else as defaulting on a loan destroys currency, shrinking its overall supply. It’s a painful cycle that creates an even stronger dollar.

Exporters manipulate Dollar to be Stronger - Japan, China, Europe, South Korea/Taiwan

Globalization = USD based foolish Importer from all over the world

A weaker dollar is often welcome news for U.S. equities, as it makes exports of U.S. good cheaper to foreign buyers.

Commodities and Gold - prices reduce, more affordable as Dollar Weakens

Conversely,a weaker dollar comes as a relief to emerging markets, where borrowing in dollars has risen in recent years. A weaker buck can also be a positive for commodities that are priced in the monetary unit, making them cheaper to users of other currencies.

A strong global reserve currency is deflationary for the world

USD Trend Analysis

DXY

  • The DXY index tracks the strength of USD vs a basket of six major world currencies

1980 Plaza Accord to Devalue USD

The 80s bull run was stopped by the Plaza Accord. France, West Germany, Japan, the US and the UK all got together to agree to devalue the dollar together by intervening in currency markets.

  • Long term - had gone to 160 in 1982s on high inflation even as US interest rates at 14%

2010-2018 Global QEs Transfer Liquidity into USA - Rising Dollar

  • 2018 Dollar Milkshake Theory by Brent Johnson,CEO of Santiago Capital, an investment firm which specialises in gold, argues has effectively “swapped out a syringe for a straw.”
  • Global central banks injected $20T of liquidity into the “milkshake” of the global market between 2010-2018
  • US had higher relative interest rates
  • US had strong, well-regulated (safer) and the deepest capital markets
  • By 2017 new US tax policy provided lower taxes, but in general US had much lower total taxes than wellare states of Europe
  • US dollar payment system accepted everywhere
  • US Softpower and global dominance (bases,etc) of the US military h

  • As a result, the "liquidity" ALL goes to the USA - sucking the milkshake out via a a straw

  • European Central Bank, the Bank of Japan and the Bank of England running the printing presses/pouring liquidity into the financial system
  • These currency competitors are lowering rates even if already at NIRP/ZIRP
  • The Federal Reserve is hiking rates, and reducing its balance sheet (till 2020)
  • Deck of the global monetary system is stacked in the favor of the U.S. dollar,
  • It doesn’t matter which central bank starts quantitative easing (QE) – but rather which central bank CAPTURES that QE
  • Ultra-bullish view on the U.S. dollar and dollar-denominated assets that USD will remain strong
  • Gold will tend to struggle in a bear market (as priced in dollars) - gold is trampled by the rampaging dollar elephant in the markets

2020 Covid Strengthening on Fear, then weakening into June'20 reopening cheer

  • 2020 Global flood of Liquidity
  • NIRP embedded in Europe/Japan gilts
  • Capital flows in trillions are being sucked into the US

USD Bull market could end VERY BADLY

  • Johnson thinks that DXY 94 levels could rise to 150 in next few years - really bad for gold as the stronger a fiat currency is, the more gold you can buy with it.

This will happen again when dollar strength cripples asset valuations everywhere except the US, and other nations beg the US to devalue the dollar.

Understanding FED monetary system since 1933

Fed regulates short term Rates Capped in USA!

Fed can reserve money from banks - pool from many banks

Fed protects against Bank Runs with unlimited liquidity!

U.S. banks hold an account at the Fed and can, in theory, receive unlimited liquidity from the Fed if necessary. These required reserves and Fed backing make U.S. Dollar deposits in U.S. banks inherently less risky, and Eurodollar deposits slightly more risky, which requires a slightly higher interest rate.

For US-residents FDIC protects bank deposits to high balances - but low rates after Big Four monopoly!

Digital banks emerged to attract funds FDIC - much higher than Big Four

Credit card system 17%+ for personal, 23%+ for Store CCs

Global Trade in Eurodollars - Key factors, Trends

FACT: Eurodollars serve Global Trade priced in Dollars

  • Most Global transactions are done with USD - digital bank "notes" = Eurodollars American policy since 1948 is to ensure that the US Dollar become the reserve currency of the post WW2 World.

  • Gradually, after World War II, the quantity of U.S. dollars outside the United States increased significantly, as a result of both the Marshall Plan and imports into the U.S., which had become the largest consumer market after World War II.

  • What this means is US paid for everything in US Dollars, building up "reserves" at banks and used as principal currency trade flows

  • Oil - Petro-dollars
  • European - US trade - Eurodollars
  • Japan, Korean Trade
  • Ironically, the drug cartels insisted in payment in USD as well - they did not want Mexican pesos, etc subject to devaluation!

FED ROLE: Fed backstops Global USD flows including Eurodollars

  • Reality is Fed is bound to support every dollar floating around - if these dollars are not saved, and with it would go US hegemony.

  • In 2008 crisis, Fed provided a backstop for Eurodollars by providing massive liquidity and FIs - even while they let Lehman fall.

Rise of EuroDollars for non-US-residents - Not subject to US Banking Regulations

USD is a reserve currency but split into two sections - USD Bank controlled and Offshore or Eurodollars.

Eurodollars are bank deposit liabilities denominated in U.S. dollars but not subject to U.S. banking regulations. For the most part, banks offering Eurodollar deposits are located outside the United States.

Called as Eurodollars as dollar-denominated deposits not subject to U.S. banking regulations were held almost exclusively in Europe. Now they also are held at U.S. IBFs and in such places as the Bahamas, Bahrain, Canada, the Cayman Islands, Hong Kong, Japan, the Netherlands Antilles, Panama, and Singapore.

Year | Eurodollar 1970 | 385 b

RATES: Better interest rates on Eurodollars than in USA Fed-Rate Capped!

Eurodollars can have a higher interest rate attached to them because of the fact that they are out of reach from the Federal Reserve and cap rates.

  • Eurodollar deposits were a cheaper source of funds yet more profits for global banks because
  • They were free of reserve requirements
  • No costs for deposit insurance assessments
  • Can provide syndication, resales to reduce risks across many creditors - not just specific banks

In the mid-1950s, Eurodollar trading and its development into a dominant world currency began when the Soviet Union wanted better interest rates on their Eurodollars and convinced an Italian banking cartel to give them more interest than what could have been earned if the dollars were deposited in the U.S. The Italian bankers then had to find customers ready to borrow the Soviet dollars and pay above the U.S. legal interest-rate caps for their use, and were able to do so; thus, Eurodollars began to be used increasingly in global finance.

Global USD-denominated loans - avoids Forex risks

Eurodollar deposits were lent on as U.S. dollar loans to businesses in other countries where interest rates on loans were perhaps much higher in the local currency, and where the businesses were exporting to the US and being paid in dollars, thereby avoiding foreign exchange risk on their loans.

SECURITY: Eurodollars cannot be "Frozen" by US Government

  1. USSR kept lots of dollars under certificate in US banks. But after the invasion of Hungary in 1956, as the Soviet Union feared that its deposits in North American banks would be frozen as a retaliation. Later it then shifted to the Moscow Narodny Bank, a Soviet-owned bank with a British charter. The British bank would then deposit that money in the U.S. banks. There would be no chance of confiscating that money, because it belonged to the British bank and not directly to the Soviets. On 28 February 1957, the sum of $800,000 was transferred, creating the first eurodollars. Initially dubbed "Eurbank dollars" after the bank's telex address, they eventually became known as "eurodollars".

IBFs compete to attract USD deposits - GLOBAL REACH - can operate on lower margins

Early-on in 1957 on, a major role was played by City of London banks, as the Midland Bank, now HSBC, and their offshore holding companies. Later central European banks like Swiss Bank and Deutsche Bank became strongly involved.

  1. Banks in the Eurodollar market, including U.S. IBFs, compete with banks in the United States to attract dollar-denominated funds.

  2. Global Reach - given an initial deposit eg by Apple holding $200b in Ireland, etc can be thereupon used directly or after conversion into another currency for lending to a nonbank customer, perhaps after one or more redeposits from one bank to another. So these Apple USD retained overseas USD earnings can end up financing Turkish government purchases of S400s from Russia! Often these EU banks like DB, HSBC, etc serve as conduits of this global transactions.

  3. Since the Eurodollar market is relatively free of regulation, banks in the Eurodollar market can operate on narrower margins or spreads between dollar borrowing and lending rates than can banks in the United States.

Eurodollar deposits may be owned by individuals, corporations, or governments from anywhere in the world, with the exception that only non-U.S. residents can hold deposits at International Banking Facilities (IBFs).

Since late 1981 non-U.S. residents have been able to conduct business free of U.S. banking regulations at International Banking Facilities (IBFs) in the United States.

TREND: Rapid Growth of Size of Eurodollars

The tremendous growth of the Eurodollar market in the last two decades has largely resulted from efforts to move dollar financial intermediation outside the regulatory jurisdiction of the United States.

Banks provide funds for business growth!

Host countries have competed eagerly for Eurodollar business by promising relatively few regulations, low taxes, and other incentives. Even the United States, through IBFs introduced in 1981, is now competing for Eurodollar business.

HOW: Eurodollar creation - sources

  • What is the source of Eurodollar deposits? Many parts ..
  • U.S. balance-of-payments deficits (put in hands of foreigners - but not necessarily converted to Eurodollars - suck up as Tbills?)
  • Dollar reserves of non-U.S. central banks
  • The proceeds from the sale of Euro-dollar bonds.

HOW: Eurodollar multiplier

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