What is Eurodollar?
No, it’s not the exchange rate of euro to dollar. That is forex.
Eurodollar is the US Dollar (USD) that is held in banks outside of the US. The majority of the banks holding this Eurodollar are US banks themselves holding it in their branches outside the US. How is it different from the regular USD?
The USD is created by the Federal Reserve (FED) and they regulate its supply through interest rate control and changing reserve requirements for the banks. But Eurodollar is outside the regulation of the federal reserve i.e, there are no minimum reserve requirements when the banks lend Eurodollar. Also, there is no FDIC insurance on the Eurodollar means there is no insurance on deposits if a bank went bankrupt.
Domestic US dollars in circulation can be measured in the M2 money supply, which as of January of 2021 was $19 trillion. Eurodollars are, therefore, all other US dollars in circulation not accounted for by M2. It means by and large Eurodollars are just bank liabilities, there are no actual dollars. It is all credit-based.
How it originated?
After World War II the US emerged as a major economic power. A lot of USD was sent overseas to reconstruct the fallen European countries. Why USD only? Because of the Breton woods agreement in 1945, USD was decided to be the world reserve currency. Hence it was accepted as a medium of international exchange. This was how it began.
But in around the 1950s, the cold war hit, and tensions rose between the soviet union and the US. The Soviet Union was paid in USD for all of its international trade which was stored in US banks in US. Due to the rising tension, Soviet Union was afraid that the US might confiscate their US dollar. Therefore, they took the USD out of the US banks and stored that USD in the banks overseas. Moscow Narodny Bank was one such bank. And after that, the trend picked up and many large banks started holding the USD outside the US which is Eurodollar.
It is estimated that over 90% of international trade is financed through the eurodollar market.
How it is connected to the dollar crisis?
There are normally 2 ways money is created
1. The central banks simply print more money.
2. The commercial banks lend the deposits over and over and create more money due to the interest they charge on the money lend (of course this is done after keeping some amount of deposit as reserve). This happens due to the money multiplier effect and is called the fractional reserve banking
Eurodollar is an extension of this fractional reserve banking. There are reserve requirements, regulations, taxes, and FDIC insurance requirements in fractional reserve banking. To avoid the requirements many commercial banks in the US transferred their USD deposits to their offshore branches and started lending that USD in the Eurodollar market to make even more money. This means eventually creating more dollar debt that is outside the ambit of the FED balance sheet. The whole new way of creating new dollars. It is estimated that around $12–22 trillion is outside of the US in form of eurodollar debt.
Since most of the international lending is done in Eurodollar, therefore most debtors worldwide hold dollar debt. The interest rate at which lending takes place is known as LIBOR(London interbank offered rate). This LIBOR is conveniently decided by the pool of 14–16 big banks. So also no regulation on interest rate in eurodollar market. Meaning if banks want to lend they increase the LIBOR and if they want to borrow they decrease the LIBOR. How convenient.
Now, the banks lending in eurodollar do not have the power to print new USD. Only the FED holds the power of creating more dollars. They can only create USD debt. Hence this Eurodollar creates a huge difference between the existing USD and the existing USD liabilities.
These trillion-dollar debts have also to be paid back in USD. But no one can print more USD except for the FED. So how do the countries repay their Eurodollar debt? Where they can get the dollar?
There are several ways:
1. In a normal market, scenario countries get USD by exporting goods and services. But how can they get USD in an economic slowdown or a recession when the exports fall?
2. By selling the US assets, be it treasuries, stocks, or real estate. When the foreigners start dumping US treasuries the treasury prices drop and the interest rates spike up. And since the FED cannot afford high-interest rates therefore they will eventually have to buy those treasuries by printing more USD. This is what happened in march 2020 when the COVID pandemic hit and the international trade was put to a halt. Since the export of various countries was halted, incoming USD through exports stopped. But Eurodollar debtor countries still had to repay their Eurodollar loan, this eventually led them to sell massive US treasuries.
The Fed soon began purchasing treasuries at a scale never seen before; it became a buyer of all treasuries its banks wished to sell.
The effect of the Fed’s actions has been to keep interest rates lower than they would have been(Why?, is explained in the next section), benefiting all borrowers, including the Government, in the process.
The below chart shows how in March 2020 US treasury dropped massively as foreigners were selling US treasuries and how it immediately came back up as soon as FED started printing trillions.
3. By doing currency swaps. In this, the country that needs the dollar for payment will simply exchange its currency with the FED for USD. This means more dollar printing.
What happens if these debtors start defaulting their debts?
Well since most of the eurodollar debt is given by the big banks of the US therefore if their loan book starts seeing massive defaults they will run into liquidity problems. This again becomes a concern for the US as they do not want any of their major banks to fail or otherwise people will lose faith in the banking system which will start a domino effect and the entire banking system might collapse.
Hence the FED will rush to bail out these banks. And how they will do it? You guessed it, right. By printing more money.
Why is printing money the only solution?
Because the US govt is not running any surplus for the past 18 years. Also, the US has a negative Net investment position.
Now, what is a negative net investment position (NIIP)?
There are US assets held by foreign countries, and then there are foreign assets held by the US. The difference between this position is a Net investment position. It is negative means the US owns less foreign assets than foreigners own US assets.
The NIIP was $-1.8 trillion in 2008 and is currently at $-14 trillion as of 2021. Meaning foreigners own assets worth $14 trillion in the US above what the US holds overseas.
Hence event of a dollar shortage people will start selling US assets which can lead to a heavy fall in US asset prices. Since the US cannot afford that and also it does not have any surplus assets to sell it will have to resort to more money printing to prevent falling of asset prices.
Why can’t the US cannot afford high-interest rates?
Because interest hike means people cannot borrow more money to fund their expenses (as the US being the consumer-based economy) and it also means the interest cost on the huge US debt of $28trillion will skyrocket. These factors will immediately put the US economy into a recession. That is why FED nowadays are reluctant to not increase interest rates even when inflation is rising in the US. They say this inflation rise is temporary but while the truth of the matter being they have no other option, there is no way out for them. Simply put there are 2 ways to deal with this:
· Increase the interest rates and let the economy go into recession or even depression immediately.
· Or do not increase the interest rates and keep printing more money (which will eventually lead to hyperinflation) and keep delaying the inevitable while also making the situation much worse in the years to come.
See it’s a trap, there is no way out. What would you have chosen? Die now, or die tomorrow. Either way, death is imminent.
Conclusion
Hence at the time of economic crisis, the US has no option but to buy everything. If treasury falls buy the falling treasuries, if big banks fail, bail out the banks, if the stock market falls, buy the junk corporate bonds, if consumer demand falls, give the people stimulus checks and whatnot. And all this buying is only possible by printing more dollars out of thin air as the US government does not run any surplus.
And this is what is currently happening right now, around $180 billion is printed by the FED every month.
The US alone has a national debt of $28 trillion which it needs to service. Above that, around $15 trillion Eurodollar debt also exists. And then there is consumer debt, corporate debt, and whatnot. Now you get an idea of how worse the debt bubble has become. For decades the economic prosperity around the world has been funded by this debt. To avoid the bubble burst the US has no option but to keep printing money. How long can this last? Honestly, it’s anybody’s guess as of now. But what is sure is that nothing lasts forever.
