January 16, 2025 • 37 mins
In this special three-part series, Odd Lots is exploring the history of the eurodollar market. By the 1970s, eurodollars are hitting the headlines — and not in a good way. While this new form of money initially acted as a pressure valve for the Bretton Woods system, many now think the eurodollar market has spun out of control. What happens next — including Richard Nixon's decision to take the US off the gold standard — will not only shape the ultimate contours of today's eurodollar market, but will also give us the modern financial system itself. The story is told by Columbia Law School Professor Lev Menand and Federal Reserve Bank of New York Policy Advisor Josh Younger.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:02):
Bloomberg Audio Studios, podcasts, radio news.
Speaker 2 (00:11):
Joe, what's that moving over there? What's that shadow? It's
the shadow banking system. It's getting bigger.
Speaker 3 (00:19):
I think you've been down here, Tracy and this proverbial
bunker for a little too long, maybe, but no, it's
the final installment of our three part Euro Dollar series.
Speaker 2 (00:27):
Yeah, we've been tracing the history of euro dollars, an
incredibly important component of the global financial system and at
more than ten trillion dollars, the biggest form of shadow
banking today. There has been post World War two reconstruction,
Cold War intrigue, nineteen sixties politics, existential crisis in the
(00:49):
dollar based monetary system. But this, right here, this is
the moment when the eurodollar market really takes shape and
starts to look like it does today.
Speaker 1 (01:01):
Right.
Speaker 3 (01:01):
If you haven't caught the first and second episodes of
this series, you should first definitely go back and listen
to them, because if you don't, you're going to miss
out in a lot of the detail and you're not
going to really understand what happens next. But this is key,
because this is when the euro dollar market that we
talk about all the time and finance, etc. Actually begins
to assume its modern form and really emerge from the
(01:23):
inflation and monetary shocks of the nineteen seventies.
Speaker 2 (01:26):
And of course, this story is being told by two
odd thlots favorites, Levminand and Josh Younger.
Speaker 1 (01:32):
I'm Levminand. I'm a law professor at Columbia Law School,
where I study money in banking and the history of
central banking.
Speaker 4 (01:39):
I'm Josh Younger. I'm a policy advisor at the Federal
Reserve Bank of New York, and the views I am
going to express are my own and not necessarily those
of the Federal Reserve Bank of New York or the
Federal Reserve system.
Speaker 2 (01:49):
Now where we last left off, we closed out the
nineteen sixties, the euro dollar market has grown to about
seventy billion dollars, and that growth has bought some time
for policymakers who are trying to find a solution to
the problem of funding dollar based activity while maintaining the
gold peg. Euro dollars have become a pressure valve basically
(02:12):
to the Bretton Wood system, and they're helping it to
stay alive.
Speaker 3 (02:16):
But as a consequence of that, eurodellar market is now
really booming in a wild way, and Nixon is about
to do something really big in response. He's about to
abandon Britain Woods all together and do that famous move
where he went off the gold standard. So take a listen, Okay.
Speaker 4 (03:06):
So now it's nineteen seventy seventy one and things are
really starting to go off the rails. This system is
creaking and then swaying, and it really looks like it's
about to fall down, and your dollars are getting a
lot of the blame. They're called this hydra headed monster.
People are really worried that this is the mechanism for
funding the speculation that is being directed against the dollar
(03:26):
and really threatening to bring the whole system down. And
it's nineteen seventy You don't have to be that old.
In nineteen seventy remember the Great Depression, And one of
the theories of the Great Depression that's pretty common at
that point it still is today, is that the depression
itself was largely a consequence of monetary contraction, global monetary contraction.
So what does that mean in this context? If the
dollar system fails, the money goes away in a sense,
(03:48):
and so that monetary contraction in the early seventies represents
the same existential threat. This is going to come back again.
Everyone's really worried about this, this existential threat to the
global economy, another great depression. No one wants another great depression.
I think that's generally true, but it's very acutely true
at this point in time. And so the summer nineteen
seventy one, things are just completely untenable, and Nixon, after
(04:10):
a few days huddling with advisors at Camp David, just says,
enough foot the whole thing right. So it closes the
gold window. This is the Nixon Shock. On a Sunday evening,
he addresses the country and he says, among other things,
We're not going to be giving you gold for your
dollars anymore.
Speaker 5 (04:24):
In recent weeks, the speculators have been waging an all
out war on the American dollar. Accordingly, I have directed
the Secretary of the Treasury to take the action necessary
to defend the dollar against the speculators. I have directed
Secretary Conley to suspend temporarily the convertibility of the dollar
(04:44):
in the gold or other reserve assets accept in amounts
and conditions determined to be in the interest to monetary stability.
And in the best interests of the United States.
Speaker 4 (04:55):
This has all kinds of repercussions and it's dealt with
in various ways and their attempts to mitigate the effective it.
But like for the year at all market in particular,
it signals a shift towards a degree of flexibility and
a lack of a need to have this thing to
plug the balance of payments gap, because all of a
sudden we're in a floating exchange rate type of world,
and the imbalances can be corrected through the foreign exchange market,
(05:18):
just like people sort of intended for a long time,
as opposed to through financial engineering in different ways to
sort of prop up essentially a gold exchange standard. So
that was a major shift in policy, and it was
a big signal that the US was willing to rock
the boat, and that hadn't really been the case previously.
And you can see that in this clip of John Connolly,
he was Nixon's Treasury secretary, talking to the British ambassador
(05:39):
a few months after that, in the winter of nineteen seventy.
Speaker 6 (05:42):
One, gone, how are you it'll be better?
Speaker 7 (05:48):
That's great. Well, I'm delighted to hit you and I'm
looking forward to seeing you, Gon May.
Speaker 6 (05:53):
I've got you how very much. I admire your drive.
You're here to do and and the change of pace
you you're well keep everybody caresing that's right.
Speaker 7 (06:08):
Well, we've got some tough problems water, as you well know,
and it's hard to deal with ten nations at the
same time, and and it just takes a lot of
everything out of us. And the President has just been
magnificent in his approach and his support. So I'm trying
to carry out his wishes as best I know him,
and I think we're going to make some headway. And
(06:30):
don't you let anybody kid you that we're trying to
tear things up. We've been the most forthcoming, the most
expansionist nation in this world. You just take it from me.
We want to settle this thing, and we've offered more
to settle it than any other nation in the world
offered water.
Speaker 6 (06:45):
The reaction around Europe is that you're pretty card to
a deal and the deal has been roughed out, is
that the question of that and some of the leaders
putting the finishing tructures on it. At least the reaction
(07:06):
I get out of all recuntries over here.
Speaker 7 (07:08):
Well water, that's right. The present's options are entirely open
to it. We've tried to structure it in such a
way that we're fairly close, but those countries over there
have to be forthcoming a bit. Now we've we've already
gone further than we should. But the present has the
options that if they're if the Pompy, doot Heath and
the rest of them are are halfway reasonable, I think
(07:30):
it can be settled in the next month.
Speaker 6 (07:34):
Very important because if we let it drag on after January,
you could get into a sticky situation.
Speaker 7 (07:42):
I'm stamp and.
Speaker 6 (07:44):
Proycologtically that could be under correct given that's right, That's
what I tell them.
Speaker 7 (07:49):
They all preach it, we're having going to have a
recession of worldwide depression. And I said, well, if you
already believe that, you'll come up with something, we've made
you an offer. We're we're willing to take lesson. We
deserve to keep that from happening. Now, you all come forward,
But they talk one way, act another. That's the problem.
Speaker 1 (08:07):
Remember in the nineteen sixties we have US policymakers embracing
the euro dollar market to save Breton Woods, not for
its own sake, not to help the London financial institutions
compete in a dollar world, but to save Breton Woods,
to win the Cold War, to not embarrass ourselves in
front of the Soviet Union. And now we have Nixon saying,
you know, what the hell with it? Actually this gold drain,
(08:31):
we need to get ourselves out of this. That approach
that Kennedy rejected almost a decade earlier, Nixon embraces. And
suddenly the question is, well, why are we tolerating this
destabilizing euro dollar market. We've decided to just rip the
band aid off so.
Speaker 4 (08:47):
Now people can think about regulating it because it's not
as essential anymore. And so the BIS Bank for Initial
Settlements in Basil, recipient of the swap line to support
the ear dollar market, also starts convening central bankers and
experts and so forth to try to figure out a
way to regulate the market. And what they discover quickly
they come up with this Standing Committee on the ear
dollar system. It's convened in the early seventies after the
(09:08):
Niiction shock, and it basically doesn't come to any firm conclusions.
They agree to have a standstill, which means no new
central bank deposits. Remember, central banks are the largest or
among the largest depositors supporters of the EU dollar market.
They're putting their own money there. So they agree basically
to stop doing more of that, with a maybe we're
going to think about reducing our holdings in the future,
(09:29):
which is like, not exactly the most aggressive regulatory response,
but it's something, and it's basically the only thing they
can agree on.
Speaker 6 (09:36):
Right.
Speaker 1 (09:36):
Remember, multilateralism is hard. We spent the last ten years
basically a group of central banks building up this market
to try to save this breton Wood system. You have
all these foreign central banks investing their own reserves into
these Euro dollar deposits of their domestic banks to try
to nurture it. You have the US with its swap
(09:57):
lines trying to suggest there's a lender of last resort
backing to try to nurture this market. It's this major
project that everybody is engaged in, and all of a
sudden you have Nixon walking away from the whole system,
and now can we agree on what to do with
the year dollar market. Unsurprisingly, know, everybody's like, oh, whoa,
(10:18):
we have this whole thing that we built up. What
are we going to do with that, and the best
they can sort of do is say, well, we're gonna
stop making it bigger. It went from half a tether
to as large as one of our major banks today,
and larger really by the early seventies. It's like we
had a Bank of America and a City Group just
totally operating offshore in Europe. But the tides turned at
(10:42):
this point and you might think that there's going to
be a crackdown, But then the year dollar market gets
another dis x machina in the form of a massive
dislocation in energy markets. Here's a clip from Nightly News
with John Chancellor which is indicative of what you would
have heard during this period.
Speaker 8 (10:57):
Good evening the Middle East war developments all over the
world today, the oil producing countries of the Arab world
decided to use their oil as a political weapon. They
will reduce oil production by five percent a month until
the Israelis withdrawal from occupied territories.
Speaker 6 (11:15):
If the Arab.
Speaker 8 (11:15):
Countries keep that pledge, it would reduce their production by
almost fifty percent in one year.
Speaker 4 (11:21):
So it's the fall of nineteen seventy three and conflict
in the Middle East leads to an embargo buys the
Saudis against the United States. They will not ship oil
to the United States, and that causes the price of
oil to skyrocket. What does oil have to do with
the Eurdlin market?
Speaker 1 (11:37):
Oil has something to do with everything, right, Think about
everything that we use. Oil is an input into the
cost of everything that we use because we have to
pay to get that to you. And oil is what
is fueling global trade quite literally. So if oil price
is double or quadruple, that's going to be felt across
(11:59):
everything that you buy in consumer goods markets.
Speaker 4 (12:02):
Not good for inflation and also not good for the
global financial system because now like when oil goes up
in price, it sort of creates a lot more money
in a sense, because the value of this thing that's
flowing around the world has gone up in value a lot,
somewhat you know, exogenously, and so the world has to
find a way to deal with the money associated with
the flow of more expensive oil. And so oil is
(12:24):
not unique, but it is special in the sense that
there are producers and consumers. So the producers of oil
are taking in money and providing oil. The consumers of
oil are spending money and taking an oil, and so
the difference between those two is that the producers of
oil wants short term liquid investments to hold the proceeds
of the oil sales in safe, short term, easily accessible.
(12:45):
They could put some of that into their domestic economy,
but not all of it, especially when the price quadruples.
The consumers of oil don't want to pay that back
every day. They want long term, ideally fixed rate loans
in many cases, so there's a maturity mismatch. They're borrowers
of money to buy oil want long term loans. The
investors or sellers of oil want short term investments. And
(13:06):
so who provides intermediation when you have a maturity mismatch?
Banks and so you need some way to allow for
long term lending and short term borrowing. Eurobanks are very
well set up to do this because it's basically what
they do already. The actually live ar was invented for
euro dollar borrowings to allow them to do long term
maturity loans without taking the interest rate risk. Right, This
(13:28):
whole mechanism for making loans that are not going to
blow them up on an interest rate risk basis, but
have a longer maturity. Eur dollar deposits are considered safe
in part because of the SWAT network and its perceived backstop,
the availability of some form of lender of last resort,
although it's somewhat murkey and complicated, and so the euro
dollar system is one means by which to accomplish what
becomes known as petro dollar recycling. So the proceeds of
(13:51):
oil sales getting recycled back to the consumer of oil
and on and on again in a circle. And that's
the thing that keeps the world going because in a
world where oil supplies are suddenly interrupted, just like let's said,
I mean it's in everything, right, So if you suddenly
cut off the supply of oil, either through embargo, but
more importantly through financial collapse, well you can't actually find
a way to move the oil because the money isn't
(14:12):
there when it needs to be there. That's another recipe,
yet another Great depression risk.
Speaker 6 (14:17):
Right.
Speaker 4 (14:17):
People are very worried that the collapse of the financial
system that provides for oil to make it where it
needs to go, well simultaneous collapse world trade. And that's
yet another theory of the Great Depression, the collapse of
monetary system, the collapse of world trades. So they're looking
at a very similar set of.
Speaker 1 (14:33):
Risks, and it's hard to overstate how scary this is
to policy makers at the time, because we're engaged in
this Cold War with the Soviets, and there's a massive
shock to our whole economic system that is threatening to
disrupt our whole monetary system, which policymakers have spent the
last decade plus agonizing about and concerned that it might
(14:58):
go the way of the system in the ninety teen
thirties and jeopardize this whole almost civilizational conflict that the
United States is engaged in at the time. And so
once again, the euro dollars are there to sort of
save the day in the sense that policymakers they know
they're euro dollars are a problem now, but they need
(15:21):
a solution to this oil price shock. They need to
figure out a way to facilitate the recycling, and the
euro dollars are in some sense the easy way out.
(15:46):
By the mid nineteen seventies, there was a sense that
the whole system was in crisis. Here's a clip of
the Treasury Secretary Bill Simon in March nineteen seventy five
laying out the stakes.
Speaker 9 (15:56):
The basic underlying cause of our inflation has in the
mismanagement of the government spending and monetary policies. And unless
we change this basic direction, inflation is going to continue
to plague us for a long time to come.
Speaker 4 (16:12):
Kissinger thinks this is the biggest threat to the world
since the Second World War, so he thinks this is
like existential risk. And so to some extent, I think
they breathe a sigh of relief because of the earninar market.
I mean, a lot of the pieces are in place.
They have a pretty deep and broad network of banks
across multiple countries. The swap lines provide some degree of
liquidity support in the event of isolated instances of problems.
Speaker 7 (16:33):
Right.
Speaker 4 (16:34):
The key is you don't want amplification spillover contagion. You
want to be able to solve problems locally, and that's
what you know liquidity provision is designed to do. And
so you could imagine a world in which they go, well,
this is a disaster, But I think how we have
euro dollars because otherwise what we're going to do, Because
you could do multilateralism and try to find a way
to pipe it through the World Bank or the IMF
or something like that, but like that's again hard and.
Speaker 1 (16:56):
The Europeans do want to do multilateralism, a public sector
solution to this problem, but US policymakers are very wary
of that, in part because it's just like Bretton Woods
all over again. The US doesn't want to share, and
they're experiencing this incredible shock to their economy. We're entering
(17:18):
a period of stagflation. And if we can manage the
petro dollar recycling in such a way that the oil
producers are reinvesting disproportionally in the US, that will help
US recover. If we have to spread out that reinvestment
across Europe as well, then it's going to mean a
(17:38):
weaker outlook on the US economy. And so the US
rejects this public sector solution in the hopes that the
private sector solution euro dollar recycling of petro dollars will
actually help the US recover relative to everybody else from
the economic shock.
Speaker 4 (17:55):
Never let a crisis go waste, right, So the USC's
crisis an opportunity. The opportunity is twofold. One is the
federal government's running deficits. Somebody's got upon those deficits. These
oil producing countries have all this cash. You would be
a shame if he didn't buy some treasury bonds with
that cash, getting the statues to buy more treasuries. That
felled that Bill Simon Simon had just been appointed Treasury Secretary.
(18:17):
He succeeded George Schultz, who was a PhD economist from MIT.
Schultz had already served in two cabinet level roles before
he joined the Treasury, so he's very experienced, very expert
in economic affairs. Bill Simon grew up in New Jersey.
He went to Lafayette and one of his early profiles
said he quote unquote liked partying in sports a bit
more than studying. So he wasn't quite the same personality
(18:37):
type as an MIT PhD economist. He was actually bond
trader at Zalen Brothers, but he knew Schultz, and Schultz
brought him in as Deputy secretary, basically to be the
chief operating officer of the Treasury Department. But when there's
a need for expertise on the energy side, Nixon taps
him as the energies are to respond to the oil shock,
(18:58):
and he's immediately not very popular with the Nixon team.
They think he doesn't have enough experience with international economics
in the international monetary system to really perform that function.
But he quickly becomes the mouthpiece for Nixon policy on
petro dollar recycling, and he's firmly of the belief that
private markets, and by private markets he means commercial banks,
(19:19):
and by commercial banks he means Euro dollar banks are
the best way to keep the money and oil flowing,
the thing that was the most critical aspect of this period,
keeping that market together without monetary collapse. He thinks private
markets do that better than public alternatives. But he also
knows the banking system can only handle so much. There's
only so much of this maturity transformation that private institutions
(19:41):
can really perform. The eurobanks have been pretty vocal about
that from the beginning, so they've been warning since the
fall of seventy three that they can only get so
big and provide only so much intermediation before just prudent
risk management would dictate that they start turning deposits away,
and the Saudis are going to need an alternative, They
need a safe investment. It's an alternative to eur dollars eventually,
(20:03):
so treasury bonds are arguably the best substitute. Simon just
needs to make sure that they can buy those bonds
on terms that leave them in position they feel okay with.
They want them confidential, they want a look at the
auction pricing, they want certain kinds of special treatment to
make them comfortable with this kind of investment. And so
there's a secret mission. Bill Simon flies over to Riodd
to try to pitch the Saudi's on kind of a
(20:25):
sweetheart deal. Right, they get to bid on US Treasury
bonds at auction, but anonymously, and they don't actually have
to be part of the auction. They get what's called
an add on, So after the auction happens, if they
like the price, they can have a little more at
the price at which the auction cleared is. They're not
competitive bidders, they have an option to participate or not.
And so it's pretty attractive, right, you need something you
want to diversify, you don't want to take a lot
(20:45):
of risk, Like US treasuries seem pretty good under those contexts,
and the federal government like would love to sell you
US treasuries, and so you know that's the opportunity in
part is another buyer and a large buyer, so that
the recycling gets piped through the federal government as opposed
to the private sector. And the second is in exchange,
or at least implicitly in exchange. Maybe oil is only
(21:07):
sold in dollars, because in the fall of seventy three,
I think quarter of oil was in sterling, so the
sterling system still existed to some extent. There was still
something of a sterling block, and it was still an
international currency in some context, and one of them was
global commodities. And so you know, on the one hand,
you offer this sweetheart deal with treasury bonds, which is
sort of beneficial to both sides.
Speaker 1 (21:29):
I think that's fair to.
Speaker 4 (21:30):
Say, and on the other you kind of negotiate for
a switch in Saudi oil sale policy. And the day
after the Saudis agreed to this secret arrangement, they also
announce that Saudi oil will only be available for dollars,
no more sterling. They actually do this while the chance
with the h checkers in country, and he doesn't get
a heads up, so it's a little awkward. He sort
of telegrams back and it is like, I have no
(21:51):
idea about this, So maybe the communication could have been
handled more effectively or less effectively. I'm not sure, but
at the end of the day, the US gets their
den is it funding, they get a dollar system in oil,
and you know, it's still on a nice edge. People
are still very worried about the ability of the ear
dollar system to accommodate the continued growth. Is the price
keeps going up, right, So the price goes up, the
(22:14):
flows get bigger, the banks get more levered, and all
of a sudden there was kind of worried that there
is a point at which this is not going to
work anymore. And it turns out that point comes a
little earlier than most people expected. So that's really in
June of nineteen seventy four, which is only less than
a year after the oil shock. Initially that you get
(22:34):
really the critical event in the history of the year
dollar market, the history of the global dollar system, which
is the collapse of a bank I'm sure very few
people have heard of, which is Banko's Hirschtot in Germany.
So Bankov's Hirschtat is a private bank. It's run by
a guy named Ivan Hirschtatt, So it's an eponymous banks.
It's run by its owner and he loves speculating in
(22:55):
foreign exchange. And one of the you could call it
benefits of the niiction shock. In a world of floating
exchange rates, you can start to make money trading exchange rates.
And so for a while it's not a huge business
for them, but pretty soon most of their revenue I believe,
was generated by foreign exchange trading. And he sees this
as his big moment or something, as he writes an autobiography,
(23:16):
and he's very excited about the opportunity presented by these
trading dynamics. And problem trading is sometimes you make money
and sometimes you don't. And they put a big bet
on the dollar that goes sour in June and they're
closed by the German regulators. Now Hirstatt has no regrets,
he writes an autobiography later called How My Life's Work
Was Stolen from Me. So he's perfectly fine with this outcome.
(23:38):
But the global economy is not super fine with this outcome.
Speaker 1 (23:41):
Has little Dick fold Lehman brothers to it.
Speaker 4 (23:44):
So the problem, among others is that the Germans come
in in the German evening, and if you're very active
in foreign exchange markets, you're going to make a mark payment,
the deutsch mark payment in German time, and at the
time a dollar payment in New York time. The problem
is that the German regulators close herstot before they're able
(24:04):
to make their dollar payments. So this is now called
Hirschtot risk right, which is probably better known than Benka's Hershtot,
And it's just timing mismatches in transactions and the necessity
of lining those up. Otherwise, if somebody goes out of business,
they may not make good on one side of the trade,
but they will make it on the other. And everybody
in New York freaks out. Everyone in London freaks out.
The foreign exchange mark grinds to a halt. There is
(24:25):
something like two transactions or something like that in the
whole day after this happens. Almost all these transactions happen
in New York. By the way, almost all foreign exchange
transactions with a dollar leg or settled in New York.
So it affects a lot of trades because New York
time is the one that's affected, and you have a
sudden stop to the foreign exchange markets, and that's really scary.
Speaker 1 (24:46):
And you also have a run in the euro dollar
market and in the money markets more generally. So we've
had a decade plus of US policymakers build enough this market.
Now it's reached a size and scale where a run
(25:06):
on it might jeopardize US financial stability. More generally, this
one bank fails in Europe and the contagion starts to
spread on shore in the United States. And there's one
bank in particular that gets caught up right away, and
(25:28):
it's this bank called Franklin National Bank. And Franklin National
Bank has a bank charter, so it's not a shadow bank.
Speaker 4 (25:37):
They invented credit cards. They're like a Long Island local bank, right,
I mean, they do that business.
Speaker 1 (25:42):
They were an early promoter of credit cards. You know,
they are pushing the envelope type of bank, and they
are chartered bank, but they are getting involved in shadow
banking type funding sources. And so you can run your
bank with just deposits on your right hand side. That's
the normal way to do it. But over the last
(26:05):
ten plus years, these deposit alternatives have been proliferating. One
is an offshore US dollar deposit, that's what we've been
talking about. That's a year dollar. Another is a repurchase
agreement that can be an onshore or an offshore transaction
and Franklin National Bank is doing both. They're doing both
of these, and so they have deposits, but they also
(26:26):
have these deposit alternatives that are highly runnable, that are
not FDIC ensured, and they experience a run, and if
you look at their balance sheet over the course of
the summer of nineteen seventy four, it's a run that
looks a lot like the run on Lehman Brothers. They
are rebot. Counterparties drop away and they have to turn
to the FED for a massive discount window loan, and
(26:50):
suddenly the FED is thrust into the crisis that policymakers
have been worrying about for the last several years. The
hydra headed monster is looking to consume the system, and
the problem of the year dollar market overseas has hit
the US domestic financial system. And the story is going
(27:13):
to have a lot of resonance for anybody who lived
through two thousand and eight because it starts in much
the same way and it also sort of ends in
a similar way.
Speaker 4 (27:23):
So now it's the summer seventy four, things are falling
apart that mood that we talked about about, maybe we
should crack down on euro dollars like that doesn't make
sense anymore, and there's a bunch of op eds that's like, explicitly,
now is not the time to regulate this market. It's
precisely opposite. Deregulate the market, make sure it doesn't fall
apart because people are just looking for the next domino
next to you to drop. And so the world gets
(27:44):
together in June. In July rather can't really come to
a really firm agreement. They're not willing to make a
firm comitment. And by September like it's very clear that
something needs to be done, and so the BIS convenes
the group of ten countries central bank governors and they
put out a very unusual thing, which is a public statement,
and they say, we are here to backstop the year
dollar market. I'm paraphrasing, we're here to back stop the
(28:06):
year dollar market, and we are convinced that the means
are available to do so. And so that's an implicit
reference to the swap lines, and the FMC and others
are sort of aware of the fact that the swap
lines are kind of the backbone of that commitment, But
what they're really doing is saying there is a lender
of last resort. You all thought there might be there is.
It's us, and we're here to fix the system. And
(28:27):
that has a really seismic impact. It really cures the
problem because people are aware of the fact that this
announcement effect at its finest right, this is like whatever
it takes for Mario Draghi is just the mere fact
of the public statement is enough to cure the run.
And then it's really off to the races because this
market has been identified by the most powerful countries in
(28:49):
the world as critical to financial stability and national security,
and so the limits on its growth are really pulled back.
Speaker 1 (28:57):
So I think it's worth it saying that the work
on understanding what happens in nineteen seventy four, a lot
of archival work was done by Ben Braun and his
co authors Ari Krump and Steven Morale, and they call
this communicay the original whatever it takes moment, the original
sort of central bank response to a run where the
(29:19):
central bank basically implicitly commits to use its money printing
ability to stop the run like behavior. And that's an
incredibly powerful tool that central banks have because they can
print money, they can make good on everybody's money denominated obligations.
(29:39):
And in seventy four you have this critical moment where
the central banks, especially the US Central Bank, commits itself
to this sort of policy. Remember in the nineteen thirties,
that's not the attitude of the Federal Reserve, and over
a third of the bankings system closes its doors. In
(30:02):
nineteen seventy four, you have the Federal Reserve essentially committing
to support the banking systems of European countries that are
doing a dollar banking business without following any of the
rules that govern the dollar banking business domestically, and that
puts out this fire in two thousand and eight is
just in many ways a repeat of nineteen seventy four,
(30:25):
where it's not clear is the US going to do
whatever it takes, And eventually that is made clear and
the fires ultimately subside, and we still sort of live
in this world where there are lots of runnable money
claims in the monetary system, and there's always a question
(30:48):
about the extent to which the central bank is there
standing behind them.
Speaker 4 (30:53):
So if this was a movie, this would be the
point where you have the contemplative music and the like,
what happens to all the characters in the movie, and
so in this one there's really in one character that's
really important. That's the ear dollar market. And so you know,
just for a sense of scale, by the mid eighties
there are more euro dollars than dollars, which is kind
of a remarkable fact. By the mid two thousands, there's
much more one hundred and fifty and seventy percent depends
(31:15):
on how you count them. So the ear dollar market
becomes in some sense, the dollar market becomes the much larger,
more important, more globalized market that like keeps the whole
system running.
Speaker 1 (31:26):
This is why everybody uses libor as a measure of
interesting rate. The London Interbank Offer rate is the euro
dollar market interest rate. We don't actually look to the
federal funds rate because the real rate that mattered in
the market once more dollars were being created offshore was
(31:49):
the offshore dollar rate libor, and so libor is perhaps
the best sort of known simpol of the euro dollar market.
And by the time you get to thousand and eight,
the whole system is key to the rates in this
offshore dollar market as opposed to the rates in the
onshore market. That the US banking system was sort of
(32:12):
developed around.
Speaker 4 (32:13):
So global trade settled in euro dollars. Euro dollars are
a huge asset that people have, so in a sense,
it's both the backbone and the life blood in the
body analogy, right, It's the lifeblood and the backbone of
the whole global dollar system. It still is in a
lot of ways. And in the contemplary of music overlay
version of the program, like you could say, it all
really goes back to the sixties, and so we're left
(32:34):
with this remnant of hold war competition that in some
sense was antithetical to US monetary sovereignty, but served a
very particular purpose at the time. And it's really a
lesson in how, for lack of a better word, you know,
decisions have consequences, and how financial systems evolve in unexpected ways,
(32:55):
and particularly when the government supports something, it gets a
lot of room to row and run, and it's very
hard to predict what comes next. And so you know,
it does all start in Yugoslavia, but it becomes obviously
a much much bigger thing over the subsequent fifty years.
So you know, we're recording this in the fiftieth anniversary
roughly of the intervention the Communicate, so Stall, the run
(33:18):
on the Earl market in nineteen seventy four and so like.
It's a time for reflection in a sense. But I
think more importantly, it's just a really compelling story. It's
a how we got o where we are, which is
a question I think we don't ask enough and be
like the real sort of underlying reasons why systems evolved
in the way that they did, which can tell us
a lot about the future as well.
Speaker 2 (33:44):
Oh look, we're free, We're out of the bunker or
the vaults or the archive or whatever this is was.
Speaker 3 (33:52):
Uh is the story over?
Speaker 2 (33:54):
I guess it is. All good things must come to
an end. I feel like I learned a lot. I
love these historical deep dives, and Lev and Josh really
dove deep for this one.
Speaker 3 (34:05):
Actually, Like, honestly though, is unreal. I mean, just the
fact that we got to listen to them talk for
that long about this really intense historical work. I'm actually
going to miss hearing about euro dollar history for real.
Speaker 2 (34:18):
Yeah, me too. The good news on that front is
we are not quite done. Josh and Lev. They've walked
us through the history, so we have a much better
sense of where euro dollars come from and the problems
they were intended to solve. But I think there's still
a lot of open questions about the Euro dollar markets
role today and also how it fits into the ongoing
(34:39):
debate about the future of the US dollar totally.
Speaker 3 (34:42):
There's like a lot of discussions still about whether the
dollar can maintain its special reserve currency status. People love
talking about that, whether it can maintain its status within
the financial system, and euro dollars, as we learn from
this series, are one of the most important types of
dollars out there. They facilitate global trade, investment, liquidity, and
all that stuff. So all of these debates that everyone
(35:03):
is having all around they sort of come back to
this area.
Speaker 2 (35:06):
Yeah, so we definitely need to talk more about the
future of the euro dollar market and buy extension the
future of the dollar system, and to do that, we
are going to bring back lev later this week in
an episode of Lots More to talk about all of that.
So definitely look out for lots more with lov on
euro dollars. But for now, this is the end of
(35:28):
our historic look back at this market. We hope you
enjoyed listening to Josh and Lev as much as we did.
Speaker 4 (35:35):
I also just want to thank a bunch of folks
at various archives because a lot of this work was
based on primary sources and dusty books and forums and
things like that. So definitely that at the New York
fed the Archives there have been extraordinarily helpful, the Bank
Financial Settlements in Basel, the JFK Library and the LBJ
Library who've been super kind to provide stuff. Columbia has
a clearinghouse archives which we've had a chance to go through,
(35:56):
and the National Archives in general. Just a big thanks
to all of them.
Speaker 2 (35:59):
Shall we leave at that.
Speaker 1 (36:00):
Let's leave it there.
Speaker 2 (36:01):
This has been another episode of the Authoughts podcast. I'm
Tracy Aalloway. You can follow me at Tracy Alloway.
Speaker 3 (36:07):
And I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow one of our special guests, levmanand he's at levmanand
our other special guest, Josh Younger he's not on Twitter.
Thanks to our producers Kerman Rodriguez at krbin Ermann, Dashel
Bennett at Dashbot, and Kilbrooks at Kelbrooks. And special thanks
to our sound engineer Blake Maples from our Oddlots content.
(36:28):
Go to Bloomberg dot com slash odd Lots, where we
have transcripts, a blog, and a daily newsletter, and you
can chat about all of these topics twenty four to
seven in our discord Discord dot gg slash od lots.
Speaker 2 (36:39):
And if you enjoy odd Lots, if you like it
when we bring you the hidden history of euro dollars,
then please leave us a positive review on your favorite
podcast platform. And remember, if you are a Bloomberg subscriber,
you can listen to all of our episodes absolutely ad free.
All you need to do is find the Bloomberg channel
on Apple Podcasts and follow the instructions there. Thanks for listening.
Bloomberg Audio Studios, podcasts, radio news.
Speaker 2 (00:11):
Joe, what's that moving over there? What's that shadow? It's
the shadow banking system. It's getting bigger.
Speaker 3 (00:19):
I think you've been down here, Tracy and this proverbial
bunker for a little too long, maybe, but no, it's
the final installment of our three part Euro Dollar series.
Speaker 2 (00:27):
Yeah, we've been tracing the history of euro dollars, an
incredibly important component of the global financial system and at
more than ten trillion dollars, the biggest form of shadow
banking today. There has been post World War two reconstruction,
Cold War intrigue, nineteen sixties politics, existential crisis in the
(00:49):
dollar based monetary system. But this, right here, this is
the moment when the eurodollar market really takes shape and
starts to look like it does today.
Speaker 1 (01:01):
Right.
Speaker 3 (01:01):
If you haven't caught the first and second episodes of
this series, you should first definitely go back and listen
to them, because if you don't, you're going to miss
out in a lot of the detail and you're not
going to really understand what happens next. But this is key,
because this is when the euro dollar market that we
talk about all the time and finance, etc. Actually begins
to assume its modern form and really emerge from the
(01:23):
inflation and monetary shocks of the nineteen seventies.
Speaker 2 (01:26):
And of course, this story is being told by two
odd thlots favorites, Levminand and Josh Younger.
Speaker 1 (01:32):
I'm Levminand. I'm a law professor at Columbia Law School,
where I study money in banking and the history of
central banking.
Speaker 4 (01:39):
I'm Josh Younger. I'm a policy advisor at the Federal
Reserve Bank of New York, and the views I am
going to express are my own and not necessarily those
of the Federal Reserve Bank of New York or the
Federal Reserve system.
Speaker 2 (01:49):
Now where we last left off, we closed out the
nineteen sixties, the euro dollar market has grown to about
seventy billion dollars, and that growth has bought some time
for policymakers who are trying to find a solution to
the problem of funding dollar based activity while maintaining the
gold peg. Euro dollars have become a pressure valve basically
(02:12):
to the Bretton Wood system, and they're helping it to
stay alive.
Speaker 3 (02:16):
But as a consequence of that, eurodellar market is now
really booming in a wild way, and Nixon is about
to do something really big in response. He's about to
abandon Britain Woods all together and do that famous move
where he went off the gold standard. So take a listen, Okay.
Speaker 4 (03:06):
So now it's nineteen seventy seventy one and things are
really starting to go off the rails. This system is
creaking and then swaying, and it really looks like it's
about to fall down, and your dollars are getting a
lot of the blame. They're called this hydra headed monster.
People are really worried that this is the mechanism for
funding the speculation that is being directed against the dollar
(03:26):
and really threatening to bring the whole system down. And
it's nineteen seventy You don't have to be that old.
In nineteen seventy remember the Great Depression, And one of
the theories of the Great Depression that's pretty common at
that point it still is today, is that the depression
itself was largely a consequence of monetary contraction, global monetary contraction.
So what does that mean in this context? If the
dollar system fails, the money goes away in a sense,
(03:48):
and so that monetary contraction in the early seventies represents
the same existential threat. This is going to come back again.
Everyone's really worried about this, this existential threat to the
global economy, another great depression. No one wants another great depression.
I think that's generally true, but it's very acutely true
at this point in time. And so the summer nineteen
seventy one, things are just completely untenable, and Nixon, after
(04:10):
a few days huddling with advisors at Camp David, just says,
enough foot the whole thing right. So it closes the
gold window. This is the Nixon Shock. On a Sunday evening,
he addresses the country and he says, among other things,
We're not going to be giving you gold for your
dollars anymore.
Speaker 5 (04:24):
In recent weeks, the speculators have been waging an all
out war on the American dollar. Accordingly, I have directed
the Secretary of the Treasury to take the action necessary
to defend the dollar against the speculators. I have directed
Secretary Conley to suspend temporarily the convertibility of the dollar
(04:44):
in the gold or other reserve assets accept in amounts
and conditions determined to be in the interest to monetary stability.
And in the best interests of the United States.
Speaker 4 (04:55):
This has all kinds of repercussions and it's dealt with
in various ways and their attempts to mitigate the effective it.
But like for the year at all market in particular,
it signals a shift towards a degree of flexibility and
a lack of a need to have this thing to
plug the balance of payments gap, because all of a
sudden we're in a floating exchange rate type of world,
and the imbalances can be corrected through the foreign exchange market,
(05:18):
just like people sort of intended for a long time,
as opposed to through financial engineering in different ways to
sort of prop up essentially a gold exchange standard. So
that was a major shift in policy, and it was
a big signal that the US was willing to rock
the boat, and that hadn't really been the case previously.
And you can see that in this clip of John Connolly,
he was Nixon's Treasury secretary, talking to the British ambassador
(05:39):
a few months after that, in the winter of nineteen seventy.
Speaker 6 (05:42):
One, gone, how are you it'll be better?
Speaker 7 (05:48):
That's great. Well, I'm delighted to hit you and I'm
looking forward to seeing you, Gon May.
Speaker 6 (05:53):
I've got you how very much. I admire your drive.
You're here to do and and the change of pace
you you're well keep everybody caresing that's right.
Speaker 7 (06:08):
Well, we've got some tough problems water, as you well know,
and it's hard to deal with ten nations at the
same time, and and it just takes a lot of
everything out of us. And the President has just been
magnificent in his approach and his support. So I'm trying
to carry out his wishes as best I know him,
and I think we're going to make some headway. And
(06:30):
don't you let anybody kid you that we're trying to
tear things up. We've been the most forthcoming, the most
expansionist nation in this world. You just take it from me.
We want to settle this thing, and we've offered more
to settle it than any other nation in the world
offered water.
Speaker 6 (06:45):
The reaction around Europe is that you're pretty card to
a deal and the deal has been roughed out, is
that the question of that and some of the leaders
putting the finishing tructures on it. At least the reaction
(07:06):
I get out of all recuntries over here.
Speaker 7 (07:08):
Well water, that's right. The present's options are entirely open
to it. We've tried to structure it in such a
way that we're fairly close, but those countries over there
have to be forthcoming a bit. Now we've we've already
gone further than we should. But the present has the
options that if they're if the Pompy, doot Heath and
the rest of them are are halfway reasonable, I think
(07:30):
it can be settled in the next month.
Speaker 6 (07:34):
Very important because if we let it drag on after January,
you could get into a sticky situation.
Speaker 7 (07:42):
I'm stamp and.
Speaker 6 (07:44):
Proycologtically that could be under correct given that's right, That's
what I tell them.
Speaker 7 (07:49):
They all preach it, we're having going to have a
recession of worldwide depression. And I said, well, if you
already believe that, you'll come up with something, we've made
you an offer. We're we're willing to take lesson. We
deserve to keep that from happening. Now, you all come forward,
But they talk one way, act another. That's the problem.
Speaker 1 (08:07):
Remember in the nineteen sixties we have US policymakers embracing
the euro dollar market to save Breton Woods, not for
its own sake, not to help the London financial institutions
compete in a dollar world, but to save Breton Woods,
to win the Cold War, to not embarrass ourselves in
front of the Soviet Union. And now we have Nixon saying,
you know, what the hell with it? Actually this gold drain,
(08:31):
we need to get ourselves out of this. That approach
that Kennedy rejected almost a decade earlier, Nixon embraces. And
suddenly the question is, well, why are we tolerating this
destabilizing euro dollar market. We've decided to just rip the
band aid off so.
Speaker 4 (08:47):
Now people can think about regulating it because it's not
as essential anymore. And so the BIS Bank for Initial
Settlements in Basil, recipient of the swap line to support
the ear dollar market, also starts convening central bankers and
experts and so forth to try to figure out a
way to regulate the market. And what they discover quickly
they come up with this Standing Committee on the ear
dollar system. It's convened in the early seventies after the
(09:08):
Niiction shock, and it basically doesn't come to any firm conclusions.
They agree to have a standstill, which means no new
central bank deposits. Remember, central banks are the largest or
among the largest depositors supporters of the EU dollar market.
They're putting their own money there. So they agree basically
to stop doing more of that, with a maybe we're
going to think about reducing our holdings in the future,
(09:29):
which is like, not exactly the most aggressive regulatory response,
but it's something, and it's basically the only thing they
can agree on.
Speaker 6 (09:36):
Right.
Speaker 1 (09:36):
Remember, multilateralism is hard. We spent the last ten years
basically a group of central banks building up this market
to try to save this breton Wood system. You have
all these foreign central banks investing their own reserves into
these Euro dollar deposits of their domestic banks to try
to nurture it. You have the US with its swap
(09:57):
lines trying to suggest there's a lender of last resort
backing to try to nurture this market. It's this major
project that everybody is engaged in, and all of a
sudden you have Nixon walking away from the whole system,
and now can we agree on what to do with
the year dollar market. Unsurprisingly, know, everybody's like, oh, whoa,
(10:18):
we have this whole thing that we built up. What
are we going to do with that, and the best
they can sort of do is say, well, we're gonna
stop making it bigger. It went from half a tether
to as large as one of our major banks today,
and larger really by the early seventies. It's like we
had a Bank of America and a City Group just
totally operating offshore in Europe. But the tides turned at
(10:42):
this point and you might think that there's going to
be a crackdown, But then the year dollar market gets
another dis x machina in the form of a massive
dislocation in energy markets. Here's a clip from Nightly News
with John Chancellor which is indicative of what you would
have heard during this period.
Speaker 8 (10:57):
Good evening the Middle East war developments all over the
world today, the oil producing countries of the Arab world
decided to use their oil as a political weapon. They
will reduce oil production by five percent a month until
the Israelis withdrawal from occupied territories.
Speaker 6 (11:15):
If the Arab.
Speaker 8 (11:15):
Countries keep that pledge, it would reduce their production by
almost fifty percent in one year.
Speaker 4 (11:21):
So it's the fall of nineteen seventy three and conflict
in the Middle East leads to an embargo buys the
Saudis against the United States. They will not ship oil
to the United States, and that causes the price of
oil to skyrocket. What does oil have to do with
the Eurdlin market?
Speaker 1 (11:37):
Oil has something to do with everything, right, Think about
everything that we use. Oil is an input into the
cost of everything that we use because we have to
pay to get that to you. And oil is what
is fueling global trade quite literally. So if oil price
is double or quadruple, that's going to be felt across
(11:59):
everything that you buy in consumer goods markets.
Speaker 4 (12:02):
Not good for inflation and also not good for the
global financial system because now like when oil goes up
in price, it sort of creates a lot more money
in a sense, because the value of this thing that's
flowing around the world has gone up in value a lot,
somewhat you know, exogenously, and so the world has to
find a way to deal with the money associated with
the flow of more expensive oil. And so oil is
(12:24):
not unique, but it is special in the sense that
there are producers and consumers. So the producers of oil
are taking in money and providing oil. The consumers of
oil are spending money and taking an oil, and so
the difference between those two is that the producers of
oil wants short term liquid investments to hold the proceeds
of the oil sales in safe, short term, easily accessible.
(12:45):
They could put some of that into their domestic economy,
but not all of it, especially when the price quadruples.
The consumers of oil don't want to pay that back
every day. They want long term, ideally fixed rate loans
in many cases, so there's a maturity mismatch. They're borrowers
of money to buy oil want long term loans. The
investors or sellers of oil want short term investments. And
(13:06):
so who provides intermediation when you have a maturity mismatch?
Banks and so you need some way to allow for
long term lending and short term borrowing. Eurobanks are very
well set up to do this because it's basically what
they do already. The actually live ar was invented for
euro dollar borrowings to allow them to do long term
maturity loans without taking the interest rate risk. Right, This
(13:28):
whole mechanism for making loans that are not going to
blow them up on an interest rate risk basis, but
have a longer maturity. Eur dollar deposits are considered safe
in part because of the SWAT network and its perceived backstop,
the availability of some form of lender of last resort,
although it's somewhat murkey and complicated, and so the euro
dollar system is one means by which to accomplish what
becomes known as petro dollar recycling. So the proceeds of
(13:51):
oil sales getting recycled back to the consumer of oil
and on and on again in a circle. And that's
the thing that keeps the world going because in a
world where oil supplies are suddenly interrupted, just like let's said,
I mean it's in everything, right, So if you suddenly
cut off the supply of oil, either through embargo, but
more importantly through financial collapse, well you can't actually find
a way to move the oil because the money isn't
(14:12):
there when it needs to be there. That's another recipe,
yet another Great depression risk.
Speaker 6 (14:17):
Right.
Speaker 4 (14:17):
People are very worried that the collapse of the financial
system that provides for oil to make it where it
needs to go, well simultaneous collapse world trade. And that's
yet another theory of the Great Depression, the collapse of
monetary system, the collapse of world trades. So they're looking
at a very similar set of.
Speaker 1 (14:33):
Risks, and it's hard to overstate how scary this is
to policy makers at the time, because we're engaged in
this Cold War with the Soviets, and there's a massive
shock to our whole economic system that is threatening to
disrupt our whole monetary system, which policymakers have spent the
last decade plus agonizing about and concerned that it might
(14:58):
go the way of the system in the ninety teen
thirties and jeopardize this whole almost civilizational conflict that the
United States is engaged in at the time. And so
once again, the euro dollars are there to sort of
save the day in the sense that policymakers they know
they're euro dollars are a problem now, but they need
(15:21):
a solution to this oil price shock. They need to
figure out a way to facilitate the recycling, and the
euro dollars are in some sense the easy way out.
(15:46):
By the mid nineteen seventies, there was a sense that
the whole system was in crisis. Here's a clip of
the Treasury Secretary Bill Simon in March nineteen seventy five
laying out the stakes.
Speaker 9 (15:56):
The basic underlying cause of our inflation has in the
mismanagement of the government spending and monetary policies. And unless
we change this basic direction, inflation is going to continue
to plague us for a long time to come.
Speaker 4 (16:12):
Kissinger thinks this is the biggest threat to the world
since the Second World War, so he thinks this is
like existential risk. And so to some extent, I think
they breathe a sigh of relief because of the earninar market.
I mean, a lot of the pieces are in place.
They have a pretty deep and broad network of banks
across multiple countries. The swap lines provide some degree of
liquidity support in the event of isolated instances of problems.
Speaker 7 (16:33):
Right.
Speaker 4 (16:34):
The key is you don't want amplification spillover contagion. You
want to be able to solve problems locally, and that's
what you know liquidity provision is designed to do. And
so you could imagine a world in which they go, well,
this is a disaster, But I think how we have
euro dollars because otherwise what we're going to do, Because
you could do multilateralism and try to find a way
to pipe it through the World Bank or the IMF
or something like that, but like that's again hard and.
Speaker 1 (16:56):
The Europeans do want to do multilateralism, a public sector
solution to this problem, but US policymakers are very wary
of that, in part because it's just like Bretton Woods
all over again. The US doesn't want to share, and
they're experiencing this incredible shock to their economy. We're entering
(17:18):
a period of stagflation. And if we can manage the
petro dollar recycling in such a way that the oil
producers are reinvesting disproportionally in the US, that will help
US recover. If we have to spread out that reinvestment
across Europe as well, then it's going to mean a
(17:38):
weaker outlook on the US economy. And so the US
rejects this public sector solution in the hopes that the
private sector solution euro dollar recycling of petro dollars will
actually help the US recover relative to everybody else from
the economic shock.
Speaker 4 (17:55):
Never let a crisis go waste, right, So the USC's
crisis an opportunity. The opportunity is twofold. One is the
federal government's running deficits. Somebody's got upon those deficits. These
oil producing countries have all this cash. You would be
a shame if he didn't buy some treasury bonds with
that cash, getting the statues to buy more treasuries. That
felled that Bill Simon Simon had just been appointed Treasury Secretary.
(18:17):
He succeeded George Schultz, who was a PhD economist from MIT.
Schultz had already served in two cabinet level roles before
he joined the Treasury, so he's very experienced, very expert
in economic affairs. Bill Simon grew up in New Jersey.
He went to Lafayette and one of his early profiles
said he quote unquote liked partying in sports a bit
more than studying. So he wasn't quite the same personality
(18:37):
type as an MIT PhD economist. He was actually bond
trader at Zalen Brothers, but he knew Schultz, and Schultz
brought him in as Deputy secretary, basically to be the
chief operating officer of the Treasury Department. But when there's
a need for expertise on the energy side, Nixon taps
him as the energies are to respond to the oil shock,
(18:58):
and he's immediately not very popular with the Nixon team.
They think he doesn't have enough experience with international economics
in the international monetary system to really perform that function.
But he quickly becomes the mouthpiece for Nixon policy on
petro dollar recycling, and he's firmly of the belief that
private markets, and by private markets he means commercial banks,
(19:19):
and by commercial banks he means Euro dollar banks are
the best way to keep the money and oil flowing,
the thing that was the most critical aspect of this period,
keeping that market together without monetary collapse. He thinks private
markets do that better than public alternatives. But he also
knows the banking system can only handle so much. There's
only so much of this maturity transformation that private institutions
(19:41):
can really perform. The eurobanks have been pretty vocal about
that from the beginning, so they've been warning since the
fall of seventy three that they can only get so
big and provide only so much intermediation before just prudent
risk management would dictate that they start turning deposits away,
and the Saudis are going to need an alternative, They
need a safe investment. It's an alternative to eur dollars eventually,
(20:03):
so treasury bonds are arguably the best substitute. Simon just
needs to make sure that they can buy those bonds
on terms that leave them in position they feel okay with.
They want them confidential, they want a look at the
auction pricing, they want certain kinds of special treatment to
make them comfortable with this kind of investment. And so
there's a secret mission. Bill Simon flies over to Riodd
to try to pitch the Saudi's on kind of a
(20:25):
sweetheart deal. Right, they get to bid on US Treasury
bonds at auction, but anonymously, and they don't actually have
to be part of the auction. They get what's called
an add on, So after the auction happens, if they
like the price, they can have a little more at
the price at which the auction cleared is. They're not
competitive bidders, they have an option to participate or not.
And so it's pretty attractive, right, you need something you
want to diversify, you don't want to take a lot
(20:45):
of risk, Like US treasuries seem pretty good under those contexts,
and the federal government like would love to sell you
US treasuries, and so you know that's the opportunity in
part is another buyer and a large buyer, so that
the recycling gets piped through the federal government as opposed
to the private sector. And the second is in exchange,
or at least implicitly in exchange. Maybe oil is only
(21:07):
sold in dollars, because in the fall of seventy three,
I think quarter of oil was in sterling, so the
sterling system still existed to some extent. There was still
something of a sterling block, and it was still an
international currency in some context, and one of them was
global commodities. And so you know, on the one hand,
you offer this sweetheart deal with treasury bonds, which is
sort of beneficial to both sides.
Speaker 1 (21:29):
I think that's fair to.
Speaker 4 (21:30):
Say, and on the other you kind of negotiate for
a switch in Saudi oil sale policy. And the day
after the Saudis agreed to this secret arrangement, they also
announce that Saudi oil will only be available for dollars,
no more sterling. They actually do this while the chance
with the h checkers in country, and he doesn't get
a heads up, so it's a little awkward. He sort
of telegrams back and it is like, I have no
(21:51):
idea about this, So maybe the communication could have been
handled more effectively or less effectively. I'm not sure, but
at the end of the day, the US gets their
den is it funding, they get a dollar system in oil,
and you know, it's still on a nice edge. People
are still very worried about the ability of the ear
dollar system to accommodate the continued growth. Is the price
keeps going up, right, So the price goes up, the
(22:14):
flows get bigger, the banks get more levered, and all
of a sudden there was kind of worried that there
is a point at which this is not going to
work anymore. And it turns out that point comes a
little earlier than most people expected. So that's really in
June of nineteen seventy four, which is only less than
a year after the oil shock. Initially that you get
(22:34):
really the critical event in the history of the year
dollar market, the history of the global dollar system, which
is the collapse of a bank I'm sure very few
people have heard of, which is Banko's Hirschtot in Germany.
So Bankov's Hirschtat is a private bank. It's run by
a guy named Ivan Hirschtatt, So it's an eponymous banks.
It's run by its owner and he loves speculating in
(22:55):
foreign exchange. And one of the you could call it
benefits of the niiction shock. In a world of floating
exchange rates, you can start to make money trading exchange rates.
And so for a while it's not a huge business
for them, but pretty soon most of their revenue I believe,
was generated by foreign exchange trading. And he sees this
as his big moment or something, as he writes an autobiography,
(23:16):
and he's very excited about the opportunity presented by these
trading dynamics. And problem trading is sometimes you make money
and sometimes you don't. And they put a big bet
on the dollar that goes sour in June and they're
closed by the German regulators. Now Hirstatt has no regrets,
he writes an autobiography later called How My Life's Work
Was Stolen from Me. So he's perfectly fine with this outcome.
(23:38):
But the global economy is not super fine with this outcome.
Speaker 1 (23:41):
Has little Dick fold Lehman brothers to it.
Speaker 4 (23:44):
So the problem, among others is that the Germans come
in in the German evening, and if you're very active
in foreign exchange markets, you're going to make a mark payment,
the deutsch mark payment in German time, and at the
time a dollar payment in New York time. The problem
is that the German regulators close herstot before they're able
(24:04):
to make their dollar payments. So this is now called
Hirschtot risk right, which is probably better known than Benka's Hershtot,
And it's just timing mismatches in transactions and the necessity
of lining those up. Otherwise, if somebody goes out of business,
they may not make good on one side of the trade,
but they will make it on the other. And everybody
in New York freaks out. Everyone in London freaks out.
The foreign exchange mark grinds to a halt. There is
(24:25):
something like two transactions or something like that in the
whole day after this happens. Almost all these transactions happen
in New York. By the way, almost all foreign exchange
transactions with a dollar leg or settled in New York.
So it affects a lot of trades because New York
time is the one that's affected, and you have a
sudden stop to the foreign exchange markets, and that's really scary.
Speaker 1 (24:46):
And you also have a run in the euro dollar
market and in the money markets more generally. So we've
had a decade plus of US policymakers build enough this market.
Now it's reached a size and scale where a run
(25:06):
on it might jeopardize US financial stability. More generally, this
one bank fails in Europe and the contagion starts to
spread on shore in the United States. And there's one
bank in particular that gets caught up right away, and
(25:28):
it's this bank called Franklin National Bank. And Franklin National
Bank has a bank charter, so it's not a shadow bank.
Speaker 4 (25:37):
They invented credit cards. They're like a Long Island local bank, right,
I mean, they do that business.
Speaker 1 (25:42):
They were an early promoter of credit cards. You know,
they are pushing the envelope type of bank, and they
are chartered bank, but they are getting involved in shadow
banking type funding sources. And so you can run your
bank with just deposits on your right hand side. That's
the normal way to do it. But over the last
(26:05):
ten plus years, these deposit alternatives have been proliferating. One
is an offshore US dollar deposit, that's what we've been
talking about. That's a year dollar. Another is a repurchase
agreement that can be an onshore or an offshore transaction
and Franklin National Bank is doing both. They're doing both
of these, and so they have deposits, but they also
(26:26):
have these deposit alternatives that are highly runnable, that are
not FDIC ensured, and they experience a run, and if
you look at their balance sheet over the course of
the summer of nineteen seventy four, it's a run that
looks a lot like the run on Lehman Brothers. They
are rebot. Counterparties drop away and they have to turn
to the FED for a massive discount window loan, and
(26:50):
suddenly the FED is thrust into the crisis that policymakers
have been worrying about for the last several years. The
hydra headed monster is looking to consume the system, and
the problem of the year dollar market overseas has hit
the US domestic financial system. And the story is going
(27:13):
to have a lot of resonance for anybody who lived
through two thousand and eight because it starts in much
the same way and it also sort of ends in
a similar way.
Speaker 4 (27:23):
So now it's the summer seventy four, things are falling
apart that mood that we talked about about, maybe we
should crack down on euro dollars like that doesn't make
sense anymore, and there's a bunch of op eds that's like, explicitly,
now is not the time to regulate this market. It's
precisely opposite. Deregulate the market, make sure it doesn't fall
apart because people are just looking for the next domino
next to you to drop. And so the world gets
(27:44):
together in June. In July rather can't really come to
a really firm agreement. They're not willing to make a
firm comitment. And by September like it's very clear that
something needs to be done, and so the BIS convenes
the group of ten countries central bank governors and they
put out a very unusual thing, which is a public statement,
and they say, we are here to backstop the year
dollar market. I'm paraphrasing, we're here to back stop the
(28:06):
year dollar market, and we are convinced that the means
are available to do so. And so that's an implicit
reference to the swap lines, and the FMC and others
are sort of aware of the fact that the swap
lines are kind of the backbone of that commitment, But
what they're really doing is saying there is a lender
of last resort. You all thought there might be there is.
It's us, and we're here to fix the system. And
(28:27):
that has a really seismic impact. It really cures the
problem because people are aware of the fact that this
announcement effect at its finest right, this is like whatever
it takes for Mario Draghi is just the mere fact
of the public statement is enough to cure the run.
And then it's really off to the races because this
market has been identified by the most powerful countries in
(28:49):
the world as critical to financial stability and national security,
and so the limits on its growth are really pulled back.
Speaker 1 (28:57):
So I think it's worth it saying that the work
on understanding what happens in nineteen seventy four, a lot
of archival work was done by Ben Braun and his
co authors Ari Krump and Steven Morale, and they call
this communicay the original whatever it takes moment, the original
sort of central bank response to a run where the
(29:19):
central bank basically implicitly commits to use its money printing
ability to stop the run like behavior. And that's an
incredibly powerful tool that central banks have because they can
print money, they can make good on everybody's money denominated obligations.
(29:39):
And in seventy four you have this critical moment where
the central banks, especially the US Central Bank, commits itself
to this sort of policy. Remember in the nineteen thirties,
that's not the attitude of the Federal Reserve, and over
a third of the bankings system closes its doors. In
(30:02):
nineteen seventy four, you have the Federal Reserve essentially committing
to support the banking systems of European countries that are
doing a dollar banking business without following any of the
rules that govern the dollar banking business domestically, and that
puts out this fire in two thousand and eight is
just in many ways a repeat of nineteen seventy four,
(30:25):
where it's not clear is the US going to do
whatever it takes, And eventually that is made clear and
the fires ultimately subside, and we still sort of live
in this world where there are lots of runnable money
claims in the monetary system, and there's always a question
(30:48):
about the extent to which the central bank is there
standing behind them.
Speaker 4 (30:53):
So if this was a movie, this would be the
point where you have the contemplative music and the like,
what happens to all the characters in the movie, and
so in this one there's really in one character that's
really important. That's the ear dollar market. And so you know,
just for a sense of scale, by the mid eighties
there are more euro dollars than dollars, which is kind
of a remarkable fact. By the mid two thousands, there's
much more one hundred and fifty and seventy percent depends
(31:15):
on how you count them. So the ear dollar market
becomes in some sense, the dollar market becomes the much larger,
more important, more globalized market that like keeps the whole
system running.
Speaker 1 (31:26):
This is why everybody uses libor as a measure of
interesting rate. The London Interbank Offer rate is the euro
dollar market interest rate. We don't actually look to the
federal funds rate because the real rate that mattered in
the market once more dollars were being created offshore was
(31:49):
the offshore dollar rate libor, and so libor is perhaps
the best sort of known simpol of the euro dollar market.
And by the time you get to thousand and eight,
the whole system is key to the rates in this
offshore dollar market as opposed to the rates in the
onshore market. That the US banking system was sort of
(32:12):
developed around.
Speaker 4 (32:13):
So global trade settled in euro dollars. Euro dollars are
a huge asset that people have, so in a sense,
it's both the backbone and the life blood in the
body analogy, right, It's the lifeblood and the backbone of
the whole global dollar system. It still is in a
lot of ways. And in the contemplary of music overlay
version of the program, like you could say, it all
really goes back to the sixties, and so we're left
(32:34):
with this remnant of hold war competition that in some
sense was antithetical to US monetary sovereignty, but served a
very particular purpose at the time. And it's really a
lesson in how, for lack of a better word, you know,
decisions have consequences, and how financial systems evolve in unexpected ways,
(32:55):
and particularly when the government supports something, it gets a
lot of room to row and run, and it's very
hard to predict what comes next. And so you know,
it does all start in Yugoslavia, but it becomes obviously
a much much bigger thing over the subsequent fifty years.
So you know, we're recording this in the fiftieth anniversary
roughly of the intervention the Communicate, so Stall, the run
(33:18):
on the Earl market in nineteen seventy four and so like.
It's a time for reflection in a sense. But I
think more importantly, it's just a really compelling story. It's
a how we got o where we are, which is
a question I think we don't ask enough and be
like the real sort of underlying reasons why systems evolved
in the way that they did, which can tell us
a lot about the future as well.
Speaker 2 (33:44):
Oh look, we're free, We're out of the bunker or
the vaults or the archive or whatever this is was.
Speaker 3 (33:52):
Uh is the story over?
Speaker 2 (33:54):
I guess it is. All good things must come to
an end. I feel like I learned a lot. I
love these historical deep dives, and Lev and Josh really
dove deep for this one.
Speaker 3 (34:05):
Actually, Like, honestly though, is unreal. I mean, just the
fact that we got to listen to them talk for
that long about this really intense historical work. I'm actually
going to miss hearing about euro dollar history for real.
Speaker 2 (34:18):
Yeah, me too. The good news on that front is
we are not quite done. Josh and Lev. They've walked
us through the history, so we have a much better
sense of where euro dollars come from and the problems
they were intended to solve. But I think there's still
a lot of open questions about the Euro dollar markets
role today and also how it fits into the ongoing
(34:39):
debate about the future of the US dollar totally.
Speaker 3 (34:42):
There's like a lot of discussions still about whether the
dollar can maintain its special reserve currency status. People love
talking about that, whether it can maintain its status within
the financial system, and euro dollars, as we learn from
this series, are one of the most important types of
dollars out there. They facilitate global trade, investment, liquidity, and
all that stuff. So all of these debates that everyone
(35:03):
is having all around they sort of come back to
this area.
Speaker 2 (35:06):
Yeah, so we definitely need to talk more about the
future of the euro dollar market and buy extension the
future of the dollar system, and to do that, we
are going to bring back lev later this week in
an episode of Lots More to talk about all of that.
So definitely look out for lots more with lov on
euro dollars. But for now, this is the end of
(35:28):
our historic look back at this market. We hope you
enjoyed listening to Josh and Lev as much as we did.
Speaker 4 (35:35):
I also just want to thank a bunch of folks
at various archives because a lot of this work was
based on primary sources and dusty books and forums and
things like that. So definitely that at the New York
fed the Archives there have been extraordinarily helpful, the Bank
Financial Settlements in Basel, the JFK Library and the LBJ
Library who've been super kind to provide stuff. Columbia has
a clearinghouse archives which we've had a chance to go through,
(35:56):
and the National Archives in general. Just a big thanks
to all of them.
Speaker 2 (35:59):
Shall we leave at that.
Speaker 1 (36:00):
Let's leave it there.
Speaker 2 (36:01):
This has been another episode of the Authoughts podcast. I'm
Tracy Aalloway. You can follow me at Tracy Alloway.
Speaker 3 (36:07):
And I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow one of our special guests, levmanand he's at levmanand
our other special guest, Josh Younger he's not on Twitter.
Thanks to our producers Kerman Rodriguez at krbin Ermann, Dashel
Bennett at Dashbot, and Kilbrooks at Kelbrooks. And special thanks
to our sound engineer Blake Maples from our Oddlots content.
(36:28):
Go to Bloomberg dot com slash odd Lots, where we
have transcripts, a blog, and a daily newsletter, and you
can chat about all of these topics twenty four to
seven in our discord Discord dot gg slash od lots.
Speaker 2 (36:39):
And if you enjoy odd Lots, if you like it
when we bring you the hidden history of euro dollars,
then please leave us a positive review on your favorite
podcast platform. And remember, if you are a Bloomberg subscriber,
you can listen to all of our episodes absolutely ad free.
All you need to do is find the Bloomberg channel
on Apple Podcasts and follow the instructions there. Thanks for listening.
Hosts And Creators
Joe Weisenthal
Tracy Alloway
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