-- SOURCE: Macro Voices with Jeffrey P. Snider - A Five Part Series can be found at Macro Voices


Eurodollar University 02 aIn Part 1, the story began in 1944 when the US dollar was chosen to serve as the world’s reserve currency at the Bretton Woods Conference. Because this meant that the dollar would be used for all international trade settlement, that meant that all other nations around the globe needed to have dollars in order to transact international commerce.

By the 1950s, an offshore market for US dollars had developed in the form of the banker’s acceptance market. Effectively, banker’s acceptances were like money orders or cashier’s checks that were payable in US dollars. These dollar-denominated IOUs were the first incarnation of the Eurodollar market.

By the 1960s, there was a full-fledged offshore Eurodollar market operating entirely outside of the US banking system and therefore without US regulation. But the Federal Reserve didn’t even gain awareness of what was going on in the Eurodollar market until about 1962 when the phrase “Eurodollar” first starts to appear regularly in FOMC minutes.

Through the 1960s, the Eurodollar system created new US dollar money supply out of thin air, at the stroke of a bookkeeper’s pen, with no backing by gold or by physical cash issued by the US Treasury. And all of this happened in the 1960s when the United States was still on the Bretton Woods gold standard system.

In a series of articles, Milton Friedman demonstrated how the Eurodollar system had created $30 billion of new US dollar money supply out of thin air without gold or physical cash backing. Because all of this was happening outside the US banking system, it was exempt from regulation that would have prevented it from occurring inside the US banking system.

Not wanting to be left out of the profits that were being made by offshore banks, the major US banks established European subsidiaries so that they too could participate in this opportunity to conjure money out of thin air without gold backing.

The key point to remember is that, through all of this, the new money that was being created at the stroke of a bookkeeper’s pen somewhere in Europe was never backed by an ounce of gold, or a penny of actual money issued by the US Treasury. It was all occurring entirely in the shadows, and it was exempt from oversight or even the awareness of US regulators.

In Part 2, we went on to expand the conversation into the wholesale component of the Eurodollar system which essentially allows US banks to create money supply out of thin air through creative accounting.

We learned that by 1974 the Fed realized that they didn’t know how to measure the money supply accurately, because the system had become so complex.


We discussed how the repurchase system, which is used by banks to facilitate short-term financing, played a key role in expanding the wholesale component of the Eurodollar system. Officials at the time were challenged to even understand what was happening and didn’t know how to categorize repo transactions, because their full effect was not completely understood.

Official statistics of the day did not accurately reflect the money supply that was being created in the wholesale Eurodollar system or the role that the repo market played in creating it.


We heard the fascinating story of how major banks – Salomon Brothers most visibly – were overbidding for Treasury paper in the early 1990s, because they’d figured out a way to beat the system and rehypothecate the very best collateral assets, using them to collateralize multiple loans. Thus, effectively, conjuring even more money out of thin air using the repo market to create wholesale Eurodollars.

Jeff opined that the Fed’s literal inability to accurately measure the money supply that was being created by the Eurodollar system probably played a key role in the early 1990s policy shift in which the Fed began targeting the federal funds rate rather than money supply as a monetary policy tool.

In Part 3, Jeff described Alan Greenspan as an accidental genius, suggesting that what seemed at the time to most observers to be organic economic growth through the 1990s may really have been bolstered to a great extent by new money supply creation that was occurring in the wholesale Eurodollar system.

And of course that money creation has a stimulative effect similar to what quantitative easing was intended to accomplish in the wake of the great financial crisis.


We discussed the role that the Basel Bank Accords played in enabling banks to increase their leverage considerably while maintaining the same on-paper capital ratios, thanks to provisions of the Basel Accords that allowed some collateral, including mortgage-backed securities, to enjoy a special discounted reserve ratio requirement.


This led to increased demand for mortgage-backed securities to serve as collateral to fuel the growth of the wholesale Eurodollar system. And that extraordinary demand may have contributed to the overall failure of the investment community to realistically price default risk in those securities.

Off-balance sheet accounting further enabled growth and expansion of the wholesale Eurodollar market.

And Jeff walked us through a series of hypothetical examples illustrating how this process occurred.

In Part 4, And then, finally, in this episode, Part 4, we heard the story of Wall Street legend Tom Jasper’s Primus Guaranty, which wrote $13 billion of notional credit default swap exposure entirely off-balance sheet, leading to its eventual failure in 2009.


Something I never learned until this interview is, not only was AIG at the center of counterparty risk in 2009, but much of the credit default swaps they’d written were sold to banks who were using them to play accounting games and further leverage their balance sheets through the Eurodollar system and its ability to create money. So AIG was all over every aspect of the Eurodollar system from credit default swaps to repurchase agreements.


We heard how the Gramm–Leach–Bliley legislation was sold to the public as an enabler of financial one-stop shopping – supposedly good for the consumer – but how, in reality, it enabled retail banks to play in the same Eurodollar wholesale money creation playground that the shadow banking institutions had been enjoying for years.

Jeff explained that the Fed was asleep at the switch in the early ‘90s, focusing monetary policy decisions on the federal funds rate with no apparent cognizance of the massive money supply creation that was occurring at the time in the wholesale Eurodollar market.

We discussed how – although the supposed purpose of the banking system is to facilitate the efficient formation of capital to finance the expansion and creation of new businesses – ever since the 1960s the Eurodollar system has really taken on a life of its own, creating bubbles as money creation occurs in the shadows with no regulatory oversight or even awareness on the part of regulators that it was occurring.


Jeff opined that this contributed to the 2007-2008 housing crisis, because the demand for collateral to facilitate Eurodollar money creation helped to fuel the bubble in sub-prime mortgage-backed securities.

Jeff explained that even to this day hardly anyone really understands how big the Eurodollar system is or the role that it plays in the global financial system.

  • Regulators basically don’t pay attention to it. It’s not on their radar.
  • Economists don’t recognize the Eurodollar systems in their models.

Jeff believes that Eurodollar system money creation fueled the 1990s stock market boom, and few people appreciate that point.

And, finally, the point that Jeff made most emphatically is that we cannot possibly expect the problems and risks that are being created by growth of the Eurodollar system to ever be corrected until, first, regulators develop an awareness and understanding of the system’s true inner workings and the risk that it poses.