Speaker 1: Bloomberg Audio Studios, podcasts, radio news.
Speaker 2: Joe, Joe, what's the noise?
Speaker 3: Where's this going?
Speaker 2: Tracy, I'm setting the scene?
Speaker 3: What was that?
Speaker 1: All right, let's just start.
Speaker 2: I'm Joe Wisenthal and I'm Tracy Alloway and this is
Speaker 2: a very special edition of the All Thoughts podcast.
Speaker 4: Tracy.
Speaker 1: So, one thing I've been really fascinated by, and I
Speaker 1: mentioned it on some episodes lately, I've been really getting
Speaker 1: into Cold War history actually, and I guess I don't know,
Speaker 1: probably because I'm a middle aged man and that's a
Speaker 1: middle aged man hobby. You start reading about twentieth century history,
Speaker 1: but particularly Soviet and Chinese history. And one thing I've learned,
Speaker 1: and this did actually come up on an old episode,
Speaker 1: there's some interesting financial linkages in the past that people
Speaker 1: might not have expected at all, and I feel like
Speaker 1: more people should be talking about this.
Speaker 2: I agree. And also, if you like Cold War history, Joe,
Speaker 2: you are going to love what we are about to do,
Speaker 2: because there is a big connection between the history of
Speaker 2: the Cold War and the development of the modern financial system,
Speaker 2: and that connection is euro dollars. And of course, just
Speaker 2: to be clear, this is not the euro dollar exchange rate.
Speaker 1: I will fully admit that it took me ten years,
Speaker 1: like ten years, maybe less, maybe five, No, it probably
Speaker 1: was closer to ten. That euro dollar did not mean
Speaker 1: the euro the EU R USD exchange rate.
Speaker 2: It can be admittedly confusing, So why don't we just
Speaker 2: define it right away? So euro dollars are dollar denominated
Speaker 2: bank deposits held at foreign banks or overseas branches of
Speaker 2: US banks. And you can think of them as basically
Speaker 2: offshore dollars that sit outside the US banking system and
Speaker 2: kind of away from the Federal Reserve. They're basically a
Speaker 2: very special form of money. You could call them shadow money.
Speaker 1: And it's totally gigantic. So it's almost ten trillion dollar
Speaker 1: And I just find it so interesting, right because when
Speaker 1: I think of dollars, they're either coming from you know,
Speaker 1: the government spends dollars into existence or US bank credit.
Speaker 1: US banks licensed to de facto create dollars or deposits
Speaker 1: it will.
Speaker 4: And yet euro.
Speaker 1: Dollars are kind of this weird thing, I guess, because
Speaker 1: they're not that.
Speaker 2: Yeah, they're not either of those. And euro dollars didn't
Speaker 2: just spring up fully formed out of thin air. They
Speaker 2: were the result of a series of decisions, all aimed
Speaker 2: at solving particular problems. And that's what we're going to
Speaker 2: hear about today. So the origins of the euro dollar market,
Speaker 2: and this story has a lot in it. There's political intrigue,
Speaker 2: rivalry between the East and West, big existential questions about
Speaker 2: the role of the US dollar itself in the global
Speaker 2: financial system. Just a lot of fascinating history to satisfy
Speaker 2: your new middle aged man fans.
Speaker 1: Thank you. And we literally literally have the perfect guests
Speaker 1: to tell this story.
Speaker 2: While we're trapped in this bunker or vault.
Speaker 1: Yeah, you might recognize our storytellers. We're going to be
Speaker 1: speaking once again with Levmnand and Josh Younger.
Speaker 4: I'm levmanand I'm a law professor at Columbia Law School,
Speaker 4: where I study money and banking and the history of
Speaker 4: central banking.
Speaker 5: I'm Josh Younger. I'm a policy advisor at the Federal
Speaker 5: Reserve Bank of New York and the views I am
Speaker 5: going to express are my own and not necessarily those
Speaker 5: of the Federal Reserve Bank of New York or the
Speaker 5: Federal Reserve System.
Speaker 1: They have been digging deep into archives and are ready
Speaker 1: to tell us the story of the hidden History of
Speaker 1: Your Dollars in this very special series. There's going to
Speaker 1: be three episodes with Levin.
Speaker 2: Josh and because it's so good, they tell the story
Speaker 2: so well, Joe and I aren't going to say anything
Speaker 2: at all. We're just going to listen in.
Speaker 1: I love this. We should do all of our episodes
Speaker 1: like that, where we just get to.
Speaker 2: There, just cut ourselves out, all right, let's do it.
Speaker 5: So euro dollars are among the most important financial instruments
Speaker 5: in the world, really the backbone of the global dollar system.
Speaker 5: But they come from a very humble beginnings, very idiosyncratic start,
Speaker 5: and really it all started in Yugoslavia. And I mean
Speaker 5: that quite literally. This is like the original sin that
Speaker 5: leads to the development of euro dollars, and it starts
Speaker 5: especially when Marshal Tita takes over in Yugoslavia. So in
Speaker 5: nineteen forty five and November there's a communist revolution and
Speaker 5: the US is miffed in a bunch of ways, but
Speaker 5: one of them is that the old government owes them money,
Speaker 5: and so the question is how are they going to
Speaker 5: get it? And a few months later, Tito asked for
Speaker 5: his gold back because the Yugoslav government had seventy million
Speaker 5: dollars worth of gold in New York, and the Secretary
Speaker 5: of State, George Marshall, of the Marshall Plan, he realizes
Speaker 5: he's got a bargaining ship, which is the gold. It's
Speaker 5: in New York, and they don't get it back until
Speaker 5: they settle their claims. Now, even people within the State
Speaker 5: Department were kind of skeptical of this. The Yugoslavian government
Speaker 5: is obviously furious, and so the Russians, who at this point,
Speaker 5: you know, Tito and Stallin have a falling out eventually
Speaker 5: a few years later, but at this point they're quite
Speaker 5: closely aligned, and so the Russians are furious. The Yugoslavian
Speaker 5: government is furious. The State Department internally has some turmoil
Speaker 5: over this, and they take it to the UN, which
Speaker 5: has just been constituted, and the UN says pass they
Speaker 5: won't consider the claim, and so the Russians get the
Speaker 5: sense that the US is willing to use gold as
Speaker 5: a bargaining ship. They'd previously actually been building up dollar
Speaker 5: balances in New York. This is kind of a misnomer
Speaker 5: about the post war period. There's this sense that the
Speaker 5: Russians are extracting all their resources from but they're actually
Speaker 5: building up reserves of dollars because the thought is, we're
Speaker 5: probably going to need to trade with these people. We
Speaker 5: have a trading company based in the US, and they
Speaker 5: need resources, and so they're building up foreign currency deposits
Speaker 5: and gold. But in nineteen forty seven they realize it's
Speaker 5: not going to go well potentially, and they.
Speaker 3: Pull all the gold out.
Speaker 5: They actually just called banks in New York and they say,
Speaker 5: we want to go back, a massive reversal of the policy.
Speaker 5: And the questions where's it going to go? And so
Speaker 5: they need dollars because the US dollar is the currency
Speaker 5: of foreign exchange. If they want to trade with the West,
Speaker 5: they have to trade in dollars. They need gold because
Speaker 5: gold is the basis for the monetary system. And so
Speaker 5: the question is where can they put gold and dollars
Speaker 5: in a safe place that's still on the right side
Speaker 5: of what was then already known as the Iron Curtain.
Speaker 5: And so it turns out Paris is the ticket. They've
Speaker 5: actually been secretly stockpiloting cash and gold in Paris. They
Speaker 5: put it in briefcases. They would fly people to Paris
Speaker 5: and put it in the consulate offices. They would just
Speaker 5: build up piles of cash and gold. And in particular
Speaker 5: there's a bank b SENT that I won't try to
Speaker 5: do it in French and BCN is owned by or
Speaker 5: run by a notorious communist synthesizer who has a very
Speaker 5: good relationship with the Palaparo. And so there's a friendly
Speaker 5: bank and so they take on deposit the Soviet money
Speaker 5: and Bsen's moniker and the telex system that they used
Speaker 5: to communicate was Eurobank, and so euro dollars were initially
Speaker 5: in the late forties just deposits issued by Eurobank BCN
Speaker 5: generally for the Soviet, so they're also for the Chinese.
Speaker 5: And slowly this starts to percolate. There's another communist O
Speaker 5: one bank in London, there's one in Brussels which DCIA
Speaker 5: just describes as run by someone with few scruples, I
Speaker 5: think was the way they put it. And so there's
Speaker 5: some friendlies across Europe are willing to take their money,
Speaker 5: and the euro dollar market begins this way, which is
Speaker 5: preempt to sanctions evasion, basically that we might be sanctioned.
Speaker 5: It happened to Tito, it might happen to us, and
Speaker 5: so we need a safe place to go, and the
Speaker 5: European regulations allowed for this, and they need dollars again
Speaker 5: because they trade with the West, and so the first
Speaker 5: severe dollars is for that, and also to replace the
Speaker 5: salaries of striking French coal miners. See an Their potential
Speaker 5: place to do this is the record's not super clear.
Speaker 4: I think it's worth pausing here for a second to
Speaker 4: ask why wouldn't the Soviets have just been in France
Speaker 4: all along? Why were they in New York initially? Why
Speaker 4: had another people thought of this? And I think the
Speaker 4: answer is the dollar liabilities of communist sympathizing French bank
Speaker 4: are not the same thing as the dollar liabilities of
Speaker 4: a bank headquartered in New York. And I think it's
Speaker 4: helpful to think about why we even hold the dollar
Speaker 4: liabilities of a bank headquartered in New York, Like even today,
Speaker 4: when you log onto your bank account and you see
Speaker 4: a balance five thousand dollars, ten thousand dollars, the bank
Speaker 4: doesn't hold US government dollars to back that, and yet
Speaker 4: we are very comfortable treating those as equivalent. We aren't
Speaker 4: concerned that those those dollars are not the same thing.
Speaker 4: And why is that? There's a number of factors that
Speaker 4: go into it. Of course, since nineteen thirties, we've had
Speaker 4: deposit insurance up to a two hundred and fifty thousand
Speaker 4: dollars balance. Of course, businesses routinely hold larger balances and
Speaker 4: they are comfortable treating them as equivalent. Well, there's the
Speaker 4: implicit backing of the United States that comes from the
Speaker 4: fact that your bank was actually chartered by the US government,
Speaker 4: it's supervised by the US government. There's a sense that
Speaker 4: it's backed by the US government. And then there's the
Speaker 4: actual institutional apparatus of the Federal Reserve, which has a
Speaker 4: facility the discount window. And if you do go to
Speaker 4: your bank and say I actually want to turn this
Speaker 4: balance into government cash, the bank can go to the
Speaker 4: Federal Reserve and get that cash. The FED can print
Speaker 4: it for the bank and hand it over. And so
Speaker 4: there's this whole apparatus that facilitates you treating your balance
Speaker 4: at a US bank as equivalent to government cash. Those
Speaker 4: are trading at par This bank over in France that's
Speaker 4: now issuing these dollar liabilities that the Soviets are holding.
Speaker 4: Why should we think that that should maintain par equivalents
Speaker 4: to US government dollars, that bank's not FDIC insured, that
Speaker 4: bank's not chartered by the US government, that bank's not
Speaker 4: supervised by the US government, and that bank can't call
Speaker 4: up the FED when the Soviets are drawing down their balance,
Speaker 4: and the FED won't print money and hand it over.
Speaker 4: And so this move by the Soviets, they're taking on
Speaker 4: a lot of risk to get out of the US,
Speaker 4: and they're doing it because they're worried about the risk
Speaker 4: on the other side, the Yugoslavia risk, the risk that
Speaker 4: the US will actually freeze their balances, and so they
Speaker 4: have much higher risk tolerance, and they are willing to
Speaker 4: go out and try something different, which is whole dollar
Speaker 4: balances offshore.
Speaker 5: And it's the risk for the bank taking it as well,
Speaker 5: because the question for Beesson and others is what are
Speaker 5: you going to do with this money. So there's actually
Speaker 5: an antecedent to the eurodona market from the twenties when
Speaker 5: the dollar is actually the global reserve currency in the twenties,
Speaker 5: and then it lost that status in the thirties. But
Speaker 5: at that time dollar acceptances, which is a form of
Speaker 5: trade finance, were larger than ones drawn on London, and
Speaker 5: the dollar was the currents eve international trade and in
Speaker 5: particular the reserve currency of the world. It was the largest,
Speaker 5: was much bigger than Stirling, at least for a few years.
Speaker 5: And as a consequence of that, some of the Austrian
Speaker 5: banks in particularly started issuing dollar deposits. There's one in
Speaker 5: particular in Austria that did a pretty brisk business in this,
Speaker 5: and they were doing inter bank deposits. They were doing
Speaker 5: private deposits like non bank deposits. It looked a lot
Speaker 5: like the euro dollar market. The difference is they were
Speaker 5: basically holding it in cash on the other side, so
Speaker 5: it was more of a correspondent custody type arrangement. And
Speaker 5: so the question for a bank taking deposits is not
Speaker 5: are you comfortable issuing deposits? Of course they're comfortable issuing deposits.
Speaker 5: What are you going to do with the money? And
Speaker 5: so what can a communist own bank in Paris in
Speaker 5: nineteen forty eight do with the money? And at the
Speaker 5: time there was still some trade between the East and
Speaker 5: the West cross Iron Curtain. Now the Soviets don't like
Speaker 5: this in general because they have this policy of self
Speaker 5: reliance for obviously, since they don't want to rely in
Speaker 5: the West for anything, and we actually don't know how
Speaker 5: much of their trade this was because you'd be sent
Speaker 5: to the goolog for talking about economic data, So no
Speaker 5: talking about payrolls Joe in Soviet Russia in the forties,
Speaker 5: at least starting in the forties. But the key was
Speaker 5: there was enough to make a business out of it,
Speaker 5: and it was in dollars. So using these dollar deposits
Speaker 5: to finance East West cross Iron Curtain trade was profitable
Speaker 5: in two respects. One is you just making more money
Speaker 5: on loans and you make on cash. The others you
Speaker 5: don't have to hedge it because you have a dollar
Speaker 5: asset a dollar loan to facilitate trade, and a dollar
Speaker 5: liability a dollar deposit, so you're not taking foreign exchange risk.
Speaker 5: And so that turns out to be an okay business.
Speaker 5: Like there's not enough of that to make for a
Speaker 5: large market, but it grows. You know, it's two hundred
Speaker 5: million dollars in the early fifties and so like this
Speaker 5: is the seed that's planted, and it basically sets a precedent,
Speaker 5: which is banks are willing to do this. But the
Speaker 5: question is how do you make this a bigger business?
Speaker 5: What are the business opportunities to do it, and that's
Speaker 5: where the early fifties are a critical period because after
Speaker 5: the war, most foreign exchange markets are you're straight up closed.
Speaker 5: The British in particular are like heavily controlling their currency.
Speaker 5: London's the obvious place to do this kind of business.
Speaker 3: It's still a.
Speaker 5: Center for international trade, but they can't hedge, so if
Speaker 5: they issue dollar deposits, they're just holding dollars. And unless
Speaker 5: they have a dollar loan to make, on the other hand,
Speaker 5: which they didn't necessarily have at the time, you're just
Speaker 5: warehousing the risk that the dollar depreciates or appreciates relative
Speaker 5: to sterling, which is ultimately what you pay employees in
Speaker 5: that's your sterling funder, meaning like you are a British business,
Speaker 5: you care mostly about Stirling. Then in nineteen fifty two,
Speaker 5: as things are starting to improve, the Marshall Plan is
Speaker 5: mostly done, the dollar gap has been mostly filled. We'll
Speaker 5: talk about that a little little bit, and things are normalizing,
Speaker 5: so the British feel comfortable partially liberalizing their foreign exchange
Speaker 5: markets now, not all at once. The spot meaning today
Speaker 5: you want to exchange sterling for dollars, the rate at
Speaker 5: which you can do. That is still heavily controlled by
Speaker 5: the Bank of England. It's in a range that's widened,
Speaker 5: but it's still pretty narrow. But in particular they've liberalized
Speaker 5: the foreign exchange futures market or forward market. So what
Speaker 5: is a foreign exchange forward. A foreign exchange forward is
Speaker 5: I'm going to give you dollars for sterling, not today,
Speaker 5: maybe tomorrow, maybe in a month, maybe in a year.
Speaker 5: This is a very very large market today. It's a
Speaker 5: critical piece of hedging equipment for a bank because you
Speaker 5: can use those forwards. If you've borrowed dollars and lent
Speaker 5: them out for say a year, you don't want to
Speaker 5: hedge your dollar risk today. You want to hedge it
Speaker 5: for the return of those dollars in a year. You
Speaker 5: want a coverage for the full term of the loan.
Speaker 5: So the forwards market is critical to this, and so
Speaker 5: the Bank of England says, now you can trade forwards
Speaker 5: on dollar, sterling and other major currencies, but in particular
Speaker 5: dollars sterling, and we won't control that rate. So now
Speaker 5: there's a hedging instrument. And now banks in London can
Speaker 5: look around and say what can I do with this?
Speaker 5: Because there's clearly interest as a precedent for dollar deposits,
Speaker 5: and then the question is what can I do with it?
Speaker 3: And so they.
Speaker 5: Figure out so it still happens today, which is there's
Speaker 5: a shortage of dollars in the UK. That means if
Speaker 5: they were to borrow dollars and functionally lend them out
Speaker 5: through the FX markets, they can construct arbitrage type arrangements.
Speaker 5: And by arbitra, I mean I borrow a dollar, I
Speaker 5: hedge that dollar, I use the sterling proceeds of the
Speaker 5: hedge to buy an on shore sterling asset, and I
Speaker 5: collapse the whole thing when everything matures. So this is
Speaker 5: just cross border interest rate arbitrage. Today we'd call it
Speaker 5: a cross currency basis, but it is not perfectly efficient,
Speaker 5: meaning if there's more demand for dollars or more demand
Speaker 5: for sterling, the pricing can get out of whack relative
Speaker 5: to the relative.
Speaker 3: Interest rates on those two instruments.
Speaker 5: And so the banks in London and particular Midland Bank
Speaker 5: realizes that if they issue Euro dollars, use the dollars
Speaker 5: they borrow through year dollar issuance to buy sterling assets
Speaker 5: and hedge that package, they can make arbitrage profits and
Speaker 5: so the first use case of your dollars is sanctions evasion.
Speaker 5: The second use is to facilitate cross iron curtain trade,
Speaker 5: although that's a pretty small business. And so the third
Speaker 5: and much larger business is cross border interest rate arbitrage.
Speaker 5: And that sounds really technical, but what it's really doing
Speaker 5: is using foreign exchange markets and derivative markets to source
Speaker 5: dollars that the UK particular needs in this post war environment.
Speaker 5: So imagine a euro dollar bank. A eurobank takes in
Speaker 5: a euro a dollar deposit, which means it gets a
Speaker 5: dollar in cash. Let's think of a physical bill. That's
Speaker 5: an asset. It issues a euro dollar liability, and then
Speaker 5: what is it going to do next, because it needs
Speaker 5: to do some sort of investing. And what it does
Speaker 5: is it exchanges that dollar asset for a sterling cache
Speaker 5: and it invests that sterling cash in some short term
Speaker 5: sterling investment that's short bills or something like that. And
Speaker 5: after it does that, it says, I want to hedge
Speaker 5: my foreign exchange risk because now I have a dollar
Speaker 5: liability and a sterling asset, So I'm going to use
Speaker 5: the foreign exchange forward market to agree to sell that
Speaker 5: sterling back for dollars at some point in the future
Speaker 5: at a fixed price that we agree on today. So
Speaker 5: that's the bank's position. Who's on the other side of
Speaker 5: that trade. Let's say a corporation, a manufacturing entity. They
Speaker 5: make radios, and that radio production process requires inputs. Those
Speaker 5: inputs are imported, and so that radio production company needs
Speaker 5: dollars with which to buy the raw materials that it
Speaker 5: uses to make the radio that it then sells four
Speaker 5: dollars in foreign markets, and so they get those dollars
Speaker 5: from the Eurobank in exchange with the sterling they have
Speaker 5: on hand. They go buy all the parts, but they
Speaker 5: want to make sure that they know how much they're
Speaker 5: going to receive in local currency at the end of
Speaker 5: the production process when they sell that radio broad They
Speaker 5: don't want the value of the dollar to go down,
Speaker 5: so they sell those dollars forward in exchange for sterling,
Speaker 5: and so they ventured into a derivative agreement, which is
Speaker 5: the opposite of the one that the Eurobank has or
Speaker 5: the eurobanking system. And so then they put together the radio,
Speaker 5: they sell it abroad, they receive dollar proceeds, turn those
Speaker 5: into sterling, which is what they pay their employees in
Speaker 5: that's what they pay for their land and equipment in
Speaker 5: and that exchange rate was the one they agreed upon
Speaker 5: in advance through the foreign Exchange forward contract. And so
Speaker 5: basically what's happening is the eurobanks are pulling in dollars
Speaker 5: from abroad, distributing them through the foreign exchange market that's
Speaker 5: trading on shore to those that need dollars today, and
Speaker 5: then providing hedges to those that will receive dollars in
Speaker 5: the future, and in the case of the Eurobank, the
Speaker 5: dollars they'll owe in the future potentially to the euro
Speaker 5: dollar deposit holder.
Speaker 4: Think about this from the perspective of the city of
Speaker 4: London coming out of the war and those bankers and
Speaker 4: the world that they grew up in, which is a
Speaker 4: world that we've completely forgotten, but was the world of
Speaker 4: sterling dominance before the First World War and the role
Speaker 4: that the Empire played in financing global trade. What we're
Speaker 4: looking at in the fifties is a group of London
Speaker 4: based financial institutions trying to figure out a way to
Speaker 4: continue their dominance in global economy that runs on dollars
Speaker 4: now and not on starling. And so the euro dollars
Speaker 4: are sort of worth the risk to the City of
Speaker 4: London and to some extent to UK financial regulators like
Speaker 4: the Bank of England, because they need to fix their
Speaker 4: business model for a dollar world, and they want to
Speaker 4: get in on the dollar world. Dealing in dollars is
Speaker 4: going to be a necessary part of that, and so
Speaker 4: the UK is adapting here by turning to dollars and
Speaker 4: embracing dollar liabilities for its own institutions.
Speaker 5: And in the UK this was a particular problem because
Speaker 5: they imported so much of what they used to produce
Speaker 5: products that were manufactured to sell finish goods abroad, and
Speaker 5: so there's a great newsreel from the late forties for
Speaker 5: the British populations and you have to go without today
Speaker 5: for high quality, clean manufactured goods so that we can
Speaker 5: export as much as possible and source the dollars. But
Speaker 5: another way to do it is to get euro dollars.
Speaker 6: The Smith household is very dissatisfied. Dad wants a new wallace,
Speaker 6: mother wants a sewing machine, and Betty wants glamorous beauty preparations.
Speaker 6: But these are needed for export because we must build
Speaker 6: up overseas markets. We sell these goods overseas for foreign
Speaker 6: currency to buy the food and raw materials we need
Speaker 6: to live and work. These things would soon vanish if
Speaker 6: we couldn't pay for them. We must sell the things
Speaker 6: we'd like to buy the things.
Speaker 5: We need, and so this cross border interest rate arbitrage
Speaker 5: is really just a way markets distribute the currency according
Speaker 5: to who needs it and provide the hedges that facilitate
Speaker 5: the functioning of British corporations as well. It's what we'd
Speaker 5: call now like a use case. Right, there's like a
Speaker 5: real underlying use case that doesn't involve the Soviet Union
Speaker 5: for dollar deposits issued by non US banks, which you
Speaker 5: can't emphasize enough how fundamentally strange that is, because if
Speaker 5: I tried to make dollars by writing another piece of paper,
Speaker 5: I don't think I'd get very far. But at the
Speaker 5: time that's essentially what these banks are doing, and in
Speaker 5: particular London is a more let's say, reputable locale, particularly
Speaker 5: banks that are not known to be Communist sympathizers. There's
Speaker 5: a little bit of a funny thing about being a
Speaker 5: communist bank, but we won't get into that specifically, but
Speaker 5: these are blea chip banks in London issue even dollar
Speaker 5: deposits and that means you can use them for things
Speaker 5: and you can feel more comfortable. Along the lines of
Speaker 5: what Love was talking about, you can feel much more
Speaker 5: comfortable with Midland Bank, which was among the largest in
Speaker 5: the city, than BSEN, which is a tiny little place
Speaker 5: on the continent. And so the market starts growing. It
Speaker 5: has a bunch of things going for it, and the
Speaker 5: most important, arguably is that they can pay higher interest
Speaker 5: rates than banks in the US in general. I think
Speaker 5: you've done podcasts before about the impact of regulation Q
Speaker 5: at different times. Regulation Q is a ceiling interest rates
Speaker 5: that banks can pay. It's a depression your regulation designed
Speaker 5: to mitigate races to the bottom and bad decision making
Speaker 5: among commercial banks, and so they are limited in what
Speaker 5: they can pay. Now, we don't have to talk about
Speaker 5: whether or not that should or should not have been done.
Speaker 5: It was definitely in place in the fifties and sixties,
Speaker 5: and so if you go to London there is no
Speaker 5: regulation queue, so you can offer dollar deposits and pay
Speaker 5: a higher rate of return. So that's more money, right,
Speaker 5: So that's appealing as long as you can get your
Speaker 5: head around the counterparty risk meeting. This is not a
Speaker 5: New York Bank they don't have.
Speaker 3: Access to the FED.
Speaker 5: But as long as this market is reasonably small, they
Speaker 5: have enough dollars on hand, they have enough dollars in reserve.
Speaker 3: You know, maybe I feel comfortable.
Speaker 5: The second is a much more practical thing, which it
Speaker 5: was just hard to call New York from London. I
Speaker 5: was somewhat surprised to learn this and reading around, but
Speaker 5: you know, the first translanted cable for telephone communications is
Speaker 5: nineteen fifty six, so it's after the first few out
Speaker 5: dollars are issued by non communist banks. And even then
Speaker 5: there were thirty six circuits, which means if you want
Speaker 5: to call New York from London, you have to wait
Speaker 5: online for one of thirty six open lines at some
Speaker 5: point during the day, which could take a long time.
Speaker 5: Was very expensive and perhaps more problematically, these cables would
Speaker 5: get cut with some frequency, and so you've got one
Speaker 5: transatlantic cable that can get cut for any number of reasons,
Speaker 5: with indeterminate resolution times, and so it's just hard. There
Speaker 5: was a telegraph cable, but like that wasn't great, and
Speaker 5: so basically it's just like annoying to deal with an
Speaker 5: overseas bank, especially if you need money soon. So New
Speaker 5: York banks would generally not offer same day liquidity.
Speaker 3: To European customers for obvious reasons.
Speaker 5: And there's a gold rush in the transatlantic cable business.
Speaker 5: So the next cable comes in fifty eight, there's another
Speaker 5: one in sixty one, so the capacity expands, but you're
Speaker 5: still talking about a few dozen lines here. So it's
Speaker 5: just hard to manage your liquidity.
Speaker 3: Let's say if you have.
Speaker 5: To wait online for six hours to call your bank,
Speaker 5: and it's a lot easier to walk down the street.
Speaker 5: And so to the extent that dollars are used for
Speaker 5: a national trade that trade flows through London, these banks
Speaker 5: are in London. You know, why not have a local
Speaker 5: branch essentially of your bank to deal with. And so
Speaker 5: if you're offering higher interest rates and much greater convenience,
Speaker 5: it's a very attractive product, and so it grows pretty rapidly.
Speaker 5: It's still inhibited on the continent because you haven't restored
Speaker 5: full convertibility until nineteen fifty eight, but at that point
Speaker 5: you do, and you have this dramatic expansion, and you're
Speaker 5: at all deposits, in particular their use for the thing
Speaker 5: for which they will become famous, which is trade so
Speaker 5: now most cross border trade or intra European and global
Speaker 5: trade is done in dollars. That's a breton Woods thing.
Speaker 5: We'll talk about breton Woods later, but you essentially have
Speaker 5: to use dollars to do international trade. You often need
Speaker 5: to borrow money to facilitate trade. Trade is very heavily
Speaker 5: dependent on credit. So now you have the beginnings of
Speaker 5: a real like I said, was a real business when
Speaker 5: you're doing a cross border arbitrage, but that goes away
Speaker 5: if enough people do it. Trade is expanding dramatically. The
Speaker 5: world in the late fifties is growing enormously quickly, and
Speaker 5: a lot of that is driven by international trade. So
Speaker 5: the demand for credit to facilitate that trade is growing
Speaker 5: just as fast as the trade itself, and a lot
Speaker 5: of other banks start to get in on the action.
Speaker 5: So what was a London city bank dominated market city
Speaker 5: of London banks becomes really international market based in London.
Speaker 5: So by the early sixties there are a bunch of
Speaker 5: US banks who have opened branches in London to facilitate
Speaker 5: your dollars. They find this to be a good way
Speaker 5: to get around regulation que because I want to pay
Speaker 5: up for deposits, I can't do that in New York,
Speaker 5: I might as well just do it in London. It's
Speaker 5: all dollars at the end of the day. So they
Speaker 5: having branches in London. They're Japanese banks in London. There
Speaker 5: are Continental banks in London. There's euro dollars in Paris
Speaker 5: and Milan. So it's turning into a real global business,
Speaker 5: all in dollars, and so that obviously gets everyone's attention
Speaker 5: and it starts to raise a few eyebrows. And this
Speaker 5: is where people start to notice who are not directly
Speaker 5: involved in the market. It was previously kind of a
Speaker 5: practitioner's market. If you were involved in international trade, fans
Speaker 5: you would know about your dollars, but I wouldn't say
Speaker 5: anyone on the street would know about your dollars now.
Speaker 5: But if you were involved in finance, now you've heard
Speaker 5: of them. That becomes to be more the case, and
Speaker 5: by the late fifties they attract the attention of the
Speaker 5: Federal Reserve, who actually gets an inquiry from a third
Speaker 5: party saying these are interesting, why don't you look into it?
Speaker 5: And so they dispatch a couple of senior officers, Allen
Speaker 5: Holmes and Fred Klopstock. Allen Holmes becomes a sower manager eventually,
Speaker 5: and Fred Klopstock is kind of like this giant of
Speaker 5: international finance, so though he's at the beginnings of his career.
Speaker 5: But senior officers, you know, they run departments and they're
Speaker 5: sent to Europe on.
Speaker 3: I mean, I would love to go in this work trip.
Speaker 5: It's like twelve different European cities and you know, all
Speaker 5: good food places, right, and it wasn't easy to get
Speaker 5: to Europe in nineteen fifty nine. So they go on
Speaker 5: this like barnstorming tour of Europe, basically talking to anyone
Speaker 5: who will take the meeting, A bunch of central bankers,
Speaker 5: a bunch of private bankers, and they come back with
Speaker 5: this big, thick confidential report that is later summarized for
Speaker 5: public use. But they have this big report about you
Speaker 5: know what this thing is, how big it is. They
Speaker 5: don't know, by the way, how big it is. They
Speaker 5: just know it's big. So they know it's at least
Speaker 5: a billion dollars, which back in the day was a
Speaker 5: lot of money.
Speaker 4: Although let's size this a little bit, right, it was
Speaker 4: a billion dollars in say nineteen sixty, which is maybe
Speaker 4: the equivalent of fifty billion dollars today, that's still half
Speaker 4: of a tether. You know, tether is you know, one
Speaker 4: hundred billion dollar basically Euro dollar bank. And so what
Speaker 4: we have is the FED looking into this market when
Speaker 4: it has gotten to the point of being about half
Speaker 4: of the size of tether's balance sheet. So we have
Speaker 4: way more to go in terms of the growth of
Speaker 4: this market subsequent to nineteen sixty. It's still pretty nascent
Speaker 4: in nineteen sixty. It's where some action is in London.
Speaker 4: The policymakers here, they're already on top of this at
Speaker 4: half the size of a tether, and they're off trying
Speaker 4: to get to the bottom of what's going on.
Speaker 5: And so when they come back, as they say, this
Speaker 5: is interesting, and this is interesting in two respects. One,
Speaker 5: is it just weird that you can do this still,
Speaker 5: You can just write a dollar a piece of paper
Speaker 5: and people will take it. But they also more importantly say,
Speaker 5: you know, this makes the dollar more useful. They literally
Speaker 5: say useful in the report. And so the question is
Speaker 5: what does useful mean? And useful in this context means
Speaker 5: you're earning enough interest on this dollar that you're willing
Speaker 5: to hold it as a dollar deposit and on the
Speaker 5: other hand, like you're willing to hold dollars in balances
Speaker 5: instead of spending them immediately, and so like this is
Speaker 5: a short term liquid investment in dollars that is appealing,
Speaker 5: especially to the central banks, which are rapidly accumulating dollars
Speaker 5: through the growth of international trades, so they need somewhere
Speaker 5: to put it. You know, if I'm at central bank,
Speaker 5: I taken a dollar, I can go turn it in
Speaker 5: for gold. If I want gold, I can hold it
Speaker 5: as a dollar, maybe buy treasury security, or I can
Speaker 5: put it in a year dollar bank, and something like
Speaker 5: one out of five of the early year dollars maybe more.
Speaker 3: There's some estimates are.
Speaker 5: Up to forty percent or from central banks themselves, European
Speaker 5: central banks that we're facilitating the market, and so that's
Speaker 5: a way to keep dollars circulating offshore.
Speaker 3: Not in the US.
Speaker 5: So you have a functional dollar financial system, at least
Speaker 5: the beginnings of one that doesn't really touch the US
Speaker 5: financial system. And so that is both interesting but also
Speaker 5: useful in the sense that this becomes an increasingly valuable
Speaker 5: tool because behind the scenes of all of this, we're
Speaker 5: kind of focused on the year dollars themselves, that's not
Speaker 5: the big story here. The big story is the balance
Speaker 5: of payments crisis, which is what they called it, which
Speaker 5: is really just the fact that the US had written
Speaker 5: too many claims on its gold. They'd issued a lot
Speaker 5: of dollars. Those dollars were exchangeable for gold, and now
Speaker 5: there were way more dollar claims on their pile of
Speaker 5: monetary gold than there was gold, and increasingly people were
Speaker 5: turning their dollars in.
Speaker 4: Well before we get to the bread and wood system,
Speaker 4: just on the usefulness of dollars, I think it's helpful
Speaker 4: to reflect on how for ordinary people we take for
Speaker 4: granted the usefulness of the dollar. We don't actually think,
Speaker 4: should I pay for this coffee with yen? When we're
Speaker 4: operating the domestic economy, the dollar is just self evidently
Speaker 4: the useful form of money. But when you're talking about
Speaker 4: international trade and finance, currencies are in legitimate competition with
Speaker 4: each other for uses, and so you know, put your
Speaker 4: core or treasurer hat on of a nineteen fifty's UK
Speaker 4: business engaged in import or export. Part of what Josh
Speaker 4: is illustrating is suddenly the dollar is a more attractive
Speaker 4: currency to use in various ways because you can maintain
Speaker 4: dollar balances at a nearby bank that you've banked with,
Speaker 4: you have a strong relationship with. You don't need to
Speaker 4: have some transatlantic relationship with the New York banks. So
Speaker 4: suddenly there's more transactions that you will do, trade financing
Speaker 4: and actual trade invoiced and denominated in dollars because suddenly
Speaker 4: the dollar is a more appealing currency for you. So
Speaker 4: the dollar's usefulness has grown. And to the New York
Speaker 4: Fed team that is looking into this, they are pleased
Speaker 4: with this development to see that the euro dollar market,
Speaker 4: this nascent development of European sovereigns essentially is actually going
Speaker 4: to be a good thing for the currency that we
Speaker 4: in the United States are creating in terms of its
Speaker 4: competitiveness with other currencies in the global marketplace.
Speaker 5: So the question at this point is it's innascent market.
Speaker 5: It's half a tether, and it's unclear whether or not
Speaker 5: it's become a big, major global actor. We know it
Speaker 5: eventually becomes that. At the time that's super unclear, but
Speaker 5: it becomes eventually and soon the solution to a big problem.
Speaker 5: So your dollars are the solution to a big problem.
Speaker 5: Because in the background of all of this build up.
Speaker 5: There's massive trouble brewing and the whole global edifice of
Speaker 5: the dollar system is starting to crack, and the question is,
Speaker 5: you know, how are we going to save it?
Speaker 3: Or should we?
Speaker 1: That was the first installment of our special three part
Speaker 1: series examining the Origins of Your Dollars. It's so funny
Speaker 1: to hear about the communist origins of Like, here's this
Speaker 1: thing that we hear about every day. They're big in
Speaker 1: the news, et cetera, and it actually had communist origins
Speaker 1: in the nineteen fifties.
Speaker 2: Yeah. In the next episode, Josh and Lev are going
Speaker 2: to continue the story into the turbulent nineteen sixties, with
Speaker 2: that cracking dollar system now morphing into a major campaign
Speaker 2: issue in the race between John F. Kennedy and Richard Pixon.
Speaker 1: Will it be euro dollars to the rescue? Find out
Speaker 1: in the next installment.
Speaker 2: But in the meantime, this has been another episode of
Speaker 2: the Authoughts podcast. I'm Tracy Alloway. You can follow me
Speaker 2: at Tracy Alloway and.
Speaker 1: I'm Joe Wisenthal. You can follow me at the Stalwart.
Speaker 1: Follow one of our special guests, levmanand he's at levmanand
Speaker 1: our other special guest, Josh Younger, He's not on Twitter.
Speaker 1: Thanks to our producers Kerman Rodriguez at carbin Ermann dash,
Speaker 1: Ol Bennett at Dashbot and Kilbrooks at Kelbrooks, and special
Speaker 1: thanks to our sound engineer Blake Maples. From our odd
Speaker 1: loads content, go to Bloomberg dot com slash odd Lots,
Speaker 1: where we have transcripts, a blog, and a daily newsletter
Speaker 1: and you can chat about all of these topics twenty
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