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