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The Eurocurrency Market and the Recycling of Petrodollars

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The Eurocurrency Market and the Recycling of Petrodollars This PDF is a selection from a published volume from the National Bureau of Economic Research Volume Title: Supplement to NBER Report Fifteen Volume Author/Editor: Raymond F. Mikesell Volume Publisher: NBER Volume ISBN: Volume URL: http://www.nber.org/books/mike75-1 Conference Date: Publication Date: October 1975 Chapter Title: The Eurocurrency Market and the Recycling of Petrodollars Chapter Author(s): Raymond F. Mikesell Chapter URL: http://www.nber.org/chapters/c4216 Chapter pages in book: (p. 1 - 7) october 1975 15 NATIONAL BUREAU REPORT supernent The Eurocurrency Market and the Recycling of Petrodollars by RaymondF. Mikesell NationalBureau of Economic Research, Inc., and University of Oregon I.. NATIONAL BUREAU OF. ECONOMIC RESEARCH, INC. NEW YORK; N.Y. 10016 National Bureau Report and supplements thereto have been exempted from the rulesgoverning submissionof manuscriptsto, and critical reviewby, the Board of Directorsof the National Bureau. Each issue, however, is reviewed and accepted for publication by a standing committee of the Board. Copyright©1975 byNational Bureau of Economic Research, Inc. All Rights Reserved Printed in the United States of America THE EUROCURRENCY MARKET AND THE RECYCLING OF PETRODOLLARS l)y RaymondF. Mikesell National Bureau of Economic Research, Inc. and University of Oregon Following the 1973 quadrupling of. oil asset holders throughout the world can ad- prices, the oil producing countries began to just their portfolio holdings in a variety of invest a substantial portion of their sur- currencies without having to deal with for- pluses in the Eurocurrency market. As a eign banks, and the U.S. and foreign resi- result new interest was sparked in the role dents can receive interest on dollar deposits of the Eurocurrency market in international with a maturity of less than thirty days, finance. With the annual OPEC (Organiza- even overnight deposits.Finally, the tion of Petroleum Exporting Countries) cur- vast worldwide interbank market for Euro- rent account surpluses expected at around currencies provides a mechanism which al- $50 billion for the next several years (per- lows banks to adjust their position in vari- haps aggregating some $250—$300 billion ous currencies at a minimum transactions before leveling off), the Eurocurrency mar- cost. ket's capacity to perform a major function in the recycling of petrodollars has been a The Origin of the Eurocurrency Market source of uneasiness in financial markets. and Its Growth to 1973 The principal explanation for the develop- A Eurocurrency deposit is a time deposit ment of the Eurocurrency market lies in its denominated in the currency of a country ability to surmount various legal barriers to other than the country in which the bank the how of funds between national capital is located.Sources of funds for the Euro- markets, and in the cost advantage to banks dollar market include Eurodollar deposits in dealing with liabilities denominated in of nonbank firms and individuals, central foreign currencies free of national currency bank deposits, and dollars injected into the deposit reserve requirements. Multinational market by the Eurobanks themselves, either firms based in the United States have been by the conversion of other currencies into able to borrow in the Eurocurrency market dollars or through swap transactions with from foreign branches of U.S. banks, un- central banks(i.e., dollars acquired from restrained by U.S. capital export. controls, the central banks in exchange for domestic and to hold their liquid funds in Eurodollars currencies). About three-fourths of total and other Eurocurrency deposits subject to Eurocurrency deposits are denominated in neither national currency reserve require- dollars,withthe remainderin German ments nor U.S. interest payment regulations. marks, Swiss francs,poundssterling, Thus, interestrates on loans have been and French francs, in that order. lower and rates paid on deposits higher Demand for Eurocurrency loans, rather than they would have been in transactions than supply of deposits, has proven to be carried on with U.S. resident banks. Liquid the prime mover behind the past expansion Note: This paper was completed in June 1975. phases ofthe Eurocurrency market, and The repayments. together with additional foreign branches of U.S. commercial banks Eurodollar deposits, were used for loans to have played a leading role in this expansion. U.S. firms operating abroad and to other U.S. parent banks increased the number of foreign businesses and governments. In fact, their foreign branches substantially during between the end of 1969 and the end of the 1960s.They were encouraged in this 1972, the Eurocurrencv market more than expansionbytheexemptionofforeign doubled in size, to an estimated S105 billion. branches from Regulation Q (which sets Demand for such Eurocurrency loans was ceilings on interest rates paid on deposits stimulated by U.S. government controls, both made for more than 30 days and prohibits on loans by banks and other financial in- payment of any interest at all on deposits stitutions to foreign residents, including U.S. for less than 30 days) and from the Fed's subsidiaries,andondirect investments reserve requirements. They were prodded, abroad,2 which drove parent firms in the also, by the credit stringency in the United United States to finance their foreign capital States and the financing requirements of expenditures by borrowing from the Euro- their corporate customers abroad. Borrow- dollar and Eurobond markets. ing by the head offices from foreign branches The growing weakness of the dollar in jumped from $1.2 billionat the end of 1970 and 1971 also contributed to an in- 1964 to a high of $14.5 billion at the end crease in the demand for Eurodollar loans. of November 1969, an important factor in With a view to speculating against the dollar, the rapid expansion of the Eurocurrency borrowers converted their dollar credits into market during that period (from a net size currencies such as German marks and Swiss of about $14 billion to an estimated $50 francs.The introductionoffloating ex- billion).' changeratesinMarch1973,however, The repayment of parent-bank indebted- tended to reduce Eurodollar borrowing of a ness to foreign branches (down to $1.3 speculative nature. billion by the end of 1971) that followed The relative importance of the various the imposition of reserve requirements by sources of Eurodollar deposits has under- the Federal Reserve authorities late in 1969 gone considerable shifts'over the past decade. failed to hamper the continued growth of Prior to 1970, the major source of Euro- the Eurocurrency market. (Until September currency funds was private nonbank de- 1969, Eurodollar borrowings were not sub- posits, including those of multinational firms. jecttoreserverequirements.Effective Federal Reserve controls on the interest September 1969, a 10% marginal reserve rates that U.S. banks could pay to depositors requirement was placed on any increase in played an important part here. Both U.S. Eurodollar borrowing by U.S. banks from residents and residents of foreign countries foreign branches above the May 1969 level.) (including subsidiaries of U.S. finns) were induced by the higher interest rates paid The sizeof the Eurocurrency marketis abroad to hold their dollar deposits in, the measured by total Eurocurrency deposits of Euro- form of Eurodollar deposits.During the banks for which reports are available less inter- 1971—1973 period,central banks'dollar bank balances. The gross size of the Eurocurrency market as of mid-May 1974 was estimatedat deposits in Eurobanks provided a major $360 billion (World Financial Markets, Morgan source of the increase in Eurodollar funds. Guaranty Trust Company, New York, July16, 1974, p. 4).Figures given by the Morgan Guar- 2EffectiveJanuary1,1968, mandatory ceilings anty Trust Company are somewhat higher than were placed, on U.S. direct foreign investments thosereportedbythe Bank forInternational witheitherdollarsexported fromtheUnited Settlements because 'of the wider coverage of the States or with foreign earnings. No controls were former. The Eurobariking system includes banks placedonU.S.corporateinvestmentsabroad outside of Europe. financed by funds borrowed abroad. 2 Finally, in 1974 theoil-exporting countries throughthecreationofadditional bank became the most important single source of credit. Eurocurrency funds, while their borrowing Since Eurocurrencydepositsaretime fromtheEurocurrencymarketsimulta- deposits, they are not ordinarily used as a neously plummeted. direct means of payment. The creation of a With the growing apprehension over the Eurodollar deposit as a result of the deposit exchange value of the dollar in 1970—1971, of a foreign currency by an individual or changes occurred in the makeup as well as nonbank firm does not create new purchas- inthe sources of Eurocurrency holdings. ing power.Itis analogous to the deposit Foreign private nonbank holdings of Euro- in a savings bank of a check drawn on a dollar deposits tended to decline, while hold- demand deposit. (Much of the debate re- ingsofnondollar Eurocurrency deposits garding multiple expansion of the Eurocur- grew significantly, indicating a preference of rency depositsarises, however, from the portfolio holders for nondollar currencies. identification of such deposits with direct After December 1971, however, foreign pri- means of payment.) The existence of non- nonbank holdings of Eurodollar de- bank Eurocurency deposits ultimately de- posits
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