IE1cmlffi1k li ©llffi 1F 1 fS\ffi\ (Cli cc July 27, '1979

Eurodollarsand E u rocu rren ci es

Financial analysts have become intensely Why these markets evolved interested in the Eurodollar and other Euro­ The Eurocurrency markets evolved in the currency markets in recent years, at least first place because some depositors wanted partly because of the massive size of these to hold deposits denominated in a certain markets, which on a gross basis may reach currency at banking offices outside the as high as $800 billion. Some analysts ques­ country issuing that currency, and because tion whether the existence of these markets banks were willing to bid for such deposits. has contributed to worldwide inflation. And One of the earliest depositors in the 1950's from a more parochial point-of-view, others was the Soviet-controlled Banque Co·mmer­ question whether some Eurodollar deposits ciale Pour L'Europe, whose code name should be included by the Federal Reserve Eurobank provided the inspiration for the in its measures of the u. S. money supply. name of the market. That bank desired to hold dollar deposits because of the dollar's What are Eurocurrencies? role in international transactions, but for Eurodollars are simply dollar-denominated political reasons preferred not to hold such deposits at banking institutions outside the deposits in the United States because of fear United States. U.S. banks are active partici­ of seizure. pants in the Eurodollar market when they accept dollar-denominated deposits at their In recent years, banking regulations and branches outside this country. restrictions on capital flows (or fear of such restrictions) have strongly stimulated the growth of the Euromarkets. A number of Similar Euro-currency markets for Euro- rules affecting U.S. banking operations - sterling, Euro-Deutschemarks, Euro-Swiss prohibitions on interest payments on all francs, Euro-French francs, and Euro-yen deposits of less than thirty days maturity, - exist when banking offices located outside a restrictions on interest rates payable on certain country accept deposits denominat­ some longer-term deposits, and rules requir­ ed in that country's currency. Forexample, if ing non-interest bearing reserves on all an office of a British bank in Paris accepts deposits - have all reduced the attractive­ deposits in OM, it is engaging in Euro-OM ness of placing deposits at banking offices activities. Yet despite the growing impor­ located in the United States. By contrast, tance of these markets in non-dollar Eurodollar deposits tend to be free of these currencies, Eurodollar deposits probably restraints. constitute about three-fourths of the total of all Eurocurrency deposits. For example, a banking office outside this country is not required to incur the costs of Eurocurrency deposits are not denominated holding non-interest bearing reserves on in the currencies of the countries where the large Eurodollar time deposits, and thus can deposit-accepting banking offices are offer depositors a slightly higher rate of located, and they are not subject to the return on dollar deposits while also enjoying reserve requirements and interest-rate limits a slightly lower net cost offunds to itself. In applied to local currency deposits. The essence, the bank and the depositors share absence of required reserves is a major the savings from not holding required reason why some observers are concerned reserves - a cost they would have incurred about the inflationary impact of these had the deposits been booked at a banking markets. office in the United States. ill) (CDTI

Opinions expressed in this nevvsletter do not necessari!v reflect the of the rnanagement of the Federal Bank of San Francisco, nor of the Board of Covernors of the Federal Reserve System.

Contribute to worldwide inflation? domestic CDs than to the types of trans­ Despite widespread debate on the subject, actions balances included in the narrow M1 there is no simple answer to the question of and M2 monetary aggregates. (Bank of whether the Euromarkets contribute to England data suggest that the average worldwide inflation. Several important in­ maturity of Eurocurrency deposits in the stitutional facts must be remembered in any London market is in the range of 1-2 analysis of the issue. months.) Such Eurocurrency deposits thus should be analyzed in relation to the First, a large proportion of Eurocurrency broadest monetary aggregates, such as M4 deposits are interbank transactions. and M5 (which include CDs), rather than in (According to recent testimony of Federal relation to the more narrowly-defined Reserve Governor Wallich, only a fraction monetary aggregates. - perhaps $1 50-1 75 billion of total Eurocurrency deposits represents liabilities Thirdly, there is reason to question the to nonbanks, and perhaps one-third of that allegation that Eurocurrency multipliers are amount is already included in some coun­ very high.and unstable because of the try's monetary aggregates.) Transactions absence of any required reserves. (The among banks are an efficient way of re­ argument states that any inflow of funds into allocating funds from capital-surplus to the market will result in excess multiple­ capital-deficit areas, but these transactions deposit creation, since banks will not be do not of themselves directly increase the restrained in their ability to relend the supply of money or credit. In the United funds.) In a closed domestic-banking States, interbank deposits are netted from system, the proceeds of any loan are auto­ total deposits in computing the monetary matically redeposited in the commercial aggregates to avoid double-counting. banks, wh ich can relend the funds except for those funds required to be kept as reserves. Secondly, a very large proportion of In the Eurodollar and other Eurocurrency Eurocurrency deposits held by nonbank markets, however, the proceeds of loans are institutions have size and maturity charac­ not automatically redeposited in the system. teristics which make them more similar to Most of the proceeds of Eurodollar loans are converted into foreign currencies for purchases or investments abroad, or trans­ ferred into transactions balances in the United States for purchases or investments in this country. Since most of the proceeds are not redeposited in the Eurodollar market, any deposit multiplier involved would tend to be quite small. Thus, the Eurocurrency system may be thought of as analogous to the U.S. system of nonbank financial institu­ tions, which receive as redeposits only a small percentage of the proceeds of the loans they make.

The simple multiplier approach to credit creation appears generally inapplicable.

2 ------. --_. _---_._- In addition, recent innovations in port­ estimates suggest that nonbank U.S. resi­ folio-balance theory suggest that inflows dents hold about $30-35 billion in Euro­ into the Euromarkets will tend to depress dollar deposits, which amounts to about 3V2 Euromarket interest rates relative to interest percent of M4 and 2 percent of M5 (the two rates in national markets, which in turn will measures which include CDs). Thus induce an offsetting outflow of funds from Eurodollar deposits remain only a small the Euromarkets back to national financial fraction of the total deposit holdings of U.S. markets. These theoretical considerations residents. However, in view of the size and strengthen the view that the credit-creating growth of the Euromarkets, the Bach potential of the Euromarkets is limited. Committee advised the Federal Reserve to improve its monitoring of these deposits. Finally, despite the Euromarkets' limited ability for multiple-deposit creation, they Certain Eurodollar deposits namely, may be able (as noted above) to reallocate dollar-denominated deposits held by U.S. credit and possibly create liquidity. Accord­ residents at branches of U.S. banks in such ing to a study by the Federal Reserve Bank of offshore banking centers as Nassau and the Boston, the maturity of Eurodollar deposit Cayman Islands - have grown rapidly in liabilities in recent years has tended to be recent months. In view of the lack of statis­ shorter than the maturity profile of Euro­ tics on the characteristics and maturity of dollar loans. This tendency towards maturity these deposits, the Federal Reserve has transformation, where depositors obtain a instituted a special one-time survey to liquid asset and borrowers a longer-term. determine whether they are readily trans­ loan, suggests that the Euromarkets may in ferable into immediately-available funds in fact be creating liquidity. Although Euro­ the United States. If this one type of Euro­ dollars are not transaction-type balances, dollar deposit is indeed readily transferable the existence of such liquid assetsin into transaction-type balances, then investors' portfolios may allow them to consideration will need to be given to economize somewhat on transactions including such deposits.in the u.s.mone- balances. Thus, this might increase the taryaggregates. . - velocity by which existing deposits can be S. Terrell utilized.

Included in U.S. money supply? The question of whether Eurodollar deposits should be included in the U.S. money supply is a complicated issue, similar to the question of whether repurchase agreements shou Id be considered as money or close substitutes for money. The Advisory Committee on Monetary Statistics (Bach Committee) concluded in its 1977 report that Eurodollar deposits held by U.S. resi­ dents should not be included in the narrow U.S. monetary aggregates, because they mostly represent large time deposits which are analogous to CDs. The best available

3 U018U!4SE'Me 4E'ln e uo8<3JOe E'PE'J\<3Ne 04E'PI !!E'ME'H E'!UJ0J!lE':) E'UOZ! N. E'>jSE'IV JJ

·MII?:::>'o:JsPUI?JJ CG) lS.! ·ON OIVd lS Od ·s·n ll VW SSV1:::>lSlIU

BANKING DATA-TWELFTH fEDERALRESERVE DISTRICT (Dollar amountsin millions) SelectedAssets and Liabilities Amount Change Changefrom large CommercialBanks Outstanding from yearago@ 7/11/79 7/4/79 Dollar Percent Loans(gross, adjusted) and investments* 128,648 2 + 17,854 + 16.11 Loans(gross, adjusted) - total# 106,225 101 + 16,790 + 18.77 Commercialand industrial 30,831 17 + 3,567 + 13.08 Realestate 38,595 256 + 8,214 + 27.04 Loansto individuals 22,040 13 NA NA Securitiesloans 1,830 - 83 NA NA U.s. Treasurysecurities* 7,604 19 - 239 - 3.05 Othersecurities* 14,819 - 80 + 1,303 + 9.64 Demanddeposits - total# 44,116 - 2,537 + 2,685 + 6.48 Demanddeposits - adjusted 32,069 58 + 1,681 + 5.53 Savingsdeposits total 30,540 203 + 40 + 0.13 Time deposits- total# 50,008 - 985 + 4,623 + 10.19 Individuals,part. & corp. 41,513 - 815 + 5,453 + 15.12 (Largenegotiable CD's) 17,448 - 744 - 147 - 0.84 WeeklyAverages Weekended Weekended Comparable of Daily Figures 7/11/79 7/4/79 year-agoperiod MemberBank Reserve Position ExcessReserves (+ )/Deficiency(- ) 3 56 39 Borrowings 281 221 34 Net free reserves(+ )/Net borrowed(- ) - 284 165 73 FederalFunds - Sevenlarge Banks Net interbanktransactions + 2,063 75 + 205 [Purchases(+)/Sales (-)] Net, U.s. Securitiesdealer transactions + 388 + 270 + 43 [Loans(+ )/Borrowings(-)] * Excludestrading account securities. # Includesitems not shownseparately. @ Historicaldata are not strictly comparabledue to changesin the reportingpanel; however, adjustments havebeen applied to 1978data to removeas much as possible the effectsof the changesin coverage.In addition,for someitems, historical data are not availabledue to definitionalchanges. Editorialcomments may be addressedto the editor (William Burke)or to the author.... Freecopies of this and other FederalReserve publications can beobtainedby callingor writing the PublicInformation Section, FederalReserve Bank of SanFrancisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184.