Banking in the Shadows

TLDR: The Eurodollar system began when the US dollar became the world’s hegemonic currency, and it involves foreign and domestic banks creating US dollars "at the stroke of a bookkeeper’s pen".

Part 1. Offshore

@CharlieLongren

Lately I have been watching a television show from the early 2000s called House MD. Dr. House is a master diagnostician who is addicted to solving medical cases that no one else is able to solve. To get to the correct diagnosis House often has many wrong ideas first. If he treats the wrong disorder and the patient does not get better or they get worse, he learns at least two new key pieces of information. The first being the patient does not have the illness that he thought they did. The second is how the patient reacted to the wrong treatment. It is an incredibly entertaining show, but, more than that, the show demonstrates many effective methods of problem solving.

When I first started learning about the world’s financial and economic systems I thought that world governments and central banks were responsible for many of the world’s financial woes. I knew the symptoms; the increasing wealth gap, asset “bubbles” in various sectors, astronomical levels of debt. It made sense that when central banks debase the world’s currencies through money printing and interest rate manipulation prices would increase because of inflation. It makes sense that the wealthy (the owners of capital) would benefit most from that price inflation, while most other people just suffer the consequences. It makes sense that the lower interest rates go, the more debt people are willing to take on. All the symptoms line-up and point to central banks as the problem.

But, according to Jeffrey Snider of Alhambra Investment partners my diagnosis is wrong. What's more, the central banker’s diagnoses are wrong. They think they can manipulate interest rates and use methods like quantitative easing to manage the world economy, while Jeffrey Snider equates their actions to treating the symptoms while the disorder remains undiagnosed. He believes the real problem is with Eurodollars. Ubiquitously, the definition of Eurodollars are U.S. dollar deposits at foreign banks, but that definition barely scratches the surface of what Eurodollars are. In fact, Eurodollars are not dollars at all. Eurodollars are a system of standards and protocols by which money is created “at the stroke of a book keeper’s pen” To understand why Eurodollars are the cause of the failing economy, we must first understand what the Eurodollar system is, and that requires a quick look at everyone’s favorite subject… history.

In the 18 and 1900s As the world became more globalized domestic banks required instruments that allowed them to conduct trade with foreign entities. In order for a French company to buy goods in Japan they first had to convert their francs into yen. Banks developed paper contracts that could be bought and sold globally that functioned as a means to transfer money between countries. Those instruments were called banker’s acceptances and they became the “money” for international trade. Initially banker’s acceptances were denominated in many different currencies. That changed with Bretton Woods.

Through the Bretton Woods Treaty, US dollars became the settlement currency for international trade. Dollars became the global reserve currency. Now, when a French company wants to trade with a Japanese company, instead of requiring yen they require US dollars. This meant that the demand for US dollars globally would increase, and continue to increase with the growth of the global economy. Before the Bretton Woods Treaty, most other currencies were pegged to gold. After Bretton Woods, they were pegged to the US dollar which was supposed to be pegged to gold. In order to circumvent the US dollar's gold peg banks began to use accounting tricks to increase their balance sheets.

When an individual placed $100 on deposit in London, the London bank would hold 10 of those dollars in cash and loan the other $90 to a third party. In this situation, the London bank would have $10 in deposits, have an asset in the form of $90 due from a third party, and the third party would have $90 in cash assets and a liability due to the London bank. This seems like it makes sense on paper, but if the individual were to pull their $100 deposit from the London bank, the third party would still have $90 that were created through accounting tricks and unbacked by deposits.

The banks were effectively creating a $90 increase in the world’s US dollar supply, while the calculated supply of US dollars domestically didn't change at all. If the third party were a bank themselves they could do the same accounting tricks compounding the increase in US dollars and creating money out of thin air. At first, US banks were unaware of what was happening on foreign bank balance sheets, and when they became aware they wanted in on the con. US banks began to create foreign subsidiaries, so they could expand their balance sheets in the same way that foreign banks were. This is the first part of the Eurodollar system. The second part is the wholesale market.

It was not until the 1970s that US Federal Reserve officials became aware that there was “missing money.” They measured what demand for US dollars should be and found that demand was much lower than their estimates. This led them to the conclusion that there was missing money in their models. The missing dollars were outside of what was considered traditional money supply and were fulfilling demand for US dollars globally. Economists and Federal Reserve officials began to investigate where the “missing money” was. They found that it was not missing at all, but instead their definition of money was too narrow and much of the missing money was in the Repo markets (Repurchase Agreements)…

Part 2 - October 30