Eurodollar

Definition and character

Eurodollars are U.S. dollar-denominated deposit liabilities, primarily but not exclusively time deposits, held at banks or bank branches outside the United States. The term later expanded to cover dollar deposits at banks anywhere outside the U.S. Eurodollars are outside the control of the U.S. government, carry different regulatory requirements from dollars held in U.S. banks, and because they lack U.S. deposit insurance they are riskier and demand a higher interest rate. They facilitate global trade, investment and liquidity.

Origin of the name

The 'euro-' prefix has no connection to the euro currency or the Eurozone and predates the euro. It derives from the telex address 'Eurobank' of the Banque Commerciale pour l'Europe du Nord (BCEN), a Soviet-owned bank in Paris that pioneered eurodollar accounts in the 1950s; the deposits were first called 'Eurobank dollars' and later 'eurodollars'.

Origins: competing accounts

After the Second World War, physical dollar banknotes held outside the United States increased sharply through Marshall Plan funding and European export proceeds, and some countries including the Soviet Union also held dollar deposits in American banks. Wikipedia records several competing narratives of the first eurodollar account. One is an account in France in 1949 in favour of Communist China, in which dollar notes were moved to the Soviet-owned BCEN in Paris before the U.S. froze its assets during the Korean War. Another is an account opened in 1956 by a London bank in favour of the Soviet Union after the Hungarian Revolution. Most accounts trace back to Communist governments keeping dollar deposits abroad.

The Soviet and Moscow Narodny Bank account of 1957 is the most commonly traced version, but not the sole origin. After the Hungarian Revolution of 1956, the Soviet Union feared its North American bank deposits would be frozen as a sanction and moved dollar holdings to the Moscow Narodny Bank, an English limited liability company registered in London in 1919 and owned by the Soviet Union. The bank redeposited the dollars into U.S. banks so that the funds could not be confiscated, because they legally belonged to the British bank rather than the Soviets; on 28 February 1957 the sum of $800,000 was transferred, creating the first eurodollars. One first-hand account described the outcome as 'the Eurodollar, a stateless currency that respected no borders, was invented by the Russians.'

Growth drivers in the 1950s

By mid-1955 U.S. and foreign businesses and nations were regularly using eurodollars. Large dollar holdings entered Europe after the war through the fixed exchange rate system and the Marshall Plan; Communist governments including the Soviet Union and China transferred U.S.-held balances to European banks over fear of seizure; and the 1957 sterling crisis, when the Bank of England banned sterling-financed trade for non-sterling countries after the bank rate rose to 7%, compelled London-based banks to use dollars for trade. The market was 'birthed organically' from multiple causes, not one. In the mid-1950s the Soviet Union wanted better interest rates on its eurodollars and convinced an Italian banking cartel to pay more interest than U.S. deposit rates would have earned; the Italian bankers found borrowers willing to pay above U.S. legal interest-rate caps. City of London banks such as Midland Bank, now part of HSBC, and their offshore holding companies also played a major role. The Eurodollar appeared in London in 1955, and London maintained its position as the centre of the market: its forbearance from restrictive regulation and freedom from reserve requirements and interest rate ceilings gave it a competitive advantage alongside tight restrictions elsewhere in Europe.

Regulatory arbitrage and growth

Eurodollars' appeal to bankers was that they 'didn't belong anywhere and owed no allegiance to anyone; therefore, nobody regulated them.' U.S. reserve requirements, deposit-age rules and interest-rate ceilings 'sent American banks into London, and into the Eurodollar business, where there were no interest rate ceilings and reserve requirements.' Regulation of banks varied by country and the currency, once escaped, could not be whistled home. 'Offshore' jurisdictions such as the Bahamas, the Netherlands Antilles and the Cayman Islands went beyond regulatory reach into tax reach. The Federal Reserve's Regulation Q ceiling on interest payable on domestic deposits during 1970s inflation, successive U.S. balance-of-payments deficits causing dollar outflow, and the fact that eurodollar deposits were a cheaper source of funds free of reserve requirements and deposit insurance assessments all led eurodollars to overtake U.S. bank CDs as the primary private short-term money market instrument by the 1980s. Regulation Q was repealed on 21 July 2011; until then banks could not pay interest on corporate transactional accounts and used overnight 'sweep' accounts instead.

Market size and vulnerability

The eurodollar market reached $70 billion by the end of the 1960s. In 1974, after the Nixon shock, the 1970s energy crisis and the collapse of Franklin National Bank, 10 central banks agreed to backstop the market to prevent a run. By the mid-1980s there were more eurodollars than dollars; in 1997 nearly 90% of all international loans were made via eurodollars; market size was estimated at around $13.833 trillion in 2016; use declined consistently from 2016 to 2024, and after reserve requirements were eliminated in 2020 U.S. banks shifted toward 'selected deposits', which by early 2024 made up nearly 85% of overnight volume, against about 50–50 in 2019.

Examples and markets

Eurodollar deposits commonly take the form of short-term certificates of deposit issued in U.S. dollars outside Federal Reserve jurisdiction. They are also tied to the eurodollar futures contract, launched in 1981 as the first cash-settled futures contract and traded on the Chicago Mercantile Exchange; it was used to wager on Federal Reserve policy or hedge short-term interest rates, and after the Libor scandal it was eliminated in April 2023 and transitioned to SOFR-based contracts. By 2023 most volume had moved to SOFR futures. By 1980 there were over three-quarters of a trillion dollars of eurodollar-type currency, along with Euromarks, Euroyen and Eurofrancs.

Related concepts

Bretton Woods (1944–1973) pegged currencies to the dollar, convertible to gold at $35 an ounce. By 1958 the major currencies were convertible and the dollar was preferred over gold; through the 1960s more dollars went out than came in, creating the 'overhang' of dollars abroad and U.S. balance-of-payments deficits. Eurodollars were potential claims that could 'come home', and in August 1971 the Nixon administration cut the gold–dollar tie; the world's central banks then moved to floating rates. The eurodollar market is thus an outgrowth of the Bretton Woods dollar system and survived its collapse as offshore dollar infrastructure. The market's origin is tied to Communist and Soviet dollar holdings and Cold War asset-freeze fears. The Moscow Narodny Bank London affiliate was a British-chartered company owned by the Soviet Union, registered in London on 18 October 1919, and BCEN-Eurobank in Paris was the first overseas Soviet bank. The eurodollar market sits outside Federal Reserve control, which is why its existence complicates the Fed's grip on the money supply.

Eurodollar is the founding member of the 'eurocurrency' or 'euro-' family, which includes Euroyen, Euromarks, Eurofrancs, Europound or Eurosterling, the Euroeuro market and the separate Eurobond market. The four main eurocurrencies are the U.S. dollar, the euro, sterling and the Japanese yen. Related concepts include Petrocurrency, Swap and the TED spread.

Distinctions

The name eurodollar has no connection to the European Union's euro currency and predates it. A eurodollar is defined by where the deposit is held, outside the U.S., not by the currency of the eurozone. Deposits in Asian financial centres are sometimes called Asiadollars, and the broader 'euro-' prefix can apply to any currency held outside its home country.

Eurodollars also differ from dollars held in U.S. banks. They are outside the control of the U.S. government, have different regulatory requirements, and can be riskier than assets in U.S. banks that carry at least partial deposit insurance; consequently they demand a higher interest rate. The eurocurrency market is the money market for any currency deposited outside its home market, of which the Eurodollar and Euroyen markets are the two most widely used instances; it was 'birthed organically' from the rise of the Eurodollar. Eurocurrency markets are generally preferred for lower regulatory requirements, tax laws and typically no interest caps, but carry higher risk, such as bank runs under poor solvency. The Philadelphia Fed, rather than treating stablecoins as an established extension of the eurodollar market, describes them as a new form of private money with historical parallels to Free Banking-era private banknotes, nearly all dollar-denominated, possibly strengthening the dollar by boosting demand for existing dollar assets, and quotes critics who call stablecoin issuers 'unregulated banks' subject to destabilizing runs.