Friday, August 21, 2009

Benefits and costs of the Eurodollar market

The development of Eurodollar trading has resulted in substantial benefits to the international community and especially to U.S. banks and multinational corporations. The market ensures a high degree of funds mobility between international capital markets and provides a true international market for bank and non-bank liquidity adjustments.It has provided a mechanism for absorbing huge amounts of U.S. dollars flowing overseas and generally lessened international pressure to forsake the dollar for gold and other currencies.
The market reduces the costs of international trade by providing an efficient method of economizing on transactions balances in the world‘s most heavily traded currency, the dollar. Moreover, it acts as a check on domestic monetary and fiscal policies, especially on the European continent, and encourages international cooperation in economic policies because interest-sensitive traders in the market will quickly spot interest rates that are out of line and move huge a mounts of funds quickly to any point on the global.
Central banks, such as the bank of England, the Bundesbank, and the Federal Reserve System, monitor the Eurodollar market continuously in order to moderate heavy inflows or outflows of funds which may damage their domestic economics.
The capacity of Eurocurrency market to quickly mobilize massive amounts of funds has brought severe criticisms of this market from central bankers in Europe and from certain government officials, economists, and financial analysts in the United States. They see the market as contributing to instability in currency values, particularly when Eurocurrency trading places severe downward pressure on the dollar and other key trading currencies. As noted above, the market can wreak havoc with monetary and fiscal policies designed to cure domestic economic problems. This is especially true if a nation is experiencing severe inflation and massive inflows of Eurocurrency occur at the same time. The net effect of Eurocurrency expansion, other things equal, is to push domestic interest rates down, stimulate credit expansion, and accelerate the rate of inflation. The ability of local authorities to deal with inflationary problems might be completely over whelmed by a Eurocurrency glut. This danger is really the price of freedom, for an unregulated market will not always conform to the plans of government policy makers.
It is not surprising that certain European central banks have for more than a decade called for controls on Eurocurrency trading. One of the most frequently heard proposals is to impose reserve requirements on Eurodollar deposits. For example, during the 1970s France levied a 9.5 percent reserve requirement on Eurodollar loans. But such controls have not really been effective because of unanimity among foreign governments and central banks. Funds tend to flow away from areas employing controls and toward free and open markets. The key to the future of controls in this market probably rests with the bank of England, because London is the heart of the Eurodollar market. And thus far, the Old Lady of Threadneadle Street, as that bank is often called, remains firmly against significant government restraints on Eurocurrency trading.

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