The Fed's Quandry with Uncle ED (Eurodollar)

Following up on our last post...

Summary

• The central banks of Canada, England, Japan, the European Union and Switzerland all made their dollar swap arrangements with the Fed permanent.
• This group of central banks have been charged indirectly by the Fed with backstopping the Eurodollar market.
• Asset liability and maturity mismatches can cause Eurodollar market liquidity issues.

For the remainder of this missive, these terms are interchangeable: Uncle ED, AKA Eurodollar or Extra Dollar.

What are Eurodollars? Milton Friedman:

"They are deposit liabilities, denominated in dollars, of banks outside the United States. Eurodollars have two basic characteristics: first, they are short-term obligations to pay dollars; second, they are obligations of banking offices located outside the U.S. Funds placed with these institutions may be owned by anyone: U.S. or foreign residents or citizens, individuals or corporations or governments. Eurodollar banks are subject to the regulations of the relevant banking authorities in the country in which they operate. In practice, however, such banks have been subject neither to required reserves on Eurodollar deposits nor to maximum ceilings on the rates of interest they are permitted to pay on such deposits."

Historical drivers in the Eurodollar market: The desire for dollar claims not to be subject to U.S. governmental control; evading tight money policies, circumventing Reg Q, interest rate maximums (higher rates on deposits); and exchange controls imposed by the U.S. for balance of payments purposes (taxation).

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