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Euro-Dollars: Some Further Comments

Oscar L. Altmaii *

This is the text of a speech delivered at a Conference on Inter-national Financing organized by the National Industrial Con-ference Board, New York, October 14, 1964.

ALARGE international money market in short-term dollars has devel-oped outside the United States within the past six or seven years.

This market is called the Euro-dollar market because the transactionsin it concern U.S. dollars and because these transactions are negotiatedand completed outside the United States. These transactions are madepossible because U.S. and other corporations and individuals depositdollars with banks, outside the United States, which have found profitableuses for them. Most of these dollars are deposited with banks in Canadaand London, but a substantial amount is deposited with banks in conti-nental European centers. These dollars are employed by the originalbank depositary or, through a process of redepositing, by other banks.The original dollar deposits represent funds owned by monetary authori-ties, business enterprises, and individuals in many countries. Correspond-ingly, the final users of dollar funds may be commercial banks, businessenterprises, and individuals in many countries and monetary authoritiesin a few countries.1

It may be estimated with some assurance that dollar deposits comefrom at least 25 countries and that the final users of dollars reside in atleast 35 countries.2 About 400 commercial and private banks are inthe Euro-dollar market. Many of these banks are in the market all thetime, and they may be on one side or the other, depending upon profits

* Mr. Altaian, Deputy Director of the Research and Statistics Department, andFund Historian, is a graduate of Cornell University and of the University ofChicago. He taught economics at Ohio State University and was on the staff ofthe National Resources Planning Board and of the French Supply Council. He wasDirector of Administration of the Fund until 1954. He is the author of Savings,Investment, and National Income and of a number of papers published in technicaljournals.

!For earlier discussions of Euro-dollars by the author, see "Foreign Marketsfor Dollars, Sterling, and Other Currencies," Staff Papers, Vol. VIII (1960-61),pp. 313-52; "Canadian Markets for U.S. Dollars," Staff Papers, Vol. IX (1962),pp. 297-316; "Recent Developments in Foreign Markets for Dollars and OtherCurrencies," Staff Papers, Vol. X (1963), pp. 48-96.

2 Complete data have not yet been made available on these points. Indeed, therewould be difficulties in interpreting data on the countries from which Euro-dollarsare reported to come, since many suppliers act through nominees or agents in othercountries.

1

©International Monetary Fund. Not for Redistribution

2 INTERNATIONAL MONETARY FUND STAFF PAPERS

that may be earned from interest rate differentials and arbitrage possi-bilities. Other banks are in the market irregularly in order to deal withthe financing needs or the savings accumulations of particular clients.The Euro-dollar market knows no politics. The two large communistbanks in Western Europe—the Moscow Narodny Bank in London andthe Banque Commerciale de 1'Europe du Nord in Paris—are importantcomponents of the market, sometimes to place deposits with other banks(lend) but more often to accept them (borrow). The state banks ofmost of the countries behind the iron curtain are in the market, andmany of these regularly circularize commercial banks in the West inorder to obtain deposit funds. Brokers play an important specializedrole as intermediaries among banks, and two of them—one in Paris andthe other in Lausanne—with their branches, do a large internationalbusiness.3 The market in Euro-dollars is a wide and complicated onespread over six continents and bound together by a network of cable,telex, and telephone communication. The paper work in the markettends to confirm rather than to initiate transactions. The financial stand-ing of the banks in the market is such that transactions are based onnames and do not involve collateral and guarantees.

There are three major uses for Euro-dollars.First, a large part of these dollars is used to finance external com-

mercial transactions, i.e., exports and imports. Indeed, many countriesin Europe and elsewhere try to limit Euro-dollar activities to thosebusiness enterprises that are engaged in foreign trade. These limitationsoperate through systems of capital controls, or exchange controls, ormoral suasion by central banks. Even European countries with con-vertible currencies may restrict or prohibit business enterprises notengaged in foreign trade (e.g., hotels and department stores) fromborrowing Euro-dollars, even though borrowing dollars may be cheaperthan borrowing local currency. This is, for example, the situation inFrance. In the last two or three years, with the expansion of issues oflong-term securities denominated in dollars in European capital markets,underwriters and syndicate members have used Euro-dollars to financetheir inventory positions. Italy made a large and noteworthy use of theEuro-dollar market in 1962-63 when it borrowed more than $750 million

3 Nine members of the Foreign Exchange Brokers' Association have recentlyformed a new company, FEBA (London) Ltd., to arrange Euro-dollar and otherforeign currency deposits between banks in London and those in overseas centers(The Economist, September 19, 1964, p. 1155).

I


EURO-DOLLARS: SOME FURTHER COMMENTS 3

from abroad; about half of this sum came from the Euro-dollar market.These funds were used to finance external transactions and to makepossible a continuing increase in domestic liquidity, which, in effect,reduced the drain upon official reserves. Acting under instructions fromthe Bank of Italy, the commercial banks began to reduce their netexternal liabilities in the fourth quarter of 1963 and have since gone along way toward reversing their position.

Second, some Euro-dollar funds are used to finance commercial loansand other domestic transactions, either in the form of dollars or in localcurrency purchased with dollars. There has been a large amount of suchtransactions in Germany, Italy, and Japan, and smaller amounts in manyother countries, including Switzerland. In the United Kingdom, a sub-stantial amount of Euro-dollars has been swapped into sterling and thenplaced with local authorities and installment finance companies. Belgiumhas, directly or indirectly, financed parts of some recent budget deficitswith the local currency proceeds of Euro-dollar borrowings.

The third aspect of the Euro-dollar market is in some respects themost interesting one. The Euro-dollar deposit is a new and internationalmoney market instrument that makes it possible for hundreds of com-mercial banks to deal with each other continually in order to adjusttheir own liquidity positions. Each bank makes its own adjustmentsfor this purpose by dealing in funds with different stated and implicitmaturities, different interest rates, and different counterparties.

On an international scale, Euro-dollar deposits used in this way areanalogous to the many kinds of domestic funds in the U.S. moneymarket: federal funds,4 short-term government securities, certificates ofdeposit,5 and that recent newcomer, short-term unsecured promissorynotes issued by a number of leading U.S. banks.6 European commercialbanks can invest in Euro-dollar deposits with a broad range of maturi-

4 U.S. banks have long used the market in federal funds to acquire reserves tomeet their reserve requirements. Since federal funds are an alternative to redis-counting, the interest rate on them does not exceed the rediscount rate. But inOctober 1964, one large New York City bank twice borrowed federal funds at apremium, explaining that "it chose to pay the higher rate for Federal funds inorder to feel free to lend or invest the money without any questions asked by theFederal Reserve officials. Ordinarily, banks that borrow at the 'discount window'of the Federal Reserve banks are expected to use the funds chiefly to tide them-selves over a temporary deficiency of reserves rather than to use the money toinvest or lend at a higher rate" (The Wall Street Journal, October 6, 1964).

5 In the few years since their introduction, outstanding certificates of deposit—a new monetary instrument designed to meet the competition of foreign marketsand the domestic competition of savings and loan associations and other corpora-tions—have increased to more than $12 billion.

6 The Wall Street Journal, September 3 and September 25, 1964. These promis-sory notes increase bank assets but do not create a legal reserve requirement, asdo certificates of deposit.



ties. This facility is the more important because few countries haveshort-term money markets that are as liquid, and investment media thatare as broad, as those in the United States. For one reason or another,some industrial countries have only a small volume of money marketinstruments that can be traded, while others have domestic money marketinstruments that are available only in a controlled market, or at a regu-lated interest rate. It is, therefore, understandable that commercial andprivate banks in Europe should welcome an uncontrolled, flexible, andinternational money market instrument to facilitate their own operations.Moreover, Euro-dollar deposits help commercial and private banks toobtain funds outside the channels of their regular customers.

The role of Euro-dollars as a money market instrument has someimportant implications. A substantial part of the Euro-dollar pool circu-lates and recirculates endlessly among banks. To this extent, any discus-sion about using short-term Euro-dollar funds to finance long-terminvestments in plant, equipment, or inventory is beside the point. Further-more, attempts to find the specific end-uses of particular Euro-dollardeposits are often quite vain. Euro-dollar funds and other bankingfunds are increasingly commingled. On the one hand, the sources anduses of Euro-dollars affect what the bank does with the rest of its funds;on the other hand, the funds that the bank has, and what it does withthese funds, affect its operations in Euro-dollars. As banks have acquiredmore experience with Euro-dollar operations, they have modified theirviews on putting lending and borrowing operations in Euro-dollars ina separate compartment and treating them as an adjunct to theirexchange operations. More and more banks look on their dealings inEuro-dollars as an operation run by senior officers to increase theprofits of the bank as a whole in both the short run and the long run.

This has been the attitude of U.S. banks whose foreign branches havebeen and are major operators in the Euro-dollar market. The amountof deposits accepted by foreign branches, and the interest rates paid onthem, are determined by or cleared with the head offices. A large partof the Euro-dollar deposits obtained by foreign branches of U.S. banksis made available to their head offices and commingled with other funds,although the proportion so made available has been decreasing forsome time. Three or four years ago, most of these funds, perhaps75 per cent or more, were handled in this way. But this percentage hasfallen markedly with the overseas expansion of U.S. banking andindustry. Foreign branches of U.S. banks have become more accustomedto making loans to foreign corporations as well as to foreign subsidiariesand branches of U.S. corporations. Managers of foreign branches ofU.S. banks wish to show maximum profits for their branches by lending



their own deposits—rather than the much lower profits that wouldaccrue to them from putting Euro-dollars at the disposal of their headoffices. In some cases, the percentage of Euro-dollar funds put at thedisposal of head offices is now apparently well below 50 per cent.7

II

Virtually all commentators on the Euro-dollar market have warnedof the possibilities of abusing it. And it is true that the facilities offeredby that market may be abused in a number of ways. But it is also truethat similar abuses are not unknown in commercial banking that doesnot make use of Euro-dollars.

Individual banks, or all the banks collectively, in the Euro-dollarmarket may obtain funds on short term and lend them on very muchlonger term. Though some of this is inherent in banking operations,too much of a spread between borrowing and lending maturities willimpair banking liquidity. Also, the rapid expansion of Euro-dollarfacilities, and the growing international competition among banks, caneasily lead to undue reliance on the quality of "names." Such reliance,when combined with a premium on quick decisions, can result in arelaxation of banking requirements for good and up-to-date informationon assets and liabilities, profits, and the total of outstanding borrowingsand contingent obligations. Losses within the past two years in severalwell-publicized cases have underlined the risks of such relaxation.

The rapid development of the Euro-dollar market, the facilitiesoffered by a new money market instrument, and the increased, althoughgentlemanly, competition among banks on both the domestic and inter-national scene, have been accompanied by a certain amount of exuber-ance. The recent losses in Euro-dollars appear to have curbed some ofthis exuberance and thus strengthened the market without interferingwith its growth.

The international activities of banks have developed very rapidly.Many banks and their investment subsidiaries have been anxious toget in on the ground floor. They have tried to develop, even at somecost, new customer relationships that would be profitable in the longrun. They have considered certain low-profit business as institutional

7 It may be noted in passing that this development is technically good for the U.S.balance of payments. When the foreign branches of U.S. banks lend to a foreignerdollars that have been deposited by a foreigner, the balance of payments of theUnited States is not affected. But when the head offices of U.S. banks lend to aforeigner dollars which have been deposited by a foreigner (directly or via aforeign branch), there is an increase in the balance of payments deficit as currentlycalculated.



advertising. It has taken somewhat longer, perhaps, to realize that everycountry differs from every other: in the number of sets of accountingrecords that it regards as good business; in the amount of disclosurethat it regards as good for boards of directors, stockholders, and stockexchanges; in accounting standards and practices; and in views of taxmorality.

Such a simple problem as determining how much a European cor-poration has borrowed, and from whom, may be very difficult whencorporate structures are complicated, and when borrowings are madein many countries and from many banks that have traditionally refusedto disclose anything to each other or to third parties. It is understandable,therefore, that there have been voices asking for better advisory andrating services on an international scale, and for more uniform account-ing standards and disclosure along the lines of those administered by theU.S. Securities and Exchange Commission and encouraged by stockexchanges and accounting firms. There have recently been discussionsin Europe advocating more uniform accounting practices, better report-ing, and a European credit agency which would collect and consolidatedata on corporate borrowings—what in Europe is called a centralizationof risk service. For a number of years, the Bank of France has requiredbanks in France to report all loans over stated minima to businessenterprises; the Bank tabulates these reports to obtain and makeavailable data on consolidated borrowings of various types. Italy hasrecently announced the formation of a similar official service. TheUnited Kingdom has private facilities of this type. But most otherindustrial countries have neither one nor the other.

European and U.S. bankers would undoubtedly welcome a cen-tralized system of reporting on the outstanding commercial credits ofEuropean corporations. But it will probably take a good deal of time toestablish this; and M. Julien Koszul, Director-General of Foreign Servicesof the Bank of France, may well be right in thinking that a system ofEuropean scope will depend upon the development, first, by each majorcountry of its own reporting system.8 If commercial banks in Europewill not collaborate voluntarily to report their larger loans to an inde-pendent private agency, so that they can all benefit from consolidatedtotals, information on outstanding loans and credits can then becollected only by official national agencies acting with mandatorypowers.

The point of this discussion about credit reporting and accountingstandards is that some of the possibilities of abuse in the Euro-dollarmarket are also inherent in the rapid internationalization of commercial

8 "Euro-dollar, Euro-devises," Banque (Paris), No. 218, August 1964,pp. 513-14.



banking. Many of the same banks, and many of the same bankingofficers, operate in both areas. Improvements made for Euro-dollaroperations will flow over to more customary banking operations, andvice versa. In the process, the whole level of international banking willbe raised.

A few words should be said about the supposed lack of liquidity andstability that may come in the Euro-dollar market from borrowing shortand lending long, but with the caution that some of these words may applyto commercial banking generally.

In the first place, there are no over-all or consolidated data showing thedistribution by maturity of Euro-dollar deposits and loans. Some banksmay have developed statistics covering their own operations; and Japancollects data on the distribution by maturity of Euro-dollar depositsaccepted by Japanese banks in order to improve its understanding of thebalance of payments and the significance of its international reserves.

In the second place, there would be great difficulties in interpreting dataon the maturity distribution of Euro-dollar deposits and loans, even if theywere available. Things very often are not precisely what they seem.Euro-dollar deposits may be accepted as short term by a bank, and mayso appear on its books, even though both the depositor and the bank knowthat the money will remain on deposit for substantial periods of time,perhaps for several years. The depositor may prefer to show his depositsas short term to comply with legal requirements or customary practice.For example, deposits by monetary authorities and insurance companiesare often made with this understanding. When this is true, the depositorwill, quite reasonably, expect to earn something more than the short-termrate, and actual interest payments may be renegotiated at intervals of,say, three or six months. In transactions involving several corporationsin the same business family, the maturity of loans to one may be tiedto the maturity of the deposits of others. In other cases, loans may besubject to termination, and longer-term loans may be subject to interestrate adjustments that may put pressure upon the borrower. The real oreffective distribution by maturity of Euro-dollar deposits and loans maythus differ significantly from the distribution calculated from the banks'records. Neither should it be overlooked that when banks accept risks ofthis kind, they expect to be compensated for them by charging higherrates.

In the third place, many of the world's largest and best regarded banksare in the Euro-dollar market. Not one of these banks thinks that it istaking any undue or uncompensated risks, though it may be willing toconcede or even to affirm that its competitors are doing so. Nothing inthe Euro-dollar market is equivalent to the odd-lot investor buying fiveshares of stock. The chips in this game are high, and transactions run to



six or seven figures. Everybody who operates in the market knows therisks, as well as the potential profits, of arbitrage of loans and depositsof different maturities. No one wishes to be caught in a squeeze that istoo tight or in an increase in interest rates that is too costly. Hence,behind the network of Euro-dollar deposits and redeposits, behind thenetwork of lendings and relendings, there is a network of stand-by agree-ments, lines of credit, and banking guarantees. Business enterprises mayhave these second-line defenses with banks, and banks may have themwith other banks. Exposure in the Euro-dollar market is thus both directand indirect. Some commercial banks and central banks may have alarger stake in the market than they suspect.

Despite all these qualifications, there is no doubt that some aspectsof the Euro-dollar market can be improved. The fact that individual risksmay be smaller and more widespread than appears at first glance doesnot reduce the total risks of everybody. Indeed, to the extent that thenetwork of reinsurance, in the form of lines of credit and stand-bys, islargely concentrated in the United States, the exposure of this countrymay be larger than that based only on the Euro-dollar deposits andloans of the U.S. banks that operate directly in the market. Hence stepsto improve the information available in and about the Euro-dollar marketare more than desirable; they are necessary.

Ill

Interest rates on Euro-dollars are determined by very broad competi-tive forces. These forces include interest rates on loans and deposits inthe U.S. market; interest rates on loans and deposits in such majorcurrencies as sterling, deutsche mark, and Swiss francs; and spot andforward exchange rates of each of these currencies relative to the dollar.Since there is extensive arbitrage by commercial banks among all themajor currencies, the covered interest rate paid on, say, Euro-sterlingdeposits is, except in very unusual circumstances, approximately equalto the interest rate paid on Euro-dollar deposits. Thus, in 1962, interestrates on Euro-dollar deposits averaged 3.77 per cent, while the cost ofdollars obtained through swapping sterling deposits into dollars was equalto 3.83 per cent. This cost of dollars obtained indirectly was equal to aninterest rate of 4.95 per cent on Euro-sterling deposits less the forwarddiscount of sterling, with respect to the dollar, of 1.12 per cent. In thefirst eight months of 1964, interest on 90-day Euro-dollar deposits aver-aged 4.22 per cent, while the cost of dollars obtained via Euro-sterlingwas 4.15 per cent: 4.81 per cent on Euro-sterling deposits minus0.66 per cent forward discount on sterling (Table 1).


TABLE 1. RATES OF INTEREST ON THREE-MONTH EURO-DOLLAR DEPOSITS INLONDON AND ON OTHER INVESTMENTS, 1961-AuousT 1964

(In per cent per annum)

End ofPeriod

1961JanFebMarAprMayJunJulAugSepOctNovDec

Average1962

JanFebMarAprMayJunJulAugSepOctNovDec

Average

1963JanFebMarAprMayJunJulAugSepOctNovDec

Average

1964JanFebMarAprMayJunJulAug

Average

Euro-Dollars1

(1)

3.863.603.693.663.663.503.383.313.383.443.633.88

3.58

3.443.503.663.413.813.753.843.783.944.134.003.94

3.77

3.383.503.633.723.813.884.004.004.194.134.254.25

3.90

4.064.194.254.194.254.314.254.25

4.22

U.S.Bankers'Accept-ances 2

(2)

2.862.812.882.782.682.752.752.882.752.752.753.00

2.80

3.003.003.003.002.882.983.133.133.133.003.003.00

3.02

3.073.133.133.133.133.243.413.593.633.633.713.63

3.36

3.703.753.753.803.753.753.753.75

3.75

U.S.Treasury

Bills s(3)

2.232.502.392.192.352.222.242.322.232.322.612.59

2.35

2.712.662.722.742.702.792.892.842.752.692.802.86

2.76

2.912.922.902.912.922.993.143.323.383.453.523.52

3.16

3.533.523.553.483.483.483.483.51

3.50

U.K.Treasury

Bills"(4)

4.154.404.494.414.444.546.696.706.535.735.395.36

5.24

5.245.554.454.053.823.923.893.773.643.863.743.72

4.14

3.493.433.763.713.643.703.763.723.683.753.743.72

3.68

3.724.314.304.304.384.464.654.65

4.35

U.K.Local

Authori-ties5

(5)

4.755,065.505.385.386.127.567.327.566.626.256.68

6.18

6.386.385.755.004.564.564.564.384.504.254.504.62

4.95

4.184.254.504.504.434.254.314.124.184.184.314.56

4.31

4.385.125.385.005.005.005.095.00

5.00

SterlingForward

Discount8

(6)

0.800.982.141.881.883.684.113.923.822.752.672.58

2.60

2.492.662.041.510.800.800.620.620.620.360.450.45

1.12

0.800.801.340.800.710.540.360.180.180.270.180.18

0.53

0.360.720.720.800.800.540.720.63

0.66

Euro-Sterling7

(7)

6.005.385.387.387.757.257.566.256.386.69

6.60

6.196.005.755.134.314.504.504.384.384.384.444.38

4.86

4.444.194.884.504.504.444.384.134.314.384.384.31

4.40

4.314.944.884.945.004.754.884.75

4.81

1 Rate on last working day of month, as reported in Bank of England, Quarterly Bulletin. Datafor January and February 1961 were estimated independently.

a Rate in last week of month; from Federal Reserve Bulletin.3 Rate on new issues, last week of month; from Federal Reserve Bulletin.4 Tenders, last week of month; from Deutsche Bundesbank, Monthly Report.6 From Bank of England, Quarterly Bulletin.6 Based on data from International Monetary Fund, International Financial Statistics. Com-

puted from end-of-month rates (average of buying and selling) for spot and 90-day forwardexchange, the resulting percentage being expressed as an annual rate.

7 Rate on last working day of month, as reported in Bank of England, Quarterly Bulletin.

9



In general, interest rates on deposits of all currencies that command aforward premium over the dollar tend to be lower by the amount of thispremium than interest rates on Euro-dollar deposits, while interest rateson deposits of currencies that stand at a forward discount relative to thedollar tend to be higher by the amount of this discount than interest rateson Euro-dollar deposits. All these rates are mutually setf-determining,but the foreign markets for dollars are so much more important than theforeign markets for all other currencies combined—perhaps in the orderof three to one—that the interest rates on all non-dollar Euro-currenciestend to be adjusted to the interest rate on Euro-dollars.

The rate of interest on Euro-dollar deposits is thus truly an interna-tional rate that reflects the interplay on demand and supply factors inmany countries, so that a change in any one element is unlikely to changethe nature or the course of the Euro-dollar market in any decisive way.It was often assumed, for example, that if commercial banks in theUnited States could compete, free from the restraints of Regulation Q,for the time deposits of foreign governments and foreign monetaryauthorities, they would attract large amounts of such deposits.8 Afterthese restraints were removed in October 1962, foreign time depositsincreased from about $2.2 billion to $3.2 billion at the end of 1963 andto $3.8 billion in August 1964.10 Interest rates on all other time depositswere increased at the beginning of 1962 and again at the beginning of1964,11 and the development of certificates of deposit has had the practi-cal effect of raising interest rates on the short end, despite the restrictionsof Regulation Q. Nevertheless, the Euro-dollar market is still here,stronger and bigger than ever.

8 The relationship of Regulation Q to the Euro-dollar market is discussed inO. L. Altaian, "Recent Developments in Foreign Markets for Dollars and OtherCurrencies," op. cit., pp. 78-84. The view was expressed there that the effect ofRegulation Q upon the development of the market was generally much overstated.

10 See Appendix, page 14. In 1962, Mr. Roosa, Under Secretary of the Treasury,when testifying in favor of the bill to exclude foreign time deposits from Regula-tion Q, estimated that foreign governments and international agencies held morethan $2 billion of time deposits and that, with higher interest rates, this amountmight gradually be doubled. Ibid., p. 79.

11 Maximum interest rates (in per cent) that could be paid by member banksof the Federal Reserve System on time and savings deposits were changed from

Jan. 1, 1957 Jan. 1, 1962 Jan. 17, 1964

33

332Y21

43Y2

43V22>/21

4SVi

4441

the dates shown, as follows:

Savings deposits held for1 yearLess than 1 year

Other time deposits payable in1 year or more6 months to 1 year90 days to 6 monthsLess than 90 days



Since 1961, short-term interest rates have risen in the United States,in the Euro-dollar market, and in virtually all the major countries inEurope. Euro-dollar rates have gone up less than U.S. Treasury bill rates,so that the difference between the two has become much narrower. In thelast three years, the absolute difference has decreased from 123 to 72basis points, with the result that the rate on 3-month Euro-dollars, whichwas 52 per cent higher than U.S. Treasury bill rates in 1961, was only21 per cent higher in August 1964 (Table 2).

TABLE 2. RATES OF INTEREST ON THREE-MONTH EURO-DOLLAR DEPOSITS INLONDON AND ON NEW ISSUES OF U.S. TREASURY BILLS, 1961-64

(Average of rates at end of each month)

1961 1962 1963 19641

Euro-dollar deposits 2 (per cent)U.S. Treasury bills 2 (per cent)

Difference, basis pointsDifference as percentage of yield

on Treasury bills

3.582.35123

52

3.772.76101

37

3.903.16

74

23

4.223.50

72

21

1 Through August.2 From Table 1, page 9.

The United States has been trying for several years to increase domes-tic short-term interest rates without increasing long-term rates, whichmight limit the current economic expansion before full employment isreached. Debt and monetary policies have been keyed to this objective.In the last few years, the shortest-term interest rates have risen the most,while long-term rates have been remarkably steady and mortgage rateshave been under pressure downward. The structure of interest rates in theUnited States has thus become considerably flatter. But the same devel-opment can be observed in the Euro-dollar market, within the range ofmaturities dealt with there, as well as in the major countries of Europe.

Can one conclude that short-term interest rates in the United Stateshave risen solely for domestic reasons and that interest rates on Euro-dollars have increased sympathetically? The chain of causation is muchmore complicated than that. Interest rates on Euro-dollars have clearlybeen an important factor in pulling up short-term interest rates in theUnited States. But a broader international perspective on interest ratemovements is necessary. Short-term interest rates in the major continentalEuropean countries have also increased. The pressures of full employ-ment and rising prices in these countries are increasing the demand formoney, and the monetary authorities are reacting to these pressures



with a tighter monetary policy. A number of European countries wouldprobably prefer, other things being equal, even higher interest rates. Butthese would encourage larger inflows of foreign capital, as well as largerrepatriations of funds by residents. The authorities would not like to addthe need to deal with larger capital inflows to the tasks they already have.

Interest rate developments may be interpreted in a number of ways.The increases in interest rates in the United States and in the Euro-dollar market may be regarded as permissive, in that they made it possi-ble for many European countries to follow a policy of higher interestrates without the danger of augmenting inflows of capital. Or, theincreases in interest rates in Europe may be regarded as initiating, inthat they tended to pull up rates in the United States and in the Euro-dollar market. Or, increases in European interest rates may be regardedas offsetting, in the sense that higher short-term rates in the UnitedStates would have had greater international effects if European countrieshad not seized the opportunity to tighten domestic credit. On this lastinterpretation, U.S. monetary policy would have been more effective ifEuropean countries had made greater use of fiscal policy and less useof monetary policy.

This paper does not present a brief for any of these interpretations;rather, it aims to emphasize the interaction and mutual determinatenessof short-term capital markets in the major industrial countries. Suchinternational money market instruments as Euro-dollar deposits knitnational markets closer together. They should, in the long run, considera-bly reduce interest rate differentials on short-term funds, on commercialloans, and on money generally. The United States has been learning tolive with this greater amount of internationalism, but it is not surprisingthat learning to live in this more interdependent world may create consid-erable difficulties from time to time.

IV

The preceding discussion may be summarized as follows: The largerinternational money market in short-term dollars that has developedoutside the United States since 1957 is based on dollar deposits from,and loans to, many countries. The core of the market consists of 400commercial banks, including foreign branches of U.S. banks. Commer-cial and industrial borrowers use Euro-dollars to finance imports, exports,and domestic transactions; banks use this new international moneymarket instrument to adjust their liquidity positions and to increasetheir lending capacity.



Many large participants protect their short-term positions withstand-by agreements, lines of credit, and banking guarantees. To theextent that these are concentrated upon U.S. banks, the exposure of theUnited States in the Euro-dollar market is larger than that suggested bythe Euro-dollar loans and deposits of its banks.

The pressure to obtain a foothold in the Euro-dollar market, combinedwith the impersonal and short-term character of most transactions in it,may lead some participants to borrow short and lend long, to reducecredit standards, or to rely too much upon the security of prime namesand too little upon the careful analysis of systematic and up-to-datefinancial data. But despite these possibilities, there have not been markedevidences of abuse. Furthermore, these problems are inherent in all bank-ing operations and are not confined to those conducted in Euro-dollars.

The yield on dollar deposits and the cost of dollar loans are deter-mined on an international and competitive basis; they are generally morefavorable than the comparable rates on local currency transactions innational markets. Since 1961, the differential between short-term rates inthe United States and in the Euro-dollar market has narrowed; more-over, short-term rates have increased relative to long-term rates in bothof these markets, as well as in most of Europe. The Euro-dollar marketis important in bringing the national markets closer together.

APPENDIX

Foreign Time Deposits

Beginning October 15, 1962, for a period of three years, maximuminterest rates may not be imposed under Regulation Q on time depositsof foreign governments, monetary and financial authorities of foreigngovernments when acting as such, and international financial institutionsof which the United States is a member.12 Total foreign time deposits ofmember banks of the Federal Reserve System are shown in Table 3.Since October 1962, these deposits have increased by 75 per cent. Thepart of the increase that can be attributed to the removal of interestceilings under Regulation Q must be much less than this, since timedeposits at all commercial banks increased by about 33Ys per cent.

12 See Federal Reserve Bulletin, October 1962, pp. 1279-80.



TABLE 3. FOREIGN TIME DEPOSITS * OF MEMBER BANKS OF FEDERAL RESERVESYSTEM, 1962-AuousT 1964

(In millions of dollars)

In New York City Outside New York City Total

1962MarJunSepDec

1963MarJunSepDec

1964MarJunAug

1,6191,5991,5511,782

1,9692,0522,1652,222

2,4572,5982,677

618642665739

775842892966

1,0031,0721,123

2,2372,2412,2162,521

2,7442,8943,0573,188

3,4603,6703,800

Source: Federal Reserve Bulletin.1 Deposits of foreign governments and official institutions, central banks, inter-

national institutions, banks in foreign countries, and foreign branches of U.S. banksother than the reporting bank.

Euro-dollars : nouveaux commentaires *

Resume

Le vaste marche monetaire international de dollars a court termequi s'est developpe en dehors des Etats-Unis depuis 1957 reposesur les depots et les prets en dollars en provenance et a destinationde nombreux pays. Ses activites gravitent essentiellemente autour de400 banques commerciales, dont les succursales etrangeres de banquesamericaines. Les entreprises industrielles et commerciales qui y ontrecours utilisent des Euro-dollars pour le financement des importa-tions, des exportation et des transactions effectuees dans le cadre deleurs pays respectifs; les banques se servent de ce nouvel instrumentdu marche monetaire international pour ajuster leur position de liquiditeet pour accroitre leur capacite de pret.

De nombreux participants importants protegent leur position a court

i Voir Staff Papers, Vol. VIII (1960-61), pages 313-52; Vol. IX (1962), pages297-316; et Vol. X (1963), pages 48-96.



terme au moyen d'accords de "stand-by", de lignes de credit et degaranties bancaires. Dans la mesure ou ces moyens de protection sontconcentres sur des banques americaines, les risques auxquels s'exposentles Etats-Unis sur le marche de I'Euro-dollar sont plus grands que nele laisseraient supposer les prets et depots de leurs banques en Euro-dollars.

Le desir des banques de prendre pied sur le marche de TEuro-dollar,associe au caractere impersonnel et a court terme de la plupart destransactions qui s'y effectuent, peuvent amener certaines d'entre ellesa emprunter a court terme et a preter a long terme, a assouplir leurscriteres d'octroi de credit, ou encore a se fier trop a la reputation desgrands noms et pas assez a une analyse attentive des donnees financieressystematiques les plus recentes. En depit de ces diverses possibilites,on n'a cependant pas note de signes marques d'abus. De plus, cesproblemes sont inherents a toutes les operations bancaires, et ne selimitent pas a celles qui sont traitees en Euro-dollars.

Le rendement des depots en dollars et le cout des prets en dollarssont determines a 1'echelon international et sur une base competitive;ils sont en general plus favorables que les taux d'interet comparablesafferents aux operations en monnaie locale sur les divers marchesnationaux. L'ecart entre les taux a court terme du marche americainet ceux du marche de I'Euro-dollar a diminue depuis 1961; en outre,sur ces deux marches comme sur la plupart des marches europeens,les taux a court terme ont augmente par rapport aux taux a long terme.Le marche de I'Euro-dollar joue un role important dans le rapproche-ment des marches nationaux.

Comentarios adicionales sobre el mercado de Euro-dolares *

Resumen

El gran mercado international de dinero en forma de dolares acorto plazo que se ha desarrollado fuera de Estados Unidos a partirde 1957 se basa en los depositos y los prestamos en dolares que pro-vienen de y se destinan a muchos paises. El micleo de ese mercadoconsiste en 400 bancos comerciales, con inclusion de las sucursales

1 Anteriores consideraciones sobre este tema aparecen en Staff Papers, Vol. VIII(1960-61), pags. 313-52; Vol. IX (1962), pags. 297-316, y Vol. X (1963),pags. 48-96.



en el extranjero de bancos estadounidenses. Los prestatarios de lossectores comercial e industrial utilizan los Euro-dolares para el financia-miento de importaciones, exportaciones, y transacciones internas, ylos bancos, a su vez, emplean este nuevo instrumento del mercadomonetario internacional para ajustar sus posiciones en materia deliquidez e incrementar su capacidad como fuente de prestamos.

Muchos de los principales participantes de ese mercado recurren aacuerdos de credito contingente, lineas de credito, y garantias bancariaspara defender sus posiciones a corto plazo. En la medida en que esosarbitrios se concentran sobre los bancos estadounidenses, los riesgosa que esta expuesto Estados Unidos en el mercado de Euro-dolaressuperan a lo que cabria inferir de los prestamos y los depositos de susbancos en Euro-dolares.

El afan de lograr un asidero en el mercado de Euro-dolares, conjunta-mente con la indole impersonal y de corto plazo que caracteriza a lageneralidad de las transacciones que se efectuan en dicho mercado,puede inducir a algunos de los participantes a tomar prestamos acorto plazo y concederlos a largo plazo, a aminorar sus exigencias encuanto a las normas crediticias, o a dejarse llevar excesivamente porla seguridad que brindan las firmas de primera categoria y, en cambio,demasiado poco del analisis cuidadoso de datos financieros que estenal dia. No obstante, pese a la posibilidad anotada, no se ban observadomuestras claras de abusos. Por otra parte, estos problemas son inherentesa cualquier transaccion bancaria y no se concretan unicamente aaquellas realizadas en Euro-dolares.

El rendimiento de los depositos en dolares y el costo de los prestamosse determinan sobre una base internacional y competitiva; por lo generalson mas favorables que las tasas comparables que rigen para las transac-ciones efectuadas en moneda local en los mercados nacionales. Desde1961, ha disminuido el margen entre las tasas de interes a corto plazodel mercado estadounidense y las del mercado de Euro-dolares, y,ademas, tanto en esos dos mercados como en la mayor parte de Europa,las tasas de interes a corto plazo ban aumentado en comparacion conlas de largo plazo. El mercado de Euro-dolares resulta importantepara establecer un vinculo mas estrecho entre los mercados nacionales.


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