DE ECONOMIST 121, N R .

4, 1973

INTERNATIONAL DOLLAR LIQUIDITY

AND THE EURODOLLAR MARKET1

BY

j. HERBERT FURTH*

1. INTRODUCTION: BASIC CONCEPTS

As long as the US dollar was (or still is?) the world's main means
of international payments, the supply of dollars to non-residents of
the United States ('foreigners') played in international commerce a
role similar to that of the money supply in domestic transactions;
and the US monetary authorities together with the US banking
system fulfilled internationally a function similar to that fulfilled
domestically by central and commercial banks. Needless to say, this
similarity is not identity: the dollar has never been the sole inter-
nationally accepted currency nor has it ever been international
'legal tender' (i.e., its international use has always been based on
voluntary acceptance rather than on law - although it was, until
August 15, 1971, the operational 'standard of value' for the curren-
cies of nearly all members of the International Monetary Fund).
In the absence of a Eurodollar market, any change in the supply
of US dollars to foreigners would mean a change in the international
liquidity position of the United States identical (though with oppo-
site sign) with that of the rest of the world. All liquid and near-
liquid dollar assets would be, legally as well as economically, claims
either on the US authorities (Government securities, banks notes) or
on US banks (deposits, bankers acceptances) or on other US resi-
dents (other money-market instruments and other debts considered

* F a c u l t y Associate Emeritus, Foreign Service Institute, Arlington, Virginia,U,S.A.

1 This paper is a by-product of the author's contribution to tile s t u d y 'Foreign Dollar
Balances and the I n t e r n a t i o n a l Role of the Dollar,' conducted jointly with Professor
R a y m o n d F. Mikesell and sponsored by the National Bureau of Economic Research.
Neither Professor Mikesell nor the National Bureau (nor the Foreign Service Institute}
bears, however, any responsibility for the views expressed in this paper.
348 j . H . FURTH

liquid or near-liquid); hence, any change in the gross or net dollar

assets of the rest of the world would mean an identical change in the
gross or net dollar liabilities of the United States.
From the point of view of foreign merchants and investors, the
important magnitude was their gross liquidity position: as long as a
foreign merchant had sufficient dollars, he could (in the good oid
days when foreign trade was invoiced and settled in dollars) dis-
charge all his maturing foreign obligations - just as a domestic
merchant remains solvent as long as, and only as long as, his bank
balance is sufficient to cover all his maturing obligations. Just as in
the case of a domestic merchant, it did not matter whether his
balance represented net assets or whether it was, entirely or in part,
the result of borrowing. In fact, the only function of a bank, inter-
nationally or domestically, is to furnish gross liquidity to customers
who do not own sufficient net liquid assets. Needless to say, the
merchant's need for liquid assets is reduced when he holds other
assets that can be converted into 'money' without risk, cost, or
delay: domestically, such assets are represented, say, by money-
market instruments; internationally, by 'convertible' non-dollar
currencies. Nevertheless, just as the size of his bank balance is the
focus of the merchant's domestic liquidity problem, so the size of his
(gross) dollar holdings was the focus of his international liquidity
problem.
From the US point of view, however, the situation was different.
For US merchants and investors, international liquidity was iden-
tical with their domestic liquidity: they used their domestic money
also as international means of payments. For the US monetary
authorities, however, as for banks generally, the important magni-
tude was not the gross but the net liquidity position of the United
States: in contrast to a merchant, a banker remains solvent as long
as, and only as long as, his customers believe that his liabilities are
covered by his assets. Banks are not supposed to increase their
deposits by crediting employees and suppliers with the amount of
their current claims but exclusively by lending on bankable assets -
i.e., by averting a decline in their net liquidity.
If this analogy were to be fully applied to the role of the United
States as the 'bank of issue' of international money, the supply of
dollars to foreigners should increase exclusively through lending; in
this case, the vet liquidity' of the United States (and of the rest of
the world) would not change although foreign gross liquidity could
 DOLLAR LIQUIDITY AND EURODOLLAR MARKET 349

continuously and rapidly expand (just as the domestic money supply

can be continuously and rapidly expanded by bank lending). Un-
fortunately, there has been no international banking law that would
have compelled the US authorities and residents to act in this man-
ner. Nether the US authorities nor US residents were prevented
from supplying dollars to the rest of the world through the acqui-
sition of illiquid assets ('soft' loans to foreign countries in the case of
the Government, 'direct' investments in the case of corporations) or
even through spending on 'current account' (grant assistance to
foreign countries and military expenditures in the case of the
Government, excessive imports of goods and services on the part of
the public). The role of the dollar in the international economy has
been threatened not, as Professor Triffin had predicted, by the mere
absolute rise in foreign dollar holdings but b y the fact that, in recent
years, this rise has not been associated with a corresponding rise in
US liquid or near-liquid claims on foreigners, i.e., by the decline in
US {and the corresponding rise in foreign) net international liquidity.
As long as the US dollar was formally convertible into other types
of international money (gold or foreign exchange), there was a sub-
stantial difference between US liabilities to foreign official institu-
tions and to other foreigners : only the former were entitled to present
their doilar holdings for redemption to the US Treasury, and thus
only liabilities to foreign official institutions could impair the ability
of the US authorities to maintain dollar convertibility. Moreover,
non-official foreigners presumably held all their dollar assets volun-
tarily: if they increased those holdings, on a gross or even on a net
basis, they presumably needed the increase, say, in order to finance
the ever expanding volume of international commerce. Hence, seri-
ous disequilibrium (rather than mere accounting imbalance) in the
US international liquidity position was indicated only by a large
persistent increase in net liabilities to foreign official institutions
(gross liabilities minus US official reserve assets) rather than in total
net liabilities to all foreigners.
The emergence of the Eurodollar market changed the situation.
First, foreigners (and US residents) could now acquire and hold
liquid dollar assets that were claims not on the United States but on
other foreigners ; hence, a change in foreign gross dollar liquidity did
no longer necessarily mean a corresponding change in US gross lia-
bilities to foreigners - although a change in foreign ~et dollar liquid-
ity still meant a corresponding change in US net liabilities to for-
 350 J.H. PURTH

eigners. Second, foreign central banks began to switch their dollar

holdings between placement in the United States and in the Euro-
dollar market, for reasons that had nothing to do with the US eco-
nomy. If, say, the German Federal Bank transferred $1 billion from
banks in the United States to the London branches of German banks,
the claim was, according to US statistics, transformed from a US
liability to a foreign official institution into a US liability to foreign
commercial banks; hence, the US official liquidity position showed
an improvement of $1 billion although materially neither the inter-
national liquidity of the German Federal Bank nor that of the
United States had changed at all. Hence, it became necessary, for
realistic economic analysis, to consider not just changes in the US
official liquidity but also (and perhaps primarily) changes in the
total US net liquidity position. 2
In order to be able realistically to analyze the relationships be-
tween the Eurodollar market a and international dollar liquidity, we
must first eliminate that statistical confusion. We shall do so by
treating Eurodollar banks in respect to their transactions in the
Eurodollar market as part of the US banking system rather than as
'foreigners'. 4 There are three reasons for this decision. First, as
Eurodollar banks deal in 'American' dollars (see footnote 3, under),
they perform the functions of US rather than of foreign banks.
Second, in respect to their 'American' dollar holdings, they act as

2 F o l l o w i n g t h e e x a m p l e of t h e f o r e m o s t US e x p o r t o n p a y m e n t s s t a t i s t i c s , W a l t h e r
L e d e r e r , t h e a u t h o r tries to a v o i d t h e t e r m s ' b a l a n c e of p a y m e n t s ' a n d e s p e c i a l l y t h o s e
of p a y m e n t s ' s u r p l u s ' or ' d e f i c i t , ' a n d i n s t e a d s p e a k s of c h a n g e s ( i n c r e a s e or decrease)
in a c o u n t r y ' s i n t e r n a t i o n a l l i q u i d i t y p o s i t i o n . T h e r e a r e t w o r e a s o n s for t h i s d e c i s i o n :
first, t h e t e r m ' b a l a n c e of p a y m e n t s ' is n o t o r i o u s l y a m b i g u o u s ; a n d s e c o n d , t h e t e r m s
' s u r p l u s ' a n d ' d e f i c i t ' c o n n o t e a v a l u e j u d g m e n t t h a t is as o f t e n as n o t u t t e r l y m i s l e a d i n g
( w h e n a p a y m e n t s ' d e f i c i t ' is ' b a d , ' i.e., i n c o n s i s t e n t w i t h e c o n o m i c e q u i l i b r i u m - as t h e
US ' d e f i c i t s ' h a v e b e e n since t h e m i d - s i x t i e s - , t h e c o r r e s p o n d i n g ' s u r p l u s ' of o n e or
m o r e f o r e i g n c o u n t r i e s m u s t be e q u a l l y ' b a d ' ; a n d w h e n a s u r p l u s is ' g o o d ' - as t h a t of
C o n t i n e n t a l E u r o p e in t h e e a r l y 'fifties - , t h e c o r r e s p o n d i n g ' d e f i c i t ' of one or m o r e o t h e r
countries must be equally 'good').
s I n a c c o r d a n c e w i t h c o n v e n t i o n a l ( t h o u g h i n a c c u r a t e ) t e r m i n o l o g y , we s h a l l call US
d o l l a r s p l a c e d in t h e U n i t e d S t a t e s ' A m e r i c a n ' d o l l a r s ; s u c h d o l l a r s p l a c e d w i t h b a n k s
outside the United States 'Enrodollars'; and banks accepting such deposits (including
t h e f o r e i g n b r a n c h e s of US b a n k s ) ' E u r o d o l l a r b a n k s . ' T h e t e r m ' E u r o d o l l a r m a r k e t '
itself is m i s l e a d i n g i n s o f a r as t h i s m a r k e t d e a l s in ' A m e r i c a n ' r a t h e r t h a n in E u r o d o l l a r s :
t h e d o l l a r l o a n s m a d e b y E u r o d o l l a r b a n k s to t h e i r c u s t o m e r s (or to e a c h other) a r e p a i d
o u t a n d r e p a i d in ' A m e r i c a n ' dollars, a n d t h e i r r e s u l t i n g c l a i m s o n t h e i r c u s t o m e r s a r e
thus 'American' dollar claims - although their resulting claims on each other are indeed
'Eurodollar' balanees.
a W. L e d e r e r h a s s u g g e s t e d to t r e a t f o r e i g n b r a n c h e s of US b a n k s as U S r a t h e r t h a n
as f o r e i g n b a n k s . As t h e E u r o d o l l a r t r a n s a c t i o n s of t h e s e b r a n c h e s a r e i n d i s t i n g u i s h a b l e
f r o m t h o s e of o t h e r E u r o d o l l a r b a n k s , it s e e m s c o n s i s t e n t to a p p l y t h a t t r e a t m e n t to all
Eurodollar banks.
 DOLLAR LIQUIDITY AND EURODOLLAR MARKET 351

mere intermediaries between depositor and borrower or purchaser

('final user') of these dollars: they acquire and hold these dollars not
in order to increase their own purchasing power (i.e., liquidity) but
in order to enable their customers to increase theirs. It is therefore
the nationality of their customers rather than their own that is
economically relevant. 5 Third, the analogy with domestic banking
also suggests the exclusion of their 'American' dollar holdings from
the computation of 'foreign' dollar liquidity, just as the cash holdings
of domestic banks are excluded from the computation of the money
stock held by the public. 6
Eurodollar transactions m a y affect all three important types of
international dollar liquidity: foreign total gross liquidity, foreign
and US total net liquidity, and foreign and US official liquidity.
These three effects are interrelated: at present, foreign private dollar
holdings are hardly ever considered deficient, and any substantial
increase in foreign private net liquidity, or even in foreign private
gross liquidity not associated with an increase in net liquidity, is
likely to generate a flow of dollars to foreign central banks (i.e.,
conversion into foreign currencies), which means an increase in
foreign official dollar liquidity. The accrual of unwanted dollar as-
sets to foreign central banks is called dollar redundancy; it is the
central phenomenon of the present malaise in international monetary
relationships. 7
The impact of Eurodollar market transactions on international
dollar liquidity may be direct and indirect. In line with our treat-
ment of Eurodollar banks as part of the US banking system, the
direct impact of transactions involving Eurodollar banks will be
considered exactly the same as would be the impact of identical

5 T o s t r e s s t h e l o c a t i o n of t h e E u r o d o l l a r b a n k s r a t h e r t h a n t h a t of t h e i r c u s t o m e r s
is o u t r i g h t m i s l e a d i n g . T h e m o s t i m p o r t a n t E u r o d o l l a r b a n k s a r e l o c a t e d in L o n d o n ,
a n d t h e i r ' A m e r i c a n ' d o l l a r h o l d i n g s a p p e a r t h e r e f o r e s t a t i s t i c a l l y as B r i t i s h assets.
A c t u a l l y , h o w e v e r , B r i t a i n is s u f f e r i n g f r o m a s h o r t a g e r a t h e r t h a n f r o m a g l u t of dollars,
a n d t h e e x c e e d i n g l y l a r g e ' A m e r i c a n ' d o l l a r a s s e t s of t h e ' B r i t i s h ' E u r o d o l l a r b a n k s are
in t r u t h h o l d i n g s of t h e i r o v e r w h e l m i n g l y n o n - B r i t i s h E u r o d o l l a r d e p o s i t o r s .
6 A s t a t i s t i c a l d i f f i c u l t y lies in t h e p o s s i b i l i t y of E u r o d o l l a r b a n k s a c q u i r i n g ' A m e r i c a n '
d o l l a r s n o t for use in t h e E u r o d o l l a r m a r k e t b u t for t h e i r o w n o p e r a t i o n s , e.g., p l a c e m e n t
in t h e U n i t e d S t a t e s . T h e s e a m o u n t s s h o u l d be i n c l u d e d in f o r e i g n d o l l a r h o l d i n g s ; t h e y
are, h o w e v e r , so s m a l l ( a b s o l u t e l y a n d e s p e c i a l l y r e l a t i v e to t h e s u m s i n v o l v e d in E u r o -
d o l l a r m a r k e t t r a n s a c t i o n s ) t h a t t h e e r r o r r e s u l t i n g f r o m t h e i r e x c l u s i o n is negligible.
v As l o n g as t h e d o l l a r w a s de /acto as well as de iure c o n v e r t i b l e , d o l l a r r e d u n d a n c y
t y p i c a l l y r e s u l t e d in p r e s e n t a t i o n of t h e r e d u n d a n t d o l l a r s to t h e US T r e a s u r y f o r
r e d e m p t i o n ; t h e c h a n g e in US official r e s e r v e s was, t h e r e f o r e , a n e x c e l l e n t i n d i c a t o r of
d o l l a r r e d u n d a u e y - u n t i l t h e US T r e a s u r y i n d u c e d f o r e i g n G o v e r n m e n t s to a b s t a i n f r o m
such presentation.
352 j.H. rURT~

transactions involving banks in the United States. The indirect -

and probably more important - impact, however, may be very
different, viz., insofar as Eurodollar banks are more or less likely to
engage in certain types of transactions (e.g., lending to foreigners, or
selling dollars to foreign central banks) that have a direct impact on
international dollar liquidity.S

2. DIRECT IMPACT OF EURODOLLAR MARKET TRANSACTIONS

Let us discuss the impact of the following important types of

transactions with and of Eurodollar banks:
(a) deposits of 'American' dollars with Eurodollar banks by (i)
US residents, (ii) foreign central banks, and (iii) other foreigners
(deposits among Eurodollar banks may be ignored as they do not
change the total amount available in the market - just as interbank
deposits may be ignored in discussing the domestic money supply) ;
(b) lending of dollars to (i) US residents (mainly banks in the
United States), and (ii) foreigners (lending to foreign central banks
appears to be negligible, and lending among Eurodollar banks m a y
be ignored for the reason given under (a), above);
(c) sales of dollars to foreign central banks (sales to other foreign-
ers against foreign exchange would not affect the Eurodollar market ;
and sales to US residents are quite unlikely).
Withdrawals of deposits, repayments of loans, and purchases of
dollars obviously have the opposite effects of those transactions, and
need therefore not to be discussed separately.
(a) Deposits o~ Dollars with Eurodollar Banks - It should be
stressed that such deposits are the only way in which Eurodollar
balances are originally created. 9 Obviously, the depositor may have
acquired the 'American' dollars through all kinds of transactions
(through receipt, on current or capital account, from US residents or
from foreigners; through purchases from a central banks; through
s F o r a d e t a i l e d d i s c u s s i o n of p r o b l e m s . m e n t i o n e d in t h i s I n t r o d u c t i o n , see R a y m o n d
F. Mikesell, The US Balance o/Payments and the International Role o/ the Dollar, A m e r i c a n
E n t e r p r i s e I n s t i t u t e , W a s h i n g t o n , DC, 1970, a n d ' F o r e i g n D e m a n d f o r L i q u i d D o l l a r
A s s e t s , ' Journal o/Money, Credit, and Banking, V (1972), p p . 6 4 3 - 6 8 3 , esp. p. 643, w i t h
a w e a l t h of d a t a a n d a n e l a b o r a t e S t a t i s t i c a l A p p e n d i x . F o r a s o m e w h a t d i f f e r e n t
a p p r o a c h , see - a m o n g m a n y o t h e r s - Fritz Machlup, ' E u r o - D o l l a r s , O n c e A g a i n , ' Banca
Nazionale del Lavoro Quarterly Review, N ° 101 (1972), esp. p . p . 1 1 9 - 1 3 7 w i t h a b r i e f r e v i e w
of t h e m o s t i m p o r t a n t r e c e n t l i t e r a t u r e o n t h e s u b j e c t .
9 A c c o r d i n g to all r e p o r t s , E u r o d o l l a r b a n k s d o n o t c r e a t e E u r o d o l l a r b a l a n c e s ' o u t of
t h i n a i r , ' as c o m m e r c i a l b a n k s a r e s o m e t i m e s s u p p o s e d to d o ; in t h i s r e s p e c t , t h e y a c t
like s a v i n g s i n s t i t u t i o n s .
 DOLLAR LIQUIDITY AND EURODOLLAR MARKET 353

borrowing from banks in the United States, Eurodollar banks, or

other foreign banks) ; regardless of the way they have been acquired,
however, the 'American' dollars give rise to the creation of Euro-
dollar balances only when they are deposited with a Eurodollar bank
in such a way that the bank becomes the holder of the 'American'
dollars and the depositor is credited with a Eurodollar balance.
(i) Deposits by US residents - According to the conventional treat-
ment of Eurodollar banks, such a transaction would directly increase
foreign gross dollar liquidity. According to our method, however, it
would have no such direct impact - just as a deposit with a bank in
the United States would have no such effect. Regardless of accept-
ance or rejection of our method, the transaction has no direct impact
on US or foreign net liquidity (as the new claim of the Eurodollar
bank on a bank in the United States is exactly offset by the new
claim of the US depositor on tile Eurodollar bank) and obviously no
direct impact on US or foreign official liquidity.
(ii) Deposits by a /oreign central bank - According to the con-
ventional treatment, such a transaction would directly improve the
US official dollar liquidity position, and thus, by implication, reduce
the foreign official liquidity position. According to our method, such
an unrealistic consequence is averted: both US and foreign official
liquidity positions remain unchanged - just as if the central bank
had shifted its dollar holdings from one bank in the United States to
another. Regardless of acceptance or rejection of our method, the
transaction would have no direct impact on total foreign or US
gross or net liquidity.
(iii) Deposits by other/oreigners - Regardless of the treatment of
Eurodollar banks, such a transaction has no effect on international
dollar liquidity of any type.
(b) Lending o/Dollars by Eurodollar B a n k s - Again it should be
stressed that Eurodollar banks lend 'American,' not Eurodollars.
The borrower m a y redeposit these dollars with a Eurodollar bank
(including the lending bank); as discussed under (a), above, such a
deposit would have no direct impact on international dollar liquidity,
and can therefore, at this point, be left out of discussion.
(i) Lending to U S residents, and especially to banks in the United
States - Such a transaction creates a liability of a US resident to the
lending Eurodollar bank and at the same time extinguishes the
liability of the US bank, with which the 'American' dollar balance
involved had been held, to the Eurodollar bank. Hence, there is no
354 j.H. FURTH

direct impact on any type of international dollar liquidity, and the

popular belief that US borrowing in the Eurodollar market improves
the US 'balance of payments" directly is therefore erroneous; we
shall see, however, that there is nevertheless some truth in the
popular belief.
(ii) Lending to/oreigmrs - According to the conventional treat-
ment of Eurodollar banks, such a transaction leaves foreign gross
dollar liquidity unchanged while lending to a foreigner by a bank in
the United States would have increased such liquidity (under neither
treatment would the transaction affect net or official liquidity). In
line with our method, this divergence disappears: since the Euro-
dollar bank is regarded as part of the US banking system, a loan to a
foreigner increases foreign gross dollar liquidity exactly as would a
loan by a bank in the United States.
This the;is has an important corrollary: as Eurodollar banks can
lend the 'American' dollar balances underlying their Eurodollar
deposit liabilities only once, they can lend them either to a US
resident or to a foreigner but not to both at the same time. Hence,
any increase in lending to US residents means a decrease in lending
to foreigners, i.e., a decrease in the expansion of foreign gross dollar
liquidity and, under present conditions, a decrease in the flow of
redundant dollars to foreign central banks, i.e., a decrease in the
deterioration in the US official international liquidity position (in
conventional terminology: a decrease in the US 'official reserve
transactions' deficit). Conversely, net repayments by US borrowers,
relent to foreigners, mean a sharp increase in the expansion of
foreign gross dollar liquidity, and consequently in dollar redundancy
and in the deterioration of the US official liquidity position. This
reasoning can be readily applied to the changes in the US liquidity
position in 1966-69 (when US banks borrowed heavily in the Euro-
dollar market) and in 1970 71 (when they repaid the borrowed
funds). As lending to foreigners (just as lending to US residents) has
n9 direct impact on the US or foreign net liquidity position (lending
creates simultaneously identical claims and liabilities: the bor-
rower's claim on the 'American' dollar balance and his repayment
liability to the lending bank), the changes in the US official liquidity
position do not imply similar changes in the net liquidity position;
hence, in conventional terminology, the 'official reserve transactions'
balance and the 'tier liquidity balance' may move in opposite di-
rections (as in 1969, when the 'official reserve transactions ~ balance
 DOLLAR LIQUIDITY AND EURODOLLAR MARKET 355

showed a surplus while the 'net liquidity' balance was in record

deficit). Similarly, our reasoning shows the core of truth in the
popular belief that US borrowing in the Eurodollar market 'im-
proves' the US payments balance (see under (i), above): it tends
indeed to 'improve' the US international official liquidity position
(though not its total net liquidity position) but it does so indirectly,
not because of the effects of the borrowing itself but rather because
of the effects on foreign gross dollar liquidity, and hence on dollar
redundancy, of the associated decline in Eurodollar bank lending to
foreigners: the effects would be the same if the Eurodollar banks
reduced their lending to foreigners and then, instead of increasing
their lending to US residents, kept the 'American' dollar balances
involved idle.
It should be remembered that the effects on the US international
liquidity position would have been the same if, in the absence of a
Eurodollar market, banks in the United States had sharply cur-
tailed lending to foreigners in 1966-69 and then resumed such
lending in 1970-71. Whether or not banks in the United States
would have acted in this way, and whether or not the existence of
the Eurodollar market can be held responsible for the dramatic
changes in the international position of the US dollar in the period
1966-71, is another question (which will be discussed under B, (b),
below).
(c) Sale o/ Dollars by Eurodollar B a n k s to Foreign Central B a n k s -
Such sales obviously affect the US and foreign official dollar liqui-
dity positions in exactly the same way as would identical sales by
banks in the United States. Again, the question of whether banks in
the United States would have engaged in such sales to the same
extent as Eurodollar banks apparently have done in recent years,
will be discussed under B, (c), below.

3. INDIRECT IMPACT OF EURODOLLAR MARKET TRANSACTIONS

Let us again discuss the impact of the transactions mentioned

under A, above.
(a) Deposits o~ Dollars with Eurodollar B a n k s - The main indirect
effects of such deposits - whether b y US residents or by foreign
central banks or b y other foreigners - are: (i) the impact on the
willingness of the depositors to hold dollars, and (if) the impact on
the ability of Eurodollar banks to extend dollar loans.
356 j.H. FURTH

(i) W i l l i n g n e s s to hold dollars - The popularity of the Eurodollar

market, shown by the almost unbelievable expansion of Eurodollar
balances (which apparently even survived the shock of the dollar
depreciation of August-December I971 and may well survive the
shock of the dollar devaluation of February 1973), proves con-
clusively that the Eurodollar market gave dollar holders, and es-
pecially foreigners, a welcome alternative use for their accruing
dollar balances. To the two previous options (viz., conversion into
foreign currencies or placement in the United States) the option of
placement in the Eurodollar market at attractive yields was added:
Eurodollar balances not only promised higher (and at times sub-
stantially higher) interest returns than placement in the US money
market but also provided important 'fringe benefits' (e.g., payment
of interest on demand deposits, forbidden under the Federal Reserve
Act; and especially lessened accessability to Government inquiries
about tax evasion and other illegal behavior).
While we must assume that a large part of placements in the
Eurodollar market substituted for placements in the United States
and therefore did not help to 'improve' the US liquidity position, we
may be certain (despite the absence of the necessary statistical infor-
mation) that a large part substituted for conversion into foreign
currencies, and thus averted a deterioration in the US official liqui-
dity position (i.e., reduced dollar redundancy). As dollar redundancy
has, in recent years, been the main (or only) serious threat to the
maintenance of the present international payments system, 10 this
tendency to reduce dollar redundancy clearly serves to support the
viability of the international payments system.
(ii) A bility o~ E u r o d o l l a r banks to le~d dollars - This ability obvi-
ously depends entirely on the size of the banks' deposits. If we must
come to the conclusion that Eurodollar banks are more likely than
banks in the United States to make loans to foreigners rather than
to US residents (see under (b), below), an increase in the lending
capacity of Eurodollar banks, i.e., an increase in their dollar de-
posits, indirectly tends to result in an increase in dollar lending to
foreigners, and thus to an increase in foreign gross dollar liquidity
and, under present conditions, to an increase in dollar redundancy.

10 T h e o n l y o t h e r serious t h r e a t w o u l d b e p o s e d b y a g r a v e d e f i c i e n c y of d o l l a r s - b u t
t h e d a n g e r of s u c h d e f i c i e n c y h a s r e c e n t l y b e e n negligible, a n d if it e v e r arose, it c o u l d
be e a s i l y a n d q u i c k l y a v e r t e d b y a n i n c r e a s e in t h e o u t f l o w of d o l l a r s f r o m t h e U n i t e d
States.
 DOLLAR LIQUIDITY AND EURODOLLAR MARKET 357

In this way, an expansion of the Eurodollar market tends to impair

the viability of the present international payments system, thus
offsetting (in part, entirely, or more than entirely) the effect men-
tioned under (i), above.
(b) Lending o~ Dollars by Eurodollar Banks - The crucial problem
of the impact of the Eurodollar market on the international dollar
liquidity situation is the degree to which Eurodollar banks are more
likely to make dollar loans to foreigners than banks in the United
States would in the absence of a Eurodollar market. There can be
no doubt that ordinarily a Eurodollar bank would be more likely to
make loans to a foreigner than a bank in tile United States: the
overwhelming majority of its customers are foreigners while the
overwhelming majority of the customers of a bank in the United
States are US residents. There are exceptions to that rule, however:
prior to tile enactment of the US 'voluntary' restraints on bank
lending to foreigners, some banks in the United States reportedly
followed the principle of lending to foreigners the counterpart of
deposits held by foreigners. Moreover, foreign affiliates of US corpo-
rations, and other 'multinational' enterprises, are believed to be the
most important customers of Eurodollar banks; and the US parents
or affiliates of such enterprises would presumably have easy access
to banks in the United States if the Eurodollar market did not exist.
Nevertheless, we m a y assume that Eurodollar bank lending to
foreigners has, in recent years, increased foreign gross dollar liquidity
substantially more than lending by banks in the United States would
have done in the absence of a Eurodollar market (and even in the
absence of the 'voluntary' restraints on lending to foreigners, im-
posed on banks in the United States since 1965).
While the basic mechanism by which bank lending increases li-
quidity is identical in the case of Eurodollar banks and banks in the
United States, there are two quantitative differences. First, a bank
in the United States can expand its loans not by the entire amount
of a newly acquired deposit but only by a percentage determined by
the applicable minimum reserve ratio requirements. In contrast,
there are no statutory and apparently no conventional reserve
requirements for Eurodollar banks - presumably because there is no
need for them to keep any reserve in dollars as long as they have
adequate reserves in their local convertible currency. Hence, there is
no reason for a Eurodollar bank not to relend immediately 100 per
cent of any deposited 'American' dollar balance.
358 j. ~. FURT•

Second, and more importantly, the funds borrowed by the cus-

tomer of a bank in the United States are generally, sooner or later,
redeposited - by the customer's payees - with another bank in the
United States, where they give rise to further lending. In this way,
the original deposit is likely, within a rather short period, to give
rise to a multiple credit expansion, whereby the multiple again is
determined by the applicable minimum reserve ratio requirements.
In contrast, it would be a mere coincidence if the payee of a Euro-
dollar bank's customer decided to deposit the 'American' dollar
balance received in payment with another (or the same) Eurodollar
bank in exchange for a Eurodollar balance. Hence, we may assume
that the primary creation of additional gross liquidity is also the
final one. In other words, the deposit of, say, $1 million in 'American'
dollars with a Eurodollar bank is likely, if lent to a foreigner, to
increase foreign gross dollar liquidity by $1 m i l l i o n - but not by
more.
The further effects of the resulting increase in foreign gross dollar
liquidity depend on the global adequacy of the supply of dollars. If
without new lending to foreigners the dollar supply were inadequate
for the financing of all economically appropriate international trans-
actions, the increase in liquidity will facilitate such financing and
thus help to expand international commerce. Moreover, as the ability
of US residents to finance their international transactions does not
depend on the supply of dollars to foreigners, Eurodollar lending to
foreigners will not increase US imports or US investments abroad but
only the imports and investment~ of residents of other countries.
Hence, such lending will 'improve' the US net receipts on current and
capital investment account, and thus the US net international liqui-
dity position.
Under conditions of global adequacy or even redundancy of dol-
lars, the effects of Eurodollar bank lending to foreigners are quite
different. Even if the borrower uses the borrowed dollar funds for
financing an international transaction, dollars will become redun-
dant because the borrower would have had, in the absence of Euro-
dollar bank lending, to acquire the funds in the exchange market or
from foreign central banks. Furthermore, the borrower himself will
often use the borrowed funds not for financing of international
transactions but rather for conversion into a foreign currency : either
as a speculation 'against' the dollar, or because a forward discount
on the dollar in foreign-exchange markets makes the 'covered' inter-
 DOLLAR LIQUIDITY AND EURODOLLAR MARKET 359

est cost of a dollar loan cheaper than that of a foreign-exchange loan.

In this way, part or all of the dollar funds borrowed from Eurodollar
banks will flow to foreign central banks, aggravating any developing
or existing dollar redundancy.
It should be remembered, however, that the problem of dollar
redundancy has been created, in all probability, by the appalling rise
in foreign net dollar liquidity rather than by a mere rise in gross
liquidity - and that dollar lending, whether by banks in the United
States or by Eurodollar banks, can never be responsible for a de-
terioration in the US net liquidity position. Moreover, large as the
rise in foreign gross dollar liquidity as a result of Eurodollar bank
lending has been, it has generally accounted for only a fraction of
the total increase in such liquidity. Between the end of 1966 and the
end of 1971, foreign gross claims on the United States (as measured
conventionally, with Eurodollar banks treated as foreigners) rose by
$ 37 billion ($15 billion in 1966-69, and $ 22 billion in 1969-71 ), while
the US net liquidity position deteriorated by $35½ billion ($12
billion in 1966-69, $23½ billion in 1969-71). Over the same period,
Eurodollar bank lending to non-official nonbank foreigners ex-
panded (as estimated by Professor Mikesell) by $19 billion ($5
billion in 1966-69, $14 billion in 1969-71) ; according to our thesis,
this expansion should represent the rise in foreign gross dollar liqui-
dity attributable to the Eurodollar market. Thus, Eurodollar market
transactions were responsible for only about one-half of the rise in
foreign gross dollar liquidity connected with changes in foreign
claims on US residents; not astonishingly, the portion was much
smaller in 1966-69, when US banks borrowed heavily from the
Eurodollar market, and larger in 1969-71, when US banks repaid
the borrowed funds.
Hence, while t h e activities in the Eurodollar market may have
helped to trigger the dollar 'crisis' of 1971, they have certainly not
been the basic cause of that crisis. Moreover, these activities proba-
bly prevented a 'crisis' from developing in 1966-69 (when the US
international net liquidity position deteriorated dramatically, de-
spite the 'surplus' on 'official reserve transactions' account in 1969).
If we assume - as we should - that both the United States and the
rest of the world were better prepared to meet a 'crisis' in 1971 than
they would have been in 1966-69, this delay may well be considered
a blessing.
(c) Sale o / D o l l a r s to FOreign Central B a n k s - Banks in the United
360 j . H . FURTH

States presumably never sell idle dollar holdings to a foreign central

bank while Eurodollar banks presumably do not hesitate to do so.
In this respect, too, an increase in 'American' dollar balances de-
posited with Eurodollar banks would indirectly aggravate dollar
redundancy while an identical deposit with a bank in the United
States would not have done so. There is no evidence, however, to
warrant the belief that such sales had a substantial impact on the
US and foreign official dollar positions. In contrast, sales of dollars
by foreign customers of Eurodollar banks may well have amounted
to $16 billion in 1970-71 (to judge from their net Eurodollar po-
sition, which - as estimated by Professor Mikesell - shifted from a
credit balance of $ 6 billion in 1969 to a debit balance of $10 billion in
1971). In this case, however, we may doubt whether foreigners (and
perhaps also some US residents) would have acted differently if they
had held their dollar balances in the United States rather than with
Eurodollar banks.

4. SUMMARY AND CONCLUSIONS

To sum up: applying the basic concepts set forth in the Intro-
duction, transactions with and of Eurodollar banks (deposits, loans,
sales of dollars) have the same direct effects on US and foreign gross,
net, and official international dollar liquidity as do identical trans-
actions with and of banks in the United States. In particular,
lending to foreigners, while having no direct impact on net or
official dollar liquidity, increases foreign gross dollar liquidity.
The indirect effects are more complicated and interesting. On the
one hand, by providing an attractive alternative for the placement
of otherwise redundant dollar holdings, the Eurodollar market in-
creases the willingness of foreigners (official institutions, banks, non-
banks) to hold dollars: in our terminology, it tends to reduce dollar
redundancy, and therefore to help maintain the present international
payments system, which has been based on the international role of
the dollar. Moreover, when Eurodollar bank lending to foreigners
contracts, the resulting decline in foreign gross dollar liquidity also
helps to decrease redundancy.
On the other hand, whenever Eurodollar banks lend dollars to
foreigners more freely than banks in the United States would have
done in the absence of a Eurodollar market, the market increases
foreign gross dollar liquidity. If the international supply of dollars
 DOLLAR LIQUIDITY AND EURODOLLAR MARKET 361

were deficient, this increase would help to expand international

commerce and actually help to improve the US payments balance
on current and investment capital accounts. Under conditions of an
adequate or even more than adequate dollar supply, however, at
least part of the dollars lent by Eurodollar banks to foreigners flows
to foreign central banks, affecting the US and foreign official dollar
liquidity positions, and thus aggravating a developing or existing
dollar redundancy.
The resulting flows help to explain on the one hand the 'strength'
of the dollar, and the emergence of a 'surplus' on US official liquidity
account in 1969; and on the other hand the explosive development
of the dollar 'crisis' in 1970-71 - although the market transactions
have not substantially affected the deterioration in the US net
international liquidity position, which has been the basic cause of
the difficulties confronting the international role of the dollar and
thus the preservation of the present international payments system.

Summary
INTERNATIONAL DOLLAR LIQUIDITY AND THE ]~URODOLLAR MARKET

Transactions of Eurodollar banks affect international dollar liquidity

(and the US payments balance) exactly as would identical transactions of
US banks. Eurodollar banks are, however, usually more likely to grant
credits to foreigners than US banks, and thus to raise foreign gross
(thought not net) dollar liquidity. In times of international dollar glut, an
expansion of the Eurodollar market (e.g., through shifts of deposits from
US to Eurodollar banks or through US banks repaying Eurodolla~
borrowings) thus tends to aggravate unwanted dollar flows to foreign
central banks and the US 'reserve transactions' (though not the 'net
liquidity') payments deficit.