The Monetary Fifth Column: The Eurodollar Threat to Financial Stability and Economic Sovereignty

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ABSTRACT

Eurodollars are dollar-denominated deposit liabilities of banks outside the United States. Even though estimates of the size of the Eurodollar market exceed $5 trillion, these instruments are virtually unregulated. Legal scholarship has very little to say about Eurodollars, and the economic literature on the subject is geared toward economists and banking professionals rather than policy makers and attorneys. Furthermore, the economic scholarship is focused on describing the way Eurodollar markets function rather than critical examination of their nature and attendant risks. This Note is an attempt to get to the bottom of this ubiquitous yet mysterious financial instrument. It describes the nature and history of the Eurodollar and discusses potential challenges the Eurodollar market poses to financial stability and monetary sovereignty. It then examines the evolution of international bank regulation, pointing out why current measures are insufficient to address the risks posed by the Eurodollar. Finally, it considers possible solutions to these problems and proposes an approach to regulating the Eurodollar market consisting of a scheme of international reserve requirements.

TABLE OF CONTENTS

 I. INTRODUCTION
 II. BACKGROUND
     A. What Is a Eurodollar?
     B. A Brief History of the Eurodollar
     C. Eurodollar Uses
     D. Expanding Balance Sheets and Clearinghouse
        Concerns
     E. The Eurodollar and Foreign Bank Bailouts
III. STABILITY AND SOVEREIGNTY ISSUES
     A. Central Banks and Control
     B. Global Financial Stability: Eurocurrencies
        Pose Systemic Risk
 IV. INTERNATIONAL REGULATORY REGIMES: BRETTON
     WOODS AND THE BASEL ACCORDS
     A. International Monetary Agreements: From
        Bretton Woods to Basel II
     B. Basel Failures
     C. Basel III--Another Half-measure
 V. POSSIBLE SOLUTIONS
    A. Introduction: Action vs. Inaction
    B. Unilateral Action
       1. Unilateral Elimination of the
          Eurodollar
       2. Host Country Regulation
       3. Shortcomings of Unilateral Regulation
    C. International Agreements
       1. Multilateral Agreements Imposing
          Reserve Requirements
       2. Elimination of the Eurodollar by
          International Agreement
       3. Obstacles to International Agreements
       4. Disclosure Requirements
    D. Consequences of Continued Inaction
 VI. Conclusion

I. INTRODUCTION

In 2008, at the height of the financial crisis, the biggest beneficiaries of the Federal Reserve's emergency loans were not American banks but European ones. (1) By means of an interbank transfer called a foreign central bank liquidity swap, the U.S. central bank lent nearly $600 billion to foreign central banks. (2) The Federal Reserve reopened these dollar-liquidity swap lines during the Eurozone crisis, loaning ailing foreign institutions an additional $109 billion. (3) At the center of these foreign bank bailouts was a financial instrument called the Eurodollar.

Outside of the world of traders and economists, little is spoken of the Eurodollar. For most attorneys, indeed for most people, the words Eurodollar or Eurocurrency probably bring to mind the transnational currency introduced in 1999 and currently used as the medium of exchange in eighteen European nations. (4) However, a Eurocurrency need not have any relation to Europe or the Euro. A Eurocurrency is a deposit liability issued by or "held by" (5) a bank located in one country but denominated in units of another country's currency. (6) A Euro dollar, for example, is a type of Eurocurrency consisting of a U.S. dollar-denominated deposit in a bank outside the United States. (7) While this is a benign enough definition, Eurodollars comprise an estimated $5 trillion market (8) and present all the attendant risks of such a large market. (9)

Despite their prevalence, Eurodollars are some of the least understood financial instruments. Describing them in 1969, decades after their initial creation, (10) the preeminent economist Milton Friedman wrote that Eurodollars were "the latest example of the mystifying quality of money creation to even the most sophisticated bankers, let alone other businessmen. …