Over the past 7 decades, the monetary system evolved in a way few understand. What is taught in Economics class is nowhere near the reality of the system we operate under. Even if some of the lessons were applicable at one time, we are in a completely different environment.
Monetary history tends to be misunderstood to the point where most miss the entire premise of what took place. There are a lot discussion money yet they completely ignore the Eurodollar System. This is a market that far outpaced the domestic money supply yet few are familiar with it.
It was one that flew under the radar for a number of decades. There were signs that something was taking place yet policy makers were not able to pinpoint what the cause was.
Offshore Dollar Market
The money supply is convoluted in a number of ways.
These days, there are banknotes which are created by the central bank. The Federal Reserve is responsible for the physical currency although the commercial banks tend to make the demand on half of their customers.
Inaddition to this, we have the deposits within the commercial banks. These are the results of loans since that is how the US dollars, in digital form, are created. Many call this credit but it ends up as a liability for the banking system.
The money supply increases when bank lending outpaces the repayment plus default of previous loans. If people reduce their debts through the banks, either through payments or default, the money supply contracts.
Here we have the basic essence of currency creation under fractional reserve banking. Both these forms of money are legal tender. They can be used in the purchase of goods and services, servicing of debt, and payment of taxes.
The Eurodollar System took this to a completely different level. While the domestic banking system creates most of the US dollars, the offshore system usurps it.
It was something that was noticed by the Fed in the early 1980s. The were questions about the effectiveness of monetary policy if most of the monetary creation was taking place without expanding U.S deposits.
Financing of Trade
The Eurodollar System was designed to counter the constraints on capital flow restrictions placed by the Bretton Woods agreement. Demand was present and the financial institutions developed a system to meet that need.
A chain is formed between the end user of the funds and the lender. There are a number of financial intermediaries along the way. This forms a chain as each party focuses upon its area of specialization. Naturally, each is taking a small piece of the action, bringing them into the market.
This is how global trade is financed. Companies enter the market looking for funding and deposits are used to finance this. Due to the interest rate differential, the appeal of the offshore market was more appealing then the domestic money market.
Forty years ago, the pace of growth of this market was outpacing the domestic supply. This was during an era when currency was still involved in the system. Deposits were greatly enhanced by the addition of US dollar denominated assets such as US Treasuries. These were used as collateral, effectively making it part of the global money supply.
Dollar Shortage
Since the Great Financial Crisis (GFC), we have a major issue to deal with. The global supply of dollars is stifled. More accurately, it is the eurodollar that is in short supply. This is the essence of balance sheet constraint.
It is also why inflation was not present the last few years. Prices increases due to something other than the expansion of the money supply. In this instance, it was the shutting down of the global economy causing supply chain issues.
The fact we have a system that is constrained is ironic since this is what pushed for its creation to begin with. A lack of capital flow in the established system caused the banks to go around it.
We still have demand. The global economy continually needs more money to keep growing. The stock in trade in this arena is US dollars. Historically, the Eurodollar System created more dollars than the domestic one. It is something that accelerated over the 25 years since the Federal Reserve started to pay attention.
