Most have an outdated understanding of money. This is something that we discuss on a regular basis. Sadly, many are in the 1920s as opposed to the 2020s.
Because of this, few realize how the system truly works. This is a world of accounting, collateral, and communications. There is little-to-no currency involved. Yet, people still try to apply concepts like we are still dealing with banknotes.
The Eurodollar System is one of ledgers. This is what truly drives the global economy.
Before getting to how it world, let's cover a bit of history.
Source: Pavel's Snapshots
Where Did The Eurodollar System Come From
The Eurodollar System is something that eludes most. It is not taught in Economics courses nor is it really discussed by the financial media. Instead, the attention is put on many topics that have little impact.
Post World War II, the world changed. One of the key factors was the onset of globalization. The world became smaller due to advancements in communication and transportation. The next 50 years would see things move even faster.
We also have the United States stepping forward as the global financial superpower. The U.S. dollar became the reserve currency, matched by the fact the economy was the largest in the world. All of this, combined with the military might exhibited during the war, put the U.S. centerstage.
Part of the post WWII process was the Unite States sending money to both Europe and Japan for reconstruction. These became known as eurodollars even though asiadollars was tried for a while.
A eurodollar is simply a US dollar that is a foreign bank. It has nothing to do with the euro currency.
As tens of billions started to be distributed, the international banks started to developed a system to meet the global trade needs.
This was created without oversight from central banks. There was no knowledge of this by governments. The bankers simply created a system that operated outside the reach of both these entities.
Over the next half century, this became the most powerful monetary system in the world.
What Is The Eurodollar System
The Eurodollar System is a network of financial institutions that engage in lending that drives the global economy.
Basically, we see borrowing, lending, cross border payments, collateralization, and remittance all taking place. Much of this operates on a peer-to-peer, or bilateral basis.
The best way to explain it is to use an example.
- An automobile manufacturer in Japan wants to borrow dollars to build a new plant
- A Japanese bank wants to provide the loan, but they don’t have enough dollars. However, the bank does have some United States Treasury notes
- The Japanese bank pledges the notes with a money lender in Australia
- The Australian money lender accepts the notes as collateral and issues the Japanese bank US dollars, which the bank then makes the loan in USD to the automobile manufacturer
This illustrates how the Eurodollar System works. Involved in this is a corporation, a bank, and some other financial institution (or maybe a second bank). What is not involved in this is currency. There are no actual currency involved.
So how does this work?
The answer likes in the idea of ledger based money. All transactions are processed and the ledgers updated to reflect the changes.
What we have is the reality that the reserve currency is not the US dollar. Instead, we see how the eurodollar has taken over. This is due to the sheer magnitude of the numbers involved.
The exact numbers are unknown but the trilateral agreements amount to $4T-$5T per day. Some estimate the bilateral agreements might rival that.
Either way, we are looking at more than 90% of global trade being funded through this system.
Getting Money Where It Is Needed
The Eurodollar System is based upon relationships. It is self regulating which means that participants have to trust each other. This is done through the relationships formed over many years.
It also explains why sanctions placed by the United States and its allies tend not to work. They can kick banks of SWIFT but cannot stop the Eurodollar System. After all, this was designed to get money where it is needed, when it is needed. The idea of obstacles placed by governments or central banks do not exist.
We are dealing with a system that was build outside these entities. Therefore, the impact, at least directly, is not there.
The numbers are simply overwhelming. We also see the tentacles reaching all aspects of the financial system. Brokerage firms, money market accounts, insurance companies, and hedge funds are also involved into this.
From this perspective, we can see there is a layer beyond what most people discuss when it comes to money, global finance, and trade.
It is the Eurodollar System, the ledger that drives the global economy.
