The Euro Currency And Euro Bond Markets 5s866
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The Euro Currency and Euro Bond Markets:
Eurocurrency Markets: An Introduction Eurocurrency markets are defined as banking markets which involve short-term borrowing and lending conducted outside of the legal jurisdiction of the authorities of the currency that is used. For example, Eurodollar deposits are dollar deposits held in London and Paris. The Eurocurrency market has two sides to it; the receipt of deposits and the loaning out of those deposits. By far the most important Eurocurrency is the Eurodollar which currently s for approximately 60–65% of all Eurocurrency activity, followed by the Euroeuro, Eurofrancs (Swiss), Eurosterling and Euroyen. The use of the prefix Euro is somewhat misleading because dollar deposits held by banks in Hong Kong or Tokyo are equally outside the legal jurisdiction of the US authorities and also constitute Eurodollar deposits. This more widespread geographical base means that Euromarkets are often referred to as ‘offshore’ markets.It is different than the Foreign Exchange Market, wherein the currency is bought and sold. Euro (€) is a single currency 1
which was launched on 1st Jan’1999. (With 11 of 15 member countries of the European Union participating in the experiment) .Now Euro (€) is the official currency of 16 of the 27 member states of the European Union (EU). These 16 states include some of the most technologically advanced countries of the European continent and are collectively known as the Euro zone. The Euro is an important international reserve currency. Euros have sured the US dollar with the highest combined value of cash in circulation in the world. The name euro was officially adopted on 16 December 1995. The euro was introduced to world financial markets as an ing currency on 1 January 1999, replacing the former European Currency Unit (ECU) at a ratio of 1:1. The currency was introduced initially in non-physical forms, such as travellers’ checks and electronic bank in Euro coins and banknotes entered circulation on 1 January 2002.The Euro is istered by the European Central Bank (ECB) based in Frankfurt, and the Euro system, comprising of the various central banks of the Euro zone nations. One of the factors that make the Eurocurrency Market unique compared to many other money market s is the fact that it is largely unregulated by government entities. Since the banks deal with a variety of currencies issued by foreign entities, it is difficult for domestic governments to intervene, particularly in the United States. However, with the establishment of the flexible exchange rate system in 1973, the Federal Reserve System was given powers to stabilize lending currencies in the event of a crisis situation. But one problem that arises is that these crises are not defined by the regulations, meaning that intervention must be established based on each case and the Federal Reserve must work directly with central banks around the world to resolve the matter. This adds to the volatility of the Eurocurrency Market. Despite its name, the Eurocurrency Market is primarily influenced by the value of the American dollar. Nearly two-thirds of all assets around the globe are represented by U.S. currency. The challenge with foreign banks revolves around the fact that regulations enforced by the Federal Reserve are really only enforceable within the U.S. The taxation level and exchange rate of the American dollar varies depending on the nation. For example, an American dollar in Vietnam is worth more than it is in Canada, further influencing the market The following five countries are responsible for the growth of the Euro-Currency Market: China (fear that its Fx in USD would be blocked).USA (indeed blocked identifiable Fx in USD in1950, federal Reserve Act, regulation ‘Q’ and ‘M’; control and restrictions on borrowing funds in US in 1965, and introduction of interest equalization tax in 1963) .Korea (War broke out in 1950).Russia (erstwhile USSR){because of their banking presence in Paris and London} .UK (policy of not granting sterling loan outside sterling area in 1957)
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Features of Eurocurrency Markets: FEATURES EURO CURRENCY MARKET:
Types of Transactions:
Japanese Exporter, earning USD, keeps these USD in London Bank (say AMEX)as Deposit. AMEX bank may use such deposits for lending to a French Importer. Indian exporter, earning Japanese Yen, keeps these Yen in Korea as Deposit .Nigerian Importer avails loan in INR from Russia to import machinery from India.
Huge amounts of Transactions:
Generally they are in only millions of USD.This has lead to Syndication of loans, where large numbers of banks participate in the lending operations.It also consists of pool of large number of short term deposits, which provides the biggest single source of funds for commercial banks .
Highly Competitive Market:
There are no entry barriers. There is free access to the new institutions in the market. The lending rates are low and deposit rate are high, thus allowing a wafer thin margin for operations. Consumers, i.e. investors and borrowers derive advantage out of this situation.
Floating rates of interest based on LIBOR:
The rate of interest in the market is linked to the Base Rate usually LIBOR, i.e. London InterBank Offered Rate .The rate of interest on advances and deposits is reviewed periodically and amended according to changed circumstances, if any in LIBOR
Dominance of Dollar denominated transactions:
Dollar is a leading currency traded in the market (about 90% to 95% market share).However other currencies are now emerging thus reducing the role of dollar somewhat (about 80% market share) Euro Japanese Yen Pound Sterling
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Origin of the Euro-Currency Market: The origin of the Eurocurrency market-that is, the market in currency trading outside their respective domestic economy. Several factors were behind their birth. 1. The centrally planned economies were reluctant to hold bank deposits in the United States, so they put their dollar earnings on deposit in London. Gradually other European dollar holders did the same, a tendency that was particularly marked when the United States ran large balance of payments deficits. 2. Balance of payments pressures made the United Kingdom government limit British banks' external use of sterling, so they had a strong incentive to develop business in foreign currencies. 3. By the end of 1958 the main industrial countries had restored full convertibility of their currencies. The new freedom produced a surge of international banking business. The growth of the Eurocurrency market was also stimulated by certain monetary regulations in the United States. For instance, Regulation Q put a ceiling on the interest rates that banks operating in the United States could offer to domestic depositors were naturally attracted to Eurobanks that were not bound by Regulation Q. In addition, banks in the United States were required to hold non-interest-bearing reserves. By diverting dollar deposits to their offshore branches or subsidiaries, U.S. banks were able to avoid tying up so much of their funds in reserve requirements at a zero rate. General controls on the movement of capital also helped to boost the Eurocurrency markets. One example was the introduction, in 1965, of the Voluntary Foreign Credit Restraint Program (VFCR) in the United States. The specific goal of the VFCR was to limit the growth of foreign lending by U.S. banks. Instead, their foreign branches-which were not subject to the VFCR- took deposits and onlent them outside the ceiling. Between 1964 and 1973 the number of U.S. banks with overseas branches increased from 11 to 125. The number of branches increased from 181 to 699 over the same period. At the end of the 1960s and during the early 1970s the Eurocurrency markets, which had been located in Western Europe (and centered in London), expanded to a number of other "offshore" banking centers. These were typically small territories that had tax, exchange control, and banking laws favorable to international banks. The business was entrepot in nature, with foreign currency funds deposited by one foreign source and then onlent to another. Offshore centers have been set up in the Caribbean area, Latin America, the Middle 4
East, and establishment of international banking facilities (IBFs) in the United States designed to bring the locus of American banking business back "onshore". With the recent strong growth of domestic currency lending abroad, total international lending is now the most meaningful lending aggregate, and it encomes Eurocurrency market activity.
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Significant Events in Eurocurrency Markets: 1) George Soros and the British Pound Year: 1992 The 1990s, though generally a very prosperous decade for the world economy, were rife with currency market tumult in just about every corner of the world. During the early phase of Europe’s single currency, the euro, the E.U. had a currency control known as the exchange rate mechanism, meant to keep the major currencies there in a range of relative value with each other. At the time, the U.K. was considering ing the monetary union — though reluctantly. With an economy on the verge of a downturn, the U.K. struggled to keep the British pound within the appropriate range of the German mark, whose value has been inflated by very high interest rates connected to the borrowing costs of German unification. Investor George Soros, then an active currency trader, and others in the market, undertook massive and relentless short-selling of the British pound, devaluing it to the point that its inclusion in the trading band was threatened. The British government fought back by raising interest rates and intervening in the markets. In the end, the traders prevailed and Britain quit the European Exchange Rate Mechanism. For his part, Soros reportedly made a billion dollars.
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2) Euro-Dollar Parity & Then Some Year: 2000 As Argentina unraveled, another exchange-rate parity story was unfolding across the Atlantic. Europe’s single currency hit the markets in 2000 with a launch rate equal to about $1.16. After an initial rise, the euro began a long and deep descent for most of the year, worth about 84 cents at its worse, as capital rushed to the booming U.S. economy and its attractive assets. The major central banks worked together, buying the euro in the markets to increase its value but little was accomplished. King dollar was back and the new kid on the block was temporarily put in its place. Eight years later, the table would be turned and the euro would be worth more than a dollar and a half.
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3) LIBOR Manipulation Scandal:
Year: 2012 The scandal over manipulation of the LIBOR and EURIBOR rates—benchmark lending rates for global banks—is complex, as it involves derivatives that most people have never even heard of.On June 27, the U.K.'s Financial Services Authority published detailing some of Barclays' infractions in manipulating LIBOR. So far, the company has agreed to shell out £290 million ($455 million) in fines due to the scandal. Not to mention various resignations and suspensions, and conspirators could even face the prospect of criminal charges. So why lie about LIBOR? Here's a brief explanation. LIBOR is used to settle contracts on money market derivatives. Every day, 18 banks are polled by the British Bankers Association and asked the question, "At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?"The 18 banks all submit responses, telling the Thomson Reuters data collection service that handles LIBOR submissions the price they would offer to loan money (LIBOR) on a variety of different timetables. The service throws out the top and bottom four submissions, then takes the average of those submissions to determine these official BBA rates. Bets involving Eurodollar futures—which allow traders to take bets on how interest rates will move over certain time periods—caused Barclay's submitters to alter the lending rates they reported to the BBA that would make up LIBOR. Eurodollar futures (and the derivatives related to them) s for some $360 trillion in global trade, and typical contracts involve at least $1 million. It's no surprise, then, that Barclays stood to gain a lot of money off of even small changes in the LIBOR rate—generally just a few basis points.
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Benefits and Costs of Eurocurrency Markets: Beginning in the 1980s, the Eurocurrency market witnessed rapid growth in medium-term credit arrangements between international banks and their corporate and governmental customers. These so-called note issuance facilities (NIFs) often span five to seven years and allow the customer to borrow in his or her own name by selling short-term IOUs (typically maturing in three to six months) to investors. The underwriting bank or banks backstop this customer paper either by purchasing any paper that remains unsold or by providing standby credit at an interest rate spread over LIBOR. The notes issued are usually denominated in U.S. dollars with par values of $100,000 or higher. With bank , NIFs are roughly equivalent to Eurocurrency CDs and compete with them for investor funds. Benefits and Costs of the Eurocurrency Markets For the most part, the development of Eurocurrency trading have resulted in substantial benefits to the international community, especially to banks and multinational corporations. The market ensures a high degree of funds mobility between international capital markets and provides a true international market for bank and nonbank liquidity adjustments. It has provided a mechanism for absorbing huge amounts of U.S. dollars flowing overseas and lessened international pressure to forsake the dollar for gold and other currencies. The market reduces the cost of international trade by providing an efficient method of economizing on transactions balances.1 Moreover, it acts as a check on domestic monetary and fiscal policies and encourages international cooperation in economic policies, because interestsensitive traders in the market will quickly spot interest rates that are out of line and move huge amounts of funds toward any point on the globe. Central banks, such as the Bank of England and the new European Central Bank created by the European Economic Community, monitor the Eurocurrency markets continuously in order to moderate inflows or outflows of funds that may damage their domestic economies.The capacity of Eurocurrency markets to mobilize massive amounts of funds has occasionally brought severe criticism from regulators in Europe, the United States, and Asia. They sometimes see the market as contributing to instability in currency values. Moreover, the market can wreak havoc with monetary and fiscal policies designed to cure domestic economic problems. This is especially true if a nation is experiencing severe inflation and massive inflows of Eurocurrency occur at the same time. The net effect of Eurocurrency expansion, other things being equal, is to push domestic interest rates down, stimulate 9
credit expansion, and accelerate the rate of inflation (which may ultimately result in higher market interest rates). The ability of local authorities to deal with inflationary problems might be overwhelmed by a Eurocurrency glut. This danger is really the price of freedom, for an unregulated market will not always conform to the plans of government policymakers.
The Contribution of the Euro-dollar Market to the Modern Financial World: The Euro-dollar market had caused many changes to the modern financial world in which, the open competitive effect of the international money market caused the liberalization by almost all industrialized countries of domestic money and banking markets. The market acted as a fully international mechanism for attracting deposits and offering loans, over a broad range of maturities and at highly competitive rates. The first important development of Euro-dollar business came after the Second World War, when Soviet bloc holders of dollar balances wanted to keep them in a form not subject to control by the US authorities. They kept them with London banks. However, the development of the market as a large-scale international structure really dates from 1957. It was given its impetus then by a rise in UK Bank rate to 7% and the imposition of restrictions on sterling credits to finance trade between non-sterling countries. At that time, banks in the US were limited (by Regulation Q) as to the amount of interest they might pay on deposits. Banks outside the US were able to offer a higher rate for dollar deposits, and yet, by operating on finer margins, to offer competitive for dollar loans. Many banks were well placed to take advantage of this situation. This was because of their wide overseas connections, long experience of international business and variety of outlets for making international loans. The first substantial development of the market took place in London, and London conducted much of the largest share of the business, which contributed considerable invisible earnings to the UK balance of payments. The role of sterling has been a central point to the development of the Euro-dollar market. To the sense that, the control of sterling has not only been a central preoccupation of British governments, but largely determined Britain's strategy towards the international financial market. Since 1958, governments have found themselves in a "dilemma" by the pressures of which the international use of sterling had placed on the British economy where "depleted" reserves of the entire sterling area constituted the most significant constraint on achieving economic growth. The management of sterling was the heart of governing Britain until conditions allowed the convertibility of the currency in the late 1950s. The central point that, throughout the postwar period, the British government sought agreements that enabled US dollars to flow to Britain whilst restricting the convertibility of sterling in domestic and foreign 10
hands, (the Washington Loan Agreement, the Marshall Plan, and military assistance programmers’ encouraged a flow of dollars to Britain). The UK government placed particular emphasis on exports to the dollar area (dollar-earning exports), with sterling area exports deemed next in importance. As early as the 1950s, Conservative governments, set about reasserting the international status of sterling and the importance of the City of London as the world's premier financial centre. In 1953, commodity markets and exchanges for raw materials were re-opened in London. March 1954 saw the long awaited return of London Gold Market (open to all non-residents of the sterling area). Changes were made in currency regulations in 1955, which allowed the partial convertibility of the pound for non-sterling area residents and non-dollar area residents. This was followed finally by the full convertibility of sterling in December 1958, and by the Bank of England's decision in 1962 to provide cheap foreign exchange cover and allow non-residents to hold dollar balances with the Bank of England (thus signaling the beginning of the Euro-dollar market). Dollars could now be deposited with the Bank of England in an external , thereby escaping US exchange regulations and earning a higher rate of interest than obtainable in the US. The aim here was well calculated. London's position as the main financial centre would be re-established and the City would quickly become the world's leading Euro-dollar market. However, the real significance of the Euro-dollar market lay in the fact that it originally drew its funds from non-bank suppliers and ultimately lent them to non-bank s, in which the established market was not dependent upon the existence on the USA remaining in deficit. As, the market soon become an integrated international money market providing its own specialized service which had shown considerable powers of survival. Merchant banks simply turned to the expatriate dollars, and used them in the way they have used sterling, operating freely on a global scale in the financing of international trade and the arrangement of longer term loans. American and other foreign banks wanting to take advantage of the paucity of financial controls in the UK soon ed this new market that was dominated by the merchant banks. Hence, between 1967-1978 the representation of foreign banks in London grew from 113 to 395. As, for the City's banks, the establishment of sterling convertibility in 1958 "was arguably the most important event of this century", for it heralded the rise of the London Eurodollar market. The table below shows how dramatic the Euro-dollar market had indeed become. A total of 91 international Euro-currency issues totaling the equivalent of $1,884m took place in 1967. The firms shown below are ranked in order of the aggregate amount of issues for which they acted either as managers or as co-managers. Apart from those listed, there were 45 firms active in such management. Karl Marx claimed that, "the abstraction of the state as such belongs only to modern times. The abstraction of the political state is a modern product”. The Euro-dollar market inherently being a new phenomenon proved some uncertainty to the British Labor government during the mid11
1960s, which had to approach the new market through an analysis of the world in which the Labour Party sought to govern. Such an analysis posed a variety of questions. Firstly, why particular institutions and processes posed such a set of problems for the individual Labor governments? Secondly, why particular issues come to preoccupy political debate in one period only for it to dwindle in importance in the next? Finally, why particular patterns of political and social cleavage prove so tenacious? With such questions, and a new market developing, the British Labor Government had to respond with a set agenda in order to control specified targets including the sequence of booms and slumps, the differing strengths of the national economy, the rise and significance of multinational corporations, the role of international financial agencies, and the changing role of the government in economic and social life. Such a task seems a formidable one, but one that was not considered impossible. As what holds the analysis together is the recognition that the world during the 1960s was capitalist to the sense that Marx used the term. The law of value still operated throughout the major economic and social processes. Due to this reason, the preceding outline of Marx's analysis remains relevant, as it provides the means by which the true nature of the British government's dilemmas can be explained and understood. To Marx, the executive of the modern state is portrayed as "a committee for managing the common affairs of the whole bourgeoisie". However, there is a problem, which must confront any contemporary theory of Marxism, namely the relation between appearance and reality. The state appears as independent from the sphere of market exchange, but in reality it is a different matter. The Euro-dollar is an example of such a case, in essence a phenomenon of the 1960s, an international money market where commercial banks undertook wholesale transactions involving foreign currencies. It had been a growing market, which has often involved conflicts with the state. As governments change, the market had been growing at a rapid pace, which had proved to be difficult to regulate. It seems that the Euro-dollar market was one of the initiating processes, which led to what is known today as globalization. To the sense that, the market had caused many changes to the modern financial world which, evolved on a global scale. The open competitive effect of the international money market had caused the liberalization by almost all industrialized countries of domestic money and banking markets. Where, successful participants in the money market of today, have a far more sophisticated understanding of financial risk, and the tools to manage them. As the changes in the markets have required many banking institutions to change in the way of financial regulation. However, when examining the Euro-dollar market, one has to turn to the 1960s which witnessed the focus of the changing relationship between the national state and the global financial markets, where the policies of Keynesian sought to bring "economic forces" under control. The idea was that the state should assume responsibility for the economy, intervening 12
where the market fails to stimulate economic growth. In times of a recession, the state should stimulate demand through deficit financing (such as, state expenditure based on credit). The state was thus charged with creating demand through an increase of the money supply. Keynesian raised these means to the principle of capitalist reproduction. Governments used these methods in a form of expansionary policies. Keynesianism depended upon the use of money for expansive industrial development and the management of "sound" finance.
One major question arose, throughout the paper: what are the risks and problems of the Eurodollar market, and is the growth of this market a "welcome tonic or a slow poison" to the international financial system (with particular emphasis to the United Kingdom)? There was no doubt that the growth of the Euro-dollar market had contributed spectacularly to the easing of the world liquidity problem. In less than a decade, the market grew from nothing to $13,000 million compared with an increase in official world reserves of only $21,000 million from 1951 to 1965. However, the growth of this market merely "put-off" the evil day when the reserve currency countries, and in particular the United States, had to adjust their payment situations to the facts of life. On the technical level the growth in the Euro-dollar market exposed the world in general and Britain in particular to every similar dangers to those experienced in the early thirties. Of its nature it was a market notable for its lack of regulation and control. No one country could exercise control over it. Euro-dollar deposits were no longer used solely for trade finance, and hence were not self-cancelling. Although individual banks observed limits to the amount of dollars they were to lend to individual "names", countries or areas, deposits ed through many hands before they had reached the final . It was almost impossible to tell the extent to which any country or individuals were committed to repaying Euro-dollars. If a serious breakdown occurred anywhere in the system, the strain would be transmitted to the centre. Britain's involvement in this market was so extensive with 13
£2,773 million liabilities and £2,487 million credits, by 1968, that a breakdown would inevitably throw doubt on Sterling . The risks and problems associated with the Euro-dollar market made themselves felt at three levels: the individual bank, the individual country, and at the level of the international financial system as a whole. For an individual bank the main risk was the possibility that a borrower may not repay his Euro-dollar loan. The borrower for any number of purposes – over which because of their unsecured nature, the lending bank had very little control, may use Euro-dollar funds. For an individual country, the problems created by the Euro-dollar market were two-fold: Firstly, the danger that the domestic banks involved in the market may over-extend themselves and thereby place demands on the official foreign exchange reserve. Secondly, the fact that the existence of the Euro-dollar market had provided another channel through which short-term capital can flow internationally and, hence, had tended to increase the volume of short-term capital moving into or out of any particular country". There were difficulties in establishing a mechanism that could bring about the necessary degree of international control over the Euro-dollar market. The most important was the fact that there was no single institution, either national or international, that could control the market, and act as an international lender of last resort in the same way that a national central bank can in the case of a national money market. There seemed to be a system of informal understanding among the central banks, developing probably as part of their co-operation in fighting exchange crisis, under which substantial volumes of US dollars could be mobilised quickly to meet any serious destabilising forces in the Euro-dollar market. In circumstances where the needs of the Euro-dollar market did conflict with other policy objectives, however, it was doubtful the national central banks would give priority to the Euro-dollar market. This was the basic weakness. As, in order to avoid this situation, the US dollar funds needed to stabilise the Euro-dollar market would have had to be made available on a more formal basis – such as by means of pre-arranged swap and stand by arrangements between the national central banks and the BIS. In this situation the BIS would be free to call on these swap funds in accordance with the needs of the Euro-dollar market. In addition, to meet these requirements during a period of crisis the volume of US funds at the disposal of the BIS would have had to be substantial. Undoubtedly, the major portion of these swap funds had to originate from the Federal Reserve System. In the 19th century, it was the competitiveness of "British industry" which led to the international use of sterling. However, by the late 1950s, the lack of competitiveness of Britain's industrial base (particularly "via" Europe) now meant that the international use of sterling could quickly turn from an asset to a liability. As sterling was made convertible, short-term capital inflows and outflows increased in volatility. In these circumstances, the Bank of England found 14
it increasingly difficult to defend the exchange rate – where the slightest "rumour" could lead to a massive speculation against the pound, destabilising the domestic economy. Although these pressures were seen to exist even as early as 1956 (when sterling was only partially convertible) over the first two days of Britain's invasion of Egypt there was a massive outflow of $50 million – (they became more acute over the next 20 years). From the early 1960s, the "British economy" was dominated by a pattern which saw rising levels of imports, falling exports, and when the balance of payments surplus diminished the introduction of high interest rates to attract short-term capital (hot money) to London. On entering office in 1964, Wilson found that convertibility and the establishment of the Eurodollar markets had produced a situation whereby financial markets could validate or disapprove of policy measures within hours. In many ways, the story of the Wilson's government is one of speculative action against the pound followed by international rescue operations to shore up the sterling exchange rate. Deflationary measures pursued throughout 1965, and 1966 failed to stem the tide of speculation, forcing the government to devalue in November 1967 and to negotiate a $1,5 billion standby credit from the IMF. Wilson agreed with the Bank of England and the Treasury that devaluation was a strategy to be avoided unless the Labour Government was willing to destroy confidence in sterling and the City as the premier financial centre. So relatively, the development of the Euro-dollar market coincided with the recoveries of the capitalist economies and the growing pressure of the US economy. The shortage of dollars gradually changed into dollar saturation. This market took over aspects of a developed domestic credit system, which was operating globally and independently from the central banks. Speculative capital assumed the function of national and international institutions, financing budget and balance of payments deficits. Such "money" existed as a claim on central bank money in national states on unregulated financial markets. The global role of the City foresaw the result as the dominance of financial over industrial capital. To the sense that although Britain was a low-wage and low-productivity country, it was a centre of global finance (due to the contribution of the Euro-dollar market). However, this did not mean that British industry had been undermined as a consequence of financial interests and policies favouring the concerns of financial markets, although the global role of the City "has had" a detrimental effect on British industrial development. Rather, the development of London as the centre for the global circulation of capital expressed the organisation of "British" capital at the most developed level of global capitalist relations. However, this development of the dominance of financial capital over productive capital must be treated with caution, since it was high interest rates that attracted money capital to London and the fact that the UK is one of the main countries attracting productive investment (particularly from US-based multinationals).
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So what can we learn from the British experience? The British case illustrates that there is nothing simple about the choice between government and the market: both are flawed mechanisms in of maximising efficiency and both require a deeply rooted underlying consent about their manner of operation and acceptance of their distributional outcomes. Lever later acknowledged in 1974/75 that, "modern governments, overestimated their ability to shape and manage the complex drives of a mature economy. They wrongly assumed that they understood all the reasons for its shortcomings and so, not surprisingly, were all too ready to lay hands on superficial remedies for overcoming them. And all this without any attempt to understand the economies of an increasingly interdependent world" . It remains to be said that that the nation-state provides the domestic political underpinning for the stability of global capitalist relations. Therefore in order to maintain the position of a nation state's integration into the "world market" nation states are under constant pressure to make more efficient use of available resources. Failure to achieve this will result in a loss of reserves, precipitated by balance of payments difficulties, and inflationary pressure, provoking global exchange instability and financial crisis.
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Analysis of Euro-Currency Market: An analysis of the Euro-Currency Market as on March 25th 2012 by Chris Ridder Today the euro made a 21-month low and traders/investors are curious as to how to position themselves, and what their competitors are doing. However, large institutions dominate foreign exchange (FX) trading, and the traders there get to see the flow of orders coming in and can take notice of which way clients are leaning. Are the weak hands buying? Is the smart money selling out? Since this market is primarily traded over the counter most of this information is available to only a privileged few. But, there is still a small sliver of the financial markets where a snapshot of how various players are positioned is revealed. The information is released each Friday by the CFTC in its "Commitment of Traders" (COT) report. The data represents positions as of the previous Tuesday. The publicly traded FX futures market is much smaller than the over the counter FX market but information about what actors are doing, with a delay in timing, is available. Here is a chart showing how the various players positioned themselves over the last six years, through May 15, 2012.
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One can see that dealers are very much net long. However, dealers (banks) also trade the cash OTC FX market and will arbitrage the cash and futures markets. So even though they are net long, there is the possibility of them being net short the cash market and having a neutral position. Here is how dealers have acted over time vs the FXE (euro etf).
Over the last several months the net long position for dealers in the futures markets has not worked, and the same for net short position in 2006 and 2007. Most likely the dealers/banks are hedged and not losing money, except for JP Morgan Chase (JPM).The report also includes asset managers and their collective view on the market:
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Over the last two months their outlook has turned negative on the euro. Next up, is the category of levered money, i.e. hedge funds:
One can see that over the years this "group" has very much been on the correct side of the market. It has been net short since July of 2011. It appears wise to trade along side of these funds.Finally, we come to those traders so small that their positions don't need to be reported
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One can see that the "small speculators" have been net bearish since 2011 too. I have noticed in the past that when this category gets a market call "right" in other markets, it typically leads to a very large move. This is because the normally correct "smart" money is on the wrong side and now has to reverse positions. Such a thing happens when the fundamentals of a market change quickly, as in the case of coffee futures in 1994. A freeze occurred and the long small "specs" were very much on the right side of the market, much to the surprise of the normally, "correct" commercials. Now this is possibly occurring in a much larger market. A potential dramatic change in the political stability and financial integrity of Europe exists.
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Euro Bond Market The Eurobond market is made up of investors, banks, borrowers, and trading agents that buy, sell, and transfer Eurobonds. Eurobonds are a special kind of bond issued by European governments and companies, but often denominated in non-European currencies such as dollars and yen. They are also issued by international bodies such as the World Bank. The creation of the unified European currency, the euro, has stimulated strong interest in eurodenominated bonds as well; however, some observers warn that new European Union tax harmonization policies may lessen the bonds' appeal. Eurobonds are unique and complex instruments of relatively recent origin. They debuted in 1963, but didn't gain international significance until the early 1980s. Since then, they have become a large and active component of international finance. Similar to foreign bonds, but with important differences, Eurobonds became popular with issuers and investors because they could offer certain tax shelters and anonymity to their buyers. They could also offer borrowers favorable interest rates and international exchange rates.
DEFINING FEATURES Conventional foreign bonds are much simpler than Eurobonds; generally, foreign bonds are simply issued by a company in one country for purchase in another. Usually a foreign bond is denominated in the currency of the intended market. For example, if a Dutch company wished to raise funds through debt to investors in the United States, it would issue foreign bonds (dollar-denominated) in the United States. By contrast, Eurobonds usually are denominated in a currency other than the issuer's, but they are intended for the broader international markets. An example would be a French company issuing a dollar-denominated Eurobond that might be purchased in the United Kingdom, , Canada, and the United States. Like many bonds, Eurobonds are usually fixed-rate, interest-bearing notes, although many are also offered with floating rates and other variations. Most pay an annual coupon and have maturities of three to seven years. They are also usually unsecured, meaning that if the issuer were to go bankrupt, Eurobond holders would normally not have the first claim to the defunct issuer's assets. However, these generalizations should not obscure the fact that the of many Eurobond issues are uniquely tailored to the issuers' and investors' needs, and can vary in and form substantially. A large number of Eurobond transactions involve elaborate swap deals in which 21
two or more parties may exchange payments on parallel or opposing debt issues to take advantage of arbitrage conditions or complementary financial advantages (e.g., cheaper access to capital in a particular currency or funds at a lower interest rate) that the various parties can offer one another.
MARKET COMPOSITION The Eurobond market consists of several layers of participants. First there is the issuer, or borrower, that needs to raise funds by selling bonds. The borrower, which could be a bank, a business, an international organization, or a government, approaches a bank and asks for help in issuing its bonds. This bank is known as the lead manager and may ask other banks to it to form a managing group that will negotiate the of the bonds and manage issuing the bonds. The managing group will then sell the bonds to an underwriter or directly to a selling group. The three levels—managers, underwriters, and sellers—are known collectively as the syndicate. The underwriter will actually purchase the bonds at a minimum price and assume the risk that it may not be possible to sell them on the market at a higher price. The underwriter (or the managing group if there is no underwriter) sells the bonds to a selling group that then places bonds with investors. The syndicate companies and their investor clients are considered the primary market for Eurobonds; once they are resold to general investors, the bonds enter the secondary market. Participants in the market are organized under the International Primary Market Association (IPMA) of London and the Zurich-based International Security Market Association (ISMA). After the bonds are issued, a bank acting as a principal paying agent has the responsibility of collecting interest and principal from the borrower and disbursing the interest to the investors. Often the paying agent will also act as fiscal agent, that is, on the behalf of the borrower. If, however, a paying agent acts as a trustee, on behalf of the investors, then there will also be a separate bank acting as fiscal agent on behalf of the borrowers appointed. In the secondary market, Eurobonds are traded over-the-counter. Major markets for Eurobonds exist in London, Frankfurt, Zurich, and Amsterdam.
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Analysis of Euro Bond Markets International financial markets have endured intense volatility over the last few weeks. Indeed, leading international equity indices have continued to follow the upward trend began in March, with the Dow Jones Industrial back above the 10,000 level for the first time since October 2008. Even currency markets have seen a lot of action, with the Euro moving back past the 1.49 mark against the US Dollar - a level last seen in August 2008. But the financial market excitement has not spread to major international bond markets, which appear to be going through a phase of apparent calm notwithstanding the recent signs of economic improvement. Yields on the short and long end of the curve have been relatively unchanged both in the US and in the Euro area over the past few weeks. In the US, the 10-year Government bond yield remained below 3.5%, while the 2-year note yield continued to hover around the 1% level. The bond market has been substantially quiet this week notwithstanding the dollar’s fall against major international currencies and the jump in gold prices to the historical high of US$1066oz. This is clear evidence that bond investors do not fear a dangerous increase in inflation, as the uptrend in gold prices and the US Dollar might indicate. Indeed, inflation expectations for the years ahead have been moderate, as the trend followed by the inflation-indexed securities (Tips) has shown. The implicit inflation estimate for 10-year Tips stands at 1.8%, well below the 2.2% historical average. With a real rate of 1.5%, the Tips also indicate that the market does not expect the U.S. economy to make a comeback to robust growth in the coming years, contrary to what the recent equity market rebound would suggest. Restrained inflation and economic growth expectations for the years to come are a source of considerable concern for U.S. Government bonds going forward. In fact, should inflationary pressure increase or economic growth be stronger than expected, Treasury yields would rise sharply and lead to capital losses. Moreover, for non-US investors, the US Dollar trend is another risk factor for the U.S. bond market. A continuation of the US currency downtrend, in fact, would ensure that the returns yielded by the coupons would not be able to offset the accumulated currency translation losses.
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The European bond market outlook looks rosier, particularly due to the single currency strength against the greenback. Indeed, inflation in the Euro area would remain more moderate than in the U.S. should the international economy recovery heighten inflationary pressures, hence delaying and limiting a monetary tightening by the ECB. Indeed, even a possible reversal of the Euro’s uptrend will likely have a limited impact on the near-term inflation and monetary policy prospects. Based on a study by some OECD economists ("Standard shocks in the OECD Interlink model" by Dalsgaard, André and Richardson), a 10% decline in the Euro would push up inflation by 0.4% in each of the following two years - not particularly worrying given the now restrained inflationary pressures. A reverse scenario, i.e. the emergence of deflationary pressures should leading international economies fail to pull themselves out of the crisis, would enable the bond market to post positive performances. As the ECB is likely to raise rates in small and not too frequent steps, short and medium term bonds are to overweight in a bond portfolio. Indeed, long term bonds would face greater risks in the face of heightened inflationary pressures. Only a deflationary scenario, which is highly unlikely to materialize any time soon, would lead investors to invest on the long end of the curve.
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Conclusion: The Eurocurrency and Euro Bond markets even now play a pivotal role in the Global Economy. Because of Europes traditional conservative nature; these bonds are regarded as stable but yielding low returns. The big worry a year ago was that Greece would collapse under its debts, upend Europe's markets and set off a global financial crisis. But the world's most dangerous bond market turned out to be one of the world's best bets last year: Greece's government bonds soared 97 percent as the debt crisis eased. Across Europe, many of the region's stock markets outpaced those in the U.S. "It has been a great investment opportunity, because a year ago at this time Europe was a big mess," said Geoffrey Pazzanese, who manages an international stock fund at Federated Investors. The worst is likely over, most investors say. And that's where any agreement ends. A lot appears to be going right in Europe's financial markets. Greece is no longer a threat, banks are looking stronger, and government borrowing costs are down. Yet Europe's economy remains in a slump. The 17 countries that share the euro currency recently slid into their second recession in three years, and the European Union's statistical agency reported Tuesday that the unemployment rate had reached a new high of 11.8 percent. Either the pain will and markets will continue surging ahead, investors say, or it's going to be a painful slog for many more years to come.
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Bibliography http://www.cnbc.com/id/47770902/page/6 http://www.eubusiness.com/topics/euro/financial-markets http://www.businessinsider.com/how-barclays-made-money-on-libor-manipulation-2012-7 http://www.articlesbase.com/economics-articles/the-contribution-of-the-eurodollar-market-tothe-modern-financial-world-170973.html http://seekingalpha.com/article/167148-rosier-european-bond-market-outlook
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Eurocurrency Markets: An Introduction Eurocurrency markets are defined as banking markets which involve short-term borrowing and lending conducted outside of the legal jurisdiction of the authorities of the currency that is used. For example, Eurodollar deposits are dollar deposits held in London and Paris. The Eurocurrency market has two sides to it; the receipt of deposits and the loaning out of those deposits. By far the most important Eurocurrency is the Eurodollar which currently s for approximately 60–65% of all Eurocurrency activity, followed by the Euroeuro, Eurofrancs (Swiss), Eurosterling and Euroyen. The use of the prefix Euro is somewhat misleading because dollar deposits held by banks in Hong Kong or Tokyo are equally outside the legal jurisdiction of the US authorities and also constitute Eurodollar deposits. This more widespread geographical base means that Euromarkets are often referred to as ‘offshore’ markets.It is different than the Foreign Exchange Market, wherein the currency is bought and sold. Euro (€) is a single currency 1
which was launched on 1st Jan’1999. (With 11 of 15 member countries of the European Union participating in the experiment) .Now Euro (€) is the official currency of 16 of the 27 member states of the European Union (EU). These 16 states include some of the most technologically advanced countries of the European continent and are collectively known as the Euro zone. The Euro is an important international reserve currency. Euros have sured the US dollar with the highest combined value of cash in circulation in the world. The name euro was officially adopted on 16 December 1995. The euro was introduced to world financial markets as an ing currency on 1 January 1999, replacing the former European Currency Unit (ECU) at a ratio of 1:1. The currency was introduced initially in non-physical forms, such as travellers’ checks and electronic bank in Euro coins and banknotes entered circulation on 1 January 2002.The Euro is istered by the European Central Bank (ECB) based in Frankfurt, and the Euro system, comprising of the various central banks of the Euro zone nations. One of the factors that make the Eurocurrency Market unique compared to many other money market s is the fact that it is largely unregulated by government entities. Since the banks deal with a variety of currencies issued by foreign entities, it is difficult for domestic governments to intervene, particularly in the United States. However, with the establishment of the flexible exchange rate system in 1973, the Federal Reserve System was given powers to stabilize lending currencies in the event of a crisis situation. But one problem that arises is that these crises are not defined by the regulations, meaning that intervention must be established based on each case and the Federal Reserve must work directly with central banks around the world to resolve the matter. This adds to the volatility of the Eurocurrency Market. Despite its name, the Eurocurrency Market is primarily influenced by the value of the American dollar. Nearly two-thirds of all assets around the globe are represented by U.S. currency. The challenge with foreign banks revolves around the fact that regulations enforced by the Federal Reserve are really only enforceable within the U.S. The taxation level and exchange rate of the American dollar varies depending on the nation. For example, an American dollar in Vietnam is worth more than it is in Canada, further influencing the market The following five countries are responsible for the growth of the Euro-Currency Market: China (fear that its Fx in USD would be blocked).USA (indeed blocked identifiable Fx in USD in1950, federal Reserve Act, regulation ‘Q’ and ‘M’; control and restrictions on borrowing funds in US in 1965, and introduction of interest equalization tax in 1963) .Korea (War broke out in 1950).Russia (erstwhile USSR){because of their banking presence in Paris and London} .UK (policy of not granting sterling loan outside sterling area in 1957)
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Features of Eurocurrency Markets: FEATURES EURO CURRENCY MARKET:
Types of Transactions:
Japanese Exporter, earning USD, keeps these USD in London Bank (say AMEX)as Deposit. AMEX bank may use such deposits for lending to a French Importer. Indian exporter, earning Japanese Yen, keeps these Yen in Korea as Deposit .Nigerian Importer avails loan in INR from Russia to import machinery from India.
Huge amounts of Transactions:
Generally they are in only millions of USD.This has lead to Syndication of loans, where large numbers of banks participate in the lending operations.It also consists of pool of large number of short term deposits, which provides the biggest single source of funds for commercial banks .
Highly Competitive Market:
There are no entry barriers. There is free access to the new institutions in the market. The lending rates are low and deposit rate are high, thus allowing a wafer thin margin for operations. Consumers, i.e. investors and borrowers derive advantage out of this situation.
Floating rates of interest based on LIBOR:
The rate of interest in the market is linked to the Base Rate usually LIBOR, i.e. London InterBank Offered Rate .The rate of interest on advances and deposits is reviewed periodically and amended according to changed circumstances, if any in LIBOR
Dominance of Dollar denominated transactions:
Dollar is a leading currency traded in the market (about 90% to 95% market share).However other currencies are now emerging thus reducing the role of dollar somewhat (about 80% market share) Euro Japanese Yen Pound Sterling
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Origin of the Euro-Currency Market: The origin of the Eurocurrency market-that is, the market in currency trading outside their respective domestic economy. Several factors were behind their birth. 1. The centrally planned economies were reluctant to hold bank deposits in the United States, so they put their dollar earnings on deposit in London. Gradually other European dollar holders did the same, a tendency that was particularly marked when the United States ran large balance of payments deficits. 2. Balance of payments pressures made the United Kingdom government limit British banks' external use of sterling, so they had a strong incentive to develop business in foreign currencies. 3. By the end of 1958 the main industrial countries had restored full convertibility of their currencies. The new freedom produced a surge of international banking business. The growth of the Eurocurrency market was also stimulated by certain monetary regulations in the United States. For instance, Regulation Q put a ceiling on the interest rates that banks operating in the United States could offer to domestic depositors were naturally attracted to Eurobanks that were not bound by Regulation Q. In addition, banks in the United States were required to hold non-interest-bearing reserves. By diverting dollar deposits to their offshore branches or subsidiaries, U.S. banks were able to avoid tying up so much of their funds in reserve requirements at a zero rate. General controls on the movement of capital also helped to boost the Eurocurrency markets. One example was the introduction, in 1965, of the Voluntary Foreign Credit Restraint Program (VFCR) in the United States. The specific goal of the VFCR was to limit the growth of foreign lending by U.S. banks. Instead, their foreign branches-which were not subject to the VFCR- took deposits and onlent them outside the ceiling. Between 1964 and 1973 the number of U.S. banks with overseas branches increased from 11 to 125. The number of branches increased from 181 to 699 over the same period. At the end of the 1960s and during the early 1970s the Eurocurrency markets, which had been located in Western Europe (and centered in London), expanded to a number of other "offshore" banking centers. These were typically small territories that had tax, exchange control, and banking laws favorable to international banks. The business was entrepot in nature, with foreign currency funds deposited by one foreign source and then onlent to another. Offshore centers have been set up in the Caribbean area, Latin America, the Middle 4
East, and establishment of international banking facilities (IBFs) in the United States designed to bring the locus of American banking business back "onshore". With the recent strong growth of domestic currency lending abroad, total international lending is now the most meaningful lending aggregate, and it encomes Eurocurrency market activity.
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Significant Events in Eurocurrency Markets: 1) George Soros and the British Pound Year: 1992 The 1990s, though generally a very prosperous decade for the world economy, were rife with currency market tumult in just about every corner of the world. During the early phase of Europe’s single currency, the euro, the E.U. had a currency control known as the exchange rate mechanism, meant to keep the major currencies there in a range of relative value with each other. At the time, the U.K. was considering ing the monetary union — though reluctantly. With an economy on the verge of a downturn, the U.K. struggled to keep the British pound within the appropriate range of the German mark, whose value has been inflated by very high interest rates connected to the borrowing costs of German unification. Investor George Soros, then an active currency trader, and others in the market, undertook massive and relentless short-selling of the British pound, devaluing it to the point that its inclusion in the trading band was threatened. The British government fought back by raising interest rates and intervening in the markets. In the end, the traders prevailed and Britain quit the European Exchange Rate Mechanism. For his part, Soros reportedly made a billion dollars.
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2) Euro-Dollar Parity & Then Some Year: 2000 As Argentina unraveled, another exchange-rate parity story was unfolding across the Atlantic. Europe’s single currency hit the markets in 2000 with a launch rate equal to about $1.16. After an initial rise, the euro began a long and deep descent for most of the year, worth about 84 cents at its worse, as capital rushed to the booming U.S. economy and its attractive assets. The major central banks worked together, buying the euro in the markets to increase its value but little was accomplished. King dollar was back and the new kid on the block was temporarily put in its place. Eight years later, the table would be turned and the euro would be worth more than a dollar and a half.
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3) LIBOR Manipulation Scandal:
Year: 2012 The scandal over manipulation of the LIBOR and EURIBOR rates—benchmark lending rates for global banks—is complex, as it involves derivatives that most people have never even heard of.On June 27, the U.K.'s Financial Services Authority published detailing some of Barclays' infractions in manipulating LIBOR. So far, the company has agreed to shell out £290 million ($455 million) in fines due to the scandal. Not to mention various resignations and suspensions, and conspirators could even face the prospect of criminal charges. So why lie about LIBOR? Here's a brief explanation. LIBOR is used to settle contracts on money market derivatives. Every day, 18 banks are polled by the British Bankers Association and asked the question, "At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?"The 18 banks all submit responses, telling the Thomson Reuters data collection service that handles LIBOR submissions the price they would offer to loan money (LIBOR) on a variety of different timetables. The service throws out the top and bottom four submissions, then takes the average of those submissions to determine these official BBA rates. Bets involving Eurodollar futures—which allow traders to take bets on how interest rates will move over certain time periods—caused Barclay's submitters to alter the lending rates they reported to the BBA that would make up LIBOR. Eurodollar futures (and the derivatives related to them) s for some $360 trillion in global trade, and typical contracts involve at least $1 million. It's no surprise, then, that Barclays stood to gain a lot of money off of even small changes in the LIBOR rate—generally just a few basis points.
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Benefits and Costs of Eurocurrency Markets: Beginning in the 1980s, the Eurocurrency market witnessed rapid growth in medium-term credit arrangements between international banks and their corporate and governmental customers. These so-called note issuance facilities (NIFs) often span five to seven years and allow the customer to borrow in his or her own name by selling short-term IOUs (typically maturing in three to six months) to investors. The underwriting bank or banks backstop this customer paper either by purchasing any paper that remains unsold or by providing standby credit at an interest rate spread over LIBOR. The notes issued are usually denominated in U.S. dollars with par values of $100,000 or higher. With bank , NIFs are roughly equivalent to Eurocurrency CDs and compete with them for investor funds. Benefits and Costs of the Eurocurrency Markets For the most part, the development of Eurocurrency trading have resulted in substantial benefits to the international community, especially to banks and multinational corporations. The market ensures a high degree of funds mobility between international capital markets and provides a true international market for bank and nonbank liquidity adjustments. It has provided a mechanism for absorbing huge amounts of U.S. dollars flowing overseas and lessened international pressure to forsake the dollar for gold and other currencies. The market reduces the cost of international trade by providing an efficient method of economizing on transactions balances.1 Moreover, it acts as a check on domestic monetary and fiscal policies and encourages international cooperation in economic policies, because interestsensitive traders in the market will quickly spot interest rates that are out of line and move huge amounts of funds toward any point on the globe. Central banks, such as the Bank of England and the new European Central Bank created by the European Economic Community, monitor the Eurocurrency markets continuously in order to moderate inflows or outflows of funds that may damage their domestic economies.The capacity of Eurocurrency markets to mobilize massive amounts of funds has occasionally brought severe criticism from regulators in Europe, the United States, and Asia. They sometimes see the market as contributing to instability in currency values. Moreover, the market can wreak havoc with monetary and fiscal policies designed to cure domestic economic problems. This is especially true if a nation is experiencing severe inflation and massive inflows of Eurocurrency occur at the same time. The net effect of Eurocurrency expansion, other things being equal, is to push domestic interest rates down, stimulate 9
credit expansion, and accelerate the rate of inflation (which may ultimately result in higher market interest rates). The ability of local authorities to deal with inflationary problems might be overwhelmed by a Eurocurrency glut. This danger is really the price of freedom, for an unregulated market will not always conform to the plans of government policymakers.
The Contribution of the Euro-dollar Market to the Modern Financial World: The Euro-dollar market had caused many changes to the modern financial world in which, the open competitive effect of the international money market caused the liberalization by almost all industrialized countries of domestic money and banking markets. The market acted as a fully international mechanism for attracting deposits and offering loans, over a broad range of maturities and at highly competitive rates. The first important development of Euro-dollar business came after the Second World War, when Soviet bloc holders of dollar balances wanted to keep them in a form not subject to control by the US authorities. They kept them with London banks. However, the development of the market as a large-scale international structure really dates from 1957. It was given its impetus then by a rise in UK Bank rate to 7% and the imposition of restrictions on sterling credits to finance trade between non-sterling countries. At that time, banks in the US were limited (by Regulation Q) as to the amount of interest they might pay on deposits. Banks outside the US were able to offer a higher rate for dollar deposits, and yet, by operating on finer margins, to offer competitive for dollar loans. Many banks were well placed to take advantage of this situation. This was because of their wide overseas connections, long experience of international business and variety of outlets for making international loans. The first substantial development of the market took place in London, and London conducted much of the largest share of the business, which contributed considerable invisible earnings to the UK balance of payments. The role of sterling has been a central point to the development of the Euro-dollar market. To the sense that, the control of sterling has not only been a central preoccupation of British governments, but largely determined Britain's strategy towards the international financial market. Since 1958, governments have found themselves in a "dilemma" by the pressures of which the international use of sterling had placed on the British economy where "depleted" reserves of the entire sterling area constituted the most significant constraint on achieving economic growth. The management of sterling was the heart of governing Britain until conditions allowed the convertibility of the currency in the late 1950s. The central point that, throughout the postwar period, the British government sought agreements that enabled US dollars to flow to Britain whilst restricting the convertibility of sterling in domestic and foreign 10
hands, (the Washington Loan Agreement, the Marshall Plan, and military assistance programmers’ encouraged a flow of dollars to Britain). The UK government placed particular emphasis on exports to the dollar area (dollar-earning exports), with sterling area exports deemed next in importance. As early as the 1950s, Conservative governments, set about reasserting the international status of sterling and the importance of the City of London as the world's premier financial centre. In 1953, commodity markets and exchanges for raw materials were re-opened in London. March 1954 saw the long awaited return of London Gold Market (open to all non-residents of the sterling area). Changes were made in currency regulations in 1955, which allowed the partial convertibility of the pound for non-sterling area residents and non-dollar area residents. This was followed finally by the full convertibility of sterling in December 1958, and by the Bank of England's decision in 1962 to provide cheap foreign exchange cover and allow non-residents to hold dollar balances with the Bank of England (thus signaling the beginning of the Euro-dollar market). Dollars could now be deposited with the Bank of England in an external , thereby escaping US exchange regulations and earning a higher rate of interest than obtainable in the US. The aim here was well calculated. London's position as the main financial centre would be re-established and the City would quickly become the world's leading Euro-dollar market. However, the real significance of the Euro-dollar market lay in the fact that it originally drew its funds from non-bank suppliers and ultimately lent them to non-bank s, in which the established market was not dependent upon the existence on the USA remaining in deficit. As, the market soon become an integrated international money market providing its own specialized service which had shown considerable powers of survival. Merchant banks simply turned to the expatriate dollars, and used them in the way they have used sterling, operating freely on a global scale in the financing of international trade and the arrangement of longer term loans. American and other foreign banks wanting to take advantage of the paucity of financial controls in the UK soon ed this new market that was dominated by the merchant banks. Hence, between 1967-1978 the representation of foreign banks in London grew from 113 to 395. As, for the City's banks, the establishment of sterling convertibility in 1958 "was arguably the most important event of this century", for it heralded the rise of the London Eurodollar market. The table below shows how dramatic the Euro-dollar market had indeed become. A total of 91 international Euro-currency issues totaling the equivalent of $1,884m took place in 1967. The firms shown below are ranked in order of the aggregate amount of issues for which they acted either as managers or as co-managers. Apart from those listed, there were 45 firms active in such management. Karl Marx claimed that, "the abstraction of the state as such belongs only to modern times. The abstraction of the political state is a modern product”. The Euro-dollar market inherently being a new phenomenon proved some uncertainty to the British Labor government during the mid11
1960s, which had to approach the new market through an analysis of the world in which the Labour Party sought to govern. Such an analysis posed a variety of questions. Firstly, why particular institutions and processes posed such a set of problems for the individual Labor governments? Secondly, why particular issues come to preoccupy political debate in one period only for it to dwindle in importance in the next? Finally, why particular patterns of political and social cleavage prove so tenacious? With such questions, and a new market developing, the British Labor Government had to respond with a set agenda in order to control specified targets including the sequence of booms and slumps, the differing strengths of the national economy, the rise and significance of multinational corporations, the role of international financial agencies, and the changing role of the government in economic and social life. Such a task seems a formidable one, but one that was not considered impossible. As what holds the analysis together is the recognition that the world during the 1960s was capitalist to the sense that Marx used the term. The law of value still operated throughout the major economic and social processes. Due to this reason, the preceding outline of Marx's analysis remains relevant, as it provides the means by which the true nature of the British government's dilemmas can be explained and understood. To Marx, the executive of the modern state is portrayed as "a committee for managing the common affairs of the whole bourgeoisie". However, there is a problem, which must confront any contemporary theory of Marxism, namely the relation between appearance and reality. The state appears as independent from the sphere of market exchange, but in reality it is a different matter. The Euro-dollar is an example of such a case, in essence a phenomenon of the 1960s, an international money market where commercial banks undertook wholesale transactions involving foreign currencies. It had been a growing market, which has often involved conflicts with the state. As governments change, the market had been growing at a rapid pace, which had proved to be difficult to regulate. It seems that the Euro-dollar market was one of the initiating processes, which led to what is known today as globalization. To the sense that, the market had caused many changes to the modern financial world which, evolved on a global scale. The open competitive effect of the international money market had caused the liberalization by almost all industrialized countries of domestic money and banking markets. Where, successful participants in the money market of today, have a far more sophisticated understanding of financial risk, and the tools to manage them. As the changes in the markets have required many banking institutions to change in the way of financial regulation. However, when examining the Euro-dollar market, one has to turn to the 1960s which witnessed the focus of the changing relationship between the national state and the global financial markets, where the policies of Keynesian sought to bring "economic forces" under control. The idea was that the state should assume responsibility for the economy, intervening 12
where the market fails to stimulate economic growth. In times of a recession, the state should stimulate demand through deficit financing (such as, state expenditure based on credit). The state was thus charged with creating demand through an increase of the money supply. Keynesian raised these means to the principle of capitalist reproduction. Governments used these methods in a form of expansionary policies. Keynesianism depended upon the use of money for expansive industrial development and the management of "sound" finance.
One major question arose, throughout the paper: what are the risks and problems of the Eurodollar market, and is the growth of this market a "welcome tonic or a slow poison" to the international financial system (with particular emphasis to the United Kingdom)? There was no doubt that the growth of the Euro-dollar market had contributed spectacularly to the easing of the world liquidity problem. In less than a decade, the market grew from nothing to $13,000 million compared with an increase in official world reserves of only $21,000 million from 1951 to 1965. However, the growth of this market merely "put-off" the evil day when the reserve currency countries, and in particular the United States, had to adjust their payment situations to the facts of life. On the technical level the growth in the Euro-dollar market exposed the world in general and Britain in particular to every similar dangers to those experienced in the early thirties. Of its nature it was a market notable for its lack of regulation and control. No one country could exercise control over it. Euro-dollar deposits were no longer used solely for trade finance, and hence were not self-cancelling. Although individual banks observed limits to the amount of dollars they were to lend to individual "names", countries or areas, deposits ed through many hands before they had reached the final . It was almost impossible to tell the extent to which any country or individuals were committed to repaying Euro-dollars. If a serious breakdown occurred anywhere in the system, the strain would be transmitted to the centre. Britain's involvement in this market was so extensive with 13
£2,773 million liabilities and £2,487 million credits, by 1968, that a breakdown would inevitably throw doubt on Sterling . The risks and problems associated with the Euro-dollar market made themselves felt at three levels: the individual bank, the individual country, and at the level of the international financial system as a whole. For an individual bank the main risk was the possibility that a borrower may not repay his Euro-dollar loan. The borrower for any number of purposes – over which because of their unsecured nature, the lending bank had very little control, may use Euro-dollar funds. For an individual country, the problems created by the Euro-dollar market were two-fold: Firstly, the danger that the domestic banks involved in the market may over-extend themselves and thereby place demands on the official foreign exchange reserve. Secondly, the fact that the existence of the Euro-dollar market had provided another channel through which short-term capital can flow internationally and, hence, had tended to increase the volume of short-term capital moving into or out of any particular country". There were difficulties in establishing a mechanism that could bring about the necessary degree of international control over the Euro-dollar market. The most important was the fact that there was no single institution, either national or international, that could control the market, and act as an international lender of last resort in the same way that a national central bank can in the case of a national money market. There seemed to be a system of informal understanding among the central banks, developing probably as part of their co-operation in fighting exchange crisis, under which substantial volumes of US dollars could be mobilised quickly to meet any serious destabilising forces in the Euro-dollar market. In circumstances where the needs of the Euro-dollar market did conflict with other policy objectives, however, it was doubtful the national central banks would give priority to the Euro-dollar market. This was the basic weakness. As, in order to avoid this situation, the US dollar funds needed to stabilise the Euro-dollar market would have had to be made available on a more formal basis – such as by means of pre-arranged swap and stand by arrangements between the national central banks and the BIS. In this situation the BIS would be free to call on these swap funds in accordance with the needs of the Euro-dollar market. In addition, to meet these requirements during a period of crisis the volume of US funds at the disposal of the BIS would have had to be substantial. Undoubtedly, the major portion of these swap funds had to originate from the Federal Reserve System. In the 19th century, it was the competitiveness of "British industry" which led to the international use of sterling. However, by the late 1950s, the lack of competitiveness of Britain's industrial base (particularly "via" Europe) now meant that the international use of sterling could quickly turn from an asset to a liability. As sterling was made convertible, short-term capital inflows and outflows increased in volatility. In these circumstances, the Bank of England found 14
it increasingly difficult to defend the exchange rate – where the slightest "rumour" could lead to a massive speculation against the pound, destabilising the domestic economy. Although these pressures were seen to exist even as early as 1956 (when sterling was only partially convertible) over the first two days of Britain's invasion of Egypt there was a massive outflow of $50 million – (they became more acute over the next 20 years). From the early 1960s, the "British economy" was dominated by a pattern which saw rising levels of imports, falling exports, and when the balance of payments surplus diminished the introduction of high interest rates to attract short-term capital (hot money) to London. On entering office in 1964, Wilson found that convertibility and the establishment of the Eurodollar markets had produced a situation whereby financial markets could validate or disapprove of policy measures within hours. In many ways, the story of the Wilson's government is one of speculative action against the pound followed by international rescue operations to shore up the sterling exchange rate. Deflationary measures pursued throughout 1965, and 1966 failed to stem the tide of speculation, forcing the government to devalue in November 1967 and to negotiate a $1,5 billion standby credit from the IMF. Wilson agreed with the Bank of England and the Treasury that devaluation was a strategy to be avoided unless the Labour Government was willing to destroy confidence in sterling and the City as the premier financial centre. So relatively, the development of the Euro-dollar market coincided with the recoveries of the capitalist economies and the growing pressure of the US economy. The shortage of dollars gradually changed into dollar saturation. This market took over aspects of a developed domestic credit system, which was operating globally and independently from the central banks. Speculative capital assumed the function of national and international institutions, financing budget and balance of payments deficits. Such "money" existed as a claim on central bank money in national states on unregulated financial markets. The global role of the City foresaw the result as the dominance of financial over industrial capital. To the sense that although Britain was a low-wage and low-productivity country, it was a centre of global finance (due to the contribution of the Euro-dollar market). However, this did not mean that British industry had been undermined as a consequence of financial interests and policies favouring the concerns of financial markets, although the global role of the City "has had" a detrimental effect on British industrial development. Rather, the development of London as the centre for the global circulation of capital expressed the organisation of "British" capital at the most developed level of global capitalist relations. However, this development of the dominance of financial capital over productive capital must be treated with caution, since it was high interest rates that attracted money capital to London and the fact that the UK is one of the main countries attracting productive investment (particularly from US-based multinationals).
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So what can we learn from the British experience? The British case illustrates that there is nothing simple about the choice between government and the market: both are flawed mechanisms in of maximising efficiency and both require a deeply rooted underlying consent about their manner of operation and acceptance of their distributional outcomes. Lever later acknowledged in 1974/75 that, "modern governments, overestimated their ability to shape and manage the complex drives of a mature economy. They wrongly assumed that they understood all the reasons for its shortcomings and so, not surprisingly, were all too ready to lay hands on superficial remedies for overcoming them. And all this without any attempt to understand the economies of an increasingly interdependent world" . It remains to be said that that the nation-state provides the domestic political underpinning for the stability of global capitalist relations. Therefore in order to maintain the position of a nation state's integration into the "world market" nation states are under constant pressure to make more efficient use of available resources. Failure to achieve this will result in a loss of reserves, precipitated by balance of payments difficulties, and inflationary pressure, provoking global exchange instability and financial crisis.
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Analysis of Euro-Currency Market: An analysis of the Euro-Currency Market as on March 25th 2012 by Chris Ridder Today the euro made a 21-month low and traders/investors are curious as to how to position themselves, and what their competitors are doing. However, large institutions dominate foreign exchange (FX) trading, and the traders there get to see the flow of orders coming in and can take notice of which way clients are leaning. Are the weak hands buying? Is the smart money selling out? Since this market is primarily traded over the counter most of this information is available to only a privileged few. But, there is still a small sliver of the financial markets where a snapshot of how various players are positioned is revealed. The information is released each Friday by the CFTC in its "Commitment of Traders" (COT) report. The data represents positions as of the previous Tuesday. The publicly traded FX futures market is much smaller than the over the counter FX market but information about what actors are doing, with a delay in timing, is available. Here is a chart showing how the various players positioned themselves over the last six years, through May 15, 2012.
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One can see that dealers are very much net long. However, dealers (banks) also trade the cash OTC FX market and will arbitrage the cash and futures markets. So even though they are net long, there is the possibility of them being net short the cash market and having a neutral position. Here is how dealers have acted over time vs the FXE (euro etf).
Over the last several months the net long position for dealers in the futures markets has not worked, and the same for net short position in 2006 and 2007. Most likely the dealers/banks are hedged and not losing money, except for JP Morgan Chase (JPM).The report also includes asset managers and their collective view on the market:
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Over the last two months their outlook has turned negative on the euro. Next up, is the category of levered money, i.e. hedge funds:
One can see that over the years this "group" has very much been on the correct side of the market. It has been net short since July of 2011. It appears wise to trade along side of these funds.Finally, we come to those traders so small that their positions don't need to be reported
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One can see that the "small speculators" have been net bearish since 2011 too. I have noticed in the past that when this category gets a market call "right" in other markets, it typically leads to a very large move. This is because the normally correct "smart" money is on the wrong side and now has to reverse positions. Such a thing happens when the fundamentals of a market change quickly, as in the case of coffee futures in 1994. A freeze occurred and the long small "specs" were very much on the right side of the market, much to the surprise of the normally, "correct" commercials. Now this is possibly occurring in a much larger market. A potential dramatic change in the political stability and financial integrity of Europe exists.
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Euro Bond Market The Eurobond market is made up of investors, banks, borrowers, and trading agents that buy, sell, and transfer Eurobonds. Eurobonds are a special kind of bond issued by European governments and companies, but often denominated in non-European currencies such as dollars and yen. They are also issued by international bodies such as the World Bank. The creation of the unified European currency, the euro, has stimulated strong interest in eurodenominated bonds as well; however, some observers warn that new European Union tax harmonization policies may lessen the bonds' appeal. Eurobonds are unique and complex instruments of relatively recent origin. They debuted in 1963, but didn't gain international significance until the early 1980s. Since then, they have become a large and active component of international finance. Similar to foreign bonds, but with important differences, Eurobonds became popular with issuers and investors because they could offer certain tax shelters and anonymity to their buyers. They could also offer borrowers favorable interest rates and international exchange rates.
DEFINING FEATURES Conventional foreign bonds are much simpler than Eurobonds; generally, foreign bonds are simply issued by a company in one country for purchase in another. Usually a foreign bond is denominated in the currency of the intended market. For example, if a Dutch company wished to raise funds through debt to investors in the United States, it would issue foreign bonds (dollar-denominated) in the United States. By contrast, Eurobonds usually are denominated in a currency other than the issuer's, but they are intended for the broader international markets. An example would be a French company issuing a dollar-denominated Eurobond that might be purchased in the United Kingdom, , Canada, and the United States. Like many bonds, Eurobonds are usually fixed-rate, interest-bearing notes, although many are also offered with floating rates and other variations. Most pay an annual coupon and have maturities of three to seven years. They are also usually unsecured, meaning that if the issuer were to go bankrupt, Eurobond holders would normally not have the first claim to the defunct issuer's assets. However, these generalizations should not obscure the fact that the of many Eurobond issues are uniquely tailored to the issuers' and investors' needs, and can vary in and form substantially. A large number of Eurobond transactions involve elaborate swap deals in which 21
two or more parties may exchange payments on parallel or opposing debt issues to take advantage of arbitrage conditions or complementary financial advantages (e.g., cheaper access to capital in a particular currency or funds at a lower interest rate) that the various parties can offer one another.
MARKET COMPOSITION The Eurobond market consists of several layers of participants. First there is the issuer, or borrower, that needs to raise funds by selling bonds. The borrower, which could be a bank, a business, an international organization, or a government, approaches a bank and asks for help in issuing its bonds. This bank is known as the lead manager and may ask other banks to it to form a managing group that will negotiate the of the bonds and manage issuing the bonds. The managing group will then sell the bonds to an underwriter or directly to a selling group. The three levels—managers, underwriters, and sellers—are known collectively as the syndicate. The underwriter will actually purchase the bonds at a minimum price and assume the risk that it may not be possible to sell them on the market at a higher price. The underwriter (or the managing group if there is no underwriter) sells the bonds to a selling group that then places bonds with investors. The syndicate companies and their investor clients are considered the primary market for Eurobonds; once they are resold to general investors, the bonds enter the secondary market. Participants in the market are organized under the International Primary Market Association (IPMA) of London and the Zurich-based International Security Market Association (ISMA). After the bonds are issued, a bank acting as a principal paying agent has the responsibility of collecting interest and principal from the borrower and disbursing the interest to the investors. Often the paying agent will also act as fiscal agent, that is, on the behalf of the borrower. If, however, a paying agent acts as a trustee, on behalf of the investors, then there will also be a separate bank acting as fiscal agent on behalf of the borrowers appointed. In the secondary market, Eurobonds are traded over-the-counter. Major markets for Eurobonds exist in London, Frankfurt, Zurich, and Amsterdam.
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Analysis of Euro Bond Markets International financial markets have endured intense volatility over the last few weeks. Indeed, leading international equity indices have continued to follow the upward trend began in March, with the Dow Jones Industrial back above the 10,000 level for the first time since October 2008. Even currency markets have seen a lot of action, with the Euro moving back past the 1.49 mark against the US Dollar - a level last seen in August 2008. But the financial market excitement has not spread to major international bond markets, which appear to be going through a phase of apparent calm notwithstanding the recent signs of economic improvement. Yields on the short and long end of the curve have been relatively unchanged both in the US and in the Euro area over the past few weeks. In the US, the 10-year Government bond yield remained below 3.5%, while the 2-year note yield continued to hover around the 1% level. The bond market has been substantially quiet this week notwithstanding the dollar’s fall against major international currencies and the jump in gold prices to the historical high of US$1066oz. This is clear evidence that bond investors do not fear a dangerous increase in inflation, as the uptrend in gold prices and the US Dollar might indicate. Indeed, inflation expectations for the years ahead have been moderate, as the trend followed by the inflation-indexed securities (Tips) has shown. The implicit inflation estimate for 10-year Tips stands at 1.8%, well below the 2.2% historical average. With a real rate of 1.5%, the Tips also indicate that the market does not expect the U.S. economy to make a comeback to robust growth in the coming years, contrary to what the recent equity market rebound would suggest. Restrained inflation and economic growth expectations for the years to come are a source of considerable concern for U.S. Government bonds going forward. In fact, should inflationary pressure increase or economic growth be stronger than expected, Treasury yields would rise sharply and lead to capital losses. Moreover, for non-US investors, the US Dollar trend is another risk factor for the U.S. bond market. A continuation of the US currency downtrend, in fact, would ensure that the returns yielded by the coupons would not be able to offset the accumulated currency translation losses.
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The European bond market outlook looks rosier, particularly due to the single currency strength against the greenback. Indeed, inflation in the Euro area would remain more moderate than in the U.S. should the international economy recovery heighten inflationary pressures, hence delaying and limiting a monetary tightening by the ECB. Indeed, even a possible reversal of the Euro’s uptrend will likely have a limited impact on the near-term inflation and monetary policy prospects. Based on a study by some OECD economists ("Standard shocks in the OECD Interlink model" by Dalsgaard, André and Richardson), a 10% decline in the Euro would push up inflation by 0.4% in each of the following two years - not particularly worrying given the now restrained inflationary pressures. A reverse scenario, i.e. the emergence of deflationary pressures should leading international economies fail to pull themselves out of the crisis, would enable the bond market to post positive performances. As the ECB is likely to raise rates in small and not too frequent steps, short and medium term bonds are to overweight in a bond portfolio. Indeed, long term bonds would face greater risks in the face of heightened inflationary pressures. Only a deflationary scenario, which is highly unlikely to materialize any time soon, would lead investors to invest on the long end of the curve.
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Conclusion: The Eurocurrency and Euro Bond markets even now play a pivotal role in the Global Economy. Because of Europes traditional conservative nature; these bonds are regarded as stable but yielding low returns. The big worry a year ago was that Greece would collapse under its debts, upend Europe's markets and set off a global financial crisis. But the world's most dangerous bond market turned out to be one of the world's best bets last year: Greece's government bonds soared 97 percent as the debt crisis eased. Across Europe, many of the region's stock markets outpaced those in the U.S. "It has been a great investment opportunity, because a year ago at this time Europe was a big mess," said Geoffrey Pazzanese, who manages an international stock fund at Federated Investors. The worst is likely over, most investors say. And that's where any agreement ends. A lot appears to be going right in Europe's financial markets. Greece is no longer a threat, banks are looking stronger, and government borrowing costs are down. Yet Europe's economy remains in a slump. The 17 countries that share the euro currency recently slid into their second recession in three years, and the European Union's statistical agency reported Tuesday that the unemployment rate had reached a new high of 11.8 percent. Either the pain will and markets will continue surging ahead, investors say, or it's going to be a painful slog for many more years to come.
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Bibliography http://www.cnbc.com/id/47770902/page/6 http://www.eubusiness.com/topics/euro/financial-markets http://www.businessinsider.com/how-barclays-made-money-on-libor-manipulation-2012-7 http://www.articlesbase.com/economics-articles/the-contribution-of-the-eurodollar-market-tothe-modern-financial-world-170973.html http://seekingalpha.com/article/167148-rosier-european-bond-market-outlook
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