Macrotrends.net<\/a><\/em><\/figcaption><\/figure>\nMost people don\u2019t understand that this decision wasn\u2019t made so that the U.S. could become a profligate, irresponsible spender. As the proliferation of Eurodollars helps us understand, the dollar-gold peg wasn\u2019t simply broken in a day. It was a system that was placed under increasing strain over a long period of time until, finally, it was no longer manageable. In all sensibility, it was unrealistic to expect the U.S. to continue to supply its gold to the international community at the relatively low price of $35\/ounce.<\/p>\n
1971 was the year that the U.S. publicly shirked the full responsibility of global money. Little did anybody know that it was ceding control of the global money supply to the invisible hand of the Eurodollar system.<\/p>\n
New Money<\/h2>\n
It didn\u2019t stop with the delinking from gold. Over the decades that followed, the Eurodollar system continued to grow in accordance with global commerce. This was especially in support of the emergent computer and software industry and the foreign mining operations that supplied it.\u00a0\u00a0<\/p>\n
U.S. foreign policy in the 1980s brought the Arab world deeper into the international banking community. And the development of East Asia, especially Japan and later China, offered new opportunities for Eurodollar expansion as well. <\/p>\n
Importantly, the Eurodollar system did not just grow in terms of its nominal size or its prevalence throughout the world. It also grew qualitatively. Whereas earlier-generation Eurodollars may have been certificates of deposit or other more rudimentary assets, the Eurodollar system in the 1980s started making creative use of more sophisticated instruments, such as interest rate swaps, repurchase agreements, mortgage bonds, and forward contracts; instruments less known to the public. These instruments were all used to perform monetary functions without being recognized as money.\u00a0\u00a0<\/p>\n
The end effect was that banks could become bigger, make more loans into the real economy and support more productivity. Money creation on a tremendous scale enabled by this web of interbank finance.<\/p>\n
And how did the Federal Reserve handle this expansion of money? They had some awareness of it. In 1996, sitting Federal Reserve Chairman Alan Greenspan gave his famous \u201cirrational exuberance\u201d speech, in which he insinuated that stock market strength may have partially been attributable to more than just fundamental factors. <\/p>\n
He elaborated on this concern in June 2000 with his mention of the \u201cproliferation of products.\u201d<\/p>\n
\nThe problem is that we cannot extract from our statistical database what is true money conceptually, either in the transactions mode or the store-of-value mode. One of the reasons, obviously, is that the proliferation of products has been so extraordinary that the true underlying mix of money in our money and near-money data is continuously changing. As a consequence, while of necessity it must be the case at the end of the day that inflation has to be a monetary phenomenon, a decision to base policy on measures of money presupposes that we can locate money. And that has become an increasingly dubious proposition.<\/p>\n
Alan Greenspan<\/cite><\/p><\/blockquote>\nHere, Greenspan all but admits to the public that not only can the Federal Reserve not control money, but also that they\u2019re not even able to confidently measure<\/em> it. To the astute observer, this should\u2019ve been quite worrying.<\/p>\nDon\u2019t Look Down<\/h2>\n
So what did this mean for the financial system going into the 21st century? It meant that it had organized itself using these Eurodollar instruments to enable money to be moved more quickly to where it could be put to productive use, and that commercial banks used this decentralized matrix of assets to facilitate more lending. <\/p>\n
This profusion of credit continued until it finally reached its crescendo in 2007. It was the year when the Eurodollar system started to falter. It then did something it hadn\u2019t done since its creation: It assessed its risk. <\/p>\n
And when it assessed its risk, it decided that, not only couldn\u2019t it continue its growth, but also it had grown too big. It wanted to go in reverse. The instruments that had been transmitting liquidity through the system started to transmit risk exposure instead.\u00a0 As efficiently as it used to create money, the Eurodollar system started to create hazards. <\/p>\n
We all know this reversal event and its fallout as the Global Financial Crisis. And Eurodollars explain what made it global. It was because American mortgages funded multiple layers of Eurodollar finance\u2014so much so that when they became just a little bit risky, the entire system attached to it began to seize.\u00a0\u00a0<\/p>\n
It\u2019s not as well known, but the first bank to run into trouble at the time was not Bear Stearns in 2008, but a French bank by the name of BNP Paribas in the summer of 2007. And not in U.S. mortgages or mortgage bonds, but in one of its money market funds, of all things. <\/p>\n
The Eurodollar system had gone as far as it dared. Instead of writing new loans, it began calling old loans. Instead of creating monetary assets, it began to hoard them.<\/p>\n
A Monetary Phenomenon<\/h2>\n
Fifteen years later, the global economy limps along from crisis to crisis. Interest rates remain low, reflecting a lack of opportunity in the real economy. Banks are awash with reserves and nobody to lend them to, even as interest rates have been at historic lows. <\/p>\n
For 15 years, no government has had a good answer. Central banks have gone full bore on stimulus, but just can\u2019t seem to spur growth. They try the same policies, and we hear the same stories. <\/p>\n
But in 2024, nobody thinks to ask: \u201cWhat if the Federal Reserve doesn\u2019t really control money?\u201d What if the Eurodollar system had already created all the money the global economy needed? And what if it\u2019s just been in a slow, painful contraction since 2007? What if we got it wrong?<\/p>\n
What do you think? I welcome your comments below.<\/em><\/p>\n\n
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Note By BiggerPockets:<\/b> These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.<\/p>\n<\/div>\n
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