Fed and Trump Fail the Eurodollar Market

The Eurodollar market is a huge offshore money market that also operates in NYC through international banks. This market uses American dollars deposited offshore (Eurodollars) and has, over time, exposed the Fed as a big failure. It turns out that the Eurodollar market has revealed its disappointment over the years with QE and with the Fed. It has shown that QE is not really money printing. First, an explanation of the Eurodollar market is helpful:

One of the biggest reasons the eurodollar market is popular is that eurodollar deposits are not subject to American banking regulations. Because the deposits are outside of the United States, the banks holding these deposits do not have to adhere to the Federal Reserve's reserve requirements, and the Securities and Exchange Commission does not regulate eurodollar securities. Many banks and corporations find the lack of regulation attractive because it lowers costs, increases flexibility, and allows for creative structuring of financial instruments. 
The Eurodollar Market is an interest rate market, not a currency market. It is gives a good idea about where world prosperity is heading. Eurodollar loans don't create broad money. The Eurodollar, sort of a private base money is actually loaned out, unlike excess reserves, which are not.

The Eurodollar futures market was started in 1981 at the CME.  As it turns out, the Eurodollar Market, the largest liquid market in the world, is primarily centered in London, because its markets operate during the American and Asian markets. Major America banks have their foreign subsidiaries located in London. 

In attempting to understand the Great Recession crash of 2008 and the continuing lack of recovery, insights provided by Jeffrey P. Snider, who also contributes to Talkmarkets, are worth viewing. Mr. Snider takes us through the history of Eurodollar futures behavior during this time of recession and New Normal, ie, lack of recovery of the real economy while financialization takes over:

 Eurodollar futures were a place where the biggest and most powerful financial players bought whole-heartedly the Fed story.  Even in early 2007, when things started to really diverge from the Fed’s point of view, the eurodollar futures market was not positioned to be against the Fed but more so to recognize risks that it felt the Fed would eventually have to, too. 
As Jeffrey Snider goes on to prove, the Eurodollar futures market eventually came to see that the Fed would not recognize the risks that existed. First, the Eurodollar futures market wanted QE to work and the yield curve steepened, but would always flatten out again. Mr Snider says:

What we can interpret, then, from this period and the behavior of eurodollar futures was truly in keeping with the spirit of QE.  In other words, because the futures market rebounded upon announcement of the second, it seems very clear what had caused prior consternation was not, at that time, QE itself but questions about the size of it, a quite logical first place to look. The additional balance sheet expansion in late 2010 was received favorably as fixing that possible deficiency, an experiment in one isolated parameter.
That all changed in 2011.  When a year after that in 2012 the FOMC voted once more for a third QE, this time the eurodollar futures curve didn’t budge.

The biggest move came not at its start but more so contemplating its end in the summer of 2013, during the so-called taper tantrum. It therefore provides us with a perfect benchmark for evolution in thinking and trading. If in 2010 eurodollar futures investors were to have believed that quantity was the defect in terms of QE, by 2012 they were no longer so sure that was the case.  It wasn’t until the FOMC threatened to taper QE3 (and 4) because they viewed the economy as having strengthened sufficiently that eurodollar futures began to react as they had those prior times.  If the curve had jumped on the announcement and thus by mere faith before, by 2013 it clearly wanted evidence first before reacting favorably (to the normalcy scenario). Of course, it didn’t last long (again) and never reached those former levels of faith.  On September 5, 2013, eurodollar futures broke forever from QE.  
As it turns out, it dawned on the Eurodollar futures market starting in 2011 and through the 2013 tantrum that QE had nothing to do with printing money. Indeed, as we know already, it was all sterilized. Sterilized QE, offsetting a loose policy with a tightening, did nothing to help the real economy recover.  

And as it turns out, all the excess reserves in the system were really just sitting there. Jeffrey P. Snider doesn't even consider them to be base money. They are untouchable. QE was solely for the benefit of private banks and did almost nothing for the public good. Mr. Snider goes on to say that the excess reserves did nothing to help wholesale funding of the Eurodollar markets. If anything, the Eurodollar markets would soon be starved of liquidity. They hoarded treasury bonds and their own reserves. 

We had, of course, had heard people like Larry Summers saying there was a savings glut. But there was an excess reserves gut while in other markets, we have seen that we have shortages of both bonds and dollars! The savings glut is a USA phenomenon only, that doesn't help the world economy.

In looking forward, Mr. Snider says in another article that:
By any balance sheet measure you wish to use, including derivatives balances, banks are shrinking in tandem with what we find in these more visible wholesale estimates. Banks are the eurodollar system. If QE could not even offset what we can see, how can we expect that it would have further offset what we can't?These calculations again assume that bank reserves are even enough of a close substitute to dynamic wholesale funding such that the discussion over quantity is even relevant. They are not; which means QE fails as both quantitative and easing.
Shrinking banks are always a sign of economic decline. And he goes on to say:

QE seems to have just disappeared because it was so easily swallowed up by the wholesale chasm that still continues to grow only larger and in ways bank reserves will never apply.Under these circumstances, the FOMC is neither hawkish nor dovish; it simply doesn't figure. The only relevance is what the media still gives them in terms of their proclamations, though even these are being so thoroughly devalued by events far beyond their grasp. The Fed wrote in March 2006 that they were discontinuing M3 because it didn't, "convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years." As I wrote above, famous last words. Monetary policy, real, functional monetary policy outside the PR trappings of a governmental, institutional gathering of empty suits and credentials, has been entirely contained within M3 and what was missing from it this whole time. Instead of ignoring it, they should have made it their priority, their only priority, to figure out all that lay beyond in the hidden world of wholesale, eurodollar finance.
Both domestically and in wholesale dollar funding to the Eurodollar shadow market, the Fed has failed to produce growth in the real economy because the expansion of the money supply is hidden in useless excess reserves that cannot be touched, not making its way to real lending, and real economic growth going forward. The new normal continues, some say by design. And hoarding of cash and bonds continues. New LCR reserve requirement rules will likely add to bank hoarding down the road and for good or most likely bad, will cause the Eurodollar markets to languish, and possibly Eurodollars to be repatriated. 

Even Trump wants Eurodollar profits to be repatriated as well. Some say that is inflationary, but it could be really deflationary, causing a greater dollar shortage abroad, rising costs for US multinationals who will need to pay to convert foreign currency, a rising dollar and rising costs for foreign buyers of US goods. This could reduce exports, the very thing Donald Trump does not want to happen. 

The Fed, and Donald Trump will both fail US interests big time, if that repatriation ever takes place. Some try to look into the future as Anthony Migchels does. You can decide if he sees the future clearly from his article, The Dying Dollar and the Rise of a New Currency Order. Since it was written, oil has crashed and use of the Petrodollar/Eurodollar has taken yet another hit. If America wants prosperity, it wants to possess the reserve currency, and the Eurodollar market is crucial to that prosperity. As the article below shows, financialization centered in London is a big problem for the world. But starving the real economy for eurodollars, the reserve currency, is hardly the solution. 

See also: 
Unstable Repos and the London Connection

This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/global-markets/fed-and-trump-fail-the-eurodollar-market?post=122154&uid=4798


Popular posts from this blog

Learn Economics

The Unholy Alliance of Big Banking, Neocons, Big Media and Israel

John Mauldin Discusses What Could Go Wrong