The Hidden History of Eurodollars, Part 3: Spinning Out of Control

SPEAKER_1 (0:02)

Bloomberg Audio Studios, Podcasts, Radio, News.

Tracy Alloway (0:11)

Joe, Joe, what's that moving over there? What's that shadow? It's the shadow banking system. It's getting bigger.

Joe Weisenthal (0:19)

I think you've been down here, Tracy, in this proverbial bunker for a little too long, maybe. But no, it's the final installment of our three-part Eurodollar series.

Tracy Alloway (0:27)

Yeah, we've been tracing the history of Eurodollars, an incredibly important component of the global financial system, and at more than $10 trillion, the biggest form of shadow banking today. There has been post-World War II reconstruction, Cold War intrigue, 1960s politics, existential crisis in the dollar-based monetary system. But this right here, this is the moment when the Eurodollar market really takes shape and starts to look like it does today.

Joe Weisenthal (1:01)

Right, if you haven't caught the first and second episodes of this series, you should first definitely go back and listen to them because if you don't, you're gonna miss out on a lot of the detail and you're not gonna really understand what happens next. But this is key because this is when the Eurodollar market that we talk about all the time in finance, et cetera, actually begins to assume its modern form and really emerge from the inflation and monetary shocks of the 1970s.

Tracy Alloway (1:26)

And of course, this story is being told by two Odd Lots favorites, Lev Menand and Josh Younger.

Lev Menand (1:32)

I'm Lev Menand. I'm a law professor at Columbia Law School, where I study money and banking and the history of central banking.

Josh Younger (1:39)

I'm Josh Younger. I'm a Policy Advisor at the Federal Reserve Bank of New York. And the views I am going to express are my own and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System.

Tracy Alloway (1:49)

Now, where we last left off, we closed out the 1960s. The Eurodollar market has grown to about 70 billion dollars. And that growth has bought some time for policy makers who are trying to find a solution to the problem of funding dollar-based activity while maintaining the gold peg. Eurodollars have become a pressure valve, basically, to the Bretton Woods system. And they're helping it to stay alive.

Joe Weisenthal (2:16)

But as a consequence of that, the Eurodollar market is now really booming in a wild way. And Nixon is about to do something really big in response. He's about to abandon Bretton Woods altogether and do that famous move where he went off the gold standard. So take a listen.

Josh Younger (3:05)

Okay, so now it's 1970, 71, and things are really starting to go off the rails. This system is creaking and then swaying, and it really looks like it's about to fall down, and Eurodollars are getting a lot of the blame. They're called this hydroheaded monster. People are really worried that this is the mechanism for funding the speculation that is being directed against the dollar and really threatening to bring the whole system down. And it's 1970, you don't have to be that old in 1970 to remember the Great Depression. And one of the theories of the Great Depression that's pretty common at that point and still is today is that the Depression itself was largely a consequence of monetary contraction, global monetary contraction. So what does that mean in this context? If the dollar system fails, the money goes away, in a sense. And so that monetary contraction in the early 70s represents the same existential threat. This is going to come back again. Everyone's really worried about this, this existential threat to the global economy, another Great Depression. No one wants another Great Depression. I think that's generally true, but it's very acutely true at this point in time. And so in the summer of 1971, things are just completely untenable. And Nixon, after a few days huddling with advisors at Camp David, just says enough with the whole thing. Right. So he closes the gold window. This is the Nixon shock. On a Sunday evening, he addresses the country and he says, among other things, we're not going to be giving you gold for your dollars anymore.

Richard Nixon (4:24)

In recent weeks, the speculators have been waging an all out war on the American dollar. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connolly to suspend temporarily the convertibility of the dollar in the gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.