The Eurodollar as proto-stablecoin: implications for governance issues

A close equivalent to the dollar-pegged stablecoin has already emerged once in recent financial history. For at least some period of time it functioned as a genuine dollar competitor, before becoming absorbed back into the regulatory nexus of the global American financial system. This close equivalent is the eurodollar, whose emergence and history may be informative as to the future regulatory choices and challenges facing the stablecoins of as today.

Eurodollars emerged in the 1950s as the dollar holdings of foreign banks, where a market for dollars created and traded independently of the Federal Reserve’s regulatory net grew enormously in a short space of time. By 1967, a little more than a decade after its creation, the Eurodollar market was at least around $100 billion deep (in 2020 USD): more recent estimates put its size at over $13 trillion.

The Eurodollar market originated in a variety of factors: most notable was the growing importance of the U.S as the world’s sole economic superpower and only participant in WW2 that had survived with its industrial base intact. Elevated demand in the high-growth economies of postwar reconstruction Europe for the goods and services of U.S. firms created a constant and growing flow of dollars to Europe, while in turn the U.S. became a growing export market for these same countries. This trade was generally conducted in dollars. In part, however, the Eurodollar owed its origin to global power politics, as the Soviet Union sought to insulate its dollar holdings from possible U.S. confiscation. It transferred these holdings from New York to two small Soviet-controlled European banks, the Narodny Bank of London and Le Banque Commerciale pour l’Europe du Nord of Paris. Small-scale dollar-denominated lending by Narodny Bank in 1957 is cited by some sources as a key moment for the formation of the interbank Eurodollar market.

On the side of the banks that created and facilitated the Eurodollar market, there was a profitable opportunity for interest rate arbitrage due to quirks of the regulatory & exchange control frameworks of the time. Rising interest rates in the UK coincided with interest rate ceilings in the U.S. of 1% for 30-day deposits & 2.5% for 90-day deposits, enforced by the Fed’s “Regulation Q” The Midland Bank was the first to notice the opportunity and exploit it, aggressively buying up 30-day dollar deposits in the interbank market before selling them into sterling. The trade cost the Midland 4% in total to buy the dollars, exchange them into sterling, and swap them back into the dollars while the Bank Rate was 4.5%. Meanwhile British regulators, seeing an opportunity for the wider City of London, turned a blind eye, although Midland was violating the spirit (if not the letter) of the exchange control rules in place at the time. London accordingly became the center of Eurodollar trading.

The growth of the Eurodollar market caused (and continues to cause) some consternation in the U.S. regulatory sphere, where concerns focused on growing capital outflows and the inflationary risks of increased money supply (as time deposits, eurodollars increased global m2). These are discussed in a 1977 Senate committee paper. In other nations the Eurodollar market served to insulate domestic firms from mismanagement of local currencies, as mentioned in a 1967 IMF briefing document. As the Eurodollar market grew and developed, adding features such as the SWIFT interbank messaging network, it remained largely isolated from geopolitical pressures and domestic regulatory regimes until 9/11, when the Treasury imposed subpoenas on SWIFT for access to financial data of suspected terrorists, and later negotiated a deal with the EU for continued access to this data even after SWIFT moved its servers to Belgium in response. Although nominally run by an international committee representing the major global commercial and central banks, SWIFT’s status as an instrument of American power was confirmed in 2012 with the exclusion of Iranian banks from the network, and reconfirmed in 2022 with the exclusion of seven Russian banks.

Conclusions

Eurodollars, in their original incarnation, bore much resemblance to stablecoins: dollar near-equivalents issued by private entities and used widely by firms and individuals, in part due to the dollar’s status as the currency of global trade, in part due to regulatory arbitrage (European banks with dollar-denominated liabilities are not subject to the Fed’s reserve requirements, although some argue that post-2008 regulation has effectively recreated such requirements.

Notably, however, the promise of eurodollars as functional dollar replacements was never realized, as the market transitioned from its beginnings in Soviet firms and individuals seeking financial safe harbors to the post 9/11 American reassertion of authority over global financial networks. The 2008 financial crisis saw the further formalization and consolidation of the international dollar market, with the Fed stepping into the historically unprecedented role of global lender of last resort via its credit swap lines with fellow central banks, who were able to exchange their own currencies for dollars that could be lent out locally. Despite the extraordinary success of the eurodollar and its vast market size, it remains a complement to the dollar and an adjunct of American power. Any on-chain currency that seeks to compete with the dollar will require vastly different governance requirements and far more technological insulation from the mainstream payments systems than a stablecoin that simply looks to serve as a dollar complement. Should a complementary stablecoin ever look to shift gears and become a genuine competitor, navigating the transition will likely be a key governance challenge for whatever system is in place.

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