Eurodollar

What are Euro-dollars?


Eurodollars are U.S dollar denominated time deposits held in foreign bank accounts.  The term "Euro" can be confusing; but this practice originated in London, whose banks were the first to hold dollar deposits and the terminology stuck.  The fact is that Eurodollars can be held in any foreign bank in the world and they have no connection or correlation to the Euro currency.  Additionally, foreign banks holding these dollars are not subject to the rules and regulations imposed by the federal reserve bank in the United States, reducing regulatory costs and improving profit margins.

Euro dollars are created when U.S. dollar balances, which reside in a U.S. bank, are placed on deposit in a foreign bank.  Eurodollars may also be created by foreign banks which buy U.S. dollars in the forex market and lend these domestically to customers.  The transferring of ownership through the Eurodollar reduces liabilities of the U.S. bank on their balance sheet by lowering their demand deposit account at the Fed and their reserve ratio at the same time. 

Example of Euro-Dollar Creation


Let's review the example below.  In our example, Microsoft holds their cash at Wachovia Bank.  They decide to transfer the funds over to Singapore via check; this deposit in the Singapore based Eurodollar bank now passes the ownership of that demand deposit from Wachovia to the Singapore bank in exchange for a eurodollar time deposit.  At this point, these funds will need to be lent out to a borrower in order to collect interest on that deposit; therefore, the Singapore bank lends out money to a Chip maker in China who banks with JP Morgan.  Consequently, Wachovia no longer has any position in this loop, meaning no demand deposit, no liability.  The Singapore bank will now owe Microsoft a time deposit equal to the amount deposited and the chip maker will owe the Signapore bank in the amount of the loan taken.  Finally, JP Morgan will record an increase in their liabilities by the loan amount and also their demand deposit balance at the FED.

Euro-Dollar Transaction Model
Tim Ord
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