While the eurodollar system has attained the full functions of a banking system in parallel to (and in many ways superseding) the onshore dollar version, at its core remains its primary purpose as a means to solve global payments. It is the idea of the dollar replacing gold and sterling, the reserve currency. The difference in recognizing the eurodollar as opposed to the dollar is that there is no currency in that reserve system. For the most part, especially the early days of the eurodollar, that was increasingly the point.

It’s often a difficult concept to grasp but I think it illuminates the core behavior that we even see today. Reviewing the early days in the 1960’s is especially helpful, I believe, in describing these basic functions and constructions. It is particularly poignant as there is increasingly apparent symmetry in the nature of the eurodollar as it arose and now in how it decays. At both ends, the Fed displays, and acts upon, only confusion; leaving just eurodollar banks and bank functions.

Toward the end of 1963, for example, the Italian lira was again under great pressure as it was subjected to what modern central banks attribute more exclusively to naked speculation. With devaluation predictions ripe, the Bank of Italy was into mostly defensive actions. Part of the reason for that later in 1963 was that Italian banks had been heavily borrowing in the relatively new eurodollar market to circumvent domestic Italian “tightening.” Commercial banks could easily convert what were ostensibly ledger liabilities in dollars (not physical Federal Reserve Notes) into lira or any other currency.

That had the effect in the international accounting of almost hiding Italy’s “capital outflows.” For perhaps the first time, the virtual eurodollar ledger exchanges were undermining official accounting and the standing upon which so many currency regimes were based. It wasn’t just Italy, either, as Japan had undertaken much the same with its commercial banks but without the imminent danger of devaluation; Japanese banks were actively sourcing eurodollars as a means to fund expansion without disturbing the yen at all.

As near as the Federal Reserve could figure, with assistance from the Treasury Department, Italian banks had sourced about $150 million in the eurodollar market toward the end of 1962 which equalized what would have been about $150 million in “outflows.” The Fed, always taking the wrong track with the eurodollar market, suggested this would be a short-term issue and that a reciprocal $150 million swap with either FRBNY or the Treasury would be sufficient when the “outflow” was eventually revealed.

By the following October, the eurodollar activity of Italian commercials had not ceased so the Bank of Italy was forced to begin warning against further eurodollar financing. In anticipation of that warning becoming something of a soft prohibition, the FOMC was prepared to petition the Treasury Department to begin buying lira on the “open” market through the Exchange Stabilization Fund. FOMC officials were increasingly keen on this kind of action because they believed less borrowing of eurodollars via Italy would lead to lower eurodollar rates, and thus help alleviate what they still saw as the US balance of payment deficit (it was, again, the incorrect interpretation of what eurodollars actually were and what the eurodollar market would become).