What is the Eurodollar Market?

There's maybe no more polarizing topic in markets today than the direction of the U.S. Dollar.

The Dollar Wrecking Ball, De-dollarization, BRICS, The Dollar Milkshake Theory... all of these narratives are direct offshoots or attempted explanations of where the USD is headed, its hegemony status, and by extension, how these moves will directly affect global assets, as the USD is the backbone of global financial markets.

Too often, however, these conversations fall short as they misunderstand or are completely clueless about the Dollar's oft-forgotten and significantly larger dark market brethren - the Eurodollar Market.

Understanding the USD without a fully comprehensive understanding of the Eurodollar Market would be like trying to understand Google's business model but not having any idea what the internet is.

This Editorial seeks to rectify this knowledge gap.

It will give background and context on what the Eurodollar Market (EDM) is, how it came to be from a historical perspective and its role in the global financial system. We worked closely with Jeff Snyder and Brent Johnson (two EDM experts), and so we'll be bringing their insights throughout the piece.

Key Takeaways

• When trying to forecast U.S. Dollar movements, markets tend to narrowly focus on the domestic U.S. Dollar market, as opposed to the global U.S. Dollar market, which includes all U.S. Dollars in circulation outside of the U.S.

• The Eurodollar Market is one of the fundamental reasons why monetary policy has historically been ineffective and illustrates the limitations of Central Banks in their ability to quantify U.S. Dollar supply and demand.

• We explore the origins and developments of the Eurodollar Market and conclude that without efforts to fully understand it, we’re unlikely to successfully control U.S. Dollar inflation.

Preface

“Most people realize there is a historical as well as functional significance to global reserve currencies. From global trade to gross financial investment across geographic and national boundaries, the modern, integrated economy doesn’t happen without an efficient, well-functioning dynamic global reserve system. Beyond the cursory, there’s very little depth to the public’s knowledge base. Few can describe the current monetary system’s basic factors let alone the finer details of how this reserve regime carries out these critical monetary roles. This is because the de facto global reserve currency isn’t the one you’ve been taught nor has it been for a very, very long time.” – Jeff Snider

In layman’s terms, we care about the Eurodollar Market because it has a huge impact on the global reserve system (the U.S. Dollar), which is a vital organ to a well-functioning and integrated economy.

What is the Eurodollar Market?

The standard definition of a Eurodollar is any U.S. dollar that is on deposit in a bank outside of the United States (not just in Europe, that is simply the naming convention). Domestic U.S. dollars in circulation can be measured in several different ways, but the broadest and most widely accepted is M2, which as of December 2023 is ~$20.7 trillion. Eurodollars are, therefore, by the standard definition, all other U.S. Dollars in circulation not accounted for by M2.

Jeff broadens the definition, however, to include all dollars not under the watch of the domestic U.S. monetary system (M2).

“Essentially, it’s a radical monetary evolution, away from the traditional format that was based on deposits of dollars, toward the more indescribable and ill-defined interbank market of these bookkeeper’s pen ledger balances moving back and forth.”

What Jeff is saying is that Eurodollars are made up of two distinct buckets:

1. The first is the Eurodollars found in traditional bank deposits (presented in detail by Milton Friedman).

2. The second is the addition of wholesale banking transactions that create an incremental supply of USDs that doesn’t get captured in the official statistics of M2.

It’s a difficult thing to believe, but no one really knows for sure where Eurodollars came from, but it’s generally understood that the market began sometime in the 1950s, and by the 1960s there was an unregulated monetary system blinking on the Fed's radar.

Consider this:

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