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30 years later: Money and Banking

 I was listening to a blog about money and what it is, the reason was a discussion on the fact that the Federal Reserve has been unable to control the money supplier for some time.  In fact, we are not talking about 2008 but much earlier, we are talking of the late 1980s when the Federal Reserve "discovered" the Eurodollar and its influence on US monetary policy.

Eurodollars were invented outside the US monetary system, and it was not controlled by the US in any shape or form.  It emerged in the early 1970s as international finance started to grow.  Even then the US government (via the federal reserve) had no control or even aspiration to control the Eurodollar -- laissez-faire was the order of the day since it didn't impact the US money supply or interest rates (however, it did impact liquidity).

on the other side of the world China' has always hoped for the impossible dream; the Yuan becoming a trading currency.   There are several problems with this dream; first is the "in your face" aggressive trading tactic with nation that should normally be aligned with China, but that it has managed to antagonize, second and probably more important is that the yuan is not a freely exchangeable currecy, and third is that China loves to control stuff.

Yes, the dollar is notionally controlled by the US government but in reality, it isn't, the Eurodollar is a good example, these dollars do not exist in the real world, they are book entries, and have always been book entries in the various banks, and not controlled by the US authority, the Eurodollar is the original cryptocurrency, because its a system of ledges between financial institutions. It is referenced to the US dollar but doesn't have to settle in US dollars.  

Why is 90% of trade settled in dollars because its convenient to the buyers and seller, although at the end of the day, no US dollars have changed hand, the US dollar has become a homeless method of exchange.  It also means that Eurodollar falls outside the creation of the Federal Reserve, any bank can create a loan in US dollars, but that dollar is unthreatened by the US economic system.

In 1982, when I took this course on money and banking, the Eurodollar was already a known presence in the financial world, there we so many Eurodollar loan and bond issues out of London that it became one of the standard financial instruments (granted not discussed on Wall Street).  It took the Federal Reserve almost another decade (1989) to discover the importance of the Eurodollar (after the fall of the Berlin Wall), 

This is more important than it appears since it means that the pre-eminence of the US dollar has nothing to do with the US economy, which although large is largely autarchic and self-sufficient.  In fact, the greatest weakness of the Chinese model for its currency to become a strong regional force is China's relation with it immediate trading partners (Japan, Taiwan, Korea, Australia, Indonesia, and the Philippines).  

What made the US dollar an amazing tool of exchange between nations is exactly why the Yuan will never be a widely used settlement currency.

Now, this whole story on the US dollar was used to explain how lost the Federal Reserve is at controlling inflation and monetary policy is largely ineffective.  Some even argue that the QE movement of the last 10 years has actually reduced the money supply rather than increased it because the Feds were effectively removing high-value collateral from the market.  Because the argument today is that money is based on the quality of the collateral being offered.

My point here is that students of banking and money are given terrible tools to understand what is going on, its even worse when one looks at the minutes from the FMOC where its evident that the governor of the Federal Reserve seem to be cluselss as to how to manage the money supply...




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