The Hidden History of Eurodollars, Part 2: Defending the Dollar System

Summary

Odd Lots: The Hidden History of Eurodollars, Part 2: Defending the Dollar System

Bloomberg’s Joe Weisenthal and Tracy Alloway delve into the intricate history of Eurodollars, unraveling the financial maneuvers that shaped the global economy. In this second installment of their three-part series, the hosts explore the challenges faced by the Bretton Woods system in the 1960s and the strategic measures taken to defend the U.S. dollar's supremacy.

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1. Introduction: Transitioning to the 1960s

Timestamp [01:26] – [03:21]

Tracy Alloway opens the episode by setting the historical context of the 1960s—a decade marked by societal and political turbulence, which also served as a pivotal period for Eurodollars. She states, “We have moved on from the immediate post-war period; now we’re in the 1960s, a turbulent time for society and politics, but also for Eurodollars" ([01:26]).

Josh Younger emphasizes the significance of this era, noting, “The eurodollar market was just a billion dollars or so, but it's grown from pretty much nothing. And so it's starting to attract more attention from policymakers at central banks” ([03:21]).

2. The Bretton Woods System and Its Fragility

Timestamp [04:18] – [08:46]

Lev Menand provides an in-depth analysis of the Bretton Woods Conference of 1944, highlighting its aim to restructure the global economic system post-World War II. He explains, “The whole premise of this is to find a way to restructure the global economic and monetary system after the war is over” ([04:18]).

Menand outlines the competing visions at the conference:

• American Vision: A dollar-based global monetary order backed by gold, with the U.S. holding two-thirds of global gold reserves. “Harry Dexter White has been pushing for a global dollar system... he wants the dollar to be part of global trade” ([06:00]).

• British Vision: Championed by John Maynard Keynes, proposing Bancorp—a transnational credit organization without a single global currency. “It's something like a transnational central bank... less arbitrary way” ([07:40]).

Douglas Dillon, an expert commentator, summarizes the outcome: “This is a power grab by the US... they are imposing an alternative system that puts the US much more in the driver's seat” ([08:14]).

3. Economic Pressures and the Threat to the Dollar

Timestamp [08:46] – [16:19]

Menand discusses the inherent instability of the Bretton Woods system. As global trade surged, U.S. gold reserves didn’t keep pace, leading to a gradual devaluation of the dollar. “Dollars are piling up in Europe... the US gold stock starts to decline” ([09:34]).

A critical moment unfolds during the 1960 presidential campaign. In the third debate, Richard Nixon accuses John F. Kennedy of policies that would “blow up the dollar” ([12:04]). Kennedy responds by stressing the dollar's role in national security and the fight against communism:

“The security of the dollar, therefore, is and ought to be of major concern to every nation here... We are pledged to keep the dollar fully convertible into gold and to back that pledge” ([18:02]).

4. Kennedy Administration’s Strategy: Reinforcing the Dollar

Timestamp [16:19] – [28:50]

Kennedy faces a dilemma: whether to overhaul the flawed Bretton Woods system or reinforce it through innovative measures. Initially hesitant to embrace drastic changes, Kennedy commissions Alan Sproul to produce a report advocating for reinforcement without destabilizing the existing system.

Key figures emerge:

• Douglas Dillon: Appointed Treasury Secretary, known for his business acumen and government experience.
• Bob Roos: Policy advisor from the New York Fed with wartime experience advocating for a global dollar system.
• Walter Heller: Chair of the Council of Economic Advisors, pushing for substantial reforms contrary to Treasury’s conservative stance ([22:12]).

The administration opts to reinforce the dollar without altering the Bretton Woods framework. Menand explains, “They try to figure out what Eurodollars can do for them... They want to push U.S. financial activity offshore to prevent gold outflows” ([26:09]).

5. The Creation of Swap Lines

Timestamp [28:50] – [41:47]

To stabilize the dollar and support the burgeoning Eurodollar market, the Kennedy administration introduces swap lines—agreements allowing central banks to exchange currencies, primarily to provide dollars to foreign banks without depleting U.S. gold reserves.

Lev Menand details the mechanics:

“They can lend those dollars that effectively backstop non-US Banks. So they do it through a swap transaction” ([28:50]).

However, this initiative faces resistance within the Federal Reserve. Bill Martin, Fed Chair, is hesitant about the legality and implications of these operations. Pressure from the Treasury and Kennedy's administration leads to eventual approval, supported by legal opinions from Treasury’s General Counsel and Bobby Kennedy ([32:03]).

Notable Quote:

“These are short term. You get the deposit of another currency when we pay out ours. This is ideal for the central bank to do” – Bob Roos ([22:12]).

6. Operationalizing Swap Lines and Expanding Eurodollars

Timestamp [41:47] – [43:19]

Charlie Coombs, appointed as Special Manager for Foreign Exchange, becomes the key operator facilitating swap lines across Europe. His efforts lead to the establishment of reciprocal credit agreements, creating a robust support system for Eurobanks.

Menand highlights the rapid growth:

“Eurodollars now have implicit backing from the Federal Reserve... in 1970 it's a $70 billion market” ([43:15]).

Douglas Dillon warns of the system’s fragility:

“You're putting the Fed in a tight spot... the treasury is gung ho, and this is existential for the administration” ([38:14]).

7. The Booming Eurodollar Market and Emerging Risks

Timestamp [43:19] – [45:30]

By the end of the 1960s, the Eurodollar market balloons to approximately $70 billion, equivalent to $1.8 trillion today. This exponential growth, while stabilizing the Bretton Woods system, introduces significant risks:

• Speculative Vulnerabilities: Funding speculations against the dollar.
• Lack of Uniform Regulation: Leading to potential instability.
• Liquidity Concerns: Absence of a lender of last resort in Europe, unlike the Federal Reserve for U.S. banks ([43:19]).

Lev Menand notes, “By the end of the decade, you have continued gold outflows funded in part by speculation through the Eurodollar market, and rapid movements of capital between different places” ([43:19]).

8. Conclusion: A System on the Brink

Timestamp [45:04] – [45:30]

Josh Younger wraps up the episode by highlighting the precarious balance maintained by the Eurodollar system:

“By the end of the 1960s, this market has grown from essentially nothing to about $70 billion. And that growth has been essential to maintaining the Bretton woods system. But the question is, at what cost?” ([45:04]).

Tracy Alloway teases the next episode, which will explore the tumultuous 1970s, including Nixon’s monetary policies and the eventual unraveling of the Bretton Woods system ([45:30]).

Quote:

“People are starting to get worried that the system is going to eat itself. So this is such a successful solution to the immediate problem of offshoring U.S. financial activity that by the end of the decade you have continued gold outflows funded in part by speculation through the Eurodollar market... and the whole system's getting very unstable” – Lev Menand ([43:19]).

Key Takeaways

• Bretton Woods Stability: The dollar's convertibility to gold underpinned global trade but was vulnerable to imbalances and gold outflows.
• Eurodollar Emergence: To prevent gold depletion and stabilize the dollar, the administration fostered an offshore dollar market through swap lines and regulatory incentives.
• Institutional Tensions: Conflicts between Treasury officials advocating stability and economic advisors pushing for reforms highlighted the complexities of managing global monetary policy.
• Market Growth and Risks: While Eurodollars bolstered the dollar's position, their rapid expansion introduced vulnerabilities that would later contribute to the system's unraveling.

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Stay tuned for the final installment of the series, where Weisenthal and Alloway dissect the dramatic shifts of the 1970s, including Nixon's gold shock and its lasting impact on global finance.

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Notable Quotes:

• John F. Kennedy:

  “The security of the dollar, therefore, is and ought to be of major concern to every nation here. To undermine the strength of the dollar would undermine the strength of the free world.” ([18:02])

• Lev Menand:

  “By the end of the decade, you have continued gold outflows funded in part by speculation through the Eurodollar market, and rapid movements of capital between different places” ([43:19])

• Bob Roos:

  “These are short term. You get the deposit of another currency when we pay out ours. This is ideal for the central bank to do.” ([22:12])

---

Further Resources:

For more detailed discussions and insights, visit Bloomberg’s Odd Lots where transcripts, blog posts, and a daily newsletter are available. Engage with the community on their Discord to discuss the intricate world of finance, markets, and economics.

Transcript

[Tracy Alloway]

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[Joe Weisenthal]

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[Lev Menand]

Bloomberg Audio Studios Podcasts Radio News.

[Tracy Alloway]

Tracy, are we still doing this?

[Josh Younger]

It seems like it actually.

[Tracy Alloway]

What is this supposed to be? Is this a Cold War bunker or something like that?

[Josh Younger]

That's a good question. Maybe it's a vault or the Vienna sewage system like in the third ban. Do you remember?

[Tracy Alloway]

I should see that. Okay, but in this episode we've moved on from the immediate post war period. We are now in the 1960s, a turbulent time for society and politics, but also for Eurodollars, which are the subject of our special series.

[Josh Younger]

Yep, this is the second installment of our three part history of Eurodollars. If you haven't listened to our first episode, you should definitely go back and find it. We have been tracing the origins of this very particular and special form of money to better understand how it came to be and what it actually does. And our first episode looked at the creation of Eurodollars and their perhaps unexpected communist connections.

[Tracy Alloway]

Yep, that's right. And now we're going to turn the page. New decade, a new chapter in Eurodollars existence.

[Josh Younger]

There's something else new that happens right around this time. So dollar swap lines get created. Do you remember those Joe?

[Tracy Alloway]

I read about them in that Adam 2's book crashed. But yes, they were big in 2008, then again in 2020. Also the Eurozone crisis. They're basically something that no one ever talks or thinks about outside of a crisis.

[Josh Younger]

Yeah, I think that's right. So they are dollar borrowing lines for other central banks. And I've seen swap lines described as the international lender of last resort. They tend to, as you mentioned, get tapped during big emergencies. That's when we hear about them. But swap lines basically allow central banks to exchange currencies. And in this case, it is all about getting dollars.

[Tracy Alloway]

And as a reminder, our storytellers for these episodes are Lev Menand and Josh Younger.

[Douglas Dillon]

I'm Lev Menand. I'm a law professor at Columbia Law School, where I study money and banking and the history of central banking.

[Lev Menand]

I'm Josh Younger. I'm a policy advisor at the Federal Reserve bank of New York. And the views I am going to express are my own and not necessarily those of the Federal Reserve bank of New York or the Federal Reserve.

[Josh Younger]

When we left off, we were at the end of the 1950s. The eurodollar market was just a billion dollars or so, but it's grown from pretty much nothing. And so it's starting to attract more attention from policymakers at central banks. And now, as we enter the 1960s, Eurodollars are even going to hit mainstream politics.

[Tracy Alloway]

Let's take a list.

[Lev Menand]

So now it's the fall of 1960. Kennedy's running for president in a very tight race against Vice President Richard Nixon. And in the background, the monetary system is in crisis. And it's really showing signs not just of fatigue, but of potential collapse. And so to understand why that could happen, like what does that even mean, especially in the context of the 1960s, we kind of have to go back to the war. So it's 1944 now, and 44 countries are convening in Bretton Woods, New Hampshire. Small town, big hotel. They took up most of it. It's about 700 people. And the whole premise of this is to find a way to restructure the global economic and monetary system after the war is over. It's a little presumptuous the war isn't over yet, but they're still planning ahead. And so we hear a lot about Yalta and Potsdam and the big conferences about the partition of Europe and Berlin and so forth. But this is really among the most important of these post war planning conferences. It's the brainchild of Harry Dexter White, who most people haven't heard of as well. He's been at the treasury since the mid-30s. He's a PhD economist, doesn't really like where he ends up for teaching. And Milton Friedman's professor recruits him to go to the treasury to work for Morgenthau, who's FDR's very long serving treasury secretary. I think he's the second longest serving after Gallatin, who is Jefferson's secretary. So he has the job for 12 years, which is a long time to be a Treasury secretary. And there's really two competing visions going into this conference. The first is the American vision, which is a dollar based global monetary order in which gold forms the foundation. So your dollars are convertible into gold. All foreign currencies, at least among the victors, are fixed in their exchange rates are pegged to the dollar. And so everything kind of revolves around the US dollar and the gold stock that the US has accumulated over the course of the war. The US has 2/3 of global gold reserves at this point. So it's monetary gold reserves. So they have a lot of, let's say, leverage going into this conference, and they know it. And that's been a dream of White since basically he joined the Treasury. He's been pushing for a global dollar system. He really wants the dollar to retake its prior position. Remember in the 20s, the dollar was the global reserve currency. It was the currency of trade. It lost that status over the 30s on a series of runs on the dollar. So he's very familiar. This breaks down and he wants to bring the dollar back. This is the second bite at the apple. And so he wants the dollar to be part of global trade. He wants to be the unit of account. He actually wants all the invaded territories to use the dollar. So he wants invasion currency to be printed by the Treasury. They call them yellow seal dollars. So he wants dollars everywhere, including North Africa, Germany, et cetera. And they actually do that in some places. And the British, on the other hand, are very wary of this, in large part because they don't have any gold. And so they have no leverage. But they're worried that the US will come out of this conference with way too much global power, especially relative to the European allies. And John Maynard Keynes is their champion. He comes up with an alternative arrangement. He calls it Bancorp, which is a contraction of banc and or in French. I promised earlier I wouldn't do French words, so I apologize for the accent. But you know, it's bank gold, which is. The idea is there is no global currency issued by one country. There's only a transnational credit organization, kind of like a bank where international trade happens on the books of that organization. So it's something like a transnational central bank, and it involves everyone giving up their sovereignty to some extent to facilitate global trade in what he considered sort of a fair and less arbitrary way. Meanwhile, White is very aware of the potential sacrifice of sovereignty to use the dollar as a global reserve currency in a global unit of trade. It's just he would prefer everyone else to sacrifice their sovereignty rather than the U.S. and so in the end, basically, the U.S. wins, and they win because Lionel Robbins is one of the UK delegation. This is in Ben Steele's book. He basically says we needed the cash, so they don't have a lot of leverage.

[Douglas Dillon]

This is a power grab by the US The US is by far the biggest economy in the world. It has the prevailing military in the world. And there's an opportunity here for real internationalism and cooperation around global trade and the monetary system that facilitates it. And the US rejects that and essentially imposes an alternative system that puts the US Much more in the driver's seat and everybody else in a more subordinate position.

[Lev Menand]

There's a lot of very human elements. By the end of the Bretton woods conference, it's three weeks long. No one thought it would go that long. They're tired, they're hungover, they went through a lot of liquor at this conference. There's no food left at the hotel. And so everyone just kind of wants to go home. Now, that's not a great reason to sign the world over to the US as a dollar centric universe, but there really is a human element to how all of this goes down. That's kind of one of the themes to this whole story.

[Douglas Dillon]

And multilateralism is hard, and there are a lot of frictions to get countries to cooperate on really, really high stakes issues for their domestic economies. And we'll see in the course of this story how cooperation often breaks down and shortcuts prevail over longer term, higher cost solutions to problems.

[Lev Menand]

So the Bretton woods system is one in which for $35, you can have an ounce of gold from the treasury and specifically foreign central banks. You have to be an official institution. I couldn't get $35 for gold, but the Banque de France could. And so the US is, in a sense, the world's banker because they're issuing dollars, and they can in principle issue more dollars than they have gold. So it's not a fully reserved system. There's leverage embedded in the international system. And so that happens pretty quickly because global trade expands and the US monetary gold stock is not increasing. Actually, most of the gold production is in Russia, So they're not giving it over so easy. And so over time, the world needs more and more dollars, and the value of those dollars implicitly starts to decline. Now, what does that mean in the context of A peg from the Treasury. If the treasury your dollars for an ounce of gold for $35, what does it mean for the value of the dollar to go down? Well, that's not the only gold market in town. And soon on the continent, in London at the metal Exchange, it costs a little more than $35 to buy an ounce of gold. And that's really consequence of non monetary demand. So you have some speculators, a huge fraction of gold in the world is held up in jewelry. That's a real thing. So there's reasons you would want gold other than to back your currency, I think it's fair to say. And there are more and more of those reasons and more and more demand for those purposes over time. And so this introduces a fundamental instability into the Bretton woods system because if a foreign central bank is exporting to the U.S. the U.S. is running a balance of payments deficit. That means they're importing more than they are exporting. Dollars are piling up in Europe. Those dollars can in principle be exchanged for gold at $35 an ounce. That gold can be sold for $35.15 an ounce in London and sometimes much more than that. And so slowly at first, then all at once, so to speak, the US gold stock starts to decline at the same time as their dollar liabilities are going up. So now you owe more gold in principle to more people, but you have less of it with which to pay them. That's a bank run, or at least a slow motion bank run. And so people get really worried that this is going to just accelerate and they need some way essentially to staunch the bleeding. So you have a couple of options. And I should say this becomes an election issue in Kennedy, Nixon. It comes up in the third debate. There's a big shock to the price of gold in October of 1960, where the price goes to $40 an ounce, which is kind of insane if you can buy it from the treasury at 35 and it kind of sticks there for a little while. And so Nixon is out there saying, well, Kennedy's going to blow up the dollar.

[John F. Kennedy]

Mr. Vice President, in the past three years there has been an exodus of more than $4 billion of gold from the United States, apparently for because exports have slumped and haven't covered imports and because of increased American investments abroad. If you were President, how would you go about stopping this departure of gold from our shores? Well, Mr. Vaughn, friend, the first thing we have to do is to continue to keep confidence abroad in the American dollar. That means that we must continue to have a balanced budget here at home in every possible circumstance that we can. Because the moment that we have loss of confidence in our own fiscal policies at home, it results in gold flowing out.

[Lev Menand]

And he initially kind of brushes it off. He says, oh, I guess Dick Nixon thinks I can trade gold in London. That's hilarious. And eventually his advisor is like, you have to actually address this. People are really worried that your policies are going to lead to a collapse of the dollar. And so he puts out a formal statement as the candidate pledging his support for the dollar. So this is really becoming an issue of national security. People associate the dollar with the core of NATO and the free world. And Eisenhower is pretty explicit on this point, Kennedy's pretty explicit on this point. I mean, the collapse of the dollar is not an acceptable outcome because it really reflects a collapse of the anti communist alliance that's developed over the past 10 years. So it's core to the US sense of itself that the world remain on a dollar standard, that the dollar remains strong.

[Douglas Dillon]

Part of what's gone wrong here is Harry Dexter White, in crafting this new system that puts the dollar at the center, has given something up to everybody else. And that's the peg of the dollar to gold at $35 an ounce. And the power that is given up by the US to all those foreign central banks to allow them to withdraw gold at that exchange rate. And at the time that this is done, the US has so much gold stock. But what has happened is we have recreated 19th century conditions by essentially bringing back a gold standard and the rigidity that goes with it and the runability on the currency that goes with it. Were not used to the idea of running on the currency in the United States today. But that was a problem that countries experienced a lot when they had convertibility to gold. And so we're in the post war world here and we have brought back convertibility to gold, all the risks that go with it and the rigidity that goes with it, because we no longer have the ability to control the elasticity of the money supply. There's this sort of bomb built into the system where if everybody decides to redeem all at once, the money supply is gonna start contracting rapidly and you're gonna have a crisis of confidence. And so here we are in 1960 in some sense at the apex of US power, confronting the possibility that we could be in 1932 all over again with a series of withdrawals and the US dollar breaking the peg. And that comes to take on this great significance. The idea that we won't be able to maintain the peg. Of course, from an optimal design perspective, you really want to be able to adjust that peg, but you've said it's going to be $35. And now suddenly, in the cold war world, in global politics, and even in domestic politics, this idea of the dollar maintaining its value takes on this great sense of significance. And increasingly, U.S. policymakers are in a bind.

[Tracy Alloway]

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[Lev Menand]

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[Tracy Alloway]

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[Lev Menand]

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[Tracy Alloway]

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[Lev Menand]

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[Bob Roos]

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[Lev Menand]

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[Josh Younger]

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[Lev Menand]

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[Josh Younger]

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[Lev Menand]

So in a speech to the IMF in September of 1962, Kennedy is very clear on this point that the dollar, the importance of the dollar in the fight against communism is critical to his administration.

[John F. Kennedy]

The security of the dollar, therefore, is and ought to be of major concern to every nation here. To undermine the strength of the dollar would undermine the strength of the free world. We are taking every prudent step to maintain the strength of the dollar, to improve our balance of payments and to back up the dollar by expanding the growth of our economy. We are pledged to keep the dollar fully convertible into gold and to back that pledge. We are with all our resources of gold and credit.

[Lev Menand]

This is the thing. You can fix the problem one of two ways. You can Change the peg slash, change the system. Or you can find ways to reinforce it through sort of makeshift measures. These are the shortcuts. And so Kennedy thinks this issue is public enemy number two. Number one is nuclear war. Number two is the stability of the dollar. He actually tells Arthur Schlesinger this over the course of the campaign and then into his early presidency. And so the question is, how do you do it? So among those two options, he commissions a task force, he's elected. He turns to Adlai Stevenson and he says, what do I need to focus on? And Stevenson says, definitely the dollar. In fact, this whole system isn't working, so we probably want to think about a new one. And Kennedy doesn't like that answer, because Kennedy is sensitive to a lot of different things. One is, he's portrayed as young and inexperienced. There's actually memos in the campaign about how to deal with the youth and inexperience issue. And so he's very sensitive to any sense that he's not up to the job. And he tells his advisors, if this thing falls apart, it's going to be on me. And so he doesn't like that generically. He's also fundamentally an institutionalist. He doesn't love the idea of dramatic change. He doesn't like taking those risks. And so he basically doesn't like what Stevenson and George Ball have to say. So he says, I want a new report. So he gets Alan Sproul, who is the outgoing. I think he'd left a couple of years earlier, president of the New York Fed, to write a different report. And that new report says, don't mess with it. It's probably fine. It's not a crisis. The public's impressions are wrong, but you need to address this forcefully. But don't do anything drastic. And so he basically takes that to heart implicitly. The question is, who's going to execute on this?

[Douglas Dillon]

And you think about this from the perspective of Kennedy, who's just been put into this very difficult job, and his advisors come to him and say, actually, we have an international monetary system with a basic flaw in it, which is the dollar is pegged to gold at $35 an ounce, and it's ultimately going to have to break that peg. This system doesn't work. We should do something else. You're like, is there some way to keep the thing going? And that's what leads to the second report, and that's what leads to the growth of the Eurodollar market. Because it turns out that the way to keep the thing going is to develop this offshore dollar alternative.

[Lev Menand]

So now we can meet some actual characters in this story. So there's the treasury team that comes in with Kennedy is head by, at least with respect to this issue is two people in particular. One's Douglas Dillon of Dylan Reed. His father founded Dylan Reed. He's one of the wealthiest people in the United States, the former ambassador to France. And he was selected in part because he owned a vineyard, Oprion actually, so a very well known vineyard in Bordeaux. So he had French roots, sort of, and does a good job. He's put at State, he's a contender for Secretary of State. When Dulles leaves, he ultimately doesn't get the job. But Kennedy wants to put someone at treasury who has a good business reputation, who is well respected, has government experience and people generally like this guy. He's seen as one of those consummate bureaucrats who's sharp and thoughtful and a good listener and clear and all of those things. And so he brings with him Bob Russa. Bob Russa's from the New York Fed. He actually served in the Second World War under Charlie Kindleberger. Charlie Kindleberg is the father, in some sense of the idea of the dollar as a key currency, or at least a big proponent of it. But they were doing strategic bombing targets together. Kindleberg was his commanding officer. So he had some connections to this idea through his wartime experience of a global dollar system. And their bias, both of them, is to reinforce the existing system. They kind of want to find a way to save the Bretton woods arrangement. So here's Bob Russo looking back from a few years later.

[Bob Roos]

We got them to recognize after the big flurry that came to a head Oct. 20, 1964, when the market went up to a $40 price. At that time that was looked as though as quite a threat to the stability of the monetary gold price and got them alarmed. And so after that, when it was clear, particularly by the time President Kennedy came in and made it firm that we were going to continue to support $35 price, and then the London price began coming down, it was fairly easy to persuade these other countries that, you know, we ought to be together in this, because as gold comes back into the market now, we in the United States don't want to have to just have it appear that we're always taking all the gold out, putting it in sometimes too, of course. But why don't we share this as a buying pool? When it comes into the market at 35, then we won't be in there bidding against each other. It'll be an orderly arrangement. It'll be a little bit of like a cartel, but in the interests of the world monetary system.

[Lev Menand]

On the other side you have Walter Heller. Walter Heller is the chair of the Council of Economic Advisors. Kenny's trying to balance out Dylan's somewhat conservative Eisenhower administration reputation with someone who's much more on the New Deal liberal side of things. And the New York Times calls him a prototype of the liberal economist. He's very well known for his taxpayer policy views and he often talks in terms of human flourishing. We should adjust the tax code to promote human flourishing. And he brings with him Jim Tobin, who is a very well respected economist. He won the James Bay Clark Medal, which is kind of like a Nobel Prize ish thing in 55. So he's very, very well established. And he comes in as one of the economists on the council and in particular the one tasked with international issues. And so they think this whole thing is flawed from the start and they're pushed to the President elect. And eventually the President is to do something brand new and think about all kinds of different arrangements. Heller sends out a ton of memos, that kind of list. He says he does it with rusa, but it's clear who's who in this and it turns into a pretty contentious argument. I mean there's actually in the Kennedy Library archives, they have little political cartoons the deputy National Security advisor drew making fun of Bob Russa and all the stuff he's trying to do at the same time. And in some of these memos they're kind of derogatory. No one really believes what this guy is writing. So there's a lot of tension between the treasury and the White House.

[Douglas Dillon]

Kennedy appoints Dylan, who is a prominent member of the opposing political party. So here we have this new Democratic administration coming in and one of the most important cabinet posts goes to a very wealthy Wall street scion from the other political party. And so the battle within the administration is also for the future of financial policy in the Democratic Party, where you have the New Deal liberals, the FDR crew, fighting this basically interloper who's Dylan, and losing because time and again, as Kennedy himself notes, Dylan thwarts the New Deal liberal economists in the administration. And Dylan is the one who ultimately crafts the policy of the administration and the policy that comes to dominate Democratic administrations that succeed Kennedy as well. This is a very important turning point in how the executive branch and Democratic administrations approaches financial policy. And it's no longer the FDR vision that is in the driver's seat.

[Lev Menand]

And ultimately, every time they're pitted against each other, the treasury basically wins those arguments because the Treasury's advocating stability. And the cea, the Council of Economic Advisors, is advocating upheaval now, maybe productive upheaval, but something very dramatic. And so Kennedy really isn't predisposed to go with the upheaval side of things. And they keep it up, but ultimately he wants to reinforce the existing system. So the question is, how do they do that? How do Eurodollars come in? So the first thing they do is they try to figure out what Eurodollars can do for them. And the key here is to keep a global dollar system, but to have it all offshore. Because one of the big problems with the balance of payments is that Americans are investing overseas, which means pushing dollars out of the US and taking in financial assets. So the dollars are leaving, financial assets are coming in, and that's a big source of the flood of dollars into Europe and the risk that those dollars will then be turned into gold. And so you basically want to push all of that activity. All those foreign corporations that want to borrow dollars, don't borrow them in New York, borrow them in London. And there's two ways to do that. One is you can provide incentives to push that activity offshore. They do that using the tax code. And the second is to make the euro banks, the Eurodollar issuing banks, more attractive to potential investors so they can grow their business. Because if you want to take US Financial activity and push it offshore, you need to make sure the Eurodollar system can accept it can grow to accommodate a much higher volume of transactions. And whenever banks take on more liabilities, which is the same as taking in deposits, the risk of a run grows. And so this is where people become very acutely aware of the risk that Lev talked about, which is in the US if you have liquidity problems, you can go to the Fed. In Europe, if you have dollar liquidity problems, there's nowhere to go.

[Douglas Dillon]

The goal here is not to get US financial activity offshore for its own sake. The goal is very much to stop holders of dollars, especially foreign central banks, from going to the gold window at the US treasury and draining our increasingly shrinking gold reserves. And so this is a sort of a two step move. We're going to have new investment opportunities so that you don't want to go and withdraw the gold so that you hold your dollar balances offshore. We're going to build up this market. It's going to be what they call the outer defenses of essentially the Bretton woods international monetary system.

[Lev Menand]

It's basically what Sproul advocates in his report. It's all about confidence, right? So we don't actually need to provide anything other than assurances that someone's going to have their back, because this was always a concern when the Eurodollar market was growing. Is that who's going to solve the problem of liquidity if everyone goes to their Eurobank at the same time? And so what Dylan and Rusa come up with is the swap lines. Now, the swap lines are initially from the Exchange Stabilization Fund, which created in the 30s to intervene in foreign exchange markets. So it allows the US Government to buy foreign currency. Buying foreign currency is the same as giving other people dollars. You're just saying, I need something in return. It might as well be sterling or francs or something like that. Now, the problem for Dylan Roosa is the ESF is what's called a funded vehicle, meaning it only has so much money. And by the early 60s, they've made a bunch of commitments to Latin American countries that basically mean there's no gunpowder left. The resources they have at their disposal through the esf, which is controlled by the treasury, are minimal. But guess who has essentially infinite resources when it comes to printing money is the central bank. And so they want to be able to intervene in foreign exchange markets, which is a different word for lending dollars to foreign central banks that could then lend them to Eurodollar issuers. And so if a Eurobank comes into trouble, which they will do with some frequency throughout the 60s, they go to their central bank and say, I need dollars. That central bank goes to the Fed in this case and say, I need dollars. And so you can lend those dollars that effectively backstop non US Banks. So they do it through a swap transaction, but that's just the way they structure it. The question is, is the Fed comfortable with this? Because they had done some foreign exchange transactions in the past, but it wasn't really a core part of what they did previously. And they didn't have a standing authorization to do what are called open market operations in foreign currencies. So these swaps are a new kind of open market operation that the Committee, the fomc, the Federal Open Market Committee, needs to decide is legal, authorized, is within their mandate, is something they're comfortable with from the policy perspective. And Bill Martin is the chair of the Fed. He's been the chair for a while. At this point, he's actually the treasury negotiator for the Federal Reserve Treasury Accord that de pegs the bond market after the Second World War. So he's he's been around D.C. a lot. He's a very well known character. He's a very powerful chairman and he is sort of, at least based on some of the oral interviews that are done later with Bob Roos, among others, pretty uncomfortable with this idea and it's pretty controversial across the committee now. They don't reject it outright, but they are wary. But Kennedy and Dylan and Roose are pretty adamant that this sort of has to happen and they put a lot of pressure on Martin and eventually they offer Treasury's general counsel to author an opinion saying this is legally authorized. And then they get Bobby Kennedy, which the Fed didn't ask for, to write an opinion saying this is legally authorized so they can have something in their back pocket when Congress asks questions. And Congress does ask questions pretty quickly. Foreign.

[Tracy Alloway]

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[Lev Menand]

In one of his oral history interviews, Rousse remembers the debate and the Fed's concerns in particular, getting the swap started.

[Bob Roos]

There were two problems, of course. Other countries were suspicious of that too, didn't know quite what we had in mind. And incidentally, I had to research the existing legislation very carefully. But I discovered that we didn't need laws. I could go ahead and do it under present legislation. I had to get a ruling from the General Counsel. The Federal Reserve was very suspicious and reluctant. You know, it's a big body, people from all over the country, and you can't sit down and explain it all to them all at once and expect it to go across. So I figured, and Dylan certainly agreed with this, what we had to do was prove it to him. What we had to do there with the Fed was get going by having the New York Fed, through Coombs, arrange a swap line with this bank or that central bank using treasury money. Treasury didn't have very much money, the stabilization fund at that time, and free money. We had less than $300 million. But I did a little bit of double counting. I make a deal with Germany for 100 million and France for 50 million and England for 50 million and maybe added up to 4 or 5 million million, always assuming I'd never have to use them all at once. I got up to a billion by the end of the first year. And we had used them a little by that time, not for the US but for the British. And it had proved itself enough so that we could then go to the Federal Reserve and say, look, this is a perfectly workable arrangement. These are short term. You get the deposit of another currency when we pay out ours. This is ideal for the central bank to do.

[Douglas Dillon]

And you can see why they're worried about this, right? In the 1930s, Congress sets up the Exchange Stabilization Fund and puts it in. The Treasury Department, limits its funding and says, this is the way the US Government is going to manage exchange fluctuation of the dollar against other currencies. And now we have the treasury going to the Fed and saying, we don't have enough gunpowder. Can you do it for us? So the Fed might think, well go to Congress and get more appropriation. You're kind of putting us in a tight spot here. This is just sort of also stage one, which is the foreign exchange swap lines. There becomes an additional pressure point for the Fed, which is the swap lines that are also set up in parallel to support Eurodollar issuance overseas. So the conventional swap lines, the standard account of this period when the swap lines are set up, it's all focused on replacing the ESF to intervene in foreign exchange markets. But they set up these parallel swap lines that are about lending dollars to foreign central banks. And there you have the Fed also in a spot, because the Federal Reserve act was not set up with the idea in mind that the Federal Reserve would be essentially facilitating the backstopping of Eurodollar issuers in overseas markets. But the treasury is gung ho, and this is existential for the administration because they have tied themselves to the mast of the $35 peg and they are afraid of both the political and financial consequences of showing any weakness. And so just even to have the Treasury Secretary go to Congress and say, we don't have enough resources in the esf, they would be afraid about the lack of confidence that that might signal to the market about the American ability to keep to the $35.

[Lev Menand]

So they get the approval eventually, with the backing of the treasury general counsel and Bobby Kennedy, and everyone kind of gets together and the committee approves. And so now they have swap lines and they need someone to run them. And so this is where we meet kind of the third character here. This guy, Charlie Coombs is kind of the true believer. You can think of Douglas Dillon as kind of the operator. He's like M in the James Bond canon. You could think of Bob Roos as Q, right? He's coming up with all the ideas for the different gadgets they can use. But 007 is Charlie Coombs. Francis Shott was his liaison with the treasury in those early years. And he remembers Coombs as a quote unquote, CIA type operator.

[Charlie Coombs]

He was a pretty complex personality, but underneath it all, he was a CIA type operator. He was a discreet spy, Hoover head than the national interest of the United States, which he thought he knew exactly what it was at heart. And he was willing to do almost anything in order to achieve those objectives. He was a tool operator.

[Lev Menand]

And now we don't know this for sure, but he was actually counterintelligence during the Second World War. He ends up in Greece in 1947, right after the Civil War starts. That's the origins of containment. It's the first CIA hot zone, they called it. And then he comes back to New York, he's a PhD economist and gets Bob Rousse's whole job. Actually, he was Roose's deputy. And then he gets Roose's job and Then he's selected as the Special Manager for foreign exchange in 1962. Now the system Open Market Account manager manages the bond portfolio. Still does, but they create a new position that's very senior in the organization called a Special Manager for Foreign Exchange. And his job is to negotiate and operate the swap lines. And the understanding seems to have been that the treasury would call the shots. They are what one of their former officers who was actually the gopher between the treasury and the Fed described as the treasury having political authority and the Fed having technical authority, meaning the treasury is ultimately calling the shots for who gets what when and the Fed goes out and makes that happen. Now we just know that from one oral interview. So what actually happened on a day to day basis is harder to say, but it was generally acknowledged. And Rusa represents to Kennedy the fact that treasury is in charge of international relations in a financial context. And so Charlie runs around Europe setting up swap lines. He starts with London and Paris in the usual places, but he also ends up in Basel, Switzerland. Now Basel, Switzerland is the headquarters of the bank for National Settlements, which is an old institution. It comes from, I think 1931. It's founded and it's essentially a bank to central banks. So it's a convening point for central bank, still is. It's a very important institution institution. They have their own banking services today and in the 1960s. And so he sets up a secret swap line with the bank for International Settlements that is in currencies other than Swiss francs, despite the fact that they're in Switzerland. And the explicit purpose of that which recent research has sort of revealed through archival stuff, is to support the eurodollar market. And they do that in Switzerland. They do it around year end, sort of seasonal stringency. They provide liquidity to the eurodollar market. So they're actively supporting the stability of Eurobanks. As soon as these swap lines are in place, they're relatively active use. And so now you have this reciprocal credit agreement network, that's what they call it. They didn't call them swap lines at the time. Kennedy tells Congress about this in his balance of payments message and he's very proud of this as one of the clever, effective backstops to the global dollar system, because now the US can use the firepower of its central bank to keep the dollar stable and strong internationally.

[Charlie Coombs]

But as this started out, Woza, who by then was a federal government official, was asserting the supremacy of the political arm. And Coombs and Alfred Hayes and William McChesney Martin were trying to assert the supremacy of the technical arm to carry out a technical operation, you know what I mean? Coombs and his associates were trying to make this look like you have to be really good foreign exchange man and know the markets in order to know what you're doing. And Rosa and Dylan were saying, buzz off. This is you're including on foreign policy territory and we know best what to do.

[Lev Menand]

This is the point where the system can really grow. So Eurodollars now have implicit backing from the Federal Reserve or at least by arm's length through the bis. They have a source of liquidity in dollars and so they grow rapidly. And the interest equalization tax, which is the mechanism by which they pushed some of this financial activity offshore, provides yet another use case. Eurobonds are issued, which is just dollar denominated bonds listed in Europe funded with Eurodollars. The proceeds of those raises go into the Eurodollar system and everything's set up for a virtuous cycle. And by the end of the decade it's a massive market.

[Douglas Dillon]

You go from half a tether to a Bank of America.

[Lev Menand]

Yeah. In 1970 it's a $70 billion market. If you size that to the US economy, economy, it's about $1.8 trillion in today's standards. So it's a very big market by the end of the decade and it's starting to be more trouble than it's worth. So there have been warnings along the way this thing might be a problem. It's funding speculation, potentially against the dollar. It's somewhat unstable. Regulations are not uniform. There are some attempts to control it, but the US kind of juices it a bit by regulation. Q is adjusted in a way that facilitates Eurodollars and other reasons for that. That made sense domestically, but they're willing to let the Eurodollar market grow. They don't really put reserve requirements on it. And actually Martin is quite resistant even to putting reserve requirements on US bank branches that are raising Eurodollars. He tends not to bring the issue up in meetings. And now you have this, let's call it 1.8 trillion in today's terms, growing 25% a year. And people are starting to get worried, really worried. And the French foreign minister who coined the term exorbitant privilege calls it a hydra headed monster. Now people are getting worried that the system is going to eat itself. So this is such a successful solution to the immediate problem of offshoring U.S. financial activity that by the end of the decade you have continued gold outflows funded in part by speculation through the Eurodollar market, and rapid movements of capital between different places, searching for either safety or higher interest rates or both. And so the whole system's getting very unstable because at some point, one of these two things has to give. Either Eurodollars have to be controlled or the system has to get completely reworked. And it's unclear in the early 70s which of these two forces is going to prevail.

[Josh Younger]

Dun, dun, dun. What a cliffhanger. Okay, that was the second episode of our special three part series examining the origins of Eurodollars. So by the end of the 1960s, this market has grown from essentially nothing to about $70 billion. And that growth has been essential to maintaining the Bretton woods system. But the question is, at what cost?

[Tracy Alloway]

Next time, things are about to get a little crazy as we head into the 1970s and beyond. Just sort of a wild decade, I think, for monetary policy. Nixon famously shaking up the entire post war monetary system. People love to talk about the Nixon gold shock, like what happened in 1971. All these great wild charts. They're always floating around on gold and crypto Twitter. But if I'm being honest, I have very little understanding of what that actually was, why he did it, what it meant, why it was done, and so forth. So I'm looking forward to finding out.

[Josh Younger]

Yeah, there's the gold shock and there's an oil shock, and there's also a kind of financial shock in the form of a somewhat mysterious bank collapse. And we hope you'll join us for the third installment in our ongoing series in which Josh Younger and Lev Menand continue the story of Eurodollars. But in the meantime, this has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

[Tracy Alloway]

And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow one of our special guests, Levmanand. He's Evmanand. Our other special guest, Josh Unger, he's not on Twitter. Thanks to our producers, Kerman Rodriguez, Ermin Erman, Dashiell Bennett at dashbot and Kell Brooks at Kellbrooks. And special thanks to our sound engineer, Blake Maples. For more odd lots content, go to bloomberg.com oddlots where we have transcripts, a blog and a daily newsletter. And you can chat about all of these topics 24. 7 in our Discord Discord ggottlots.

[Josh Younger]

And if you enjoy Oddlots, if you like it when we bring you the hidden history of Eurodollars, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg Channel on Apple Podcasts and follow the instructions there. Thanks for listening.

[Lev Menand]

SA.

[Josh Younger]

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