Multinational banks handle trillions of dollars a year and trade money as easily and swiftly as most persons make local telephone calls. Washington Post Business and Financial reporter Larry Kramer examines the use and abuse of the international money markets in three Sunday articles, the first of which appears today.
The problem is not that there is so much money changing hands around the world these days, even though far more money is moving faster and farther than ever before.
The problem is that no one is watching.
The sense that bankers-and not governments-slowly but surely have taken hold of the future has begun to worry some people, particularly those elected to look after the interest of the general public.
But it is now clear that the world has grown to depend upon an extremely complex, yet at the same time delicate, 20-year-old financial system that is understood by few and-more importantly-that avoids regulation by any existing government body.
What is worrying those select few who are familiar with the ballooning business of foreign currency trading and is terrifying those unfamiliar with the complex system is the growing possibility that world monetary affairs have changed so dramatically and in such a short time that they may be out of control.
In fact, the new international monetary system has linked the economies of most major nations of the world inextricably. The same system that is designed to allow countries and their business such easy access to each others' funds has done so only at a high price: an almost helpless interdependence. No single country now has the power or the funding to stop the kind of rampant inflation that could occur because of the huge amount of money freely available around the globe.
The situation is similar to that encountered by consumers in the United States. Credit is so easy to come by in the form of credit cards and other charges accounts that the American consumer is now borrowed up to his or her neck. By the time many realize how much in debt they are, it's too late.
The amount of money that is held outside the country of issue-dollars outside the U.S., British pounds outside England, etc.-is 1,720 times what it was in 1959, having increased in 20 years from about $500 million to about $860 billion.
That vast supply of money makes up what is called the Euromarket. The dollars are called Eurodollars, the French francs Eurofrancs, etc.
About 73 percent of the Euromarket is in Eurodollar holdings. That means that today an estimated $627 billion is floating around the world-give or take several billion dollars-out of the regulatory reach of U.S. banking authorities. As recently as 1970, that number was only $89 billion. Ten years before that, it was almost nothing.
That huge Euromarket is used by the banks and multinational corporation of the world to finance international transactions. It gives everyone an open marketplace for money needed for all kinds of ventures.
But critics fear that what really has been created is an international banking system that can ignore the laws of any single government.
"Our political forms are a bit obsolete and old-fashioned for today's financial world," says Dr. Hans Mast, a leading Swiss banker for Credit Suisse. "The Eurodollar market is a child of modern communications. But it has grown so fast for two reasons: the increasing speed of information transfer, and the need to work around many national rules that don't recognize the demands of world trade."
In fact, billions of dollars-sometimes $100 billion a day-change hands in seconds through a vast, electronically linked, 24-hour-a-day network of money traders who defy scrutiny.
But those traders-often acting on an unconfirmed rumor or a three-line story on the Dow Jones News Service ticker-can take actions that will have profound effects on the world economy.They move so quickly that in some cases they create the situation they thought they were responding to, like a run to sell the dollar because of fears it will drop in value.
The Eurodollar market was created not by speculators but by the huge growth of world trade and the increasing need for a common marketplace. In 1965, overall world exports and imports amounted to $350 billion. By 1977, that number had swelled to more than $2 trillion. Simply stated, the world was, and is, growing more interdependent and demands a financial system that can keep up with the needs of nations to deal with each other.
The Euromarkets provide that system. When an American firms wants to buy parts from an Italian firm, for example, it has little or no trouble going into the Euromarket for the funding. Similarly, a French firm may need to borrow dollars to open a plant in the U.S. It is the function of the Euromarket to provide a ready market for any major market for any major world currency, to allow anyone who needs to to have access to that currency.
But growing world trade and the international financial needs of nations no longer can explain the almost exponential growth of the Euromarkets. In many ways, this new system-upon which international commerce now has become almost totally dependent-may provide the kind of unbridled growth that can lead to overextension and financial chaos.
In a recent cover story on what it calls the "Stateless Economy," Business Week magazine called the Euromarkets "the new banking system that is a blessing to business [but] may in the end turn out to be a peril for the world at large. The new banking order tremendously increases the efficiency of moving cash around the globe, and that very ease of shifting billions at a moment's notice makes currency instability chronic and dollar weakness inevitable."
During the past few years, the system has become completely crazy," adds Credit Suisse's Mast. "Funds did not go to the countries that needed them but to the ones that did not."
It is important to look back at the history of the foreign exchange market to understand its many reasons for being, and the factors that led to free-floating exchange rates.
At the end of World War II, major economic powers met at Bretton Woods, N.H., to set up a new monetary system that would help facilitate world trade, but insure stability in exchange rates, i.e., keep the relationships of currencies to each other the same.
The Bretton Woods Conference established the International Monetary Fund to supervise exchange rates, and to approve any changes in the value of one currency with respect to another. The dollar was the cornerstone of the agreement because it alone always could be coverted into gold at the fixed rate of $35 an ounce, and gold was made the standard for international bartering.
But the Euromarket itself was born in the 1950s during the Cold War as a means for the Soviet Union and other Communist countries to protect their dollar holdings.
The Soviet began to worry that, in the event of heightened tensions, the U.S. could seize the Soviets' considerable deposits and loan holdings in U.S. banks. So the Communist countries asked certain European banks to take over their huge dollar deposits, and open their own corresponding accounts with U.S. banks. That way, the Soviets, for example, could keep their dollars but at arms length and out of reach of U.S. authorities.
But in the early 1960s, as the Euromarket and world trade began to grow, the Bretton Woods system was threatened by significant changes in the world economic structure. The dollar was in danger.
Confidence in the dollar dropped as the U.S. built up bigger and bigger budget deficits and the dollar began to mean less. Further, the U.S. began paying out more dollars around the world while taking back fewer and fewer. There were just too many dollars around the world.
And the ability of the U.S. to pay out-as promised-gold on demand to any foreign country offering dollars was in serious question as the size of the U.S. gold reserve began to shrink while the supply of dollars continued to grow.
Faced with worsening inflation and balance-of-payments problems, the U.S. ended convertibility of the dollar into gold in August 1971, wiping out a key support of the world monetary exchange system. Further attempts to maintain some form of fixed exchange rates between currencies failed, and slowly but surely the value of any one currency-including the dollar-began to float, that is, to rise and fall with the money traders' perceptions of the economic situation in that country.
If a country was financially sound, its money became more valuable because it was back by a stable environment. Thus as U.S. fiscal problems intensified, the value of the dollars vs. other currencies dropped.
And there was a new development Thanks to oil, the newly enriched Arabs began pumping billions of dollars into the Euromarkets-dollars that came, for a great part, directly from the U.S.
The attraction of dealing in the Euromarket grew as each nation took its own action to protect its domestic financial situation in the face of unstable world markets. Many countries, attempting to keep as much of their currency under their control as possible, set restrictions on the amount of money their banks could lend to non-residents. While this served to limit the amount of local currency that would leave the country and its controls, it also often forced that non-resident to get that currency from somewhere else.
So if Switzerland did not let an American borrow too many Swiss francs from a bank in Zurich, all the American did was go to Luxembourg and borrow Swiss francs from a bank there-perhaps even a Luxembourg branch of the same Zurich bank. The Swiss have no control over branches that Swiss banks open on foreign soil. Nor does the U.S. government, for its banks; nor the British, etc.
There you have the whole point of the Euromarket. It is the huge deposits of all major currencies outside their respective countries and outside the controls and restrictions imposed by those countries. Because the money involved is unrestricted, it is often both cheaper and more available than money in the domestic markets.
So, for example, Citibank's London branch can help finance a British company opening a plant in France by selling that company Eurofrancs-and no regulatory agency in the world can question the transaction.
Regulatory "interference" can be devastating to a potential business deal, and bankers do not underestimate the value of avoiding annoying and time-consuminng rules.
But something else is happening in the Euromarkets that is causing concern. Each time one nation imposes another form of controls on its currency, the world market finds a way to get around it. The system has become so efficient in fact, thanks to modern communications systems, that it may be hyperventilating-things may be going too fast.
Young, aggressive, but relatively unsophisticated money traders work out of an estimated 1,000 trading rooms for banks, multinationals or others around the world as part of a system that now never stops. They are linked by telephone and computer. When Europe closes down, New York is still operating. When New York winds up, Tokyo is just kicking off. Then back to Europe. Each of the 1,000 trading rooms-located in such places as London, Hong kong, Bahrain and Panama, as well as New York, Tokyo and the major European money centers-does upwards of $100 million worth of money trading every day.
Perhaps the most worrisome development is that trading no longer just reflects the needs of world trade. Rather than being used for buying or selling currencies to cover specific transactions in the world market, a significant number of foreign exchange trades now are purely speculative.
If money traders get a rumor, for example, that some national banks are planning to sell large quantities of dollars-an action that would cause the value of the dollar to drop-they frequently will try to jump on the band-wagon by also selling dollars. If they can sell fast enough, before the dollar is sold in large quantities by the central banks, the traders will make money.
How they make money is simple. As more dollars are sold, the value of the dollar drops because the supply is growing faster than the demand. So if a trader sells dollars at a higher value in the morning and buys them back at a lower value the next morning, then the difference in value is pure profit for the trader's bank.
In many cases, the trader even might borrow the dollars to sell, pay interest for a day on the money, buy it back the next day and pay off the loan. Frequently the profit on the exchange will more than offset the interest cost on the loan, and the trader has made money without using any of his company's cash.
It is not just that banks and firms want to speculate. In many cases, they now have to or risk huge losses.
As of 1975, U.S. companies must translate the value of their foreign assets, liabilities, revenues and expenses that are denominated in foreign currencies into dollars at current exchange rates every three months when they publish their income statements for stockholders. Consequently, the pressure is intense to stay in touch with the rise and fall of currencies.
Some multinationals learned that lesson the hard way, having to declare huge losses on quarterly statements merely because the value of the currency of a country in which the firm has a subsidiary dropped significantly over a three-month period, sharply reducing the value of assets there.
So companies and banks are hedging their bets with increasing frequency, and trying to make quick gains by buying and selling huge amounts of currency over short periods of times.
And when the financial community blames "those speculators" for fluctuations in the money markets on a given day, the reference is not to wild-eyed high-rollers, but to the largest bank and multinational companies in the world, who are juggling the billion-dollar Euromarkets the way the average citizen shifts funds between his or her bank accounts.
"Corporate treasurers are hedging whenever and wherever possible," says Jonathan Aronson, international relations professor at the University of Southern California. But, he warns, "This has led to tremendous new activity in market sensitive to rumors and short-term currency developments. In protecting their own positions, these coporations may actually turn spurious rumors into self-fulfilling prophecies."
Some economists blamed such speculation against the dollar for contributing to the drastic drop in the value of the dollar during 1977 and 1978, contending that the dollar dropped far lower than economic conditions would dictate because many traders were fueling the drop by "selling the dollar short"-selling it on one day for no reason except to speculate, and buying it back a short time later at a lower rate.
"Though our massive trade deficit and our inability to control inlation may be the primary reasons for the dollar's plight, it seems apparent that extreme volatility in exchange markets has resulted in exchange rates moving faster and farther-up or down-than can be justified by the underlying economic factors," says Sen. John Heinz (R-Pa.), who is on the Senate Banking Committee.
Guido Carli, former governor of the Bank of Italy, agrees, warning that "more and more exchange rates in the market do not necessarily reflect the conditions-the fundamental conditions-of the various economics in real terms."
Carli adds, "I believe that we have reached a point which necessities that a worldwide action be taken."
"There is big money to be made-or lost-by speculators. If the dollar drops 1 percent in value over two days, millions can be made.
A bank could sell $1 million for French francs on Monday, for example, and, if two days later the dollar has dropped only 1 percent aginst the franc, the bank could sell for $1.01 million on Wednesday the same amount of francs it bought on Monday and show a $10,000 profit on that one transaction alone.
That is a simplified example of how money can be made through speculation, and it is important to note that the same kind of activity can occur with a steadily rising dollar.
With money trading happening so fast, and so often without any relation to trade or other economic fators, experts fear a liquidity crisis-where money becomes so easily available that it is borrowed an spent too freely, fueling worldwide inflation.
And there is no one international agency that can stop it, or even keep track of it. CAPTION: Graph 1, Eurocurrency Market, By Bill Perkins-The Washington Post; Graph 2, Eurocurrency Holdings, By Bill Perkins-The Washington Post