"There are no controls. You can't control the flow of international capital. There are no rules to the game. The only one really is profit, profit, profit. "
U.S. Treasury Department official
For almost two years -- from early 1976 through late 1978 -- the value of the dollar fell continually.
In a one-year period beginning in the summer of 1977, the dollar dropped 35 percent in value against the German mark, 55 percent against the Japanese yen and a whopping 67 percent against the Swiss franc.
That meant that an American tourist or businessman going to Switzerland in the summer of 1978 had to spend three dollars for every one dollar spent the summer before -- for the same goods and services.
But while the dollar was going down the drain, the largest U.S. banks were making big money speculating in the world money markers that the dollar would do just what it did.
The three largest New York banks saw their net profits from foreign exchange transactions soar 238 percent between 1976 and 1978.
For Citibank, the world's second largest commercial bank, foreign exchange profits jumped from $28 million in 1976 to $105 million in 1978 -- 12.7 percent of all Citibank pretax earnings that year. Chase Manhattan's foreign exchange profits went from $47.4 million to $74.7 million (18.9 percent of total profits) during the same period, and Morgan Guaranty's leaped from $33.8 million to $56.4 million (15.2 percent of total profits).
Bankers properly argue that the huge growth in foreign exchange profits occurred because the markets were so active and the volume of trading grew exponentially, not because they deliberately were profiting on the slide of the dollar. And in fact, they point out, it is highly likely that the banks would have made just as much money had the dollar's value increased by that same amount instead of decreasing. To be sure, much of the money traded by banks in foreign exchange markets belongs to individual companies, not the banks themselves. And, according to one French banker, "If the banks stopped doing the trading for the multinational companies, then those companies would just hire the people do it for themselves."
But all the average citizen knows is that while the country was losing more and more buying power around the world, the banks were making more and more money. And the more unpredictable and volitile the markets became, the more money the banks seemed to make. There were also accusations that the banks were using the shroud of international transactions to shift profits improperly from countries where they would be subject to taxes to countries where there are little or no corporate income taxes.
The tax question is particularly annoying to federal governments. Citibank records filed in a pilvate lawsuit against the bank show, for example, that Citibank structured several transactions betwen its branches overseas to shift profits out of certain countries. Certain currency trades conducted at suspiciously-pre-set exchange rates allowed the Paris office of Citibank -- which is subjected to local income taxes -- to declare a loss, and the Nassau office, where profits are not taxed, to show a profit, for tax purposes.But in a separate set of books kept for internal purposes, including the allocation of bonuses, the bank attributed those profits to Paris. Keeping two sets of books isn't illegal, the bank points out, but tax officials in several countries nevertheless are examining bank records to see if certain profits should be allocated the same way on both sets.
Because no international organization regularly monitors them, such transactions normally almost never would come to light, lost among the literally thousands of deals struck in every one of the 1,000 trading rooms around the world. But when they do, they raise serious questions about the seemingly unbridled ability of multinational banks to get around whatever tax or currency control laws are set up by individual countries.
Prof. Charles Kindleberger of the Massachusetts Institute of Technology believes there is an "international good to be served" by the world money market in general, and even by speculation. But he is "very uneasy" about the tax havens set up by most international banks in places such as Nassau. Singapore and the island of Jersey in the English Channel.
"Tax avoidance or evasion is a big problem." he said in an interview. "In the long run, maybe we will have to internationalize taxes."
And because of the events of the past two years, it is not only the experts who are asking questions. More and more people, and congressional committees, want to know: Why was the dollar dropping so much more than would seem to be justifiable under existing economic conditions? And why were the U.S. banks making so much at the same time?
The answers vary, but one word always found its way into every response: speculation.
There are two ways to profit on foreign exchange transactions. One is to charge customers for the service of buying and selling their various currencies, and the other is for bankers -- or anyone who wants to -- to buy and sell currencies on their own, and attempt to profit on the rise or fall of the currency. The latter method is known as speculation because it is an attempt to profit on the speculated rise or fall of a currency. If you sell dollars for francs, for example, and the dollar drops in value, you then can buy more dollars back for the same amount of francs.
The consumers on the street can profit in the same way. All they have to do is buy travelers checks in a foreign currency, like Swiss francs, and hold them for a period of time during which they think the dollar might fall in value compared to the Swiss franc. Then, when the dollar's value has dropped, the consumer can sell the Swiss-franc travelers checks for dollars at the new, lower rate, and, like the sophisticated banker, get more dollars for the same amount of francs.
Some economists charged that, although the dollar should have dropped during the 1976-78 period -- perhaps because it was overvalued -- the drop that did occur was sharply accentuated by speculators gambling that just such a drop would happen, and positioning themselves to profit from that drop.
So as the dollar began to recover last fall, a new question popped up: What could be done to prevent the dollar from being victimized in such a manner again?
The answer was frighteningly simple: nothing.
"The Eurodollar market is essentially unregulated," says Sen. William Proximre (D-Wisc.), chairman of the Senate Banking Committee. "Federal regulatory agencies don't even know what the daily volume is in foreign exchange trading in New York, let alone Europe. No one seems to know how large the Eurodollar market it or just what its effect on inflation and exchange rates might be."
And, Proximire adds, "The banks do seem to enjoy handsome exchange profits, even when the markets are disorderly. Some banks are so huge that a few working together perhaps could... push the rates in a chosen direction, and, of course, profit a great deal from that."
Morgan Guaranty places the gross size of the Euromarket -- the amount of money floating around the world out of the regulatory control of its country of issue -- i.e., dollars outside the U.S., pounds outside of England, etc. -- at about $860 billion. Admittedly, that total includes a certain amount of duplication Because banks conduct currency trades with each other, for example, some of that money is counted twice. Still, that $860 billion market is 1,720 times larger than it was 20 years ago. And it continues to grow.
When asked by U.S. News and World Report a few years ago how many dollars there are overseas, Citibank Chairman Walter Wriston said "nobody knows. It depends on how many times you count the dog when he runs by the door."
Late last year, Wriston's bank estimated that Euromarket business -- the total volume of transactions in the worldwide markets, transactions out of control of any one country's regulations -- totalled about $50 trillion, a number significantly higher than the aggregate volume of all world trade.
But when a Federal Reserve Bank officer was asked about that figure, he gave an estimate of about $30 trillion.
Asked to explain such a large discrepancy, the Fed official told the Wall Street Journal: "What's $20 trillion among friends?"
It's not the $20 trillion that worries the average citizen with little or no financial acumen -- those kinds of numbers rarely mean anything real to the man or woman on the street -- it's the "friends."
In fact, bankers will be the first to say that few outsiders have any real understanding of world money markets, making regulation of that area by non-bankers almost impossible. Thus, international banking remains one of the world's most exclusive clubs. But the worrisome aspect of that club is that whenever its members get together, they can stop the world monetary system in its tracks if they want to, and no one really knows how to keep them from doing just that.
"The world has dreamed up a new kind of money," says one of New York's most prominent international bankers. "It has done so because of the demands of world trade. We're not unduly worried about this international system. If the dollar goes down as far as it did, that's because the world was telling President Carter that the U.S. is not doing its job economically. And it is in everyone's interest to keep world markets stable."
Sitting back in the plush corporate dining room and pondering the banks' role in world affairs, this same banker acknowledges that there is virtually no regulation of international banking.
"It is right to worry about that," he said. "International banking is a continuing education process, and it is changing so rapidly [that] really only those who stay on top of it all the time really know what is going on -- and even they don't know everything about it. No governments can control this market, but none of them would know how to even if they were able to."
He says he "can feel it in the air" when the Euromarket gets out of hand. He said he had such a feeling at the time of the famous Herstadt case, when a German bank finally went broke after recklessly overextending itself in the Euromarket: rolling the dice for big profits and losing.
Indeed, it is the opinion of most British bankers, and the Bank of England, that the central banks of every country should watch their own banks, and the activity of those banks around the world.
Central banks, while different in every country, essentially control the supply of money and credit as well as prevailing interest rates within their country. They are usually at least quasi-government organizations, and frequently intervene in a domestic economic crisis with actions designed to stabilize the economy. On the international front, these banks frequently also will buy or sell large amounts of money on world markets in an effort to stablize the status of their respective currencies.
If there is a run to sell the dollar around the world, for example, the Federal Reserve here might buy a large amount of dollars to prevent the supply of dollars from so outweighing the demand as to dramatically decrease their value.
Central banks can work together to exert some influence in world money markets, as in the recent effort by the key European central banks to restrict the fluctuations of European currencies with respect to each other, eventually leading to a single European currency. But the plain fact is a central bank's real authority extends only to its own country's borders. And world bankers do not hide the fact that the world money markets actually were created, to a great extent, to avoid many of the domestic sanctions and restrictions created by the central banks in several countries.
"Money is rather like water," says a Bank of England official." It flows everywhere, even under doors. There is no international regulatory agency that could watch the world money markets. They just flow too fast."
A French banker believes, however, that for the most part the foreign exchange laws of most countries are not being subverted, and the reasons for unstable currencies are unstable economies. "You can't be in favor of free trade and expect to have stable currencies," he said.
The Bank of England's Peter Cook heads up the only real international effort to monitor the money markets, known as the Cook Committee. Consisting of representatives for the 10 major international economic powers -- known as the group of 10 -- and Switzerland, the committee mostly watches for banks that might be overextending themselves, like Herstadt, or for unusual market circumstances.
They meet three times a year here in Switzerland under the auspicies of the Bank for International Settlements, a bank for central banks of the countries involved, and one for the most part owned by those banks. The BIS manages funds for various central banks, and can buy or sell currencies for those banks without making public what country is behind the transaction.
Thus, the major international agency charged with watching the world money markets in any systematic way is actually owned by the central banks it is charged with watching.
"If every supervisory authority in all countries with major banks would look after their own banks around the world then we would have a grip on the problem," says the Bank of England's Cook. And in fact, the British banking authorities long have had the reputation of being the most diligent watchdogs. But in England, bankers still are treated with much the same respect that doctors meet with in the United States: the one person you can trust. It is not, needless to say, the same in the U.S. anymore.
An American banker in Paris disagrees with Cook over bank supervision. "It just doesn't work that way. You can really only watch the banks domiciled in your own country," the banker contends.
However, "the Federal Reserve Bank (in the U.S.) is now watching the Euromarkets much more closely," one banker for Morgan Guaranty says. "They are always asking us how we feel about the market that day, or if we see anything unusual going on. And they are keeping much better numbers on the business done by American banks around the world."
But the main reason there likely never will be one international superagency to watch the foreign money markets is really quite easy to understand: Bankers don't trust governments to leave the international flow of money along. "The growth of the Euromarkets is at least partly due to the need to free up capital not subject to ridiculous national laws in many countries," one British banker claims.
The International Monetary Fund, a club of 138 governments, was created at least partially to watch the world monetary system. It is charged with making sure, for example, that countries don't try to take unfair advantage of world money markets. The IMF watches for countries that try to keep the value of their currencies down even though they are strong because those countries want to keep their exports competitive around the world. If a currency rises in value, so does the cost of the goods made in that country but sold around the world.
But the IMF has no real weapons with which to force the economic powers to do anything. If a weaker country has to borrow money from the IMF for development, then the IMF has certain powers over that country. But the more powerful countries don't need the IMF's money, and thus don't owe any obligations to the world body. Still, it is not uncommon for the larger IMF members to pressure each other to make necessary changes. For example, there was widespread pressure from world economic powers on President Carter last November to take drastic actions to protect the dollar such as increasing interest rates sharply and amassing a $30 billion pool of resources with which to defend the dollar if necessary.
Bankers in several countries acknowledge that the world system, whatever the good intentions were behind setting it up, is frequently abused. Besides the accusation that the various multinational companies and banks can play with their tax bills in each country, and cut back sharply on the taxes they should be paying by shifting profits around the world to places where there are little or no taxes, banks have been successful at circumventing virtually every national rule or regulation in the area of currency control merely by shifting to world markets.
"They may be right, the bankers, about the fact that no one understands the system" well enough to regulate it, says one congressional staffer. "But the plain fact is that people elect governments, not bankers. And a lot of people think that the answer for banks is to make their case to the government for better rules, not to just go out and break them. Who is supposed to be running the world, anyway?" CAPTION: Graph 1, Profits From Foreign Exchange Trading; Graph 2, The Value of the Dollar on Foreign Exchange Markets