REAL CORRIDORS OF POWER
EDU DDA May 23, 2024
Summary: Two matters now dominate the foreign financial affairs of the US government: Russia and China. The latter is a new development though one whose roots are very much intertwined with parts of the other. Russia is currently benefiting from the real power of the eurodollar system, inadvertently illustrating why China is not now nor will ever be able to get out from under it. We’ll discuss the short run implications as well as the long run picture.
Two issues now clearly define the top of the US federal government’s international agenda. Treasury Secretary Janet Yellen is in Germany for G-7 discussions with the group’s other Finance Ministers and Central Bank Governors. In addition to the usual boilerplate about nurturing “sustainable” development, the matters which will dominate the meetings are Russia and China.
The former is expected as it has been at the forefront of every effort since March 2022 (if not before). Chinese matters, the latter, that’s something new owing to the growing realization around the world how an increasingly desperate Xi Jinping who, in finding little success from all prior stabilization efforts, has given the nod to dump excess production on the global marketplace.
Tariffs aren’t the solution to what is a global economic problem, more the symptom to a deglobalizing and fragmenting economic world. China’s 2024 economic program is itself a response to the same which will only trigger more backlash and so on as the global economic pie not only shrinks more (in non-linear terms, meaning grows far too slowly) these counters also raise the level of inefficiency. Among other things, it will exert a further deflationary drag on all counts – money, finance, and economy.
The fact China is now a front-burner issue for the G-7 ministers and likely next month’s summit shows just how desperate the Chinese have become, how widespread dumping is thought already to be, and what that tells us about a whole range of economic factors including potential for the remainder of this year.
It’s not a good sign.
Unfortunately, for many they are led to connect all this to the Treasury bonds the Chinese are likewise dumping. As discussed last week, China sold a record amount of its UST (and agency) holdings during the first quarter. That wasn’t because of some calculated political tactic, quite the contrary it is the mechanical reaction to the same deficiency forcing the Chinese into dumping merchandise like steel on the world markets.
Dollar issues become currency issues that require use of reserves, where those dollar issues are primarily risk perceptions not interest rate differentials as is also widely believed. CNY continues to go down for what should be obvious reasons; China is a mess and getting more so to the point it is, again, increasingly desperate enough to pursue this dumping strategy (as in the goods).
As that has become quite apparent to participants in the eurodollar system, a weaker CNY reflects that acknowledgement thereby forcing China to reluctantly “dump” its USTs so that the pair of dumpings come about together. How else have they been able to slow the yuan’s decline? A steady stream of announcements about escalating “rescues” will only last so long and go so far (not far).
But the other matter on the G-7 agenda actually demonstrates the bigger issue behind everything. China and everyone else are basically stuck largely because the Russian saga almost perfectly illustrates why the eurodollar system continues to be unchallenged and therefore the world remains steadfast on its path to involuntary deglobalization and decay.
The irony is a lot of people (they’re said to be experts but it’s clear they aren’t) are claiming China is ditching the dollar as evidenced by what they’re doing with their reserve holdings when Russia’s qualified success actually shows why they can’t and never will.
Talking to German bank CEOs in Frankfurt on Tuesday, Secretary Yellen commended them for helping do “their part” clamping down on Russian military capabilities. Unlike all the confident declarations two years ago about how the US government was going to expel Russia from the “government’s” dollar system (that’s indeed how they made it sound), Yellen this week had to instead acknowledge quite a lot of eurodollar truth:
While we have seen the most concerning evasion through the use of jurisdictions like China, the UAE, and Türkiye, we are also working to disrupt evasion wherever we see it, from Central Asia to the Caucasus and throughout Europe. Across jurisdictions, financial institutions are on the front lines in implementing our global Coalition’s sanctions and export control policies.
I’ve singled out the UAE and China on several occasions for these reasons. I wrote during the SWIFT debacle at the start of March 2022 how:
Deprive some of Russia’s institutions their ability to message to correspondents using SWIFT and they’ll simply communicate (how’s that for more irony!) with them some other way (including just picking up the phone) because the offshore correspondents are still there. They will continue to conduct their monetary business regardless of the method payments requests are sent and received.
The eurodollar is indeed a complex maze of correspondents, some formalized like exchanges which act like monetary utilities while a million others remain obscure and even ad hoc – SWIFT itself has a term for them, calling them “corridors” that often include multiple sets of foreign banks. All that does is reinforce the strength of that system, its flexibility, thus why any government including the US has so much trouble actually and actively controlling any part of it.
Our world’s reserve currency is a bank currency not government money, and it gets transacted via these correspondent networks. That much remains from the very beginning. While the format these “dollars” have taken has radically evolved through time, going back to the earliest days of the eurodollar system it has been correspondent banking at its legitimate center (not central banks or governments who continuously and deceitfully claim to be, or are most often claimed by others to be).
Another central yet helpful irony of his latest Russia-dollar fiasco is the previous one (or threats of confiscation) what helped spur development of the eurodollar system at its critical beginning. One of the earliest known official works on those origins was FRBNY’s Economic Policy Review (in an article titled Market for Dollar Deposits in Europe) published in November 1960. It described:
The original impetus for the postwar development of the Continental dollar market is believed to have arisen from the desire of several banks in Eastern Europe to leave their dollar balances with their correspondents in France and England rather than carrying them in their own name in the United States. In making use of these and other dollar balances, the correspondent banks found a number of outlets, often involving the offer of these funds to foreign banks in need of dollar finance, at rates somewhat lower than would be paid for credits from United States banks. Before long other holders of dollar balances took advantage of the growing demand for this relatively inexpensive dollar accommodation, and soon an active market for dollar deposits began to develop, notably in Paris and London.
For all the US government under Eisenhower then Kennedy wanted to restrict Soviet and Eastern bloc dollar funds and access back then, correspondent banks made it practically impossible which is likely the biggest reason why it never went anywhere. In those days, pragmatic officials were more realistic, figuring out they had been outclassed so they searched for other ways to accomplish (or try to) their goals.
Since everything nowadays is for show, about pretending to wield power, they can never allow themselves to exit the theater.
It isn’t just a matter of hunting down some Russian assets in a couple banks which can then get frozen by sanctions. The term is correspondent networks. I wrote back in April 2022 about Secretary of State Blinken’s search:
Big difference; the eurodollar makes it more a game of whack-a-mole than you’d been led to believe. Give the man some credit, at least US Secretary of State Blinken was being more honest about what can be done. If they can find some accounts, fine, they’ll shut them off and freeze whatever. The flow of money via eurodollar corridors? Very different reality.
This is critical to understanding the eurodollar and its success, thereby its position as unopposed even after almost two decades of malfunctioning. It is not the dollar denomination, rather the complex and interlocking means through which this intermediating medium functions. That’s what a reserve currency is and does; it makes that medium widely available and through a variety of ways for true redundancy (except, of course, when it comes to monetary bottlenecks, but those are a different story).
Flexibility by design. Here’s another early description this time from the BIS in 1964:
There are several difficulties involved in trying to say precisely what a Euro-currency is. A Euro-dollar, for example, can be defined as a dollar that has been acquired by a bank outside the United States and used directly or after conversion into another currency for lending to a non-bank customer, perhaps after one or more redeposits from one bank to another…It will be evident, therefore, that a precise statistical picture of the Euro-currency market is not feasible. The best that can be done is to present data on the banks’ foreign currency liabilities and assets and then to arrive at some reasonable approximation of the most likely volume of funds in the Euro-currency market.
To oversimplify, it is a system which takes in money across a number of formats and channels, churns it around multiples of times before it comes out the other side often in a different form for some other specific use. How it gets to that destination is practically unknowable, as the BIS was grudgingly suggesting.
One example offered by a professor in 1970 started with bank owning francs in Switzerland and ending with another one in Paris holding British pounds all with “dollars” in between:
A bank in Switzerland, for example, may convert a Euro-dollar deposit into a Euro-sterling claim on a bank in France. The terminal stage of Euro-dollar intermediation in this case is a bank rather than a nonbank borrower.
The eurodollar system facilitates that monetary marvel through complex interactions covering uncountable directions across untraceable levels and out into the world almost anywhere. Not only is that why it is so hard to “shut down the Russians”, it is the very reason why the eurodollar system isn’t going anywhere anytime soon and cannot be competed with.
Yellen on Tuesday admitted to the first part likely without realizing the greater implications of that latter piece.
We are seeing the positive impacts of these efforts: The global financial sector, including German banks, is helping to frustrate Russia’s ability to procure goods for the battlefield and its defense industrial base. Thank you for the efforts you have already made.
However, our objectives have only been partially met. Russia continues to procure sensitive goods and to expand its ability to domestically manufacture these goods. We must remain vigilant and be more ambitious.
To be clear, what keeps the eurodollar system in place isn’t secrecy, though that’s a byproduct, above all this kind of flexibility combined with reach and capability. That’s the real secret here as it has been from the very beginning. This is exactly what a reserve currency must do.
Challenging this kind of capacity is an enormous and enormously complicated task. The Chinese know this even if those cheering on their Treasury sales as “ditching the dollar” clearly don’t. China’s banks may be among the biggest in the world, yet they couldn’t come close to replicating these functions to the necessary degree to achieve the required flexibility and reach.
It would be like replacing the entire internet starting from scratch, from burying billions of miles of new fiber optic cables to installing all new hardware even writing new code and millions of little pieces of software.
No one is doing anything close to this…at least outside of cryptocurrencies like stablecoins.
But those are understandably on miniscule scales, therefore any of the survivors through the ongoing shakeout process are many years away from even being within sight of a partial capacity for reserve currency needs.
And you can immediately dismiss anyone who says the BRICS are going to do anything meaningful; as if last year’s embarrassing freakout over the absurd “gold backed” scheme wasn’t discrediting enough. Just like that whole embarrassing petroyuan hype from 2018. Both betrayed a fundamental ignorance of these fundamental monetary concepts in the name of sensationalizing hoped-for outcomes that in reality clearly had no chance.
No one is going to replace the eurodollar, least of all China. Funny enough, this whole matter with Russian evasion actually shows why. The most either of them will be able to do in the monetary realm is small-scale bilateral and, if they’re lucky, multilateral exchanges. They’ve been doing this for well over a decade and here the eurodollar remains anyway.
The world is stuck with the dollar denomination as operated by the real bank money of the eurodollar system. That’s most obviously a problem for the Chinese because being forced to sell Treasuries is one of the clearest signs that system doesn’t like what’s happening in China as it is forced to dump merchandise only to prove those suspicions. But it’s also just as much of a long run imposition to the US, and I don’t mean trying to hunt down untraceable monetary corridors facilitating the Russians.
