The Genie That Escaped from the Bottle

MOST of the speculative money that flooded into West Germany last week came from a volatile and increasingly powerful segment of the world's financial apparatus: the Eurodollar market. That market is a curious byproduct of two decades of U.S. balance of payments deficits. Eurodollars are nothing more than U.S. dollars on deposit in private banks abroad. The pool was organized in the late 1950s by London bankers who sensed that if they could marshal the billions of dollars already overseas, they could lend them out at a substantial profit. Business has been brisk ever since.

Today the Eurodollar market has expanded into a wholesale operation on a global scale. It involves roughly 500 banks in 40 countries. The banks accept deposits (minimum: $25,000) and arrange loans (usually from $100,000 up) among one another and with their customers over a telephone and Telex network. Fed most years by continuing U.S. payments deficits, the pool of money has grown geometrically from $8 billion in 1964 to $16 billion in 1967 to $27 billion at the end of April.

Eurodollars create a mixture of benefits and headaches. On the plus side, they provide a vital source of private capital to finance world trade and the growth of international corporations. They bankroll oil exploration, highway construction and even occasional European government deficits. Without them, Europe would lack the investment capital to sustain its present Dace of economic growth. The Eurodollar pool has also become a leading haven for nervous money. Fearful of devaluation, individual speculators and treasurers of large corporations swap comparatively weak currencies like British pounds or French francs for Eurodollars.

No government controls the supply of Eurodollars; nor is there any regulation of the interest rates on Eurodollar loans or the uses to which they are put. Thus the expatriate dollars are extraordinarily sensitive to the gyrations of monetary supply and demand. They race across national boundaries in response to tiny changes in interest rates, and their existence complicates government efforts to curb currency speculation. It is hardly surprising that European moneymen have come to regard the Eurodollar as a genie that has somehow escaped from its bottle.

All in all, the Eurodollar amounts to a new and highly controversial form of international currency. Last week in Strasbourg, Vice President Raymond Barre of the Common Market warned the European Parliament that Eurodollars have become "one of our continent's top-priority problems."

Financial leaders are particularly worried because the interest rates on Eurodollars have been rising with alarming speed. They jumped from 7% in December to a record 10% last week on three-month loans. Economic policymakers complain that the rise is leading to an unwanted worldwide increase in interest costs.

The immediate reason for the jump to last week's peak was the rush to borrow Eurodollars for conversion into German marks. Big-time speculators found it much easier to borrow on the Eurodollar market than to dig into their own pockets for the money.

A longer-standing cause of the rise in rates has been the U.S. Government's efforts to curb inflation at home. For many years, Europe's moneymen complained that the U.S. was "exporting inflation" by sending so many dollars abroad. Now Europeans commonly charge that American bankers are "exporting deflation" by taking too many dollars home. Squeezed for lendable funds by the Federal Reserve Board, U.S. bankers have been borrowing Eurodollars through their foreign branches and bringing them back. Since last September, U.S. banks have temporarily siphoned $5 billion from the Eurodollar pool. Even before the crisis of the mark, this tactic had pushed up Eurodollar rates considerably.

As a result, European countries have been forced to take defensive action. A large difference between domestic and Eurodollar rates tempts European corporations and wealthy speculators to profit from the spread. They borrow cheaply at home, change the money into dollars at almost any bank, then deposit it elsewhere--usually in a foreign country--to earn enticing Eurodollar rates. For countries with low interest levels, the result is a drain on their own monetary reserves. Hoping vainly to prevent or reduce such a drain, Britain, Belgium, Sweden, Denmark and The Netherlands have raised their bank lending rates by 1% during the past three months. Many European moneymen are demanding that the Federal Reserve make it harder for American banks to bring Eurodollars home, but so far the board has spurned such appeals.

If interest rates climb any further, European central banks may be forced into a new round of rate increases or even outright exchange controls to prevent further losses of reserves. In either case, the consequences would hurt economic growth. The Eurodollar market has made the monetary problems of the U.S. and European countries unexpectedly interdependent. Central bankers on both sides of the Atlantic now face an urgent need to devise ingenious cooperative measures to avoid an international financial battle.

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