until 1963. Although customers had long been allowed to deposit US dollars and other currencies at banks in London and such deposits had been growing during the interwar years, the birth of the Eurodollar market is generally acknowledged to have been in the 1950s. A number of factors contributed to its evolution.
In the immediate aftermath of WW2, the industrial base of Europe was either destroyed or had been given over to the manufacture of war supplies. Due to its geographic position, the US had been spared much of this destruction and had seen its economy grow to account for roughly half of global GDP. US exports were in strong demand and the need to pay for these in dollars meant that the rest of the world faced a dollar shortage. Through Marshall Plan aid, the US injected $17 billion into Europe in the form of reconstruction grants. Around $4.4 billion in similar aid was given towards the reconstruction of Japan.32 Between 1947 and 1958, the US encouraged the outflow of dollars in order to provide liquidity to the international economy and, from 1950, began running a balance of payments deficit. As the post-war recovery took hold, offshore dollar balances began to accumulate. Initially, these were deposited with European banks, which in turn placed them back into the US banking system via their US branches, subsidiaries or correspondent banks.
With the rise in Cold War tensions, the Soviet Union and countries within the Eastern bloc became concerned that the US government might confiscate or freeze their dollar deposits, so they began to transfer these holdings from New York to London and Paris. The first such transfer by the Soviet Union was to the Paris-based Banque Commerciale pour l'Europe du Nord, which had the telegraphic address ‘Eurobank’. It is said that the term ‘Euro-dollar’ traces its origins to this.33
There were other attractions to holding dollar deposits offshore, however. Offshore dollar deposits were not subject to US reserve requirements that forced banks to hold a certain proportion of their deposits in non-interest-bearing accounts with the Federal Reserve. Furthermore, Eurodollar deposits fell outside the jurisdiction of the Federal Reserve Board's Regulation Q, which was promulgated in 1933 to avoid the excessive competition that had been deemed partially responsible for bank failures during the Great Depression. Between 1935 and 1956, Regulation Q capped the interest rates that US banks could pay on deposits to one percent for 30-day deposits and to 2.5 percent for 90-day deposits.34 Therefore, so long as offshore banks could lend the dollars out at market rates, they could afford to pay higher interest rates to depositors than domestic US banks.
An innovative product offering by a British bank also played a key role. Britain had devalued the pound by 30 percent in September 1949 under the weight of its balance of payments deficit but began loosening exchange controls that had been imposed at the outset of the war in the early 1950s, in line with the Bretton Woods objective of freer global trade. In 1954, restrictions on British banks operating in the forward exchange markets were lifted. When, in 1955, sterling interest rates were raised above US rates, a profitable opportunity opened up for arbitrage between sterling and dollar interest rates. Midland Bank, one of the major British clearing banks, began offering 1⅞ percent on 30-day dollar deposits, or ⅞ percent above the Regulation Q capped rate of one percent. It then sold the dollars in the spot market35 and bought them back in the forward market for a premium of 2⅛ percent, giving Midland sterling funding at 4 percent (1⅞ percent plus 2⅛ percent) versus the prevailing Bank Rate of 4.5 percent.
The Bank of England initially raised some concerns at the rapid growth in Midland's foreign currency deposits, which appeared unrelated to its commercial transactions, but decided not to restrict the activity. Maurice Parsons, who later went on to become deputy governor from 1966 to 1970, rationalised that ‘it is impossible to say to a London bank that it may accept dollar deposits but may not seek for them.’ Threadneedle Street's36 sanguine attitude towards Midland's innovation was likely influenced at least in part by the beneficial impact of these dollar inflows on Britain's balance of payments position – in June 1955 alone, the dollar deposits Midland attracted reduced the fall in the country's foreign exchange reserves from $56 million to $6 million.37 As with most financial innovations, other banks quickly copied what Midland was doing.
In the wake of the Suez crisis, sterling was hit with renewed distress, prompting the Chancellor of the Exchequer to impose new foreign exchange controls in the third quarter of 1957. The use of sterling to finance foreign trade between third parties was banned and refinance credits in sterling were outlawed. Prevented from using their sterling deposit bases for international lending, resourceful British banks began to use their dollar deposits.
Meanwhile, US multinational companies were making large investments to expand their overseas operations. Though US balance of payments deficits had been modest from 1950 to 1957, from 1958 to 1962 US deficits reached levels of between $2.5 billion and $3.8 billion.38 In 1961, the Federal Reserve began expressing concerns that the growing Eurodollar market may ‘constitute a danger to stability’,39 but by that time the Bank of England had grasped the importance of this market in developing international trade and to restoring the City of London's role as a leading international financial centre. By 1963, the Bank for International Settlements (BIS) estimated the size of the Eurocurrency market to be $12.4 billion, of which three-quarters was in US dollars. This large base of offshore dollar deposits soon became the target of bankers helping corporations to raise funds via bond issues.
The Coupon Express
In the post-war years, New York had been the principal financial centre where borrowers went in search of investment. The first international bond issue after WW2 was by the World Bank in the New York-based foreign dollar bond market (or, as it came to be known, the ‘Yankee’ market). This was largely a public sector market, with issuers including governments, government agencies and municipalities. Issues were required to comply with the 1933 Securities Act and be registered with the Securities and Exchange Commission (SEC). Regulations also required that a US investment bank acted as lead manager on the issue and that there be a US domestic underwriting syndicate. Many US public pension funds were not permitted to buy these foreign securities and US insurance companies were restricted on the amount they could hold, so these issues were increasingly bought by European investors through discretionary private banking accounts with Swiss or Benelux banks, or via London brokers. Towards the end of the 1950s, three-quarters of these issues were being bought by European investors.
It was galling to the European intermediaries that, although they were handling much of the distribution, US underwriters were earning most of the new issue fees. European distributors therefore began to look for a way to handle the entire new issue process by themselves.
At the time, Switzerland would have seemed the natural home for what would become the massive Eurobond market, since most of the early issues of US foreign dollar bonds were placed there. Switzerland itself had a sizeable market for foreign bonds issued in Swiss francs, which had started in 1947 and, by 1963, had the equivalent of around $790 million outstanding – slightly larger than the amount owed by European borrowers in the New York market.40 White, Weld & Co., a New York-based firm that was one of the most prominent players in the foreign dollar bond market, formed a close relationship with Crédit Suisse and based its European activities in Zurich. So, what led the market to come to be centred on London?
As with most such decisions in international finance, it ultimately came down to questions of regulation and tax. Switzerland imposed
