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The History of the Eurodollar Market in the 1960s

The History of the Eurodollar Market in the 1960s

THE HISTORY OF THE EURODOLLAR MARKET IN THE 1960s

(A CHRONOLOGICAL ACCOUNT)

Introduction

The Euro-dollar market* was in fact, and is indeed today, an international wholesale market in money, involving Euro-sterling and other national currencies such as Swiss franc and to a lesser degree the other major European currencies. This paper will briefly outline in a chronological order how the Euro-dollar market developed during the first five years of the 1960s. As these markets had one thing in common, the fact that they existed in centres foreign to the natural habitat of the currency concerned. US restrictions, such as Regulation Q of the Federal Reserve System limited the rates that may be paid to depositors, whether domestic or overseas, primarily in order to protect the great number of small US banks that constituted the American banking system. Hence, a banking business developed, involving borrowing and lending and, the evolution of an investment medium, in currencies outside the territory in which the currency is ordinarily regarded as domestic currency. This tended to produce a wider spread between the rate paid to overseas depositors and the rate charged to overseas lenders than was the case in London and certain other major centres.

For the second Labour government from 1966-1970, Labour’s taxation policy was important both for economic management and political strategy. This paper will briefly outline in a chronological order how the Euro-dollar market progressed during the second era of the 1960s. The UK position in the late 1960s required increases in financial capital (namely the Euro-dollar market) along with the restraint of domestic consumption. Business organisations had to be given incentives to borrow on the Euro-dollar market. Both the actual incidence of business taxation and its political impact, were going to play a part in Labour’s tax strategy. The environment of this strategy was shaped by a number of factors. The mid-1960s saw fresh hopes for the second Labour government to ending the UK’s chronic deficit in its balance of payments, which looked to be almost in balance. However, the late sixties also saw large amounts of the country’s reserves, being spent in order to defend Sterling. Euro-dollars proved to be a solution. However, the other side was how vigorously the business interest was going to respond to taxes levied against it. In the late 1940s-50s, it was criticised for being too defensive in its posture: “the attitude of industry, when EPT (Excess Profits Tax) was raised to 100% had been weak. Industrialists previously appeared to be unwilling on political grounds to fight for what they knew to be right” . However, both the Labour government and private industry were to some extent uncertain in their analysis of tax questions, and some of the issues involved in developing long-term business taxation received legislative enactment under Harold Wilson’s first government in 1965 .

1961 – “Introducing” the Euro-dollar Market

One can only guess at the amount of Euro-dollars and Euro-sterling outstanding between lenders and borrowers and, though the guesses of financial journalists have varied considerably, all of them fall in the range of billion to billion. Due to this and other market reports, it was clear that before 1961, the Euro-dollar market was well established in that not only were there large number of buyers and sellers, but that large sums could be transferred easily and without big changes in rates. Turnover in this, as in all the Euro-currency markets, was probably very big. It was also suggested that Euro-dollars constituted 90% of all Euro-currency, Euro-sterling another 5%, and all other Euro-currencies combined the remaining 5%. It was not clear as to the amount of Euro-sterling outstanding, but its turnover in the Paris market in 1961 had been estimated to have reached £10m a day at times .

The rate of expansion in the Euro-dollar market was due to two main factors: Firstly, the continuing balance of payments deficit of the USA which had put into international circulation a steadily increasing volume of dollars seeking the most profitable form of use. Secondly, the banning by the German and Swiss authorities of the payment of interest on foreign-owned balances which had caused holders of marks and Swiss francs to hawk their balances around the international money places with a view to earning any interest that can be obtained there. (The French also, followed the German and Swiss example).

This situation led to the development that depositors were able to find centres which offered a higher return, than offered at home. Also, borrowers were able to raise funds in this currency more cheaply than they would be able to do by going to the country of origin of the currency concerned or in their own currency. It was natural enough that London banks – and merchant banks in particular – with their expertise and international connections, participated actively in this business; since London was thought to be the largest market in Euro-dollars. The total of London’s liabilities in all currencies to non-sterling was a depositors was around the £1 billion mark in 1961, and after allowing for double counting it was not unreasonable to suggest that London accounted for well over half of the real total . However what was significant was the number of banking institutions in London that have been most active in the Euro-dollar markets which have increased their business enormously since the end of 1958.

The Public Archives shows that four groups of banks increased their deposits by £884m or 80% between the end of December 1958 and the end of March 1961. At the same time their overseas lending increased by £479m and their loans to UK local authorities by £119m in each case nearly a three-fold increase. Euro-dollar transactions was also reflected in changes in the net spot position of UK Authorised Dealers (these was unpublished). A net liability here can be taken as an indication of the extent to which Dealers have switched Euro-dollars, and to a lesser extent other currencies, into sterling.

The movements of highly volatile Euro-currency must make for closer integration of the world’s main money markets. This must tend to make domestic money market rates in different centres more nearly equal than they would be in the absence of Euro-currency markets. Movements of Euro-currency was certainly a significant factor in the determination of forward rates. Differences in Euro-currency rates can induce big movements of short-term funds and have to be considered jointly with interest differentials on Treasury Bills as main determinants of the size and direction of the international flow of short-term capital. So far this did not seem to have had any significant effect on the balances of payments either of the UK or of the US. Euro-currency may be used in ways that monetary authorities regard as desirable. For example, it must have reduced the cost of financing foreign trade – this must have benefited Japan in particular – and it may even have increased trade. On the other hand, it could be used to exaggerate speculative movements of short-term capital and a system cannot be without dangers where funds which was liable to be withdrawn at very short notice was used to finance hire purchase finance companies and local authorities. There were two points that was worth taking into account:

The first considers the view that “short-term capital movements will be bigger than they would otherwise have been” . This statement was true in the sense that a greater number of transactions were taking place and the total of the flows in all directions was greater. The UK tended, however, to be most concerned about the flows into and out of the United Kingdom; it seemed that Euro-sterling transactions did not, in general, add to the influx or withdrawal of sterling. In other words, for example, the fact that transactions were going on in sterling between Frenchmen and Japanese did not exaggerate the large reduction of sterling holdings in the hands of non-sterling countries in the first seven months of this year. It was possible, of course, that the existence of the Euro-sterling market resulted in the lenders holding rather larger amounts of sterling than they would otherwise have done, so that the scope for a withdrawal from sterling may have been increased. On the other hand, the fact the Frenchmen could lend sterling profitably to the Japanese, and possibly for a rather extended period, may have added some element of stability to the Frenchmen’s holding of sterling. The fact was that there was no evidence, however, to confirm either of these hypotheses.

The effect of the UK authorised dealers’ transactions in Euro-dollars was not easy to expound clearly. The limits on the authorised dealers’ operations were that there was a limit on the spot convertible currency assets which any one dealer may hold against future liabilities and furthermore each authorised dealers’ spot and forward commitments must match. Perhaps it is easiest to think in terms of the net spot position of the authorised dealers, which became increasingly minus towards the end of 1960, stayed at about minus £100 million from January to May and later declined somewhat. This minus spot position reflects the switch of Euro-dollars – and other currencies – into sterling. There can be wide variations in the gross liabilities and assets of the authorised dealers, but only the net position affects the reserves, as, each transaction is self-liquidating. Nevertheless, the reserves, reflecting as they do the authorised dealers’ spot but not their forward position, will have benefited from the growing switching of Euro-dollars into sterling and will have suffered when this switching was unwound .

1962 – Developments for the demand of US dollars and other currencies

There were considerable statistical difficulties in estimating the size of foreign markets for dollars and other currencies. Hence, any estimate was little better than a guess. Given this qualification, Altman estimated that the market in Europe for dollars, sterling and other currencies as of June 1962 was more than billion. Leading to the assumption that a world total of dollars and other foreign currencies used in foreign markets would be of the order of to billion.

It was estimated that 85% of foreign market operations in foreign currencies during 1962 were conducted in US dollars. Continental European currencies, particularly Swiss francs and deutsche marks were held and used in larger amounts in 1962 than in 1961, but, since operations in dollars were also larger, they did not increase greatly in relative importance. Deposits of Euro-sterling continued to be relatively small. The greater use of continental currencies stems from the smaller forward premium on the dollar which made it possible to pay rates of interest on Swiss franc deposits which were closer to those paid on dollar deposits. This in turn made it possible to obtain and use more Swiss francs in foreign market operations.

Euro-money operations were conducted almost entirely by commercial banks although brokers had become an important mechanism for organising the market as the number of participants has increased. A large proportion of the dollars were dealt with in foreign markets, but a modest proportion of the other currencies, were directly or indirectly owned by central banks and other monetary authorities. Altman estimated that about two-thirds of all funds in European markets in the summer of 1962 were of this character. Official funds reached the money markets in three ways: Firstly, central banks and monetary authorities provide their respective commercial banks with dollar funds through swap operations, with a general or specific understanding that these dollars will be based to acquire foreign currency assets. (The Deutsche Bundesbank had swap transactions to carry out its monetary policy). Secondly, central banks deposit dollars in domestic commercial banks without requiring the surrender of the local currency equivalent (e.g. Italy). Thirdly, central banks in Europe, Latin America, the Middle and Far East deposit dollars with commercial banks in London, Paris, Canada and other money markets. The BIS had become an important intermediary between its members and the Euro-dollar markets .

The funds other than from official sources in the market represented deposits of commercial banks and business enterprises and individuals. Banks and other business enterprises used the major part of the dollars (etc.) in foreign markets, although governments and official agencies used significant amounts. Local authorities in the UK had been important borrowers in the London Euro-dollar market. Most of the funds, however, were used by the private sector. Interest rates on dollar deposits were determined on a highly competitive basis, arrangements being available for depositing any sum for any period up to 18 or 24 months. At any one time in the market there was a range of rates rather than any one unique rate. The effective floor to the rate on Euro-dollar was determined by rates paid by US banks on time deposits and by other comparable short-term investments in the United States. In 1961, the Euro-dollar rate in London averaged 3.58% compared with 2.35% on new issues of US Treasury Bills and 2.80% on prime bankers’ acceptances. In the first eight months of 1962, the Euro-dollar rate averaged 3.66% compared with 2.76% on new issues of US Treasury bills and 3.02% on bankers’ acceptances.

The demand for Euro-dollars was obviously determined by their profitable use. Pure interest arbitrage was a factor, though not the major one, in the demand for such funds. Rates on Euro-dollars had been consistently too high to permit covered interest arbitrage in UK Treasury Bills, though not too high for uncovered movements. During periods when confidence in sterling was high, it was possible that Euro-dollars were used to finance the purchase of Treasury Bills. Local authority and finance house deposits had been a profitable outlet for Euro-dollars. On average over the period 1961 and first eight months of 1962, the covered yield on deposits with local authorities, covered forward, was approximately the same as published rates on Euro-dollars. This follows, given that Euro-dollars was an important source of funds to the local authority market, and no arbitrage transactions would tend to even out disparities in rates. These averages, however, suggested that, smaller investment opportunities had in fact existed given the spread of rates on both Euro-dollars and local authority deposits.

For the blue chip industrial and commercial customers, the rates they have had to pay for borrowing funds from the market ranged between 5½ – 5. 7/8% (i.e. prime borrowing rate on the New York market). As the commercial banks were paying between 3½-4½% for three months dollar deposits, their gross interest margin would be in the region of 1-2½%. Euro-dollar operations, however, were not confined to channelling funds to those borrowers who may be entitled to the prime rate in New York with the result that the lending rate is often considerably higher than 5 7/8%. Thus with banks being able to work on margins of 1½ % upwards, the possibility of profitable business was great .

Rates of interest paid on deposits of sterling and other non-dollar currencies were closely related to those paid on Euro-dollars taking into account the cost of forward cover. This again illustrates the integrated form of the foreign currency markets, arbitrage transactions ironing out interest discrepancies. Most of the transactions in Euro-currencies was covered forward although banks may carry open positions for considerable periods. They have been known to carry short positions in particular currencies over a long string of weekends when they expected changes in exchange parities. Loans in dollars and other foreign currencies was listed or regulated in three ways: Firstly, that attempts have been made (e.g. Italy) to increase the rate of interest charged in loans in dollars etc. Secondly, agreements have been made in some countries (e.g. Germany) that loans in foreign currencies should only be made to the foreign trade sector. This, by making an artificial distinction between the domestic and foreign trade sectors in the economy results in a highly unstable situation. Thirdly, in many European countries (e.g. the UK) the competitive effect of foreign currency loans is restricted by exchange or capital control regulations.

The effect of the abandonment of interest ceilings on foreign deposits for US banks was not, it was thought, to have a considerable effect on the Euro-dollar market. It was not clear whether US commercial banks were prepared to raise interest rates selectively to any great extent, and even if they did and funds did flow out of the Euro-market, Euro-dollar rates would be adjusted accordingly.

The growth of the Euro-dollar market raised interesting problems of monetary management for the UK authorities. The short-term money markets of the major industrial countries had become considerably unified and internationalized with the emergence of this market. It was possible for the monetary authorities to use the market as an aid to domestic control by operating in the forward market for dollars, so facilitating commercial bank buying of foreign short-term assets. If it was felt that the domestic short-term market was too liquid, it was possible for the bank, by lowering the forward premium on dollars and pegging it for such transactions, to supply commercial banks with dollars for profitable use abroad and thus reduce their supply of sterling. The Deutsche Bundesbank had great use of the swap technique in its attempt to relieve pressure on the domestic market.

On the other hand, the Euro-dollar market imposed certain limitations on domestic policy. It was one thing to encourage banks to supplement their domestic assets with foreign assets, it was another to reverse the process. A tight money policy, by raising short-rates, attracts Euro-funds thus helping to defeat the object of control. Of course given exchange control in the UK arbitrage was not perfect but nevertheless there were considerable pressures which appeared when the UK’s short-rates moved out of line with those prevailing in other centres. A very strong reason for the control of Local Authority short-term borrowing stems from the use by that market of Euro-dollars when domestic funds were in short supply. Apart from a fool-proof exchange control, the only way to regulate the flow of Euro-dollars into the UK was for the official authorities to have control over all significant short-term interest rates.

The Times on the 13/09/1962 quoted that: “the bill to remove the ceiling on interest rates paid by US commercial banks on certain dollar deposits from abroad has now passed the House of Representatives. This is bound to raise fresh doubts about the future of the market in Euro-dollars” . If passed by Congress, the Bill would remove the Federal Reserve Board’s present ceiling, which ranges up to 4% according to the size of the deposit, on interest rates paid on time deposits of foreign governments, their central banks or other monetary authorities, and international institutions of which the US is a member. This, in fact, covered a large part – perhaps as much as 50-75% – of a total Euro-dollar market with an annual turnover now running in excess of ,000 million. While the US move would undoubtedly serve to relieve the strain on the US gold stock, it must, according to The Times newspaper, ultimately be expected to diminish the size of the market in Euro-dollars to some extent. However, dealers in the market recalled the almost negligible effect of the liberalisation of the American Regulation Q, which from 1962 permitted a modest increase in rates paid on foreign deposits. It was pointed out that liquidity among US commercial banks was already running at a high level and that they would probably not be very keen in these circumstances to raise their interest rates further. Therefore, it was felt that any decline in the size of the market in Euro-dollars was likely to be a slow process.

So during the era of 1962, there was a view prevalent in the City of doubts whether there was a long-term future for the Euro-dollar market. This argument for supposing that the Euro-dollar market was a purely temporary phenomenon followed from the view that the market originated because of rigidities in the structure of interest rates in the United States. It was therefore suggested that the Euro-dollar market was born out of the banking legislation limiting the rate of interest American banks pay on foreign deposits. Similarly with Euro-sterling, the interest rates paid by British banks were so low as to encourage foreign holders of sterling to lend it to other non-residents at the higher rates that prevail in the free market outside the UK.

Given this view, the revision to Regulation Q, enabling US banks to raise their rates on foreign deposits, was regarded as the beginning of a movement to allow interest rates to reach their natural levels, which would destroy the Euro-market. This, however, was to take a rather facile view of the workings of the Euro-market. The existence of Regulation Q (or its sterling equivalent) was only a subsidiary reason for the market’s continued existence, and that market is likely to flourish so long as the American payments deficit continues to pump dollars into foreign hands. The Euro-dollar market was essentially an international money market and as such was a convenient source of credit for the borrower and a useful and profitable outlet for the lender. The market may well have been born out of interest rate rigidities, but given the apparatus of an international finance market with dealers willing to operate on small margins, the system would not be allowed to rust. As it was always useful to have a ready source of finance available.

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Of the more immediate significance was the stimulus given to the market by the American operations in the forward exchange markets. During 1961, in Switzerland and Germany, the dollar stood at a substantial forward discount against Swiss francs and D. marks respectively. By contrasting to buy forward dollars against these currencies, the US authorities attempted (with some success) to lower the dollar discount. In this operation it was fairly certain that they had “cleaned-up” some loosely held Euro-dollars (mainly from European traders worried about the exchange risk). The effects of this operation was best considered by analysing two distinct positions. Firstly, when the dollar stood at a substantial discount, holders of Euro-dollars i.e. traders, would hardly sell them forward for say D. marks because of the cost involved unless they were really panic-stricken. However, when the US authorities managed to lower the forward discount, such holders would take advantage of this in getting out of dollars and to the extent that this happened there would be a “gap” in the Euro-dollar market. This outflow from the Euro-market would be more than balanced by inflows from the United States as Regulation Q continues to exist and because European holders of dollars realised, seeing that the US authorities stood ready to correct disorderly forward exchanges, they could convert their dollar holdings into other currencies without great cost. It was this factor which was presumably acting as a stimulus to the market in that Euro-dollar holders can have confidence in the future value of their holdings. Therefore, one of the main features of the American operations has been to encourage the continued holdings of dollars in non-official sectors. The Euro-dollar market was only dangerous to the American balance of payments to the extent that holders sell their dollars to their respective Central Banks who earmark these for gold.

1963 – The “growing developments” of the Euro-dollar Market

The Euro-dollar market as a whole by 1963, amounted to -5 billion and was tending to grow. At 31st March 1963, there were about billion outstanding in the UK market alone. A world total of dollars and other foreign currencies used in foreign markets was of the order of -6 billion . Euro-money operations were conducted almost entirely by commercial banks although brokers became an important mechanism for organising the markets as the number of participants increased. Central banks and other monetary authorities directly or indirectly owned a large proportion of the dollars dealt with in foreign markets. It had been established that about two-thirds of all funds in European markets was of this character.

The supply of dollars for the Euro-market came from American residents and non-residents. During 1963, it was the non-residents who supplied the vast majority of the dollars, generated by a continuing US balance of payments deficit on current and long-term capital account. The most important suppliers of funds by country were Canada, Western Germany, Italy, Switzerland and France, although other countries had contributed. American residents added to the market (and hence to the overall US payments deficit) by switching short-term funds to European banks in order to take advantage of higher interest rates than could be obtained domestically. In actual fact, most American resident funds reached the Euro-market via Canada, in which the residents switched short-term funds to Canadian banks, which had then placed them into European banks .

The process by which these dollars reached the Euro-market was as follows: As a result of the American deficit, foreigners build-up dollar deposits in American banks on current account. The foreigner could then invest the dollars in any number of ways, but assuming that they would lend the dollars to a European bank, as that bank would be willing to pay a higher interest rate than could be earned in the American short-term money market. The ownership of the deposit is then transferred, within the American bank, to the account of the European bank which is then able to use the funds to lend. When the new owner of the dollar deposit lends to a third party, the European bank’s account in the American bank is debited and the third party’s credited. The whole process is essentially a transfer of the dollar deposits in the American banks between accounts, the deposit never actually leaving the American bank.

As stated previously, official authorities were the most important suppliers of dollars to the market. This was presumably because residents in many countries surrendered (voluntarily or otherwise) dollar earnings to their central authorities which then put the dollars back on to the market in three ways: Firstly, that central banks and monetary authorities provide their respective commercial banks with dollars through swap operations, with a general or specific understanding that these dollars will be used to acquire foreign currency assets. The Deutsche Bundesbank has over the past two years engaged in such operations. Also this operation had occurred in Italy. Secondly, central banks deposit dollars in domestic commercial banks without requiring the surrender of the local currency equivalent. In some cases this is because such deposits earn higher rates than in New York. In Italy, however, this operation was used to increase the liquidity of the banking system. Thirdly, Central banks in Europe, Latin America, the Middle and Far East, deposit dollars with commercial banks in London, Paris, Canada and other money markets. Members of the Bank for International Settlements deposit funds with it and the BIS has become an important intermediary between its members and the Euro-dollar market .

Although precise data was not available, Oscar Altman of the IMF estimates that the central monetary authorities of 20-25 countries have deposited dollars outside the United States . The non-official funds reaching the market represent the funds of commercial banks, largely in continental Europe, and funds of businesses and individuals in many countries including the United States. Corporations in the United States have made substantial time deposits in Canada and Europe in order to earn higher interest rates than can be earned domestically. The funds deposited in Canada were channelled into European banks, (particularly the UK) the Canadian banks acting as intermediaries for US dollars. Businesses and individuals in many other countries, e.g. Canada, Germany and Switzerland, can hold dollars and other foreign currencies without restriction as to time, amount or purpose. Some have themselves deposited funds in the Euro-market, or have placed them with domestic banks which have done so. In a number of industrial countries, where there is a residue of exchange control, as in France, business enterprises can hold dollars and other foreign currencies for limited periods of time through authorised banks.

The dollars emanating from the US current and long-term deficit remain deposited in the Euro-markets, and US resident funds was attracted, because of the higher interest rates paid on such deposits in these markets than in the USA. The effective floor to the deposit rate on Euro-dollars is determined for non-residents by rates paid by US banks on foreign time deposits and other comparable short-term investments in the United States. In 1961, the Euro-dollar rate in London averaged 3.58% compwasd with 2.35% on new issues of US Treasury Bills and 2.80% on prime bankers’ acceptances. In 1962, the Euro-dollar rate averaged 3.77% compared with 2.78% on US treasury bills and 3.01% on bankers’ acceptances .

The higher interest rate of dollar deposits in Europe was not the only “cost” factor determining the attraction of holding such deposits. The most favourable condition for non-American owned dollars was that the dollar exchange rate (spot) should be on the floor but that there should be no expectation of imminent dollar devaluation either in terms of foreign currencies or gold. European dollar holders did not then need exchange cover. If fears of a dollar devaluation become widespread, the supply of non-American dollars would tend to dry up as banks would sell their dollars to the central authorities which would convert into gold. If the dollar rose to the top of the range against European currencies, the possible 2% fall over three months could militate heavily against Europeans continuing to hold and lend dollars, although it would not of course affect deposits attracted from American residents.

European banks were willing to pay higher rates on dollar deposits than American banks because they could find a profitable use for them. The dollars were used in the following ways: without switching into another currency; with switching but without forward cover; and with switching and with forward cover. Any of these possibilities could lead to investment, which more than covered the deposit charge which led to a demand for Euro-dollars. The banks holding the dollar deposits lent to governments by investing in government debt instruments and to commercial borrowers. The amount of borrowing by the banks to take advantage of pure interest arbitrage was a factor, although not the major one, determining the demand for Euro-dollars. Rates on Euro-dollars had been consistently too high to permit covered arbitrage in UK Treasury Bills, but when confidence in sterling was high there has been uncovered arbitrage. However, the rates on UK local authority and finance house deposits have been high enough to enable covered arbitrage transactions to take place at times. This process was usually short lived as the process of switching on any large scale removes the arbitrage advantage.

Most of the demand for Euro-dollars came from businesses and commercial enterprises. As, the dollars may have been needed to finance export-import operations. Commercial banks may use the dollars to serve as a money market instrument. A bank that temporarily needs additional liquidity may accept dollars (or other foreign currency deposits) instead of discounting with its central bank or selling assets in the open market. Moreover, since deposits can be accepted or placed in a wide range of maturities, banks can use then very flexibly. Likewise, businesses may be in temporary need of liquidity or may need dollars to finance overseas investments. For blue-chip industrial and commercial customers the rates that they will pay for borrowing from the market will range upwards from 5½% (i.e. from prime borrowing rate in the New York market). The maximum rate that can be charged in the Euro-market is the rate that the customers would have to pay in their domestic market. As the banks will be paying in the region of 3½% – 4½% for Euro-deposits, their maximum “turn” will be in the region of 1%-2% .

Switching out of dollars into European currencies can be profitable either for the Euro-banker direct or for the borrower who wants to finance in his own currency. In such a case the limit to such an operation would be where the cost of switching into the domestic currency and covering the transaction forward equalled the cost of securing funds on the domestic market. However, the business of switching is best regarded as a specialised concern operating in certain favourable times, but not essential to the functioning of the Euro-dollar market.

The growth of the Euro-dollar market has been basically the result of the difference in the interest rate structure of New York and European centres. Interest rates had been lower in the USA than in Europe and the deficit on trade and long-term capital accounts remained deposited in Europe rather than returning to New York, which had enabled European bankers to outbid New York for deposits (and deposit rates). Secondly, and of increasing concern to the American authorities, US residents have been attracted to the Euro-market, again because of higher rates, and this has added to the US capital outflow. Also, the widespread differences between borrowing and lending rates in New York and in most domestic capital markets had enabled the Euro-bankers to outbid their domestic counterparts for lending outlets by working on smaller margins, relying on a heavy volume of business to make their profit. The market had also been stimulated by certain non-interest rigidities in domestic markets, e.g. exchange control, credit squeezes etc.

The effect of the growth of this international currency had been: Firstly, to influence the structure and level of short-term rates in a number of countries. The Euro-market had tended to internationalise interest-arbitrage transactions. Secondly, to make it more difficult to carry out large changes of domestic monetary policy. Attempts to tighten liquidity would, by raising interest rates in the domestic market, lead to inflows of Euro-dollars. Thirdly to reduce the cost of foreign trade financing as the Euro-bankers have under-cut domestic charges.Finally, to increase the importance of the dollar as an international currency used in both trade and finance. As American non-residents were more willing to hold dollars because of the attractive interest rates to be obtained, international liquidity has been increased. The Euro-dollar market had been of help to the American balance of payments to the extent that non-residents have been willing to hold dollars instead of converting them into gold. However, higher deposit rates in the Euro-market had attracted US residents to invest in the market, and thus add to the US outflow. It had therefore been argued that it would be of advantage to the USA, if the latter could be reduced or eliminated without affecting the advantage to be gained by the former.

However, although the American authorities were concerned about the resident outflow resultant on the existence of the Euro-dollar market, there was evidence to suggest that the resident outflow was more than offset by a return flow of Euro-dollars back to the USA. Between December 1963 and March 1963, UK banks which were by far the biggest operators in the Euro-dollar market, increased their dollar claims on US residents by £147m while their US resident liabilities rose by only £4 million . These figures probably overstate the net inflow of dollars to the USA, as unknown quantity of resident funds reach the Euro-market via Canadian banks and were not picked up within the scope of these figures. Nevertheless, the amount of resident funds reaching the market was small and was probably offset by a substantial return flow. This return flow arose because of the wide-spread between the deposit and lending rates of US domestic banks which enabled European banks to outbid US banks for lending outlets in the US market. The existence of the Euro-dollar market certainly facilitated the lending by European banks to US residents.

American domestic banks were limited on the interest rates that they could pay on resident time deposits by “regulation Q”. The maximum interest rates payable varied between 1% on 30-day deposits to 4% on 360-day deposits . As a result, when they were short of funds, they often encouraged their European subsidiaries to enter into the Euro-dollar market and bid for dollars, the subsidiary then repatriated the dollars to its head office in America. To the extent that the European subsidiary attracted US resident deposits, this was a roundabout way of the US bank offering American residents a deposit rate in excess of that permitted by Regulation Q. The Euro-dollar market would cease to grow when rates in New York and in Europe for lending and borrowing were exactly aligned for all types of customers and when the differential between the lending and borrowing rates was small enough to make any banking operations unprofitable. Even if such conditions held, the dollars outstanding would still continue to be utilised for arbitrage operations and so there will always be some scope for Euro-dollar operations.

When the Euro-dollar market would be naturally curtailed, there were attempts to restrict the operations of the market in the following ways: The rate of interest charged on dollar loans was artificially increased. Italy is the clearest example of this. Agreements by Italian banks covering minimum rates on loans in lire were supplemented in 1961 by minimum rates on dollars and other foreign currencies. This agreement has been continually revised. Secondly, under the stress of competition, it was agreed or understood by banks in some countries (e.g. Germany) that loans in foreign currency should be made only to the foreign trade sector. Finally, in many European countries, the competitive effect of foreign loans was restricted by exchange or capital control regulations.

There was some concern about the relationship of the Euro-dollar market to actual or potential speculation against the dollar as the Euro-market was largely beyond the immediate control of the American monetary authorities. There was two sides of the argument. As the interest rates on dollar deposits was attractive, this gives an incentive for the dollars resultant on the deficit on trade and long-term capital account to remain unconverted into gold. The fact that dollars were placed in the Euro-market rather than used to buy gold, indicated that someone was not speculating against the dollar. On the other hand, the attraction of the market did induce American residents to invest short-term capital abroad and added to the funds in the market. However, there has yet been no evidence that the market for Euro-dollars had been unstable, although these dollars could be used for a speculative attack on the dollar.

It had been suggested that it would be preferable from the point of view of speculative pressure if the dollars resultant on the American payments deficit were held by foreign central banks. If there was a speculative attack against the dollar, the dollars held in Europe in private hands would be sold to the central authorities. Thus, it was the central authorities in Europe that was the holders of Euro-dollars “at last resort”. They were the focus of changing potential into actual speculation against the dollar – to the extent that they were willing to hold dollars speculation was curbed. The real point was that New York had become an international banking centre whether or not this was liked by the American authorities and it was difficult to see what could be done about this other than by changing the payments and interest rate structure of the USA or imposing exchange restrictions. If American banks could raise the interest rates they were permitted to pay on deposits to residents, this would tend to reduce the resident funds going into the Euro-dollar market – unless European authorities raised their own rates.

The “evolution” of the Market

By 1963, Euro-dollar operations were a particular form of banking whereby foreign banks, chiefly European, accepted deposits of dollar claims and in turn, lent these dollar claims to their customers. Typically, these deposits and loans were made for short periods. The supply of funds to the market came mainly from foreigners having dollar claims as a result of the US balance of payments deficit. The correspondent banks found that, operating with only a small interest rate spread, they could make a profit by lending these dollars balances at rates lower than those charged by traditional lending outlets in the United States. Other dollar holders soon found that they could engage in similar operations. Soon, British banks offered their customers and correspondents dollar facilities to take the place of the prohibited sterling credits, obtaining requisite balances in the European dollar market .

The demand for Euro-dollars came from a variety of sources, mostly in the private sector. The commercial banks of a large number of countries accepted and employed dollar deposits for use in both international and domestic operations. A substantial amount of Euro-dollars were used to finance firms engaged in international trade. These firms used Euro-dollar finance in preference to the more normal acceptance credits because of lower interest rate charges and because of the convenience of borrowing (given both the wide range of maturities available and the ready supply of funds in the market). Japan has figured prominently in the use of Euro-dollars for international trading. The highest interest rate that a Euro-banker could charge for lending dollars would be what it would cost that borrower to raise dollars on the New York market. This does not mean however that the effective upper limit to lending charges is the New York prime rate, as relatively few foreign borrowers would be eligible for that rate .

Perhaps most of the funds provided in the Euro-dollar market were lent in the United States. Virtually since the market began, US banks, through their European branches, have been active in the borrowing side of the market. The European branches have actively bid for Euro-dollars and have then repatriated to the United States. To the extent that the subsidiaries have attracted US resident funds, domestic residents may have been paid, indirectly, rates on time deposits in excess of those permitted under Regulation Q.

A main feature in both the evolution of the Euro-dollar market and the revival of the London international capital market, was the issue of a Belgian Government loan in London during May 1963. The loan had a three-year maturity and was denominated in dollars. The subscribers were a group of British banks which, it is generally thought, financed the loan in Euro-dollars . This was a departure from the normal short-term lending prevalent in the market and was the first issue handled by British banks in currencies other than sterling since the war.

Also, by 1963, Euro-dollars were used as money market instruments by foreign commercial banks. In view of the fact that dollars could be loaned or borrowed for various periods they constitute an excellent medium for banks to adjust their liquidity positions. In these operations the market is analogous to the Federal Funds Market in the US. Often banks were trading on both sides of the balance sheet, both lending Euro-dollars and at the same time borrowing. As well as loaning dollars, Euro-bankers used the dollars to buy other currencies and lend in foreign markets. In such a case the bank will arrange to sell its foreign currency holdings for dollars at a future date, i.e. it will hedge against the exchange risk. Occasionally, dollar deposits in European banks was used to take advantage of interest arbitrage opportunities. For example, there is likely to be a strong relationship between the amount of dollars switched into sterling and loaned to the UK Local Authority Market and the margin between rates of interest on Local Authority deposits (adjusted for the cost of forward cover) and the rates on Euro-dollar deposits. At times, Local Authorities have borrowed substantial short-term funds from the Euro-dollar market. Although Euro-bankers will not usually ignore an interest arbitrage possibility, the main type of transaction is that in which dollars was loaned directly .

Selling dollars for foreign currencies can be profitable either for the Euro-banker or for the borrower who wants to be financed in his own currency. In such a case, the limit would be where the cost of borrowing dollars and switching into the foreign currency and covering the transaction for exchange risk equalled the rates charged on local funds. It can be seen that Euro-dollar operations was similar to normal foreign exchange operations. Therefore, the market can best be regarded as a supplement to normal foreign exchange operations whereby foreigners having claims on the United States sell their dollars for other currencies, and others, wanting dollars, buy them through exchanges.

It should again be emphasised that the whole complex of Euro-dollar operations was reflected in the transference of ownership of dollar deposits within the US. These dollar deposits will continue to be held in US banks unless: (1) at some stage, dollars was converted into a foreign currency, or (2) the dollars come into the hands of central banks, that, in turn, convert then into gold, or (3) the dollars were used to pay off a loan at a United States bank.

The three media articles at the back of this paper (Appendix 1 and 2 referring to The Times, and Appendix 3 referring to The Financial Times) indicates that the Bank of England underestimated the significance of the Euro-currency markets for the UK’s own problems of monetary management, internal and external. For example, in so far as short-term capital flows increasingly take the form of a movement out of sterling into the Euro-dollar market (and vice versa), what kind of offsetting action do we take? If the UK was not going to use short-term interest rates, can we in some way look to the market as a source of funds just as we have recently looked to foreign Central Banks.

The Euro-bankers were really worried by the growth of the negotiable certificate of deposit in the United States the interest rate on which has just risen so that it is now only at a slight discount on dollar deposits in the UK. UK bankers can of course increase the Euro-dollar rate (which I would suppose is inevitable) but the differential between the Euro-dollar and the time certificate of deposit rate is likely to be much less than we have seen in the past. This is because of the effective upper limit on the Euro-dollar rate of 4½%, i.e. prime lending rate in New York. If the Euro-dollar rate exceeded 4½% borrowers who previously used the Euro-dollar market would borrow direct from New York. The effect on the UK balance of payments of such a development is difficult to estimate as Europeans would still borrow dollars – switching from the Euro-market to the New York market directly.

In order to combat the increasing development of the time certificate of deposit there were ideas from the City of a “negotiable Euro-dollar deposit”. The advantage of this instrument to the Euro-bankers was that the necessary differential to attract funds would be less in the case of a negotiable dollar deposit than with the usual dollar deposit. It was thought that there was a real possibility of such a development in the Euro-dollar market. The UK should not worry about this any more than about the present state of the Euro-dollar market and in fact such a development might well be welcomed as it would avoid putting too much upward pressure on the Euro-dollar rate which could be embarrassing for domestic short rate policies. A differential between UK Treasury Bill rates (adjusted for the cost of forward cover) and the Euro-dollar rate, in favour of Euro-dollars, could lead to switching of funds previously held in the UK, by non-residents into the Euro-market. It is the general problem of separating outflows of sterling which is causing great difficulty. One can only arrive at an approximate answer by correlating relative interest rates against the outflows. However, the Euro-dollar differential appears to have exerted little influence on the switching of funds out of sterling balances. This of course does not mean that the Euro-dollar/UK Treasury Bill differential has not exerted an influence in the past – it simply means that as yet we have not proved it. As one would expect, sterling holders be tempted to switch their funds by an attractive premium in favour of Euro-dollars, (unless they was completely irrational).

The Euro-dollar market was composed of a very large amount of funds highly sensitive to relative movements in interest rates. If a position was postulated whereby UK interest rates fall relative to Euro-dollar rates, (US interest rates rise which pushes up the Euro-dollar rate and UK short rates do not follow), the effects on the UK balance of payments would be of two types: (a) funds invested in the UK directly by Euro-bankers (usually in Local Authority deposits) would be withdrawn; and (b) sterling balances of non-residents would be switched into dollars and invested in the Euro-dollar market . Funds invested in the UK directly by Euro-bankers will be shown up by changes in “Dealers’ net deposit liabilities in foreign currencies”. These liabilities reflect the extent to which banks have switched any foreign currency deposits lodged with them into sterling. In all cases, the initiative is in the hands of the banks themselves. By no means all of the switching done by the dealers is the reflection of relative interest rate advantages, but nevertheless this is bound to be a part. As a large part of the foreign deposits lodged with UK banks will be dollars on which the banks pay the Euro-dollar rate, and as generally speaking, all switching is covered forward, the banks will have usually found it unprofitable to have borrowed these funds and to have invested in UK treasury bills. However, there have been arbitrage advantages in investing in local authority deposits or finance house deposits .

1964 – “The New Labour Administration”

1964 was a significant era for the Euro-dollar market, as not only was there a change in Government, but it was at this time that Euro-dollars changed from being a new phenomenon into a prominent force in the market. The Labour Party had come to power, with Harold Wilson, as the new British Prime Minister. However, it was clear for the new Labour Administration that the UK was facing a deficit of £800m on its overseas payments for the year 1964. It was this inheritance from the Conservatives which was to dominate almost every action of the government for five years. The new administration was faced with three courses of action: devaluation of sterling, quantitative restrictions on imports (quotas), and a surcharge, in effect a temporary additional tariff, on a wide range of imports. At the time in 1964, devaluation was not an option, given the size of the new government’s majority, it was not a surprising decision. Also, the new incoming government did not fully know the true facts of Britain’s deficit. However, there was no option but to accept devaluation. In 1967, there was no alternative, central bank and governments accepted the decision as necessary. However, Wilson, had argued strongly (from 1964-67), that devaluation was not a easy way out, that by its very nature in cheapening exports and making imports dearer, it would require a severe and rapid transfer of resources from home consumption, public and private, to meet the demands of overseas markets. This would have meant, brutal restraints in both public and private expenditure over and above the domestic situation that the labour administration had inherited. Other considerations, were that devaluation could have started a competitive currency devaluations – similar to those of the 1930s, and could have led to stimulating economic nationalism and blind protection abroad .

Quotas were rejected, due to the damage it could have inflicted on industrial production, no matter how selective the system, and in particular, their effect in ossifying the industrial structure, penalising new or growing or efficient firms and “feather-bedding” the un-competitive. Tariff was the third proposition left. However, this was not an easy option either. As, it would be argued abroad that a sudden rise in the tariff over a wide range of commodities was contrary to the UK’s international obligations, particularly those of GATT, and EFTA. Other nations that had close economic relations with the UK, such as the Commonwealth countries, the Irish Republic, the USA, would have had strong grounds for protest. There was fear that once imposed, the surcharge would be difficult to remove. Other fears were that UK manufacturers that were enjoying a temporary protection against foreign competition, would slide into easy ways, instead of responding to the challenge by making themselves still more competitive. However, despite these anxieties, action had to be taken, so the import surcharge was recommended. It was decided that a rate of 15% would be imposed on all imports, except food, tobacco and basic raw materials. On the 26th October, ten days after taking office, a statement was issued underlying the “economic situation”. It concluded that the strength of sterling could and would be maintained, the underlying economic situation remained profoundly unsatisfactory. The balance of payments deficit for 1964 was most unlikely to be below £700m and might well reach £800m. While a considerable improvement was expected, in 1965, the deficit would still be at an unacceptable level. The position on imports and exports was surveyed together with the domestic economic situation, the problem of “continually rising prices” – and the position on public expenditure. The statement went on to announce the introduction of surcharges, at 15%, on all imports, except food, tobacco, and basic raw materials. In its first ten days in office, it was clear that the new Labour administration had to deal with an explosive economic situation .

The Economy – “Speculation against Sterling and the drain on reserves”

In London, there were a number of large international companies which held considerable amounts of working capital in sterling. There was a growing business in the speculation in sterling (based on selling sterling to obtain foreign currencies). These “players” held the future of sterling – particularly to the exchange rate itself – tend to move their money out, even at a relatively high cost in terms of interest, to some currency they regard as more secure. At the time of heavy balance of payments deficit there was, a large quantity of sterling splashing about in the markets of the world and, when confidence in sterling was low, dealers in many markets sold sterling for US dollars, German Marks, Swiss Francs, or anything deemed safer. The only way in which British citizens were able to take a position in sterling, (as they expected either a marginal fall or an outright devaluation) was by postponing receipt of the payments that was due to them in some foreign currency, since after the fall in the sterling rate such foreign currencies would be worth more in sterling terms .

However, importers who had to make payments in foreign currency tended to advance their payments, paying the bill beforehand. In difficult times, there was clear evidence that importers were increasing the physical qualtities of their imports, buying their raw materials 3-6, even 12 months ahead, and paying as quickly as possible for the imports thus ordered. These “Leads and lags” had the effect of running into hundreds of millions of pounds on the sterling position and thus on the reserves. On top of this, speculation grew to great proportions when a devaluation was expected. Such dealings were confined to foreign exchange dealers/speculators. These were in the form of dealers getting rid of sterling, they held or selling sterling they did not possess with the idea of buying it back some days later. This meant that, if these dealers had to pay bills in sterling, they had to borrow at extortionate rates of interest. Nevertheless, this speculation proved so severe that, it was becoming a threat to the balance of payments deficit. Indeed, it virtually disappeared as a threat once the UK moved into strong surplus, but that was after 1969. However, before the UK was in surplus, the government had to take actions against what the speculators might do, hereby looking at the “confidence factor”. So, things had to be rightly timed, in order to minimize possible speculative consequences, (this was also the case in 1969 when the UK were moving into a strong surplus). This meant that the City, closely monitored the actions of the Chancellor, the Governor of the Bank of England and the Prime Minister. One mistake the government admitted was always underestimating the power of the speculators. It was this understanding, that made the government more determined to strengthen the basic position of sterling, which meant strengthening the balance of payments – which in turn strengthening the competitiveness of British industry. This was the point of the Chancellor’s statement on the 11th November 1964. As, there was, a considerable surplus of highly volatile sterling in world markets because of the balance of payments deficit .

Since the Chancellor’s statement, both the PM and the Chancellor received a daily tally of the movements on foreign exchange markets, recorded not only by the exchange rate, but the amount of money which the Bank of England had to throw into the market to stabilise the sterling rate, together with payments on government account. This was regular right until 1969. Day by day, the government listened to demands for immediate cuts in government expenditure, and faced heavy drain on the reserves. It was a situation where 50 million pounds could have been lost, sometimes more, and the UK’s total gold reserves and convertible currency reserves barely totalled 1,000 million pounds. Short-term central bank assistance was near exhaustion, and there was no immediate prospect of the IMF borrowing on which the UK decided. The pound was at its support level. On the 25th November 1964, the Governor of the Bank of England stated to the PM that ,000 millions was successfully raised by the central bankers. It seemed that sterling was safe, for a time. Long enough, to strengthen exports to the point where day-to-day speculation was not reinforced by a chronic balance of payments deficit .

Euro-dollars – “a prominent force in the market”?

It was clear in 1964 that a large international money market in short-term dollars had developed outside the US. These transactions were made possible because Americans and foreigners deposited dollars with banks outside the US, which had profitable uses for them. It was estimated with some assurance that dollar deposits come from at least 25 countries and that the final users of dollars reside in at least 35 countries .

About 400 commercial and private banks were in the Euro-dollar market. Many of these banks were in the market all the time, and they were on one side or the other, depending upon profits that may be earned from interest rate differentials and arbitrage possibilities. Other banks were in the market irregularly in order to deal with the financing needs or the savings accumulations of particular clients. The Euro-dollar market held no bar to politics. The two large communist banks in Western Europe – the Moscow Narodny Bank in London and the Banque Commerciale de l’Europe du Nord in Paris – were important components in the market, sometimes to place deposits with other banks (lend) but more often to accept them (borrow) . The states banks behind most of the countries behind the iron curtain were in the market, and many of these regularly circularize commercial banks in the West in order to obtain funds. Brokers play an important specialised role as intermediaries among banks, and two of them – one in Paris and the other in Lausanne, with their branches – do a large international business . The market in Euro-dollars was a wide and complicated one spread over six continents and bound together by a network of cable, telex, and telephone communication. The paper work in the market tended to confirm rather than to initiate transactions. The financial standing of the banks in the market was such that transactions were based on names and did not involve collateral and guarantees.

As the market progressed, the movement of Euro-dollars became an important financial activity and it was clear from the City that there were three major uses for Euro-dollars: First, a large part of these dollars was used to finance external commercial transactions, i.e. exports and imports. Indeed many countries in Europe and elsewhere tried to restrict Euro-dollar activities to those business enterprises that were engaged in foreign trade. These restrictions operated through systems of capital controls, or exchange controls, or moral persuasion by central banks. Even European countries with convertible currencies may restrict or prohibit business enterprises not engaged in foreign trade, e.g. hotels and department stores, from borrowing Euro-dollars, even though borrowing dollars may be cheaper than borrowing local currency. This was, for example, the situation in France. In 1961-63, with the expansion of issues of long-term securities denominated in dollars in European capital markets, underwriters and syndicate members have used Euro-dollars to finance their inventory positions. Italy made a large and noteworthy use of the Euro-dollar market in 1962-63, borrowing more than 0 million from abroad, of which about half came from the Euro-dollar market . These funds were used to finance external transactions and to make possible a continuing increase in domestic liquidity, which in effect, reduced the drain upon official reserves. Acting under instructions from the Bank of Italy, the commercial banks began to reduce their net external liabilities in the fourth quarter of 1963 and had gone a long way toward reversing their position.

Second, some Euro-dollar funds were used to finance commercial loans and other domestic transactions either in the form of dollars or in local currency purchased with dollars. There has been a large amount of such transactions in Germany, Italy, Japan and smaller amounts in many other countries, including Switzerland. In the UK, a substantial amount of Euro-dollars has been swapped into sterling and then placed with local authorities and instalment finance companies. The Kingdom of Belgium has, directly or indirectly, financed part of some of recent b

Mutual Funds – An Introduction and Brief History

Mutual Funds – An Introduction and Brief History

Each one of us does not have the expertise or the time to build and manage an investment portfolio. There is an excellent alternative available – mutual funds.

A mutual fund is an investment intermediary by which people can pool their money and invest it according to a predetermined objective.

Each investor of the mutual fund gets a share of the pool proportionate to the initial investment that he makes. The capital of the mutual fund is divided into shares or units and investors get a number of units proportionate to their investment.

The investment objective of the mutual fund is always decided beforehand. Mutual funds invest in bonds, stocks, money-market instruments, real estate, commodities or other investments or many times a combination of any of these.

The details regarding the funds’ policies, objectives, charges, services etc are all available in the fund’s prospectus and every investor should go through the prospectus before investing in a mutual fund.

The investment decisions for the pool capital are made by a fund manager (or managers). The fund manager decides what securities are to be bought and in what quantity.

The value of units changes with change in aggregate value of the investments made by the mutual fund.

The value of each share or unit of the mutual fund is called NAV (Net Asset Value).

Different funds have different risk – reward profile. A mutual fund that invests in stocks is a greater risk investment than a mutual fund that invests in government bonds. The value of stocks can go down resulting in a loss for the investor, but money invested in bonds is safe (unless the Government defaults – which is rare.) At the same time the greater risk in stocks also presents an opportunity for higher returns. Stocks can go up to any limit, but returns from government bonds are limited to the interest rate offered by the government.

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History of Mutual Funds:

The first “pooling of money” for investments was done in 1774. After the 1772-1773 financial crisis, a Dutch merchant Adriaan van Ketwich invited investors to come together to form an investment trust. The goal of the trust was to lower risks involved in investing by providing diversification to the small investors. The funds invested in various European countries such as Austria, Denmark and Spain. The investments were mainly in bonds and equity formed a small portion. The trust was names Eendragt Maakt Magt, which meant “Unity Creates Strength”.

The fund had many features that attracted investors:

It had an embedded lottery.

There was an assured 4% dividend, which was slightly less than the average rates prevalent at that time. Thus the interest income exceeded the required payouts and the difference was converted to a cash reserve.

The cash reserve was utilized to retire a few shares annually at 10% premium and hence the remaining shares earned a higher interest. Thus the cash reserve kept increasing over time – further accelerating share redemption.

The trust was to be dissolved at the end of 25 years and the capital was to be divided among the remaining investors.

However a war with England led to many bonds defaulting. Due to the decrease in investment income, share redemption was suspended in 1782 and later the interest payments were lowered too. The fund was no longer attractive for investors and faded away.

After evolving in Europe for a few years, the idea of mutual funds reached the US at the end if nineteenth century. In the year 1893, the first closed-end fund was formed. It was named the “The Boston Personal Property Trust.”

The Alexander Fund in Philadelphia was the first step towards open-end funds. It was established in 1907 and had new issues every six months. Investors were allowed to make redemptions.

The first true open-end fund was the Massachusetts Investors’ Trust of Boston. Formed in the year 1924, it went public in 1928. 1928 also saw the emergence of first balanced fund – The Wellington Fund that invested in both stocks and bonds.

The concept of Index based funds was given by William Fouse and John McQuown of the Wells Fargo Bank in 1971. Based on their concept, John Bogle launched the first retail Index Fund in 1976. It was called the First Index Investment Trust. It is now known as the Vanguard 500 Index Fund. It crossed 100 billion dollars in assets in November 2000 and became the World’s largest fund.

Today mutual funds have come a long way. Nearly one in two households in the US invests in mutual funds. The popularity of mutual funds is also soaring in developing economies like India. They have become the preferred investment route for many investors, who value the unique combination of diversification, low costs and simplicity provided by the funds.

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The US Dollar Exchange Rate History Chart

The US Dollar Exchange Rate History Chart

The U.S. Dollar’s exchange rate, as expressed on any US Dollar exchange rate history chart, will only tell the story of how the dollar has performed against another specific currency. FOREX trades are made strictly in pairs, as one country’s currency versus another. How the U.S. Dollar performs against the Euro Dollar may be totally different than its price relationship to, say, the Japanese Yen.

The U.S. Dollar is the most traded financial currency of any in the FOREX market. All the most favored trades include the Dollar as one of the pair. The most often traded pair, by the way, is the Euro Dollar against the U.S. Dollar. When this trade is entered into by investors, they are betting that the relationship of the Euro and the U.S. Dollar will go the way they predict. If the trade is long, they are expecting the Euro to increase in value. If the trade is short, they are hoping for the opposite.

Back in July, 1944, at the height of the Second World War, 730 representatives from all the 44 Allied nations met at a hotel in New Hampshire for the United Nations Monetary and Financial Conference. Obviously, delegates from Germany and Japan were not in attendance, since those countries were not part of the Allied group. It was during this conference that the IMF (International Monetary Fund) was created and a system which became known as the Bretton Woods System was put into operation.

Looking at a US Dollar exchange rate history chart from that time shows the dollar to be the strongest world currency, but the war was very expensive. This system was meant to establish rules for international monetary policy and for the financial relations between member countries and their individual currencies. These rules obligated countries signing the accord to adopt financial and monetary policies that would keep the exchange rates of their respective currencies within a certain range as they related to the current value of gold.

This all changed, however, when in 1971, the U.S. unilaterally went off the gold standard by canceling the convertibility of dollars directly into gold. No longer requiring its currency to be backed by gold, the U.S. was free to print as much money as it liked. Many experts see this event as the cause of the financial meltdown suffered in the world beginning in 2007.

Currencies are now said to ‘float’ and their values, relative to one another, continually change. Bad economic news in a country can often cause their currency’s value to drop. Good news will frequently have the opposite effect.

The U.S. Dollar is currently traded against all major world currencies. This includes the Euro, the Yen, the Pound and the Swiss Franc. For an accurate US Dollar exchange rate history chart to be truly representative of dollar strength, it would have to be compared to a basket of all these individual currencies.

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Mortgage Interest Rate History, and a Change for the Future

Mortgage Interest Rate History, and a Change for the Future

Today’s economy is very dependent upon mortgage interest rates. Right now the interest rates are very low. This, of course, is good. Today, a 30-year mortgage can be obtained for about 6%, maybe less. At 6%, a 0,000 mortgage for 30 years would result in a monthly payment of ,199.10.

What would happen if mortgage rates suddenly went up to 10%? Well, this same mortgage would require a monthly payment of ,755.14. It doesn’t take much imagination to see that this would have a negative effect on the overall economy. Someone requiring a 0,000 mortgage to buy a home, would need to be able pay 0 more per month to qualify for the same loan.

To the economy, this is wasted money. If a person was required to come up with 0 more per month to buy the house because the price was that much higher, it would be negated by the fact the seller would have made more money by selling the house.

If the seller happened to be an entrepreneur, this extra money would end up creating more jobs. In any event, the extra money would be put to some use in our economy, even if it were just put into a savings account. However, paying a higher price because interest rates are higher means no one gains anything. This, in itself, would cause an economic slowdown.

However, interest rates are good and have been for quite some time. So, you may ask how do these interest rates compare with other rates throughout history?

Fannie Mae and interest rate stability

In 1938, Fannie Mae was instituted. This put mortgage rates into a particular market. Before this time, mortgage rates varied wildly from lender to lender and between different areas of the country. With Fannie Mae, loans could be sold between different institutions. Having more people involved in a market tends to stabilize the price of the underlying commodity.

Back in 1938, there wasn’t a lot of money around. Because of this, mortgage rates were very low, as low as even 3%. In the ’40s mortgage rates stayed low in part because during wartime most of the economy was regulated and buying a house was very difficult. So, there wasn’t a lot of demand for mortgage money.

The early mortgage rates

In the ’50s and right up until the mid ’60s mortgage rates hovered around 5% to 5.5%. This is very close to where mortgage rates are now. However, starting in 1971, mortgage rates started to increase. In fact by the late ’70s, they had become out of reach. People who didn’t enjoy a top credit rating were asked to pay as much as 23% for a mortgage. This of course, was devastating to the overall economy, so much so, a misery index was even created to gauge how bad consumer sentiment was.

Controlling the price of oil is not a new idea

Part of the reason interest rates were skyrocketing during the ’70s, was the fact price controls were tied to oil prices. This had a very negative effect on the overall economy. It made gas unavailable to consumers and disrupted the normal American way of life.

Starting in the early ’80s, Reagan-omics started interest rates falling once again. This trend, which started in about 1983, has not ended yet. The interest rates of the ’90s ranged between 7% and 9%. Since about 2001, they have been between 5% and 7%. All in all, for the last 20 years we’ve enjoyed moderate interest rates.

Now that we’re a closing in on a 50-year low for mortgage rates, it makes us wonder if this downward trend is ending and if mortgage rates will once again head upward. When I think of the possibilities, I must say I am petrified!

Is anybody for a change?

In this presidential election year, I hear many people say they’re looking for a change. To me, this means interest rates being low is not what these people are looking for. Perhaps they would like interest rates at 15 to 20%. In their quest for change it would mean they would have to give up on the war against terrorism. This is a war we are winning, but change would mean they’re looking to lose it.

Though the economy is no longer screaming along as it did for most of the last 23 years, the economy is not in a recession. In fact, it’s not really close. But change would mean a recession. A profound change would mean a depression.

In our current economy the unemployment rate is about 5.2%. Not long ago, full employment was considered an unemployment rate of 6%. Within the last two years the unemployment rate reached an all-time low of 4.5%. However, people are looking for change. Perhaps the German-French style 13% unemployment rate is what they desire!

During the last 20 years, we’ve made many trade agreements with other countries. This has resulted in lower prices to consumers and lower prices to small businesses. This has been healthy for our economy because it has allowed the small businesses to expand and create. It has also allowed people to save and invest.

Those looking for change want to do away with our trade agreements with other countries. They have bought into the notion that free trade exports jobs. However, without free trade the common PC would cost about ,000. This would be a change!

In 2003, our income tax rates were lowered. This has been very healthy for our economy. One of the changes some are looking for is to raise those income taxes again.

Worst of all, another one of the changes would be following those who want to put price controls on oil again. This would do the trick! It would indeed, mean change. Are you ready for 23% mortgage rates?

It?s All About Money

It?s All About Money

The India money market has come a long way since the last two decades. In short, money market means exchange of short term funds (that included, lending and borrowing). Thus the money market funds come into play. If we want to revise the history of the growth, the rise in the money market news is a clear indicator of that.

Before we discuss the India money market scenario, we first have to know what exactly are the money market funds. As we get to know from the investment dictionary, A money market fund’s purpose is to provide investors with a safe place to invest easily accessible cash-equivalent assets characterized as a low-risk, low-return investment.  The money market news tries to get the people updated with the latest money market scenario so that they can make uptheir minds regarding the kind of money markets funds they want to invest into.

The money market is a mechanism that deals with the lending and borrowing of short term funds. The India Money Market has come of age in the past two decades. In order to study the money market of India in detail, we at first need to understand the parameters around which the money market in India revolves.

The Indian Money Market is heavily dependent on the interest rate that is inflation adjusted (real interest). As is the case with the money market funds, structural barriers and other institutional factors creates distortion in the India Money Market (as it gets reflected in the money market news) though the money market is free from interest rate ceilings. Apart from the call market rates, the other interest rates in the Indian Money Market usually do not change in the short run. Like the money market funds, there are the money market deposit accounts, which play a similar role. There are others like the ultra short cash bonds, enhanced cash bonds etc. the money market news are filled with the contents and information about more such many making/increasing devices.

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Forex Rates History

Forex Rates History

As the largest financial market, forex market has a great development in recent years with a daily trading above ＄1.5 trillion. However, few systems and software in forex market can bring significant benefits to the customers.

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BIG Anniversary! Will History Repeat Itself? Don’t Leave This “Dragon” Out of Your Calculations!

BIG Anniversary! Will History Repeat Itself? Don’t Leave This “Dragon” Out of Your Calculations!

Winston Churchill said it, ” Those who fail to learn from the past are doomed to repeat it!” Today I want to  solemnly remember the Crash of 1929.  You see it was on this day some eight decades ago that the market hit an all time high only to find it about 2 months later falling 40%.  Once you read this you’ll see that market conditions TODAY are mirroring past conditions that lead to some of the worst market collapses in history.  I BEG YOU… please read this and learn the lessons.  This is NOT a time to be taking this “DRAGON” lightly.

Since we need to learn from the past, I wanted to share some of the history from past collapses.  (Excerpts from “Market Volume”.)

The Crash of 1929

On September 4, 1929, the stock market hit an all-time high.  On October 29, 1929, the stock market dropped 11.5%, bringing the Dow 39.6% off its high.

After the crash, the stock market mounted a slow comeback. By the summer of 1930, the market was up 30% from the crash low. But by July 1932, the stock market hit a low that made the 1929 crash look like a picnic. By the summer of 1932, the Dow had lost almost 89% of its value and traded more than 50% below the low it had reached on October 29, 1929. following is a look at the days following the initial panic!

October 24, 1929 – Black Thursday

The stock market really crashed over a period of five days. The first sign of trouble was on Black Thursday – October 24th, 1929. At that time, the stock exchange typically traded around 4 million shares each trading day. But on Black Thursday, a record 12.9 million shares were exchanged.

The systems for tracking the market prices could not keep up with the trading volume and that may have contributed to panic selling on that day. At one point, ticker tapes were running nearly 90 minutes behind the market. By the end of the day, the market had fallen 33 points or around 9%.

October 28, 1929 – Black Monday

Following Black Thursday, the market bounced back a bit on Friday. This lead to a sense of security over the weekend as investors felt the market could rebound. However, market conditions quickly deteriorated again on Black Monday – October 28th, 1929 – and high trading volumes once again put pressure on the flow of information.

On Black Monday, trading volumes were near 9.25 million shares and market confidence declined sharply. By the end of the day, the market was down another 13%.

October 29, 1929 – Black Tuesday

Black Tuesday – October 29th, 1929 – is that day that most historians agree dealt the final blow to the Roaring 20s and was the starting point of the Great Depression. On Black Tuesday, a record 16.4 million shares changed hands. The ticker tape machines fell behind by nearly 3 hours. With all hopes of a market recovery now gone, panic selling continued and the market fell another 12%.

Recovering from the 1929 Stock Market Crash

Over the next month the market continued to decline sharply, however, the market would not bottom out until July 1932, when the Dow hit 41 from a high of 381 in 1929. That’s a decline of nearly 90%! Even as the market started to rise in 1932, it would take another 22 years before the Dow would climb above the levels seen in 1929.

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In total, 14 billion dollars of wealth were lost during the market crash.

The Crash of 1987

The markets hit a new high on August 25, 1987 when the Dow hit a record 2722.44 points. Then, the Dow started to head down. On October 19, 1987, the stock market crashed. The Dow dropped 508 points or 22.6% in a single trading day. This was a drop of 36.7% from its high on August 25, 1987.

During this crash, 1/2 trillion dollars of wealth were erased.

The Crash of 2000
From 1992-2000, the markets and the economy experienced a period of record expansion. On September 1, 2000, theNASDAQ traded at 4234.33. From September 2000 to January 2, 2001, the NASDAQ dropped 45.9%. In October 2002, the NASDAQ dropped to as low as 1,108.49 – a 78.4% decline from its all-time high of 5,132.52, the level it had established in March 2000.  TO DATE IT’S NEVER COME BACK TO IT’S ALL TIME HIGH!

A total of 8 trillion dollars of wealth was lost in the crash of 2000.

Crash of 2008

We hit another milestone in ’09. The market had fallen farther faster than it did during the Great Crash of 1929-1932.

The stock market peaked on Oct. 9, 2007. Then, the S.&P. 500 went down 56 percent and the Dow -53 percent.
On Jan. 29, 1931 — the identical number of days after the 1929 market peak — the S.&P. 500 was down 49 percent and the Dow was down 56 percent. The 1929 crash got off to a much faster start, but we have now more or less caught up.

HERE ARE SOME THINGS TO CONSIDER:

1)  Note that it continually refers to the amount of money LOST at the end of the downturn.  THAT’S BECAUSE IT WAS LOST!!  In other words, as in never to be found again.  Why is this an important distinction?  Because I hear people all the time say, “Oh, I just lost it on paper.” or “Well I didn’t lose my principal!”  Like somehow what you LOST was not real money!

LET’S GET REAL COULD WE PLEASE! If you had taken the money out before you didn’t lose your principal YOU’D HAVE HAD A HECK OF A LOT MORE MONEY WOULDN’T YOU? So just face it YOU BLEW IT!  You lost it and can’t ever get it back.  Did you lose money in 2000-03 – how ’bout ’08?  HOW MUCH WOULD YOU NOW HAVE IF YOU’D NEVER LOST IT IN THE FIRST PLACE?  Are you back “even” yet?  If not, why are you using the same strategies and expecting to get a different result?  (Einstein said that was the definition of insanity.  So ARE YOU INSANE?!) I don’t think so.  You just don’t know you have an alternative. (and there is an alternative)

This principal of avoiding losses is called taking advantage of OPPORTUNITY COST.  In other words, if you never lose the money it will continue to earn interest for your benefit; you earn interest on your money, interest on the interest and interest on the money you would have lost but instead were wise enough to preserve; opportunity cost.  Other OC  besides losses, are fees and taxes that can be avoided.

2) THE MARKET IS COMING BACK! Really?  It hasn’t come back from 2000 yet!  What makes you think things are going to get better any time soon?  You’ll notice that  in most cases the market gave the impression that it was on the rise only to fall lower than the first crash.  And in most cases the second crash is worse than the first.  FOLKS, I BLIEVE THAT’S WHAT WE’RE HEADED FOR! If history repeats, and it usually does, we’re coming up on a worse collapse than the first.  It doesn’t take a genius to look at economic conditions, which are NOT improving, and know that something has to give.  Please, don’t let your retirement savings be the sacrificial lamb!

Most of you have been smart enough to move out of the market by now, although there are some I’ve talked to that, to their peril, are for whatever reason sticking it out and risking it all!  Congrats to those of you who at least moved to money market or CD’s.  Though there’s a problem with that as well.

The problem is your now are NOT making enough to keep up with future inflation AND the number of banks that are in trouble are at an all time high and more to come.  Here’s anther lesson from history in case you missed it; during the Great Depression the banking industry lost 44% or 10,000 banks!  What if history repeats?  How much will you lose?  Maybe everything?  The fact that it’s a possibility should be enough to make you want to find a better solution.

THE SOLUTION!

Life Insurance products! Oh, I know over the years they’ve gotten a bad name for who know what reasons.  But before you tune me out here’s another history lesson for you; during the Great Depression that spanned 24 years, the insurance industry only lost 6/10 of one percent of it’s net worth and NOT ONE PERSON WITH AN ANNUITY LOST A DIME! That’s a pretty decent record I’d say… wouldn’t you?  Here are some of the options:

* Indexed Universal Life Insurance - buy dollars with pennies, offers Tax free retirement income as well as offering a Tax Free death benefit to your heirs, tax benefits – interest tied to index for market like returns with NO RISK OF LOSS GUARANTEED!

* SPIA’s – Single Premium Immediate Annuities - Turn a lump sum of cash into a lifetime income stream – Personal Pension, if you would – exclusion ratio reduces taxes

* Fixed Annuities - Shorter terms, high interest rates than CD’s or Money Market, Tax deferred, Income guaranteed for life

* Fixed Indexed Annuities - Same as Fixed but interest earning tied to an index to give higher yield with the market WITH NO LOSS GUARANTEED!  Some longer terms but offering high interest potential – bonus offers from 4-20% added to your funds up front

* NEW income riders can be attached to some annuity products giving you a guaranteed income stream for life WITHOUT ANNUITIZATION allowing you access, use and control of your money – 4-10% GUARANTEED MINIMUM INTEREST RATES for income on some products – some offer income enhancements as high as 2x income for Long Term Care with NO underwritting

These are just a few ideas.  There are many more concepts, many I’ve discussed in other posts.  I hope this helps.  If you need more information or would like to see how these products might enhance your current plan please -

REQUEST A FREE RETIREMENT & INCOME PLAN ANALYSIS!

I can show you how long your money will last and the effects of inflation, death of a spouse, Long Term Care and other factors to your income.  ALL AT NO COST OR OBLIGATION!

Safe savings,

Roger

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