In February 2015, a 109-car CSX train derailed near Mount Carbon in West Virginia. The fire the derailment sparked was so massive that firefighters could only stand by and watch it burn itself out. That took just about a week. The reason was the train’s cargo, about 3 million gallons of North Dakota crude oil.
It was just the latest in a series of oil train disasters, the most tragic of which occurred in July 2013. The picturesque Quebec village of Lac-Magentic was almost completely destroyed when a runaway train rolled down a hill and into the center of town. The consignment was again North Dakota crude.
The economic issue, at least, is a simple one. We all don’t have an oil well in our back yard with an efficient refinery running in the front. The supply of crude has to get from one place to another, to be first turned into something useful before arriving at each and every destination where demand occurs.
To match supply with demand requires infrastructure, and a lot of it. There are pipelines and supertankers, gasoline trucks and even oil trains when any one of the other forms of conveyance isn’t readily available. There are firms dedicated to this matching function, who have the ability to move physical crude around to where it is most needed all dictated by market prices (spreads).
The global monetary system of the eurodollar really is no different, including its capacity for destruction. There are money dealers whose job is to move money from where it is to where it might be most needed. Assuming first that they have it, or, more often in the modern eurodollar case, the ability to create it.
“We” give almost no thought to this redistribution function. Most monetary theory is dedicated only to the supply of money, and even then in the orthodox form the investigation is shallow and cursory at best (it never looks at the various types of modern money; the “missing money” of the 1970’s was never actually found by Economists). Central bankers dedicate stunningly complex and elegant mathematical constructions to money demand without once quantifying all the ways in which demand could be met.
One reason for the omission is the purposeful omission of traditional money from these pathways. Not even currency flows within them. The Federal Reserve in 1957 got around to studying the rebirth of the federal funds market in the early fifties, finally publishing their findings only in May 1959. In 1920, the report recalled, the federal funds market began from:
…sharp disparities in the reserve positions of New York City banks, some having substantial excesses and others having to borrow at the Reserve Bank. At times the discount rate was above some short-term market rates, providing an additional incentive for deficit banks to borrow excess reserves of other banks. Officials of some of the New York City banks talked things over and began buying and selling excess reserves to adjust their reserve positions.
Realize what was actually happening. Not a single ounce of gold, nor a solitary Federal Reserve Note was or is ever exchanged in these types of interbank transactions. These were merely paper liabilities, on the books of the lender bank as a paper asset. These non-monetary liabilities satisfied only an accounting and regulatory necessity (reserve requirements), not a functional one.
There was no money in it, as the report spelled out: “The transfer was usually accomplished by an exchange of checks—the lender’s check being drawn on its reserve balance at the Federal Reserve Bank and presented for clearance the same day, that of the borrower being drawn on itself and payable through the clearing house the next day.” A self-extinguishing liability at that.
But what if the same type of transaction could be used instead of for regulatory purposes to achieve functional financial means? Any currency is essentially an IOU, or claim, on something else. Why not an IOU of IOU’s? In other words, a currency for currency. Federal funds was just the beginning of such qualitative money expansion, and that was 1920.
In 1920, a Federal Reserve Note was a claim on the US government’s gold (and silver for small denominations). A federal funds balance was a claim on another bank’s Federal Reserve Notes, or a claim on a claim. If those notes represented a short cut from having to move physical gold around to satisfy monetary and financial obligations, then federal funds represented another shortcut this time removing the need to exchange physical currency.
This ledger money is an order of magnitude more efficient. That’s why the wholesale system developed as it did, and then moved offshore (eurodollar) where it could realize its full potential.
But none of it can work without specific means of redistribution. There has to be dealers who like energy firms can move money around to where it is demanded; to match the supply of money with the demand for it. Money redistribution is as paramount as money supply, even in what is nothing more than a ledger system.
It sounds so very weird and strange, to be at the mercy of a computerized line item.
That’s especially true when considering in the eurodollar arrangement banks took the next step…and then the next, and the next, and so on. The liabilities that came to represent money were derivatives in every aspect of the term. These were claims on claims, and often chains of claims on claims on claims. So long as one bank accepted another’s claim on a third (or fourth), it was in every way every bit as money as if gold or FRN’s had been exchanged.
A currency swap never involves actual currency, but it requires substantial (hidden, thus shadow) commitment on both sides for it to happen. As does consideration for why it often happens (redistribution).
If there was a mistake or inherent flaw in the system, it was the combining of the supply function with the redistribution function; the dealers were responsible for both parts. They created these liabilities which often had the effect of moving “money” to where it was demanded (after 1995 without the restraint of common sense and proportion). The analogy would be when the oil train derailed and crashed in West Virginia or Quebec it had the effect of scaring oil producers into shutting down all of North Dakota’s oil pumps simultaneously.
Because of the way non-money money evolved, it almost had to involve the creation of non-money mixed with the redistribution functions for it. It’s also why the Panic of 2008 was only banks panicking; an interbank panic entirely.
The price of oil barely noticed either of those two train crashes nor the more than dozen others over the years since the shale boom took hold. The dollar’s price, however, reacts often sharply each and every time redistribution becomes relatively more difficult and rigid. Like the train derailment on May 29 whose consignment was financial collateral.
Therein may lie one part of the answer to the eurodollar predicament. On the one hand, the system survives in minimal capacities because there is simply no alternative. A global reserve currency is not something you can just will into existence overnight. It requires tremendous, almost incomprehensible (unappreciated) depth and infrastructure.
It would be like trying to switch the world economy from oil to liquified natural gas in a very short period of time; even assuming sufficient supply of LNG suddenly became available, and that at end demand there was the ability to use LNG as a perfect substitute, there just aren’t the capacities to move it around the world where it would be needed. To build them up would require massive investments of capital, time, and human ingenuity.
It truly is no different in the eurodollar world, though it is often easy to overlook these functions in a “don’t fight the Fed” mentality and its so-called printing press.
Even if the Federal Reserve did possess the ability to conjure eurodollar supply (in all its non-monetary forms, these chains of claims on claims on claims), which it doesn’t, it still lacks the capacity (nor competence) to be able to match that supply with demand (the utter failure of dollar swaps comes immediately to mind).
Creating that capacity is the biggest impediment to replacing the eurodollar; whomever would have to build hundreds of money tankers, install thousands of miles of liability pipelines, invest and build hundreds of monetary refining facilities (derivatives), and then backups like the risky (subprime SIV’s) oil trains running precariously through the backwoods because other redistribution capacities might be blocked.
Separating supply from redistribution, as how energy is moved around the planet, might solve one part of the problem. The goal of any system is to most effectively, and efficiently, match money supply with money demand. In truth, this is why the gold standard was left vulnerable to official denouncement in the early 1930’s. In this way, it is an entirely separate issue from what might constitute money supply, and deserves as much if not more attention.
That’s also why, and the only reason why, eleven years later the dollar remains the unmatched global king. A sickly, distinctly unimpressive non-money monetary monarch, to be sure, but still on top even though redistribution trains (like those running into and out of Tokyo) keep derailing to widespread deflationary destruction.