10.3 The Eurocurrency market and balance of paymen...
The central role of the Eurocurrency system in the international transfer of funds raises the question of its effects on an individual country’s balance of payments and exchange rate.From a technical point of view, the answer is straightforward.Except when a central bank is involved, Eurocurrency transactions—i.e., the short-term borrowing and lending of foreign currencies—have no effect on the balance of payments.If we go back to Transaction 2 in the previous section when Burberry’s transferred its dollar deposit from Citicorp to NatWest, we can see that the US balance of payments was unaffected.The amount of external liabilities was unchanged: only the owner changed.The UK’s balance of payments was also unaffected.The increase in short-term claims by NatWest on Citicorp was offset by the reduction in short-term claims on Citicorp by Burberry’s.The supply and demand of foreign exchange was equal and neither the balance of payments nor the exchange rate were affected.
The same goes for Transaction 3.NatWest’s increase in short-term claims as a result of the six-month loan to Honda was offset by the increase in short-term liabilities in the demand deposit owed to Honda.When Honda transferred the demand deposit to Sumitomoin Transaction 4, the supply and demand of foreign currency for all three countries involved in the transaction was perfectly matched.For the United States, the reduction in the demand deposits owed to NatWest was offset by the increase in the demand deposits owed to Sumitomo.For the United Kingdom, the decrease in demand deposits owed to Honda was offset by the decrease in demand deposits held at Citicorp.For Japan, the increase in demand deposits held by Sumitomo at Citicorp was offset by the decrease in demand deposits held by Honda at NatWest.
When a Central Bank is involved in a transaction, we might isolate the account “change in reserves” and say that the supply and demand of foreign exchange is in equilibrium but the balance of payments is affected.Suppose in Transaction 5 that Sumitomo had loaned to the Swiss Central Bank rather than to Swiss Bank Corp.The supply and demand of foreign currency would have been equal for Switzerland with the increase in time deposits owed to Sumitomo offset by the increase in demand deposits held at Citicorp.In the balance of payments accounts, however, the time deposit owed to Sumitomo would be found on the source side of short-term liabilities and the demand deposit at Citicorp would show up as an increase in reserves.