Financing balance of payments disequilibrium throu...
While it is true that Eurocurrency transactions in themselves have no effect on the balance of payments or the exchange rate, in the overall role of intermediation played by the Eurobanks, Eurocurrency transactions do have an effect.In Transaction 4, if Honda had used its Eurodollar loan to purchase goods in the United States instead of lending to Sumitomo, both the US and the Japanese balance of trade would have been affected.If the loan had been used to purchase securities in the United States, both the US and the Japanese capital accounts would have been affected.If it had been used to purchase goods, services or securities in a third country, that country’s balance of payments would also have been affected.Thus, financial intermediation through the Eurocurrency markets influences both the magnitude and direction of trade and capital flows.
This should not be surprising because that is the fundamental role of banks.Banks collect funds from lenders who have a temporary excess of funds and distribute them to borrowers who have a temporary shortage.An excess of funds means a temporary excess of purchasing power.A shortage of funds means an immediate need to purchase and a shortage of purchasing power.Bank intermediation makes it possible to transfer purchasing power to where it is needed.If the banks are doing their job right, they will not only transfer purchasing power to where it is needed, they will also see to it that it is transferred to where it can be used most productively.In the process they transform the maturities and conditions associated with the funds to suit the needs of borrowers and lenders.Many lenders, for example, prefer short-term maturities and conditions that permit access to funds on short notice.Many borrowers prefer longer maturities and conditions that assure access to the funds for as long as they need them.Without the banks the two parties might never come to an agreement.Bank intermediation makes it possible to satisfy the two and avoid wasting purchasing power.
In the Eurocurrency system, bank intermediation plays a key role in the international adjustment of balance of payments disequilibrium by taking deposits from surplus countries and lending to deficit countries.One of the best, or worst, examples of this role came in the wake of the first oil shock in 1973-1974.The oil exporting countries were unable to transform all their oil revenues into purchases of goods and services.They therefore had a tremendous trade surplus.The oil importing countries had a corresponding trade deficit.The surplus countries were unwilling to lend directly to many of the deficit countries and much of the proceeds of their surplus was held as foreign exchange reserves in the Eurocurrency market.To the Euro banks everlasting regret, they performed their role of intermediation with extreme efficiency.They channeled hundreds of billions of what were called “petrodollars” from the oil exporting countries to the oil importing countries, many of them among the poorest and most economically inefficient in the world.Unfortunately, the banks failed to appreciate the risks they were taking by indiscriminately recycling the oil exporting countries’ balance of trade surplus, and this came back to haunt them in the1980s in the form of the “debt crisis”.