International fixed-income

Most Financial-market activity takes place wholly within the boundaries of a single country and is denominated in that country’s currency. A large and growing share, however, now crosses national boundaries, as individuals move capital into currencies that seem to offer greater returns, and as borrowers search the globe for money at the lowest price. This international market for money can be divided into two segments. In some cases investors and borrowers will arrange transactions in a country other than their own, using that country’s currency. In other cases, a transaction will be arranged in a currency other than that of the country where it occurs. Until recently, the former were known simply as foreign transactions, and the latter were referred to as Euromarket transactions. The distinction between the two has blurred, however, as this article will explain.

A brief history of the Euro markets

The idea of using the money of one country to transact business in another is not a new one. Such offshore dealings have gone on for centuries, often with the aims of avoiding taxes, regulation or confiscation. The name Euro market was first applied to the acceptance of offshore deposits in 1957, at the height of the cold war, when Moscow Narodny Bank decided to transfer its dollar deposits out of the United States to foreclose the possibility that the US government would confiscate Soviet assets. The Russians had their dollars transferred from New York to a French bank that had the cable address EURO BANK, and soon all dollars deposited in European banks took the name Eurodollars.

Market surge

These dollars helped create a new financial market as a result of the Bretton Woods system of fixed exchange rates, around which the economy of the non-communist world was organised after the second world war. This system still had aspects of a gold standard: if a country had a balance-of payments deficit, it would settle the imbalance by paying gold to its creditor countries. In theory, the loss of that gold would lead the country’s central bank to contract the money supply, which would slow the economy, which would in turn reduce demand for imports and thus bring the balance of payments back into balance. By the late 1950s, however, the United States seemed to be running a persistent balance-of-payments deficit, and government officials grew concerned that the country’s gold stocks were running low. One cause of the problem was thought to be that foreigners were issuing too many securities in the United States and then exchanging the proceeds for foreign currency to use in their home countries. This worsened the US payments imbalance, putting yet more pressure on gold reserves. The US government responded with a set of policies, of which the centrepiece was the interest equalisation tax, recommended by President John Kennedy in July 1963 and enacted in August 1964. By claiming 15% of the interest received by Americans on stocks and bonds issued by Europeans (securities from Canada, Japan and less-developed countries were exempt), the tax was intended to reduce capital outflows and thus staunch the loss of gold.

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