Pre-1971 when the US ran huge trade deficits, did it continually cause the demand of USD to rise?
Large trade deficit -> More USD leaves the US -> More net foreign debt. Shouldn't this actually lead to depreciation of the dollar which in turn would lead towards a trade surplus and restore the balance?
Or did it have to do something with the reserve currency status of the dollar?
How long ll it take for another Currency like Chinese Yuan to displace the Dollar as Reserve Currency. And with so much printing by the fed and low yields will the other countries still want to hold the US govt bonds and dollars in its reserve.
1. You mentioned " As the Eurodollar market exploded, dollars started to be created out of thin air in the interbank market, backed only by a stream of interest payments to borrow them. US banks were now creating the dollars on their balance sheet, lending them out for interest, and as collateral for these loans, borrowed from the US Federal Reserve at a cheaper rate. In turn, the European or Asian bank that got these USD, further turned it into more Dollars using their original USD as collateral by re lending them out at a higher rate."
After lending the dollars to the non-US banks, why were the US banks taking collateral from the federal reserve? Shouldn't they take it from the borrowing party, i.e., non-US banks?
2. You said here "To maintain its edge, China kept buying US govt bonds to keep its currency artificially low.". Why didn't the carry trade happen from yuan to dollar like in the case of japan which would have appreciated the dollar?
3. When a commercial bank makes a loan to a person, is the money created out of thin air or taken from someone's deposit?
1. Banks need to keep aside some % of the loan as margin of sorts- they can get this from depositors or from the central bank directly- depends on which is cheaper and how long they need it. I shouldn't have used the word collateral in this context, that is is inaccurate.
2. For a carry trade to work, the interest rate in the currency you are buying has to be higher, and the one you have has to be lower. The China-US interest rate difference was not sufficiently large. Chinese Yuan is not freely convertible either, and in the 2000s, was almost completely closed. A chinese investor didnt really have the option to take a million $ worth of CNY out of china and buy USD bonds.
3. The money is created out of thin air. But to keep a cap on how much credit is created in this fashion, the bank needs to have some capital for each $ they create. For instance, for every 100$ created, it may be required to have $10 of depositor money on which it pays interest. Its earnings is the difference between the interest it pays the depositor and what it earns on the lending. In extreme cases where depositors flee, the central bank can lend to the bank in an emergency, thus letting it continue operations, and eventually if the loans are repaid, it remains solvent.
Excellent write up, thank you for taking the time to write this down.
Excellent write up. Very detailed. It was a pleasure reading this. Thanks.
Pre-1971 when the US ran huge trade deficits, did it continually cause the demand of USD to rise?
Large trade deficit -> More USD leaves the US -> More net foreign debt. Shouldn't this actually lead to depreciation of the dollar which in turn would lead towards a trade surplus and restore the balance?
Or did it have to do something with the reserve currency status of the dollar?
How long ll it take for another Currency like Chinese Yuan to displace the Dollar as Reserve Currency. And with so much printing by the fed and low yields will the other countries still want to hold the US govt bonds and dollars in its reserve.
1. You mentioned " As the Eurodollar market exploded, dollars started to be created out of thin air in the interbank market, backed only by a stream of interest payments to borrow them. US banks were now creating the dollars on their balance sheet, lending them out for interest, and as collateral for these loans, borrowed from the US Federal Reserve at a cheaper rate. In turn, the European or Asian bank that got these USD, further turned it into more Dollars using their original USD as collateral by re lending them out at a higher rate."
After lending the dollars to the non-US banks, why were the US banks taking collateral from the federal reserve? Shouldn't they take it from the borrowing party, i.e., non-US banks?
2. You said here "To maintain its edge, China kept buying US govt bonds to keep its currency artificially low.". Why didn't the carry trade happen from yuan to dollar like in the case of japan which would have appreciated the dollar?
3. When a commercial bank makes a loan to a person, is the money created out of thin air or taken from someone's deposit?
1. Banks need to keep aside some % of the loan as margin of sorts- they can get this from depositors or from the central bank directly- depends on which is cheaper and how long they need it. I shouldn't have used the word collateral in this context, that is is inaccurate.
2. For a carry trade to work, the interest rate in the currency you are buying has to be higher, and the one you have has to be lower. The China-US interest rate difference was not sufficiently large. Chinese Yuan is not freely convertible either, and in the 2000s, was almost completely closed. A chinese investor didnt really have the option to take a million $ worth of CNY out of china and buy USD bonds.
3. The money is created out of thin air. But to keep a cap on how much credit is created in this fashion, the bank needs to have some capital for each $ they create. For instance, for every 100$ created, it may be required to have $10 of depositor money on which it pays interest. Its earnings is the difference between the interest it pays the depositor and what it earns on the lending. In extreme cases where depositors flee, the central bank can lend to the bank in an emergency, thus letting it continue operations, and eventually if the loans are repaid, it remains solvent.