Wikipedia Deep Dive

Eurodollar

9 min read

The Cold War Origins of a Shadow Currency

In February 1957, Soviet officials faced a delicate problem. They held millions of American dollars in American banks—and they were terrified those dollars might disappear.

The Hungarian Revolution had just been crushed. Relations between East and West were at a low point. Soviet leadership watched as the United States froze assets belonging to countries it considered hostile. What would stop Washington from simply confiscating Soviet money held in New York?

The solution they devised would accidentally create the largest pool of stateless money in human history.

Soviet officials transferred eight hundred thousand dollars to the Moscow Narodny Bank, a British-registered company in London that happened to be owned by the Soviet Union. The London bank then deposited those same dollars back into American banks. The money never physically left North America. But legally, it now belonged to a British institution, not directly to the Soviets. Even if Washington wanted to freeze Soviet assets, these dollars were beyond reach.

They called them "Eurobank dollars" at first, after the telex address of the French-Soviet bank where some accounts were held. Eventually the name shortened to "eurodollars"—a term that has nothing whatsoever to do with the euro currency that Europeans would start using four decades later.

What Exactly Is a Eurodollar?

A eurodollar is simply a U.S. dollar deposited in a bank outside the United States. That's it. The concept is almost disappointingly simple.

If you deposit a hundred dollars in a bank in New York, that's just a regular dollar deposit. If you deposit that same hundred dollars in a bank in London, Tokyo, Singapore, or Dubai, it becomes a eurodollar. The "euro" prefix is historical—a relic from when these deposits were primarily held in European banks. Today, a more accurate name might be "offshore dollars," but the old terminology stuck.

The concept extends beyond dollars. Any currency held in a bank outside its home country gets the "euro" prefix. Japanese yen held in a German bank? Euroyen. British pounds held in a Swiss bank? Europounds. And yes, even euros held outside the eurozone become—somewhat absurdly—"euroeuros."

Why Would Anyone Want Offshore Dollars?

The answer comes down to two things: freedom and profit.

Eurodollars exist in a regulatory gray zone. They're denominated in American currency, but they sit outside the reach of American banking regulations. The Federal Reserve can't tell a London bank how much reserve capital it must keep against eurodollar deposits. The Federal Deposit Insurance Corporation doesn't guarantee these deposits if the bank fails. American laws capping interest rates don't apply.

This regulatory freedom cuts both ways. For depositors, eurodollars are riskier—there's no government safety net if things go wrong. But risk commands a premium. Banks can offer higher interest rates on eurodollar deposits than American banks can offer domestically. For decades, this interest rate advantage drew money offshore.

The real winners were borrowers. Companies doing international business loved eurodollar loans. Imagine you're a Brazilian exporter selling coffee to American supermarkets. You receive payment in dollars. If you borrow money in Brazilian reais to finance your operations, you're taking on currency risk—if the real falls against the dollar, your debt becomes more expensive even as your revenues stay the same. But if you borrow in eurodollars, your loan and your income are in the same currency. The exchange rate can do whatever it wants; you're hedged.

The Market That Ate the Dollar

What started as a Soviet scheme to protect a few hundred thousand dollars grew into something no one anticipated.

The Italian connection accelerated everything. In the mid-1950s, Soviet officials approached Italian bankers with a proposition: give us better interest rates on our dollar deposits than we can get in America. The Italians agreed, then had to find borrowers willing to pay above-market rates for access to those Soviet dollars. They found plenty.

By the end of the 1960s, the eurodollar market had grown to seventy billion dollars. By the mid-1980s, there were more eurodollars in existence than regular dollars.

Read that again. More dollars existed outside the United States than inside it.

By 1997, nearly ninety percent of all international loans were made in eurodollars. The offshore dollar had become the default currency of global commerce.

How Dollars Multiply Outside America

Understanding eurodollars requires grasping something counterintuitive: banks create money when they lend.

When you deposit a hundred dollars in a bank, the bank doesn't lock that money in a vault. It keeps a fraction in reserve and lends the rest to someone else. That borrower deposits their loan proceeds in another bank, which keeps a fraction and lends the rest. Through this process, your original hundred dollars might support several hundred dollars worth of deposits and loans across the banking system.

American banks face reserve requirements—rules about what fraction they must keep. Eurodollar banks historically faced lighter requirements or none at all. This meant the multiplication effect could run further. A dollar deposited offshore could support more lending than the same dollar deposited onshore.

This is how eurodollars came to outnumber domestic dollars. The offshore banking system was running with less friction, creating more claims on dollars than existed in the traditional banking system.

The Crisis That Almost Was

In 1974, the eurodollar market nearly collapsed.

The backdrop was grim. President Nixon had severed the dollar's link to gold three years earlier, sending currency markets into chaos. The Arab oil embargo had quadrupled energy prices. Inflation was spiking. And then Franklin National Bank—at the time, one of America's largest banks—failed spectacularly.

Franklin National had made aggressive bets in the eurodollar market. When those bets went wrong, the bank's collapse threatened to trigger a run on eurodollar deposits worldwide. If depositors in London, Zurich, and Tokyo all demanded their dollars back simultaneously, the offshore banking system could implode. And since that system now dwarfed traditional banking, the implosion would be catastrophic.

Ten central banks from around the world convened in secret. They agreed to backstop the eurodollar market—to act as lenders of last resort for a currency system that technically belonged to no one. The Federal Reserve would support dollar liquidity even for banks outside its jurisdiction. The crisis passed.

But the episode revealed an uncomfortable truth. A financial system had grown up outside the control of any government, yet it had become too important to let fail. Central banks that had no formal responsibility for eurodollars found themselves implicitly guaranteeing them anyway.

Regulation Q and the Great Escape

American regulations didn't just allow the eurodollar market to exist—they actively pushed money offshore.

The culprit was Regulation Q, a Depression-era rule that capped the interest rates American banks could pay on deposits. The idea was to prevent banks from competing recklessly for deposits by offering unsustainably high rates. In the low-inflation 1950s and 1960s, the caps weren't binding—market rates were below the legal maximums anyway.

Then came the inflation of the 1970s. Market interest rates soared well above what Regulation Q allowed American banks to offer. If you had money to deposit, you faced a choice: accept below-market rates at an American bank, or move your money to London and earn what the market was actually paying.

Money fled offshore in waves.

American corporations found clever workarounds. Banks weren't allowed to pay interest on corporate checking accounts, but they could "sweep" those funds overnight into eurodollar accounts. The money would leave the checking account each evening, earn interest offshore overnight, and return the next morning. It was a fiction, but a profitable one.

Regulation Q wasn't fully repealed until July 2011. For decades, it served as an engine driving money out of the American banking system and into the stateless eurodollar market.

The Futures Market and the Death of LIBOR

In 1981, the Chicago Mercantile Exchange launched eurodollar futures—contracts that let traders bet on where short-term interest rates were heading. These were the first "cash-settled" futures contracts in history. Previous futures contracts involved physical delivery: if you bought a wheat future and held it to expiration, someone would actually deliver wheat to you. Eurodollar futures settled in cash based on a reference interest rate. No dollars physically changed hands.

The reference rate they used was LIBOR—the London Interbank Offered Rate. Every day, a panel of major banks reported the interest rates at which they could borrow dollars from other banks. LIBOR was calculated from these submissions and became the benchmark for hundreds of trillions of dollars in financial contracts worldwide.

Then came the scandal.

Investigators discovered that banks had been lying about their borrowing costs for years. Traders manipulated LIBOR submissions to benefit their own positions. During the 2008 financial crisis, some banks reported artificially low rates to avoid looking weak. The benchmark that underpinned global finance was revealed to be, in part, a fabrication.

In April 2023, eurodollar futures contracts were officially eliminated. The market transitioned to contracts based on SOFR—the Secured Overnight Financing Rate—a benchmark calculated from actual overnight lending transactions rather than self-reported estimates.

The Slow Decline

The eurodollar market peaked around 2016, when it was estimated at nearly fourteen trillion dollars. Since then, it has been shrinking.

Several factors drove the decline. The regulatory advantages that made eurodollars attractive have narrowed as international banking rules became more uniform. The repeal of Regulation Q removed one of the main incentives for moving money offshore. And in 2020, the Federal Reserve eliminated reserve requirements entirely for American banks, erasing another regulatory disadvantage of domestic deposits.

By early 2024, "selected deposits"—domestic instruments structured to compete with eurodollars—made up eighty-five percent of overnight dollar volume, up from roughly half in 2019. The offshore dollar, which once threatened to make the onshore dollar irrelevant, is retreating toward the margins.

The Larger Lesson

The eurodollar story is a reminder that money is stranger than it appears. We tend to think of dollars as something the U.S. government creates and controls. But most dollars—even today—exist only as entries in bank ledgers, created through the lending process. And for decades, more of those ledger entries existed outside America than inside it.

The eurodollar market emerged not from any deliberate policy, but from Communist paranoia about asset freezes. It grew not because anyone planned it, but because regulations created arbitrage opportunities that profit-seeking banks exploited. It became systemically important not because governments wanted it to, but because it was simply more convenient for global trade than the alternatives.

Central banks ended up backstopping a system they never authorized and couldn't directly control. The dollar became the world's currency in a form that wasn't quite American. For half a century, the most important pool of money on Earth existed in a legal and regulatory nowhere—and the global economy ran on it anyway.