Banking, Intermediation, and the Eurodollar System

Banking, Intermediation, and the Eurodollar System

The intermediation myth

The standard model — banks borrow from savers and lend to borrowers — inverts the actual causality. Loans create deposits, not the other way around. When a bank makes a loan it simultaneously writes up an asset (the loan) and a liability (the borrower's new deposit). Money is created at the moment of lending. Deposits are a consequence of credit extension, not a prerequisite for it. This view is standard in academic monetary economics — the Bank of England stated it explicitly in 2014. The myth persists not because experts believe it but because it dominates textbooks, central bank public communications, and financial journalism. That gap is not accidental — it serves a legitimizing function. A public that understood banks as credit creators operating under a state franchise would ask different questions about who controls monetary expansion and in whose interest.

What banks actually do

Banks originate credit — they monetize a borrower's promise to repay into spendable money, creating both the asset and the liability simultaneously. Banks originate credit risk at the point of lending but may subsequently distribute or transform it through securitization, loan sales, and credit derivatives. There is no reserve requirement in the US domestic system, but this does not mean domestic banks hold no reserves — they currently hold roughly $3 trillion voluntarily. Reserves are held for clearing, liquidity regulation under Basel III, and yield — not to fund loans. Banks are better understood as state-licensed credit creators operating within capital and liquidity constraints than as financial intermediaries recycling existing savings.

Where that model breaks down: eurodollars

The franchise framing only holds for domestic commercial banks operating under a central bank's jurisdiction. Eurodollar banks — foreign institutions creating dollar-denominated liabilities outside the US — may be regulated institutions, but they operate outside the Fed's direct balance sheet and discount window. They do hold dollar-denominated assets — Treasuries, repo claims, correspondent balances — but those assets are inside the private settlement chain, not outside it. When the private liquidity chain breaks, those assets are not unconditionally settlement-final under stress. The distinction that matters is not regulatory status but balance sheet access: domestic banks have a direct claim on the Fed's balance sheet; eurodollar banks do not.

The convertibility problem

Eurodollar deposits are not a separate currency pegged to the dollar — they are dollar-denominated liabilities. The risk is not devaluation but convertibility failure at par: whether a eurodollar claim can deliver actual Fed dollars on demand. A eurodollar that cannot be delivered does not smoothly trade at a discount — convertibility becomes impaired, and in extreme cases parts of the system effectively freeze. When the correspondent banking chain seizes, the eurodollar bank has nowhere to turn — its local central bank cannot print dollars, and it has no legal claim on the Fed's balance sheet. The 2008 disruption lasted weeks and required central bank swap lines to resolve — not a routine settlement glitch but a breakdown of the assumed equivalence between two things that were supposed to be identical. The swap lines revealed the Fed as the de facto global dollar liquidity provider for offshore dollar systems outside its direct regulatory perimeter — the only mechanism capable of injecting actual dollars into a system designed specifically to avoid holding reserves.

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## Further Reading

Primary Sources

- McLeay, Radia & Thomas — Money Creation in the Modern Economy, Bank of England Quarterly Bulletin, 2014. The clearest official statement that loans create deposits, not the reverse.

- Bank for International Settlements — BIS Quarterly Review. Ongoing coverage of eurodollar funding markets, cross-currency basis, and global dollar liquidity.

Books

- Perry Mehrling — The New Lombard Street (2011). Short, readable, essential. Explains why the 2008 crisis broke the classic lender-of-last-resort doctrine and what replaced it. The theoretical foundation for the hierarchy of money framework.

- Hyman Minsky — Stabilizing an Unstable Economy (1986). The endogenous money and financial instability hypothesis. Why the system structurally requires continuous credit expansion.

- Milton Friedman & Anna Schwartz — A Monetary History of the United States (1963). The 1930s credit contraction as the definitive case study in what happens when money creation collapses.

Academic & Research

- Perry Mehrling — Coursera: Economics of Money and Banking. Free. The most accessible entry point into the money view framework.

- Zoltan Pozsar — Global Money Notes (Credit Suisse / various). Technical but unparalleled on repo markets, collateral chains, and the post-2008 plumbing of the dollar system.

- Jeff Snider — Eurodollar University (podcast/writing). Focused entirely on the offshore dollar system and its role in global credit cycles.

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This document was developed through multi-AI peer review: initial draft and framework by Claude (Anthropic), reviewed and refined with input from Gemini (Google), ChatGPT (OpenAI), DeepSeek, and Grok (xAI). Each model contributed factual corrections, terminological refinements, and substantive challenges. Final editorial judgment by the author.