602 CHAPTER 16. INTERNATIONAL FIXED-INCOME MARKETS
(that is, acceptedusddeposits), which were then used to extendusdloans instead
ofgbploans.
UScapital controls and restrictions In theus, the disequilibrium on the mer-
chandise&invisibles, aid, and direct-investment balances, combined with the grow-
ing overvaluation of theusdagainst thedemand related currencies, pushed up
usinterest rates. President Kennedy tried to alleviate the problem by imposing
theInterest Equalization Tax (1963–74) on foreign borrowing in theus. This tax
allowed internalusinterest rates to remain belowusdinterest rates offered in Eu-
rope. President Kennedy and later, President Johnson, also imposedforeign credit
restraints(1965, 1968–74) that hindered borrowing by foreigners in theusmarket.
Simultaneously,Regulation Q(enacted in 1966, relaxed in 1974, and abolished in
1986) imposed interest ceilings on domesticusddeposits withuscommercial banks.
The combined effect of all of this was thatuscorporations and investors preferred
to holdusddeposits in Europe (where they obtained better rates), and these dollars
were then re-lent to non-usborrowers who were no longer allowed to borrowusd
in theus. Finally, President Nixon’s “voluntary” (and later, mandatory)curbs on
capital exportshad the unintended result thatusmultinationals avoided depositing
their funds in theuslest these funds be blocked there. The money were deposited,
instead, in the euromarkets.
16.1.2 Comparative Advantages in the Medium Run
The eurodollar markets did not collapse after all of the regulations described above
were abolished. Nor can the above factors explain the subsequent emergence of
international markets for other currencies, like thedem, thejpy, or theecu, and—
to a lesser extent—thechf,nzd,nlg, etc. The long-term explanation of the success
of these international markets is their lower bid-offer spread (that is, the difference
between interest rates on loans and interest rates on deposits), which in turn reflects
the lower costs of international banking as compared to domestic banking. There
are many reasons for the low operating costs:
A lean and mean machineThe international market is essentially a wholesale
market, where large volumes of transactions allow narrow spreads. Eurobanks,
unlike many domestic commercial banks a few decades ago, were not expected to
offer politically or socially inspired subsidized loans to ailing companies or house-
building families. Nor do they need an expensive retail network.
Low legal costsMost euroborrowers are sovereign states or high-grade corpora-
tions. This means that there are hardly any costs of credit evaluation, bonding, and
monitoring.
Lighter regulationFor eurodollar banking (as opposed to domestic banking) there
is no compulsory deposit insurance, which means that there are no insurance costs.
Nor are there any reserve requirements (which are, in fact, similar to taxes on