International money market and foreign exchange

International money market and foreign exchange transactions deal with the issuance and trading of money market instruments in various currencies outside domestic markets. As long ago as the fifteenth century, organized international money and foreign exchange markets existed. Merchants in Italy, for example, wanting to import tapestries made in Belgium from wool produced in England, had to find ways to finance transactions that occurred outside their own country. Italian banks, such as those run by the Medici, set up foreign branches to effect payments and arrange for the delivery of the goods on behalf of their clients. The banks had to deal in currency exchange and in deposit collecting and lending in other countries and states.
These activities have continued throughout the nearly 500 years of modern banking history. The past 30 years have been especially marked by new developments, growth and change. These include Eurocurrencies, Euro- CDs and Euro commercial paper, floating rate notes, note issuance facilities, revolving underwriting facilities, and many others. origins of Eurocurrencies

The history of the international money market, since its modern (postwar) rebirth in the 1960s, is a confluence of three parallel and mutually influential events: (1) major changes in the international monetary system, (2) the evolution of a large international investor base, and (3) continuing de-regulation of domestic capital markets in major countries to align them with competitive international alternatives to domestic financing vehicles.
At the end of World War II, the capital markets outside the UnitedStates were virtually nonexistent. In 1944, the Allied Powers agreed to a postwar international monetary system at Bretton Woods, New Hampshire,in which the dollar would be the principal reserve currency (i.e., used as reserves by other countries). The dollar was to be pegged to gold, at therate of $35 per ounce, and all other currencies were to be fixed to the dollar. When balance of payments difficulties arose, it was understood to be the obligation of both the deficit and the surplus countries to modify their domestic fiscal and monetary policies to reduce the problem. Governments periodically intervened in foreign exchange markets to help the process along, and they usually relied on broad economic policy changes to affect adjustment. If the imbalance could not be redressed after suitable effort, the currency's exchange rate could be reset to the dollar, after which it would have to be defended at the new rate. To make the system work required a world in which the principal economies were growing at about the same rate and shouldering the world's military and other burdens equally. It also required, at the national level, strict economic discipline and controls and a voting public that refrained from blaming others for its problems and understood that it was necessary from time to time to takebitter medicine in the interest of the country's health over the long run.These conditions were not commonly found in the 1950s and 1960s, anymore than they are now.

In 1971, after several years of large U.S. balance of payments deficits, the Bretton Woods system collapsed. It was replaced by a floating-rate mechanism, in which all currencies were to be priced continually by the market and economic imbalances would generate corrective pressures on exchange rates. The mechanism obviated the need for capital market con- trois that restricted cross-border transfers, as harsh policies were no longer necessary: the market would administer the medicine that countries were unable to administer themselves. In time, all of the major industrial nations removed their controls on international capital movements. By the early 1980s, users and providers of capital could look overseas for capital marketopportunities that were superior to what was available at home. It alsomeant, however, that interest rate and exchange rate volatility would be much greater in the new floating exchange rate environment than in the old fixed-rate regime. As we see later in this chapter, increased volatility led to great opportunities for banks and other market makers to expand trading activities and hedging strategies.

The postwar investor population was affected by these events, and by the rapid institutionalization of markets in the United States, the United Kingdom, and some other European countries. There was also a large in crease in the population of otherwise law-abiding Europeans who wanted to transfer funds into foreign bank accounts that were beyond the scrutiny of tax authorities in their home countries. Additionally, government officials, people engaged in capital flight, and shady characters of various kinds were accumulating Irregular or dlegal funds m tax haven countries. The institutional investors were not subject to tax concerns, but they were so- phisticated asset-allocators looking for underpriced investments. Individuals, mostly investing through banks in Switzerland, Luxembourg, and other European ,enters, were highly focused on preserving their anonymity. Together,these investors were looking for opportunities that were not available in the united States. Eventually, local corporations, European subsidiaries of non-European companies, central banks, and other financial institutions discove red that they could deposit dollars they had accumulatedoutside the Unitcd States with certain banks in London that would retain them as dollars and pay dollar interest rates.