The historians say that the Eurodollar trade developed as a way for recipients of U.S. dollars to escape the Federal Reserve requirements on deposits and acquire a better interest rate. But, what had it explode in volumes and size was the fact that eurodollars were the one way people could hedge against the future exchange rate of the dollar. The dollar might be as good as gold but you had to be a central bank to be able to ask for bullion instead of paper on settlement day. Contrary to all the textbooks and most of the journal articles, the "inflation" of the 1970s that resulted in double-digit interest rates on U.S. Treasuries is best explained as the reaction of the Eurodollar market to the sustained anticipation of lower dollar exchange rates. Offering sky-high interest rates was the only way to create a Buy side for the Eurodollar trade.

The "Euro" Yuan trade that developed in Hong Kong now offers the same opportunities for hedging. But the dynamic is rather different. People now buy yuan in anticipation of selling them when they have to pay for Chinese exports - if the exporter will not accept dollars or euros. People sell yuan because the anticipate that they will get a better exchange rate now than in the future. If the markets were to anticipate a sustained fall in the exchange rate of the yuan, the result would be zero or even negative discounts for the sellers. To get someone to take the Buy side, the Sellers would have to imitate the behavior of their cousins in the 70s and offer a sufficient interest rate spread to offset the cost of the likely yuan decline.

And for those of us eating popcorn in the bleachers this will mean?: "Offshore Yuan Rebounds From Five-Year Low on Intervention Bets"

"China Fires a Warning Shot at Yuan Speculators With Bank Bans"


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