The Eurodollar Missing Link: Explaining The QE2-Related Cash Surge In US-Based Foreign Banks

Tyler Durden's picture

Two weeks ago we broke the story that the bulk of the excess reserves, and thus cash, generated as part of QE2 has gone not to US banks, but to foreign banks operating in the US. One of the generic rebuttals of this observation was that it is naive to assume that European banks have been buying up the Treasurys issued by the Fed (and flipping these to their clients) which would also leads to a contemporaneous increase in excess reserves (over $630 billion since the start of QE3). This was a good question and we did not have a ready answer. Luckily, Stone McCarthy has come up with a resolution. In a just released note to clients, SMRA hints at how these banks have loaded up on cash without having to also see domestic assets surge (and instead just have just seen the net liability owed to foreign offices increase). The answer: Eurodollars.

First, a reminder of just how much foreign held cash surged in since QE2:

SMRA's explanation:

How Did the Reserves or Cash Assets Get to Foreign Banks Operating in the US?

The skewing of the distribution of reserves towards foreign banks operating in the US was not because the LSAPs were disproportionately from these banks or from the clients of these banks.

Rather the Eurodollar market provided a vehicle enabling a skewing of reserve balances towards foreign banks operating in the US.

Effectively the affiliated foreign branch of a US bank (whether a domestic or foreign institution) would borrow dollars in the Eurodollar market. A Eurodollar is nothing more than a dollar denominated deposit at a bank outside the US. The bank holding the Eurodollar deposit will ultimately have a dollar denominated claim against a bank domiciled in the US. That US bank in turn holds reserve balances at their local Federal Reserve Banks.

When Eurodollar deposits move from one foreign bank to another, the claim against the original US bank follows the eurodollar deposit.
If a bank domiciled in the US borrows dollars from a bank outside the US, including its own foreign branch, effectively what happens is the reserve balance of the US bank underpinning the Eurodollar account is reduced, and the reserve account of the borrowing bank in the US is increased.

Overall US bank reserves are left unchanged, but the distribution of those reserves is changed from one bank in the US to another, possibility even from the books of one Federal Reserve Bank to another.

In other words, foreign banks operating in the US have an artificially pumped up cash balance creating a false sense of security, with the fungible cash having been borrowed from abroad. This also means, that when and if European banks realize they need the cash "lent out" to US-based subsidiaries, and demand the $600 billion+ in dollars, all they will see is a white flag of surrender, as the US-operating banks disclose they have pledged the cash for one thousands and one uses, and its sudden withdrawal would end up crashing the capital markets. It also means that explanations that this cash was used by European banks to satisfy regulatory capitalization shortfalls are absolute gibberish. And yes, if and when there is a surge in dollar needs out of Europe, the Fed will have two choices: QE(x) and FX liquidity swaps.

Regardless of the dynamics of the capital flow, what is without doubt is that US banks have little to no incremental cash courtesy of the $600 billion expansion in Fed excess reserves. And the other question: what did US banks do with all the money "printed" over the past 8 months, is still as relevant as always.

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qussl3's picture

Hilsenrath was babbling about how the FED would likely renew the swap arrangements with the ECB this morning on CNBS.


NotApplicable's picture

Given those are the only two participants in "the market," that the game will continue goes without saying. Which of course, is why they say it.

CNBS, master of the obvious, for all the wrong reasons.

hedgeless_horseman's picture

This is indeed a very long rally...Bernanke is like freakin' Agassi back on the baseline.

Problem Is's picture

The Bernank is like Tracy Austin on the baseline...

Bitch in a pink skirt with a weak, two handed backhand...

Bonesetter Brown's picture

An ECB draw on the FX swap line need not increase the Fed's balance sheet.  This could be qualitative easing (cf Willem Buiter)

Bonesetter Brown's picture

Not if Fed sells Treasuries to fund the deal, similar to what it did first time the FX swap line was used heavily.

Not saying it won't increase the balance sheet/M2, just saying the Fed can do the FX swap without increasing its balance sheet/M2.

Mr Lennon Hendrix's picture

You mean to write, 'not if the Fed monetizes Treasuries', which will not decrease, but rather increase M2.

Bonesetter Brown's picture

Monetizes? Sorry, I'm dense.

I see Fed sells Treasuries, collects dollars (reducing M2), turns around and hands those dollars to the ECB in exchange for Euros (M2 increases)

Net-net: no change in size of balance sheet, but Treasuries are replaced by Euros on the balance sheet.

Something like this happened in 2H08. Fed sold Treasuries and their holdings of Treasuries decreased, while FX swaps, MBS, and Maiden Lane were added. Or like QE1.0', where cash generated from MBS pay off was re-invested in Treasuries without increasing the balance sheet.

DutchZeroPrinter's picture

In 2008 people were stupid enough to buy treasuries. 

Now the Fed is the only buyer. They can't sell that crap

Bonesetter Brown's picture

When the 10yr breaks its 30 year trend I'll agree with you wholeheartedly!

XPolemic's picture

I see Fed sells Treasuries

Wouldn't that cause the yield curve to invert?

Long-John-Silver's picture

Beans, Bullets, and Bullion, stock up now.

Michael Victory's picture


B, B, B.. check.

Use temporary price declines to steadily accumulate the best PM stocks and your preferred form of bullion.

If not yet read: Are we running out of Silver? 


Fed_Printstone's picture

I much prefer:

Bernie's Bunk Buddy Bubba Bonk Bearded Bastard's Bunghole

Bam_Man's picture

It appears that finally someone understands why trillions of excess bank reserves continue to sit patiently in accounts at the Fed.

They were never intended to be "lent out" to "Main Street borrowers".

They sit there, waiting to be deployed in the event of a bank run.

If the bank run materializes in Europe, these reserves will find their way into the European banking system. And they are doing just that.

Charles Wilson's picture


In another thread, I stated that this is Bernanke acknowledging that Friedman and Scwartz were right in their analysis of Great Depression 1.  The money IS sitting there, waiting for a Bank Run.  It was not intended for lending.  It's to lessen the downward slope of the Collapse, sorta' like a Slow Rollover mechanism in Guth's Inflationary Cosmology.

A Slow Rolling Depression.


davepowers's picture

It was not intended for lending...


not for lending into real economy perhaps, but the reserves were intended for interbank lending.. that's how the reserves flowed to one group of banks, in this case apparently the domestic affiliates of foreign banks. As this article finally agrees, this sort of interbank lending polishes the balance sheet of the borrowing banks, who appear to have hefty cash reserves. As Tyler pointed out in an earlier related post, no one even focuses on the liability side of the BS, where the debt for the apparent cash asset lies.

IN addition to balance sheet polishing, reserve lending back and forth is also likely a component of various securities lending/repo agreement transactions that support/fuel stock and commodity speculation. If true, then the apparently idle/just sitting there reserves are not only lent, but the lending has financial asset impacts, extending even to prices of 'stuff.' 

It might not be lending of the old sort that fueled real economy activities (one borrowed money to build houses), but it is a replacement lending/credit system, probably the best that can be cobbled up. Like a makeshift cooling system engineered to lessen the damage from the earlier destruction of our old complex and fully functioning lending/credit system. The Fed types the reserves into existence, the reserves support stock/commodity speculation but not real world economic growth.


XPolemic's picture

is also likely a component of various securities lending/repo agreement transactions that support/fuel stock and commodity speculation

Speaking of which, it would be great to see a story on ZH on equity repos. I'm sure there plenty of shenanigans there hiding illiquidity and pumping and dumping by wall street banks.

davepowers's picture

he should focus on the securities lending business, of which repos are a part (roughtly 20% I'd guess).

Securities lending, sponsored by major banks like State Street, has the potential to to be a future scandal/catastrophe of immense impact, because not only are pension funds caught up in this, but state investment pools as well.

State investment pools are where state agencies, local/city governments and school districts park their cash. 

Imagine the impact if, say, 10% of the tax collections and cash holdings of all the school districts in a state got erased because the state investment pool got caught holding the bag in a securities lending venture that almost nobody knew about and even fewer (including the state officials charged with monitoring the program) understood.

Stay tuned, because it could very easily happen in the next liquidity crisis.

XPolemic's picture

Thanks for replying with the (horrifying) details. From your description I guess that the state investment funds are lending cash, holding equities. My experience is that equity repos have about a 3 day time horizon. Is that true of all securities lending, or is it much longer?

If there were a sudden and massive drop in equity prices, I can guess which party will be left holding the bag.


tallen's picture

Cramer's proclaiming Greece is fine. Such a deja-vu moment:


Anyone remember Cramer and Bear Stearns:

apberusdisvet's picture

It's funny how criminality feeds on itself; just when you think that your shit really doesn't stink, the fan gets turned on.  A lesson from Capone.

The Fonz's picture

I too find farting into fans rather humorous :)

swissaustrian's picture

This system is so damn fucked, now they even have ponzi schemes in reserves


Tyler, the pictures don´t show up for me...

Anyone else have the same problems?

gmj's picture

I don't see the pictures either.

baby_BLYTHE's picture

the banks are already flush with cash, the American people are the ones that are broke!

QE(s) have done absolutely nothing to create jobs in this country, it was a totally worthless endeavor.

in all honesty, as much as I despise the theory of printing money, wouldn't we have been better off if the FED printed up a trillion and divided it up to hand out to every American citizen to pay down debt, invest and/or spend in the economy?

I guess I can answer my own question as the FED really doesn't give a hoot about J6P nor the American economy at large

wombats's picture

Bush did that in '07 (maybe  '08).  I think he gave everybody a few hundred $.  It felt good at the time, but in the long run was not really worth it....kind of like drugs.

disabledvet's picture

not a very good drug apparently as "the kick" lasted but a minute.  how do you like this "drug of choice"?  hmmmm.  "Choice theory"...interesting concept

baby_BLYTHE's picture

yeah, I remember that. Marc Faber, at that time:

"The federal government is sending each of us a $600 rebate. If we spend that money at Wal-Mart, the money goes to China. If we spend it on gasoline it goes to the Arabs. If we buy a computer it will go to India. If we purchase fruit and vegetables it will go to Mexico, Honduras and Guatemala. If we purchase a good car it will go to Germany. If we purchase useless crap it will go to Taiwan and none of it will help the American economy. The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in US. I've been doing my part."

RobD's picture

My $600 went to Austria, I bought a Glock model 20 with it.

baby_BLYTHE's picture

perhaps nothing more American than what you did there. Nice!

SheepDog-One's picture

And theyre completely stuck, no way to unwind what has only served to stuff banks full of worthless FRN's.

Shell Game's picture

Looks like they're primed and ready for the coming, all out tangible asset buying spree..

LongBalls's picture

They are getting EXACTLY what they want. They are sitting on a crap pile of cash with no worries as all the hard assets of the world default back to their balance sheets. Cash means nothing to the money-changers. The markets are fixed and they can get cash when ever they want or ask the Fed for it. What they want is what YOU can produce, with what they want to pay you, with what medicine they want to give you, with what food they want you to eat. Anything left over the IRS will take care of that.

gmrpeabody's picture

Are those guys hockey players?

falak pema's picture

If you were a banker you would be money-flush but your fingers would be Dutch like  pure bred puritans on rampage, like those of  Scrooge Mcduck...stingy, a mad vacuum cleaner, running wild. We are there now and it will take us all down. Suction gone mad. These guys don't believe in creating jobs for free willed persons.

THE DORK OF CORK's picture

If people stated driving to work again and buying useless crap with their income inflation would skyrocket.

The global trade engine is broke - they have tried to artifcally keep it alive by reducing real capital investments over the years but now that all redundancy and logic has been extracted it cannot function efficiently when so much $s go up in smoke from some cargo vessel in the Middle of the Pacific - that energy is used by nobody.

The economic fabric is simply stretched too thinly.

Crab Cake's picture

It's called a jubilee, and it is a concept the modern money masters hope that nobody remembers. Why? Simply put a jubilee would fix everything, but it would absolutely wipe out the power the banking elites have hoarded and built over generations in one fell swoop. So you ask would it be better? That's relative. For you, me, Main St, and the real economy; yes of course. For the Fed, Wall St, bankster families, the ultra wealthy, and the military/industrial/financial complex aka the American superpower empire... not so much; which is why the word jubilee is anathema.

The sooner the people of the US, and Western civilization in general, rise up to reclaim their governments and declare jubilee the better off those same people will be.

Cult_of_Reason's picture

The market is acting today as if Bernank will announce continuation/extension of QE2 tomorrow.

qussl3's picture

Also read as the sharks are squeezing the shorts on a low volume session in front of a potential 1-2 punch event risk parade.

Cult_of_Reason's picture

You’re probably correct -- it is nothing more then algo assisted artificially engineered short squeeze and distribution into this artificially created forced short covering (violent mark-up and maintaining a price floor to keep a constant "squeezing" pressure on the shorts to force them to cover).

SheepDog-One's picture

Not really, just a POMO ramp of ES back over 150dma. Let anything go wrong tonite and the Euro falls, dollar shoots up, theyll lose all of this fake ramp plus a ton.

Cult_of_Reason's picture

Nothing will go "wrong" tonight, the vote has already been predetermined, a theatrical farce to make it appear as if there is still democracy in Greece (EU banksters are running the show in Greece -- Papa... is their puppet)

The Fonz's picture

I for one am counting on the Greek people to riot. If they stay in the streets it WILL escalate. After 3 weeks out there when the politicios spit in their peoples face there will be violence and suddenly all of those disparate Greek viewpoints amongst protesters will have the focus they need to team up.  If they fail at this, then the latinos can be counted on for a proper sence of rebelliousness in a few months.

Bam_Man's picture

Up 40 points on the SPX in less than three and a half trading days. On no news.

Just the big boys running the stops on the shorts. This market is their plaything.

Cult_of_Reason's picture

Yes, they know where all the stops are (like shooting fish in a barrel). It does not take much of capital for PDs to use free POMO cash from Bernank to mark up ES and to activate the stops resulting in a short covering chain reaction.

alexanderstollznow's picture

Yes, they know where all the stops are

really? perhaps you would like to say where "all the stops are", seeing as how it is so well known?