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20 April 2013

Hyperinflation Warning - The Eurodollar Menace

The existence of the Euro-dollar market increases the total amount of dollar balances
available to be held by nonbanks throughout the world for any given amount of money (currency plus deposits at Federal Reserve Banks) created by the Federal Reserve System. It does so by permitting a greater pyramiding on this base by the use of deposits at U.S. banks as prudential reserves for Euro-dollar deposits.
- Milton Friedman, Selected Papers, No. 34

Not to be confused with the Euro currency, the monetary unit of the Eurogroup, a Eurodollar is;

"U.S.-dollar denominated deposits at foreign banks or foreign branches of American banks. By locating outside of the United States, eurodollars escape regulation by the Federal Reserve Board."[1]

I present a simplistic scenario to explain the effects and dangers of the Eurodollar:

Suppose a country creates a currency as a medium of exchange. Let’s say they start with 1 million units. If they then create 1 million more units, it is reasonable to assume the value of each unit, both the existing ones and the new ones, are decreased by half. (The reciprocal of the total number of units). This is classic monetary inflation.

Original unit value = 1
Unit value after doubling the number of units = 0.5
Unit value after quadrupling the number of units = 0.25

Now suppose that the number of units is doubled, but all the new units “disappear”

Original number of units = 1 million
New units created = 1 million
Total number of units = 2 million
1 million units “disappear” – 1 million
Number of units in circulation = Still 1 million
Therefore, each unit value is still = 1, because the newly created units disappear and don’t have an effect on the value of the original units

This is what happens when U.S. dollars are created by the Federal Reserve and get converted to Eurodollars. Because of the U.S. dollar’s status as the world's reserve currency, other nations must convert (buy) U.S. dollars to conduct international trade. Some of these dollars are kept overseas and never return to the U.S. Just like in our example, they disappear.

This is a great deal for the U.S because it means it get goods essentially for free. As a nation, the U.S. can print dollars and trade them for imported goods. Because the dollars don’t come back, they do not cause inflation. It’s a free ride the country has been on since the end of the Second World War. This is the basis of America’s wealth. Not innovation, not the American work ethic; Trickery.

But in the end, the trick is on the U.S. All those Eurodollars didn’t really disappear. They are still out there. When the rest of the world decides to adopt a new reserve currency, a process that is well under way, they will no longer have a need for the 9.7 trillion dollars they now hold. The dollars will come flooding back into the U.S., inflation will quickly degenerate into hyper-inflation and the real losers will be those required to own dollars – the American taxpayer.

Are you prepared?