Price Vs. Policy: A Tale of Two Markets

Wriston, Walter B.


Eurocurrency: Inadvertent Progeny of Regulation


During 1974-78 OPEC's imports of goods and services were roughly equal to three fourths of their exports. Almost everyone underestimated how fast governments could spend money-- even though we should all know better. The OPEC surplus was further curbed by the slowing in the growth of oil consumption in the oil-importing nations. The real price of oil increased only about 4 percent from mid 1974 to early 1977 and then actually declined 4 percent by the end of 1978.

All that was exactly what an old-fashioned economist like, say, Adam Smith might have predicted. It was what the people at Citibank said would happen. But somehow it came as a great surprise to a remarkable, number of other people- especially to the people whose business in life is to regulate, and who still do not understand that the world has be come one huge financial marketplace.

At the time of the first OPEC price increases, there were already in place a Eurocurrency market and a Eurobond market capable of absorbing both the short-term and long-term investments of the newly rich oil producers many times over.

The significant fact about that market is that it was itself created in response to attempts of political authorities in various countries to control the international movement of capital. As it turned out. it was the only mechanism capable of preventing a crisis, and it existed not because of government decisions, but in spite of them. The so-called "Regulation Q" of the Federal Reserve Board, with its ceilings on interest rates: the l963 Interest Equalization tax, with its prohibitive effects on the purchase of U.S. securities issued by non-Americans: and the Foreign Direct Investment Program of 1956 had all served to drive capital into the Euromarket, where interest rates are determined by the interplay of supply and demand, not subject to the passing whims of national regulators and lawmakers.

As a result, the $60 billion increase in the OPEC surpluses found itself quickly absorbed into a market estimated in gross terms at more than $300 billion at the time, where it caused hardly a ripple - to the astonishment of those who had not anticipated the growth of Euromarkets any more than they had anticipated the oil price increases.

It was the greatest transfer of financial assets in the shortest time in the history of the world, and all handled by a market set in motion inadvertently by governments- especially our own- trying unsuccessfully to control the movement of credit and capital within their own borders. Had governments been successful in preventing the growth of the Euromarkets, the OPEC price shock might indeed have triggered an international financial crisis. As it turned out,what we saw was that the world money markets now have the necessary flexibility and strength to sustain almost any economic adjustment process. Furthermore, the world's total financial structure is now a unified system, and while the international flow of funds may be impeded from time to time by political tensions, no one nation or group of nations can successfully pursue unilateral policies without regard for the whole international community.