Forward China

The market for bankers’ acceptances was one of the first tasks of the Federal Reserve. There was a flourishing financial trade in acceptances in sterling which was purely a matter of the British pound being something like the global reserve currency, at least for a vast portion of global geography. With the United States becoming an industrial and trading power, American interests in financing trade from the point of view of the dollar were relatively uncontroversial. The Fed’s role in acceptances was to provide liquidity as “needed”, as the Fed was authorized to buy them with some discretion.

The point of these debt instruments was to finance global trade between relatively unknown systems and the private parties within them. An American exporting firm wishing to sell goods in dollars to a Chinese importer for the first time might be hesitant to engage since payment would not be due until delivery of the goods. With a bankers’ acceptance, however, the bank stands in between the transaction by essentially guaranteeing that funds have been deposited and that they will be available at the time of completion.

Markets for acceptances were robust especially in the first half of the 20th century. An acceptance would trade at a discount since the holder of the instrument might sell it before maturity. With the Fed implicitly standing behind the dollar acceptance market, they were, in essence, a form of quasi-money but one that was front-facing.

In the latter half of the 20th century, the acceptance market did not disappear as it was simply supplanted by the eurodollar market. The difference was the form of availability in eventual payment. In the acceptance market, the drawer of the acceptance is required to post funds on an individual basis immediately that become the bank’s shared liability; in eurodollars it gets more complicated.

The wholesale international paradigm of trade finance is moved to a more active intermediary basis. Take the example of firms not connected at all to the dollar directly; one in Sweden exporting goods to another in Japan. The Swedish firm must be paid in kronor, so the Japanese firm would contract with a Japanese bank to buy kronor at some specified time, usually three months forward timed to the expected delivery of the goods. If the Japanese bank carried reserves of kronor, not likely, the bank would simply charge its commission and everyone would move on. Holding reserves of this kind, however, is inefficient and costly. Instead, the Japanese bank would intermediate through eurodollars: buy dollars for yen and then sell dollars for kronor.

While that describes the intended channel, in actual practice the Japanese bank would actually engage in eurodollar forwards (or swaps). The Japanese bank could instead more efficiently buy a euro/dollar deposit maturing in three months and simultaneously sell forward those dollars into kronor. In terms of actual money or currency, delivery forward is no longer the responsibility of the Japanese bank nor of the Japanese importer; delivery rests upon the ability of the “market” to deliver on time in the form of another bank’s liability in “dollars.” If at maturity, that eurodollar bank doesn’t have “spare” dollars to place in the kronor account, that bank will simply “borrow” them elsewhere in the eurodollar market (if not simply create the requisite liability itself; but that is another story) because the “market” always has them (pre-August 2007).

Print Friendly, PDF & Email

Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

Share This Post On

Submit a Comment

Your email address will not be published. Required fields are marked *