How Eurocurrency is formed

Question

Explain how the Eurocurrency is formed.

Answer 1

The core of international money market is Eurocurrency market. Eurocurrency is a time deposit of money in the international bank situated within the country which is different from the country which issues the currency. For instance, Eurodollars are deposits of the U.S. dollars within the banks situated outside of United States. For illustration, assume a U.S. Importer who purchases $100 of merchandise from the German Exporter and also pays for purchase by drawing a $100 check on his U.S. checking account (demand deposit). In case the funds are not desired for the operation of business, German Exporter may deposit the $100 in time deposit in the bank outside the U.S. and receive a large interest rate than in case funds were put in the U.S. time deposit. Suppose that German Exporter deposits the funds in the London Euro bank. London Euro bank credits German Exporter with a $100 time deposit and deposits $100 in its correspondent bank account (demand deposit) with the U.S. Bank (banking system) to hold as reserves. Two points are important to note: Firstly, entire $100 remains on deposit in U.S. Bank. Second, $100 time deposit of German Exporter in London Euro bank specifies the formation of Eurodollars. This deposit exists in addition to dollars which are deposited in U.S. Therefore, no dollars have flowed out of U.S. banking system in the creation of Eurodollars.