Oil slide puts kink in eurodollar cashflow

As economists and consumers celebrate the boost to spending potential from plunging crude oil prices, the negative feedback loops are steadily rippling through the deflating global financial system.

Emerging market contagion from Russia's cash crunch and credit market jitters from defaulting oil companies have been some of the first areas of concern, along with fiscal problems in oil nations.

But there are potentially much broader problems brewing deep down in the plumbing of globally strategic US dollar funding markets and interest rates are rising, albeit from a low base.

Ignoring the effects on global warming, economically speaking the production of oil is about as productive as it gets. Without oil the world would grind to a halt.

However, the "petrodollar" cash flow from about 87 million barrels a day has been halved to about $US4.6 billion ($5.6 billion) a day and oil-producing nations now have much less US dollar revenue to spend or invest in the rest of the world.

The term petrodollars is outdated but it was appropriate back in the late 1970s when excess US dollars earned by oil producers were the dominant source of currency recycled back into a pool of "offshore" US dollars traded in London.

Since then, as global trade expanded, the source of these "eurodollars" has broadened to proceeds from trade and other commodities recycled by countries with trade surpluses. The $US4.9 trillion pool is now referred to as eurodollars because it's a US dollar market in Europe.

Eurodollars are not to be confused with the exchange rate between the euro currency and the greenback, and the borrowing rate for them is determined by Libor, or the London interbank offered rate. Non-US banks all use eurodollars to fund customer trade finance and capital expenditure.

Eurodollars fall out of the control of the US Federal Reserve and the US banking system, but they are "fungible" by the 22 US bank "primary dealers" with direct access to Fed funding. The dealers form the narrow bridge between the onshore US banking system and the offshore eurodollar market.

Analysts have shown that during the global financial crisis the eurodollar market was ground zero as lending froze and Libor rates soared.

The Fed prevented the system from crashing by extending its US dollar lending "window" to other central banks, including the Reserve Bank, which in turn lent Fed-sourced US dollars to domestic banks unable to roll over eurodollar liabilities as panic seized markets.

The market calmed until the eurozone sovereign debt crisis in 2010, but distrust remains elevated for less credit worthy banks in Europe and emerging markets that pay a hefty premium over Libor.

Every day, Australian and other foreign banks still tap into the eurodollar market to manage currency swaps for importer and exporter forward hedging. So if Libor rates rise because there are fewer eurodollars available from reduced oil revenues then the cost of hedging imports and bank offshore funding for mortgages will in time rise, too.

For the past six years there has been a global glut of US dollar liquidity from US quantitative easing and European Central Bank long-term lending, but the concern from plunging oil prices is the rapidly diminishing flow of eurodollars available to fund global financial markets.

It's occurring at the same time as the greenback is soaring, which makes foreign governments and companies that have US dollar liabilities susceptible to default or losses if they haven't fully hedged their exposure.

No one knows the extent of market exposure, but because forward hedging cancels out the benefit of low Libor borrowing costs, there are fears of widespread short exposure to the US dollar that will start to manifest this year when borrowers seek to roll over liabilities in tightening markets.

In a world saddled with debt, funding problems outweigh benefits from the boost to spending from low oil prices.