Offshore freedom

Two other threads of history shaped the modern financial markets. The first was America's interest equalisation tax (a tax of 15% on the interest paid by foreign issuers of bonds in America), imposed in 1963, which prompted American companies to issue bonds offshore rather than domestically. The biggest American companies formed offshore subsidiaries through which they issued so-called Eurobonds. Although these bonds were predominantly issued in dollars, the main markets for them were London and Luxembourg. The underwriting, issuing and trading of Eurobonds became one of the pivotal activities of international investment banks and a laboratory for financial innovation.

The second was America's decision in 1971 to end the dollar's link with the gold standard. The exchange rate of the dollar was allowed to float freely. In a few years, foreign-exchange trading and speculation had become a huge activity for banks. But the mechanics of forex trading changed little to take account of the increased volumes and the increased exposure to exchange-rate fluctuations. A wake-up call came in July 1974 when a German bank, Bankhaus Herstatt, was closed down before the end of the American business day. It had collected payments in yen, D-marks and other European currencies, but failed to honour its dollar payments in New York. This caused gridlock in the foreign-exchange markets, as banks panicked and refused to release payments for other perfectly sound transactions. The small Herstatt bankruptcy had worldwide repercussions, demonstrating how fast contagion could spread through the world financial system.

Stockmarkets have always been volatile, but such volatility in currencies, interest rates, bonds and even loan prices was something new. With so many new variables it was becoming increasingly important for companies and banks to find ways of protecting themselves against extreme fluctuations. This simple need gave birth to a highly complex activity: the creation, selling and trading of financial derivatives.

Pregnancy And Childbirth

Pregnancy And Childbirth

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