Are We Headed Towards a Monetary Breakdown? Jeff Snider's Warning About the Eurodollar System

Jeff Snider explains why the Federal Reserve's power is largely illusory, how the global Eurodollar system actually works, and why we may be heading toward monetary breakdown and fiscal dominance.

Key Takeaways

• The global monetary system is dominated by Eurodollars—virtual ledger entries denominated in dollars but not actual Federal Reserve liabilities
• The Federal Reserve lost control of the monetary system in the 1950s-1970s as banks created their own reserveless, cashless global currency system
• The 2008 crisis created a permanent paradigm shift where banks became risk-averse utilities rather than aggressive money creators
• Quantitative easing doesn't work because it's an external attempt to influence a system the Fed isn't actually part of
• Collateral shortages, not money printing, drive most financial market stress and limit the Fed's effectiveness
• Yield curve inversions indicate widespread hedging against economic breakdown, not just recession expectations
• Market participants increasingly ignore central bank hawkishness because they recognize monetary authorities' limitations
• The next recession could trigger a shift from QE to direct fiscal stimulus and government check-cutting programs
• Duration assets (long-term bonds) may outperform in a deflationary monetary breakdown scenario

Timeline Overview

• 00:00–08:45 — Introduction and Jeff's Background: Jeff Snider's journey from 1990s portfolio manager to monetary system researcher, discovering discrepancies in bank balance sheets that led to decades of studying the hidden Eurodollar system
• 08:45–18:30 — The Eurodollar System Reality: How virtual ledger money replaced physical currency, why most "dollars" aren't Federal Reserve liabilities, and how this global reserveless system evolved beyond traditional monetary boundaries since the 1950s
• 18:30–28:15 — Fed's Loss of Control: Why the Federal Reserve can only influence the monetary system from outside through interest rate targeting, how banks innovated beyond traditional money categories, and why monetary aggregates like M1 stopped working
• 28:15–38:40 — The 2008 Paradigm Shift: How the financial crisis permanently changed bank behavior from risk-seeking to risk-averse, why institutions became "fortress balance sheets," and the role of both psychological and regulatory factors
• 38:40–48:20 — Why QE Doesn't Work: How quantitative easing represents asset swaps rather than money creation, why transmission mechanisms fail when banks won't expand balance sheets, and how the Fed became "market maker of last resort" instead of lender of last resort
• 48:20–58:35 — The Collateral Crisis: How repo markets create fractional reserve multipliers for financial collateral, why there aren't enough treasuries for the system, and how collateral shortages drive financial stress more than money supply issues
• 58:35–01:08:50 — Understanding Yield Curve Inversions: What inversions really signal about market hedging behavior, why they indicate widespread concern rather than specific rate predictions, and how current inversions compare to historical episodes
• 01:08:50–01:18:25 — 2023 Recession Outlook: Why market curves point to significant economic downturn, how monetary breakdowns could trigger Fed pivots, and parallels to the UK gilt crisis as preview of system fragility
• 01:18:25–01:28:40 — Bank of Japan and Yield Curve Control: How YCC represents central bank admission that QE doesn't work, why the BOJ's band widening reflects curve pressure rather than hawkishness, and market indifference to central bank positioning
• 01:28:40–01:38:20 — The Path to Fiscal Dominance: Why recession could trigger government direct spending programs, how MMT thinking influences policy despite monetary misconceptions, and parallels to 1930s New Deal spending
• 01:38:20–End — Investment Implications and Long-term Outlook: Why duration assets may outperform in deflationary scenarios, how fiscal intervention might prove dis-inflationary like in Japan, and optimistic vision for eventual 1950s-style recovery in the 2030s

The Hidden Reality of the Eurodollar System

Jeff Snider's fundamental insight challenges the most basic assumptions about how money works in the modern world. The conventional view—that governments print money, banks store it, and fractional reserve lending multiplies it—bears little resemblance to the actual global monetary system that emerged in the 1950s and now dominates international finance.

The Eurodollar system represents a parallel monetary universe where banks trade virtual ledger entries denominated in US dollars but never requiring actual Federal Reserve notes or reserves. These aren't deposits backed by government money but rather direct bank liabilities that function as money because participants accept them as such. The system evolved organically as banks discovered they could conduct international business more efficiently by trading electronic claims rather than shipping physical currency across oceans.

This transformation began in the 1950s when London banks started accepting dollar deposits from Soviet institutions unwilling to hold assets directly in US banks during Cold War tensions. Rather than routing these transactions through the Federal Reserve system, banks simply created offsetting ledger entries denominated in dollars. The innovation proved so efficient that it rapidly expanded beyond political necessity into standard banking practice worldwide.

The seamless integration between domestic US banking and offshore Eurodollar markets meant that for decades, there was no meaningful distinction between "real" dollars and Eurodollars. Money flowed freely between US-based and foreign-based institutions through subsidiary relationships and direct dealing arrangements. The Federal Reserve's ability to monitor or control this expansion proved limited because much of it occurred outside traditional regulatory boundaries.

By the 1970s, Federal Reserve officials recognized they had lost effective control over monetary aggregates. The famous "Case of the Missing Money" paper by Stephen Goldfeld documented how traditional monetary metrics no longer correlated with economic activity because banks had innovated far beyond the categories regulators could track. The system had become reserveless, cashless, and largely invisible to traditional monetary authorities.

The implications proved profound because this meant the world's reserve currency system operated independently of its supposed central bank. While the Federal Reserve could influence short-term interest rates through its limited market operations, the vast majority of dollar-denominated transactions occurred in markets where the Fed had no direct presence or authority. The result was a global monetary system without a true central bank—a "non-system" that functioned through private bank relationships rather than government oversight.

The 2008 Paradigm Shift: From Risk-Seeking to Risk-Averse Banking

The 2008 financial crisis represented far more than a cyclical downturn or policy error—it fundamentally altered how banks perceive risk and conduct business. Before the crisis, the "Great Moderation" period had convinced financial institutions that traditional monetary panics were historical artifacts. Advanced mathematical models and abundant liquidity created widespread belief that risk had been conquered through sophisticated quantitative techniques.

This confidence manifested in extreme risk-taking behavior where banks convinced themselves that complex financial instruments carried minimal downside. The collapse of this worldview didn't happen gradually but arrived suddenly with Bear Stearns' near-failure in March 2008. While policymakers celebrated Bear Stearns as a successful rescue, bank managers drew opposite conclusions about the new reality they faced.

Seeing a venerable Wall Street institution nearly wiped out sent shockwaves through banking leadership worldwide. Bear Stearns wasn't a reckless subprime originator but a respected firm with deep institutional knowledge and strong client relationships. If Bear Stearns could face extinction, any bank could face similar threats. This realization triggered fundamental changes in how banks approached risk, capital allocation, and business strategy.

The transformation was immediate and permanent. Banks shifted from growth-oriented, opportunity-seeking institutions to defensive, risk-averse utilities focused on survival rather than profit maximization. Jamie Dimon's description of JPMorgan as a "fortress balance sheet" captured the new mentality—banks would prioritize safety over returns and maintain excessive capital buffers against unknown risks.

This cultural shift preceded and reinforced regulatory changes that followed the crisis. While Basel III and Dodd-Frank codified new capital requirements and business restrictions, banks had already begun voluntarily constraining their activities. Risk committees staffed by lawyers and accountants replaced trader-driven decision making. Complex approval processes replaced quick decisions on innovative transactions.

The result was a banking system that economists and policymakers didn't recognize. Instead of the aggressive money creators that had driven pre-crisis expansion, banks became ultra-conservative institutions focused on regulatory compliance and risk minimization. They preferred holding government securities over making loans, charging higher spreads over taking volume, and maintaining liquidity over deploying capital productively.

This transformation explains why traditional monetary policy transmission mechanisms broke down after 2008. Central banks designed their tools for banks eager to expand lending and take risks. When banks became risk-averse utilities more concerned with survival than growth, interest rate changes lost their traditional impact on credit creation and economic activity.

Why Quantitative Easing Represents Policy Theater

Quantitative easing emerged from Federal Reserve desperation rather than monetary theory. When traditional interest rate cuts failed to restore normal banking behavior, officials searched for new tools to stimulate credit creation. QE represented their best guess at how to influence a monetary system they didn't fully understand and couldn't directly control.

The fundamental flaw in QE lies in its asset-swap nature. When the Federal Reserve buys treasury bonds or mortgage-backed securities from banks, it simply exchanges one bank asset (the bond) for another (bank reserves). The bank's balance sheet doesn't expand—it just changes composition. If banks were already reluctant to lend because of risk aversion, providing them with additional reserves doesn't change their underlying incentives or capabilities.

This explains why massive QE programs produced asset price inflation without corresponding economic growth or consumer price increases. Banks used the spread income from trading with the Fed to rebuild capital buffers and improve profitability without expanding lending. The money never "printed" its way into the broader economy because banks had no interest in creating additional credit that might expose them to borrower default or liquidity risks.

Central bankers misunderstood their own role in the monetary system. Rather than being puppet masters pulling monetary strings, they discovered they were external observers trying to influence internal bank decisions through indirect signals. Banks could choose to ignore these signals if they conflicted with internal risk assessments or regulatory constraints.

The "abundant reserves" doctrine that followed QE represented further admission of Federal Reserve limitations. By flooding the banking system with excess reserves, officials hoped to eliminate funding constraints that might limit bank lending. Yet banks with abundant reserves continued restrictive lending practices because their constraints were risk-based rather than funding-based.

Japan's experience with QE provided clear evidence of the policy's limitations. Despite decades of aggressive balance sheet expansion, Japanese banks never resumed the aggressive lending behavior that had characterized their bubble period. Economic growth remained subdued, inflation stayed below targets, and financial markets required constant central bank intervention to maintain stability.

The Federal Reserve's own research gradually acknowledged QE's limited effectiveness. Studies showed that portfolio effects and wealth effects from higher asset prices provided marginal economic benefits while creating significant financial stability risks. Yet officials continued QE programs because they lacked alternative tools and couldn't admit their limited influence over the monetary system they supposedly controlled.

The Collateral Crisis: Shadow Banking's Achilles Heel

The modern monetary system's reliance on collateral creates vulnerabilities that most observers, including central bankers, fail to appreciate. Repo markets—where banks lend cash against security collateral—became the backbone of short-term funding for financial institutions worldwide. Yet the system's apparent stability masks fundamental design flaws that make it prone to sudden breakdowns.

Understanding repo requires recognizing that cash lenders care primarily about collateral liquidity rather than credit quality. A bank lending overnight funds wants assurance that if the borrower defaults, the collateral can be sold immediately at full value. This drives demand toward the most liquid securities—primarily US Treasury bonds—regardless of yield or duration considerations.

The problem emerges because the supply of high-quality collateral is limited while demand from the global repo system is virtually unlimited. Banks solved this constraint through re-hypothecation—lending the same treasury bond multiple times through chains of borrowing arrangements. One treasury bond might serve as collateral for several different transactions simultaneously, creating a fractional reserve system for financial collateral.

This multiplication process works smoothly until liquidity stress emerges. When banks become reluctant to lend collateral or uncertain about counterparty risks, the chains break down rapidly. Securities that previously served multiple repo transactions suddenly become unavailable, creating acute collateral shortages that can't be resolved through price adjustments alone.

The 2008 crisis demonstrated how collateral shortages could amplify financial stress beyond what traditional banking theory suggested. When mortgage-backed securities lost their status as acceptable collateral, institutions couldn't simply substitute other assets. The sudden demand for Treasury bonds as replacement collateral exceeded available supply, creating the "flight to quality" that drove Treasury yields to unprecedented lows.

AIG's failure illustrated the complexity of modern collateral relationships. The insurance giant wasn't just borrowing Treasury bonds for its own use—it was intermediating between its regulated insurance subsidiaries and its unregulated financial products division. When confidence collapsed, multiple collateral chains broke simultaneously, creating liquidity demands that no single institution could satisfy.

Federal Reserve officials never fully grasped the collateral dimension of the crisis. Their focus on bank capital and traditional lending overlooked the shadow banking system's dependence on functioning repo markets. QE actually exacerbated collateral shortages by removing high-quality bonds from the market, forcing banks to compete for remaining Treasury inventory.

Current market stress often reflects collateral constraints rather than traditional banking problems. The UK gilt crisis in September 2022 demonstrated how quickly collateral shortages can emerge and spread across seemingly unrelated markets. Pension fund leverage, European bank funding, and Swiss financial stability all connected through collateral relationships that regulators hadn't anticipated.

Decoding Yield Curve Inversions: Market Hedging vs Recession Prediction

Yield curve inversions generate widespread attention because of their historical correlation with recessions, but most observers misinterpret what inversions actually represent. Rather than precise predictions about future interest rates or economic timing, inversions reflect risk management behavior by sophisticated market participants hedging against uncertain but potentially severe outcomes.

The mechanics of inversion involve market participants buying longer-term bonds not because they expect specific rate paths but because longer-term securities provide the best hedging characteristics for portfolio risks. If an institution fears general economic deterioration, purchasing 10-year Treasury bonds protects against scenarios where the Federal Reserve cuts rates to zero regardless of the exact timing or magnitude.

Current inversions began in December 2021—months before Federal Reserve rate hikes commenced—indicating that market concerns preceded rather than resulted from monetary policy changes. The December 2025 Eurodollar futures contract inverted first, not because traders expected specific conditions in 2025 but because that contract offered the most cost-effective hedging opportunity at the time.

The severity of current inversions suggests widespread risk aversion among institutional investors. Two-year/ten-year Treasury spreads reached levels comparable to previous recession periods, while Eurodollar futures curves inverted by over 200 basis points. These extreme levels indicate that many market participants are willing to pay significant opportunity costs to hedge against tail risks.

Importantly, inversions don't predict recession timing or severity with precision. They function more like insurance policies than forecasting tools. The more inverted curves become, the more market participants are paying for protection against bad outcomes. This insurance demand can persist for months or years before the feared events actually materialize.

The pattern of inversion spread provides additional information about risk perceptions. When inversions begin at specific curve points and gradually expand to encompass more maturities, it suggests growing consensus about potential problems. Current inversions have spread from Eurodollar futures to Treasury curves to international bond markets, indicating global rather than purely domestic concerns.

Central bank attempts to fight inversions through hawkish rhetoric have proven largely ineffective. Despite aggressive rate hikes and tough talking from Federal Reserve officials, curves remain heavily inverted. This suggests market participants believe economic fundamentals will overwhelm monetary policy efforts—that recession will arrive regardless of what central bankers attempt.

The persistence of inversions even as inflation data improves supports the view that markets are hedging against broader economic breakdown rather than just inflation concerns. If inversions were purely about Federal Reserve policy errors, they should diminish as inflation moderates. Instead, curves remain inverted despite improving price data, suggesting deeper structural concerns about monetary system stability.

2023 Recession: Inevitable Downturn or Policy-Driven Crisis?

Market indicators point toward significant economic disruption in 2023, but the nature and severity of that disruption remain uncertain. Unlike previous cycles where recessions emerged from obvious imbalances or policy mistakes, the current setup involves complex interactions between global supply chains, monetary system dysfunction, and accumulated financial fragilities that make prediction particularly difficult.

The supply shock that drove 2021-2022 inflation is reversing, but the economic adjustment may prove more severe than the initial disruption. Companies that expanded capacity and inventory to meet pandemic-driven demand now face normalized consumption patterns while carrying elevated cost structures. The transition from goods consumption back to services consumption requires massive resource reallocation that typically generates unemployment and business failures.

Monetary system indicators suggest problems beyond normal business cycle dynamics. Bank lending standards continue tightening despite Federal Reserve attempts to maintain accommodation. Corporate credit spreads remain elevated relative to equity market valuations. International dollar funding markets show persistent stress despite swap line availability.

The UK gilt crisis in September 2022 provided a preview of how quickly monetary breakdowns can emerge and spread across global markets. Pension fund de-leveraging triggered collateral shortages that affected European banks and Swiss financial institutions despite appearing initially like a purely British problem. Similar dynamics could emerge from unexpected sources in 2023.

Federal Reserve officials face impossible choices between fighting inflation and maintaining financial stability. Rate hikes that successfully reduce inflation expectations may trigger credit market disruptions that force policy reversals. Yet backing down from inflation fighting could unleash currency depreciation and imported inflation that makes the problem worse.

The international dimension adds complexity because many countries face even more severe inflation and monetary pressures than the United States. European energy costs, Chinese growth slowdowns, and emerging market debt problems could all trigger capital flows that destabilize US financial markets regardless of domestic policy choices.

Corporate earnings expectations appear increasingly divorced from economic reality. Many companies continue reporting strong profits while operating metrics suggest deteriorating conditions. The gap between financial reporting and underlying business performance may close suddenly through write-downs and guidance reductions that catch investors unprepared.

Employment markets present particular puzzles because traditional recession indicators haven't emerged despite other warning signs. Labor shortages persist in many industries even as economic growth slows. This could reflect demographic changes that make employment metrics less reliable recession predictors, or it could indicate that employment effects will arrive later but more severely than historical patterns suggest.

The Path to Fiscal Dominance: From QE to Government Check-Cutting

The failure of monetary policy to generate satisfactory economic outcomes has created political pressure for more direct government intervention in economic management. Modern Monetary Theory, despite its flawed understanding of monetary mechanics, provides intellectual cover for politicians eager to bypass central bank limitations through fiscal expansion.

The 2020 pandemic response demonstrated that direct government spending could influence economic outcomes more rapidly and visibly than traditional monetary policy. Stimulus checks reached households immediately while quantitative easing remained invisible to most citizens. This experience convinced many policymakers that fiscal tools offer more reliable ways to influence economic conditions than monetary tools.

The death of bond vigilantism—the market mechanism that traditionally constrained government borrowing—removes the primary obstacle to unlimited fiscal expansion. Treasury bonds have become the world's preferred collateral and safe asset, creating artificial demand that allows governments to borrow at rates below inflation without triggering traditional crowding-out effects.

Future recessions may trigger automatic stabilizers that dwarf previous fiscal responses. Universal basic income, job guarantee programs, and direct cash transfers could become standard recession-fighting tools rather than emergency measures. The political appeal of direct payments compared to obscure central bank operations makes this transition politically inevitable once economic conditions deteriorate sufficiently.

The Japanese experience suggests that fiscal dominance doesn't necessarily generate the inflation that traditional economics predicts. Decades of deficit spending and money creation failed to produce sustained price increases because the money flowed to least productive sectors of the economy. Similar dynamics could emerge in the United States if fiscal expansion funds unproductive activities rather than growth-enhancing investments.

Corporate welfare through business subsidies and tax preferences may prove more politically feasible than direct household transfers, especially after recent inflation experiences. Japan's secondary budget became larger than its primary budget through such programs during the 1990s. Similar outcomes could emerge in the United States through "infrastructure" spending and "industrial policy" initiatives.

The transition from monetary to fiscal dominance creates new risks that policymakers haven't fully considered. Direct government spending bypasses traditional banking intermediation, potentially disrupting credit allocation mechanisms that markets have relied upon for decades. The resulting economic distortions could prove more severe than current monetary system dysfunction.

International implications of fiscal dominance remain unclear because no reserve currency country has attempted such policies at current global scales. Dollar funding markets could destabilize if foreign investors lose confidence in US fiscal sustainability. Alternatively, increased Treasury issuance could exacerbate collateral shortages that make global financial markets more fragile rather than more stable.

Investment Implications: Duration, Deflation, and Portfolio Positioning

Traditional investment frameworks break down when monetary systems malfunction and fiscal policies become unpredictable. The standard advice to "buy the dip" and "don't fight the Fed" assumes central bank omnipotence that evidence increasingly contradicts. Successful investing in the current environment requires understanding the gap between policy rhetoric and policy effectiveness.

Duration assets—long-term government bonds—may outperform despite their traditional reputation as inflation hedges. If monetary breakdown produces deflationary pressures similar to Japan's experience, bonds that appear expensive at current yields could generate substantial returns as rates fall toward zero. The Federal Reserve's rate hiking campaign has actually cheapened duration assets for investors positioning ahead of eventual policy reversals.

Equity market performance will likely depend on sector-specific factors rather than broad market trends. Companies that rely on functioning credit markets may struggle even if their underlying businesses remain profitable. Conversely, businesses with strong balance sheets and minimal financing needs could thrive in environments where credit becomes scarce and expensive.

Real estate faces complex crosscurrents from higher mortgage rates, demographic changes, and potential fiscal programs that could alter housing demand. Geographic disparities may become more pronounced as work patterns stabilize post-pandemic and local economic conditions diverge based on industrial composition and governance quality.

Cash management becomes more complex when traditional money market instruments carry duration and credit risks that weren't previously apparent. Treasury bills appear safe but may not be available in sufficient quantities. Bank deposits face potential bail-in risks in severe crisis scenarios. The apparent safety of cash may prove illusory if monetary breakdown accelerates.

International diversification strategies require careful attention to currency and political risks that weren't relevant during previous globalization periods. Countries with strong fiscal positions and independent monetary policies may outperform, but identifying such countries requires analysis that goes beyond traditional economic metrics.

Commodity investments face uncertain prospects because demand depends heavily on global economic growth while supply responds to long-term investment cycles. Energy transition policies could accelerate or decelerate depending on whether governments prioritize climate goals or economic stability when forced to choose between them.

Private equity and alternative investments may struggle in environments where credit markets don't function normally and exit opportunities become limited. Illiquid investments that appeared attractive during low-rate environments could prove problematic if refinancing markets freeze or valuation multiples compress rapidly.

Practical Implications

• Reconsider Fed omnipotence assumptions — The Federal Reserve's control over monetary conditions is far more limited than commonly believed; investment decisions based on Fed forecasting or Fed put assumptions may prove costly
• Focus on duration positioning over traditional recession hedges — Long-term government bonds may outperform despite rate hike fears if monetary breakdown triggers deflationary forces similar to Japan's experience
• Prioritize liquidity and cash flow over growth metrics — In credit-constrained environments, companies with strong balance sheets and minimal financing needs outperform those dependent on external funding regardless of growth prospects
• Understand collateral dynamics in portfolio construction — Many seemingly safe assets depend on functioning repo markets that can break down rapidly; true liquidity may be rarer than apparent liquidity
• Prepare for fiscal dominance transition — Traditional monetary policy may give way to direct government spending programs; positioning for this shift requires understanding political economy rather than just economics
• Avoid complex financial instruments dependent on interconnected markets — Shadow banking system fragilities make sophisticated financial products particularly vulnerable to sudden liquidity disruptions
• Consider deflationary scenarios in asset allocation — Despite inflation fears, monetary breakdown could produce Japan-style deflation; portfolios positioned only for inflation may underperform
• Reassess international exposure and currency risks — Global monetary system breakdown affects different countries asymmetrically; geographic diversification requires understanding monetary system dependencies
• Build hedges against yield curve steepening and flattening scenarios — Curve inversions could reverse rapidly if recession triggers Fed policy pivots; duration positioning should account for various curve scenarios
• Reduce dependence on momentum and algorithmic strategies — Market relationships established during monetary expansion may break down during monetary contraction; systematic strategies may fail when underlying assumptions prove invalid
• Focus on businesses with pricing power and essential services — Companies that can maintain margins without credit expansion may outperform those dependent on financial engineering or leverage
• Prepare for extended low-growth, low-return environment — Japanese-style outcomes suggest decades of below-normal returns across most asset classes; investment horizons and return expectations may need fundamental adjustment
• Understand political economy implications of economic policies — Investment outcomes increasingly depend on political responses to economic stress; policy analysis becomes as important as financial analysis
• Consider hard assets with genuine scarcity and utility — In monetary breakdown scenarios, assets with real-world utility and limited supply may outperform financial claims and complex instruments
• Maintain flexibility and avoid concentrated bets — Unprecedented monetary conditions make traditional forecasting unreliable; diversification and optionality become more valuable than conviction positioning