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For Release on Delivery
(Approximately 12:00 Noon
Thursday, May 12, 1966)
The Money Scene
Remarks by J. Dewey Daane
Member, Board of Governors of the Federal Reserve System
Before the Investment Bankers Association's Spring Meeting
The Greenbrier
White Sulphur Springs, West Virginia
on Thursday, May 12, 1966
The Koncy Sccno
En talking today on the subject of the money scene with such a
large groun of friends, whose mental agility and i;is den I know so
well,
I hope my remarks wilL be notable not for their notoriety hut
for their brevity, because you know me r.uch too well for me to
pontificate at lengLh.
At the r»fiire Lime, however,
1 am reminded
of the legend about Carter Glass to Lhe effect that iic haLed to make
a speech except when it could be controversial.
Without in any way
attempting to make my own brief remarks controversial,
I would like
to talk with you today mainly about seme of the issues on both the
international and domestic money scenes as I see them.
The search for a new international money
On the international scene, tJiich has absorbed much oi my own
time and energies this past year,
there has been a continuing search
for supplements to gold and dollars as the principal reserves in the
international monetary system.
This search, still in process,
agreed ways and means of deliberately creating,
for
for the first time, an
international money has indeed been an exciting one, and I would like
to highlight for you both some of the areas of agreement and seme oC the
remaining issues.
been going on,
L'hile this search for a new international money lias
there has been a separate search under way in the inter
national financial community for a better balance oi payments adjustment
process— ior better ways and means that countries might adopt to corrcct
their balance of payments di{u:x|ui Libria.
Here,
too, some of the sort of
basic issues that arise along tho way may deserve consideration.
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As to the international money search, both the International
Monetary Fund and the Group of Ten have been working diligently to
explore the many problems involved.
As you know, the Group of Ten is
an offspring of the International Monetary Fund, a ten-country offspring
self-designed to provide additional financial resources to the parent
to the tune of up to some six billion dollars.
In fact, under these
arrangements more than nine hundred million dollars has already been
provided by this group of major industrial countries.
Representatives
(the Deputies) of these ten countries (Belgium, Canada, France, Germany,
Italy, Japan, Netherlands, Sweden, United Kingdom, United States), plus
Switzerland and the International Monetary Fund and other international
financial institutions, have been meeting regularly since last fall
in response to a Mandate from the Finance Ministers and Governors of
these same countries, a Mandate asking the Deputies of the Ten to
"determine and report to Ministers what basis of agreement can be
reached on improvements needed in the international monetary system,
including arrangements for the future creation of reserve assets, as
and when needed, so as to permit adequate provision for the needs of
the world economy.n
Two questions may be raised at this point.
First, why all of the
effort and second, what progress has been made in finding agreement?
The why of the effort has been stated so many times it may sound
repetitious.
Simply stated, it is that the supply of new monetary gold
and a shrinking additional supply of dollars will not meet the future
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needs for world reserves.
If one asks oneself what have been the
sources of new international reserves over the last decade or so,
the answer is that the rest of the world has depended to a very large
extent on increases in holdings of dollars and on gold mainly acquired
from the United States.
In other words, the rest of the world has been
dependent on balance of payments deficits in the United States for in
creases in international reserves.
For a variety of reasons, which
I need not develop in detail for this audience, it is both desirable
and necessary that the U. S. balance of payments should return to
equilibrium*
For, while our balance of payments deficit has resulted
in increasing liquidity for the rest of the world, it has at the same
time reduced our own liquidity markedly--as our liabilities to the rest
of the world have increased and our own assets in the form of gold
have declined.
The flow of gold from our country, of course, does not
add net to world reserves but simply transfers ownership of existing
gold in exchange for dollars that might otherwise have served as reserves.
Meanwhile, the amount of new gold becoming available for additions to
world reserves is not large enough, given the evident desires of countries
to add to their reserves, and furthermore such new supplies of gold are
unpredictable.
Specifically, over the past six or seven years world
reserves have grown annually by perhaps a little more than two billion
dollars a year of which gold may have accounted for five or six hundred
million dollars.
Last year the contribution from new gold was only
around 250 million dollars, obviously an amount insufficient to satisfy
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the secular growth in reserve requirements of the world over time.
Thus, while the future need for reserves is difficult to quantify,
the likelihood of future need clearly exceeding growth of the stock
in monetary gold and of reserve currency holdings, specifically dollars,
leads to the decision to search for a new means of creating international
reserves.
That search is now going on under the heading of contingency
planning.
In other words, the need to add to reserves is not felt
to be immediate.
At the same time, it is thought to be prudent to put
in place, so to speak, a mechanism for reserve creation that can be
activated as and when it is needed.
As an analogy it can be thought
of as putting together an airplane with the decision to fly it post
poned to a later point in time.
What progress has been made?
A first point on which a consensus is emerging is that contingency
planning is clearly and firmly necessary.
It is generally recognized—
more clearly, I think, than when these discussions began--that the
world must be assured that it is not beyond the capabilities of
sovereign nations to agree on a means of mutually iacreasing reserves.
This need emerges from a simple set of facts.
Most countries gear
their policies to achieving a growing level of reserves over time.
no country gears its policies to a secular decline in reserves.
And
It
fallows inexorably that total reserves must grow unless some of these
policy intentions are to be frustrated.
But if some of them are
frustrated, countries will change their policies, in an effort to
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achieve rising reserves, in a way inimical to the interests of the
rest of the international community.
A second and closely related
reason for the emergence of a consensus on the need for contingency
planning is that the world must be assured that a true supplement
to limited gold supplies can be found and put in place without dis
ruption to existing international relationships.
Given this consensus, the main problems to be solved are con
cerned &ith the form of the new international assets to be created,
their institutional setting, the way in which they will be made
acceptable to monetary authorities, the way in which they will be
utilized in financing surpluses and deficits, and the way in which
the various countries of the world, in different stages of development,
will share in this process of creating and using new reserve assets*
Let me comment on some of these problems.
As regards the form of a new reserve asset, two types have been
considered.
On the one hand, a reserve unit, as it is called, could
be created and held in the reserves of the monetary authorities.
Such
a unit would be directly transferable among such monetary authorities
in a way very similar to the use of gold now.
Some feel that the
unit is more adaptable to the needs of the advanced countries, which
are the major holders of gold.
The other form of reserve asset under consideration is a socalled drawing right on the International Monetary Fund.
Such a
drawing right (which might be looked upon as a checking account at
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the IMF) would give countries the right to draw other currencies
from the International Monetary Fund as needed to finance imbalances
in their international payments.
The economic effect of using either
of these types of reserve asset would be rather similar, but at the
same time each of them has distinctive advantages.
A reserve unit,
for example, appears more clearly as a supplement to gold.
It would
be freely transferable by countries holding it without the need to
engage in transactions through an institution.
Drawing rights re
present an adaptation of a type of reserve asset already in existence;
namely, gold tranche positions in the International Monetary Fund.
The further development of this type of reserve asset would represent
a clear evolution from what is already known and tested.
The member countries of the Group of Ten have shown a preference
for one or the other of these forms of reserve asset.
Consistent with
the age old principle, well known to those so familiar with the Old
White Club here at the Greenbrier, that "no bird ever flew on one
wing", the United States has put forward a proposal which would pro
vide the airplane with two wings, both units and drawing rights, in
what we have called a "dual approach" to the problem of reserve creation.
An issue on which there has been somewhat less agreement concerns
the way in which new units would be transferred in financing payments
imbalances.
Some proposals would link the use of the new unit to
some other form of reserve--notably gold.
The argument here is that
if a new asset were linked to gold in use, it would be more acceptable
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to receiving countries and would at the same time provide a greater
incentive to deficit countries to correct their deficits#
It is
argued, on the other hand, that if a new reserve asset is to stand
on its own feet as a true supplement to traditional forms of
reserves, it ought to be usable independently of such other reserves
and not provide any inducement to those kinds of shi fts in reserve
asset composition that would cause a shrinkage of total liquidity.
Those who do not favor a link of the new reserve asset to gold,
realize that, in the initial stages at least, some limitations will
be necessary on the extent to which contributing countries can be
obligated to accept the new asset.
This could be accomplished by
having the contributing countries agree that none of them would be
obliged to hold the new asset above some sort of holding limit, with
the right to redistribute the excess to other countries.
Another major issue concerns the way in which the various countries
of the world would participate in the creation and distribution of
new reserves.
On the one hand, it is now generally acknowledged that
all countries in the world, regardless of their stage of development,
have a need for growing reserves over time.
On the other hand,
countries do differ greatly in the degree of development and in the
extent to which they may need a supplement to gold and dollars in
their own reserves.
This raises the issue whether all countries
should participate in reserve creation on the same basis, or whether
the nature of their participation should be tailored to their particular
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circumstances.
liere again, Liie United States has put forward a
proposal that attempts to recognize these diversities.
l.'e have
proposed that a unit be created for the use of the major industrial
countries (with some set aside for others to be allocated through the
IMF) and that drawing rights; in the Fund be established for all
members of the Fund on a uniform basis.
I have tried to outline in very bread terms the nature of the
issues with which the members ol die Group of Ten arc grappling.
negotiating process may seem slow.
The
But when one realizes that what
is involved here is a unique cLfort--to do, as I said earlier, what
has never been done before— it is not terribly surprising that the
pace of progress should be .slow.
The intcresLs of the countries in
volved, although identical in sere respecLs, are diverse in others.
Seme of the countries have been in surplus for a number of years and
others in (¡elicit; this iact itself inevitably colors attitudes.
of the countries are large and others are small.
Fere
Scr.ie have world
wide political and military responsibilities and others do not.
Some
have eeoncmies which are very dependent on external markets, whereas
for others international transactions comprise a relatively srail
aspect of their total economic activity.
For these and other reasons,
it is understandable that the negotiations "to construct the airplane"
are not easy.
And beyond construction there is, of course, the issue
of activation or, in other words, under what circumstances and now
the first flight is to be triggered.
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But despite these diverse interests, progress is being made, and
the seeming slowness of progress may simply ensure a safer machine.
On one of my recent trips abroad one of the stewardesses asked me
why I was going over so often.
In my own affable and artless way—
with which you are familiar— I tried to explain to the youn^ lady our
efforts to create a new international money and she then asked "Do you
think it will work?"
I answered that I could not be sure because it
did involve an uncharted and unprovable area, to which she in turn
replied, "Well, they said we couldn't fly either".
Conceding this,
It seems to me that the time schedule calling for discussion and
negotiation, both within and outside the Ten, is both appropriate
and desirable.
The Deputies of the Group of Ten are scheduled to present a
report to the Ministers and Governors late in the spring.
The report
will indicate the eiitent of agreement and presumably will also present
the issues still outstanding.
In time the discussions will be trans
ferred to what is known as the second stage— in which a broader range
of countries will participate in the discussions and negotiations.
The search for improvements in the adjustment process
As to the search for better ways and means to correct balance of
payments disequilibria, this process of improving adjustment policies
will, in all likelihood, prove to be even more time consuming.
The
smooth functioning of the adjustment mechanism is, in a very real sense,
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an even more complex problem, with implications for the world economy
perhaps even broader and more diffuse.
The forum for current international consideration of this
problem is the so-called Working Party-3 of the Organization for
Economic Co-operation and Development,
Membership of this Working
Party largely overlaps that of the Deputies of the Group of Ten and
the Ministers and Governors of the Ten have expressed the hope that
this Working Party might also make a report about the same time as
the forthcoming one from the Deputies on reserve creation and monetary
improvements,
The subject matter for Working Party-3*s study and report— the
adjustment process--refers, as I have indicated, to the policies that
countries adopt, or sometimes fail to adopt, to correct balance of
payments disequilibria.
It is generally recognized that in some cases
both deficit and surplus countries have been rather slow to adjust«
If deficit countries are too slow to restore balance, an excessive
burden can be placed on surplus countries, and in some circumstances
this burden reveals itself in the form of inflationary pressures.
the other hand, if surplus countries are too slow to adjust,
On
they absorb
excessive amounts of reserves and deficit countries are driven to adopt
measures that are in conflict with their own domestic objectives or
with the freedom of international transactions.
What is being in
vestigated is whether the process of adjustment cannot be improved in
a way that is conducive to the maintenance of steady growth and price
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stability in all countries and with a generally free climate of inter
national transactions*
What are the means by which countries can adjust imbalances in
their payments?
First, they can use fiscal and monetary policies to influence
aggregate demand*
Deficit countries can restrict total demand and
in the process reduce their imports and increase their exports.
Surplus
countries can stimulate aggregate demand and in the process increase
their imports and reduce their exports.
This is the traditional text
book prescription as handed down from the gold standard.
some circumstances it is completely appropriate today.
And In
If the country
in deficit is already suffering from excess demand at home, such policies
would serve both internal and external objectives.
Similarly, if the
surplus country were suffering from inadequate demand, the prescribed
policy would be consistent with both internal and external objectives.
We have seen in recent years, however, that countries in surplus
may be suffering from excess demand at hctne, while countries in deficit
may be experiencing inadequate domestic use of resources.
In these
circumstances the traditional textbook prescription doesn't work.
For
while possibly helping to correct the balance of payments, it aggravates
the domestic problem.
Payments imbalances often are caused by factors
other than improper levels of aggregate demand.
The second prescribed means of adjustment of balance of payments
found in the textbooks is to permit exchange rates to fluctuate freely,
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as compared to the present fixed exchange rate system in which rate
adjustments are permitted only in cases of "fundamental disequilibrium."
In general, under this prescription, exchange rates of surplus countries
would appreciate— thereby making their exports more expensive to
foreigners and imports more attractive to their own citizens; while
deficit countries would permit their exchange rates to depreciate,
with the opposite effects on their trade.
Without going into further
detail, I need only to say that for a great number of reasons, this over
simplified prescription of fluctuating exchange rates is not generally
accepted by Governments today--and, in my view, quite rightly.
In
fact, this has been ruled to be outside the framework of the Working
Party-3 study.
Another, the third, means of adjustment would be through the use
of direct restrictions on international transactions, such as import
controls, exchange controls, and bans on capital movements*
Such
restrictions on trade and capital movements proliferated in the 1930's,
and most countries came out of World War II with a panoply of such
restrictions.
Slowly and painfully, these restrictions have been
relaxed in the post-war years, especially those on current transactions.
It is generally believed that a world in which such restrictions are
minimized is one in which the allocation of resources would be more con
ducive to economic growth and development.
Recently I had the privilege of attending a session of international
economists, mainly academicians, at Princeton University on the subject
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of the adjustment process.
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Starting from the premise that the fixed
exchange rate system was a datum they explored, first, the possibilities
of achieving adjustment via the co-ordination of aggregate demand
policies in surplus and deficit countries and seemed to conclude that
within realistic limits this would not suffice.
As to the second
alternative of direct controls these would be complete anathema to
the economist group.
Thus, they were all, or almost all*, led back
to the case for exchange rate fluctuations.
But this leads me instead to a fourth alternative means of balance
of payments adjustment, one to which the United States has had recourse
in recent years.
This involves what I would call selective instruments
of adjustment, which are designed to interfere as little as possible
with private decisions regarding trade and capital movements, but which
nevertheless attempt to exert a broad policy influence over these
movements in the direction of balance of payments equilibrium.
The United States has experienced in recent year& an excessive
outflow of capital to the rest of the world.
As a country with a
current account surplus, it is quite proper that we should export
capital.
The problem has been that the capital outflow has tended
to exceed our current account surplus after allowing for military
expenditures and the external costs of aid.
flow of capital there are tssny reasons.
And for this excess out
I shall not try to develop
all of them, but let me mention the fact that we do have the largest,
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the most developed, and the most accessible capital market in the
world.
And we have a highly developed and competitive banking
system which can satisfy the borrowing needs of both American and
foreign customers efficiently and at relatively low cost.
Finally
our corporations have been eager to build up their direct in
vestments abroad on a large scale.
We have tried to cope with the excess capital outflow by the
use of selective instruments, including the interest equalization
tax and more recently the Voluntary Credit Restraint Programs
applying to banks and other financial institutions and to corporate
investors overseas.
The application of these instruments is such
that decisions on individual credits and investments remain com
pletely at the discretion of the parties concerned.
I believe I have said enough to indicate that these selective
controls are in fact different from the other types of balance
of payments adjustment policies to which I referred.
These selective
instruments can never be regarded as a substitute for adequate fiscal
and monetary policies.
But as a supplement to such policies, they
do in my judgment have great advantages over the other two forms of
adjustment--floating exchange rates and direct controls over in
dividual transactions.
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As the adjustment process study goes forward, there is reason
to hope that there will be a fair degree of agreement on the de
sirability of improving that process consistent with other important
economic objectives*
An important result of this study is likely
to be an increasing realization that "it takes two to tango.11 In
other words, the burden of adjustment should not fall only on
countries iti deficit, or only on countries in surplus.
Rather,
both surplus and deficit countries have important responsibilities
in this regard.
We can also hope that there will emerge from this study a
realization that, while improvements in the adjustment process
are necessary and desirable, imbalances in international payments
are inevitable in a dynamic world.
than stagnation*
There is nothing more stable
In a world in which countries are growing vigor
ously, in which technology is advancing rapidly, in which new
products and new techniques are continuously coming forward, in
which international transactions are relatively free--in such a
world we have to expect significant imbalances to show up in the
total payments and receipts of individual countries.
What is to be
sought is not to prevent such imbalances but to prevent immobility
in correcting them.
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The domestic money scene
When we turn our attention to the major issues on the domestic
money scene, the players and props change but the basic analytical
framework can remain much the same.
The principles involved in
the international adjustment process have their direct application
to domestic affairs.
To be sure, the analogies between international
and domestic processes are not always perfect but, if not pushed
too far, I believe they can be quite helpful in putting what you may
sometimes regard as the same trite old ideas in new perspectives.
As a starting point, let me point out that we have a domestic
"adjustment process11 and it can be implemented through the same four
policy channels that we have described a few minutes earlier as
comprising the chief alternative channels of adjustment to inter
national equilibrium.
Domestically, just as internationally, these
iour channels can be labeled, respectively:
(1) the adjustment of
aggregate demand; (2) changes in the value of the currency; (3) the
imposition of direct controls; and (4) the overlay of a supplemental
fabric of selective instruments of adjustment.
Suppose we review these together briefly, one by one.
First
and foremost position must be given to policies to moderate the
course of aggregate demand.
Basically, these policies come down
to monetary policy and fiscal policy.
Each kind of policy has its
own special attributes, its own ways of affecting demands, and its
own side effects, not all of which are benign.
You know these too
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well for me to take time to detail them here.
But what is not always
fully appreciated is how much each kind of policy benefits from, and
is reinforced by, appropriate and timely application of the other.
In a phrase, good fisqal policy makes good monetary policy work better,
and vice versa*
This is one reason why I, right now, am still in
favor of a moderate tax increase to balance our policy of aggregate
demand restraint; ideally such a reinforcing tax increase could have
come earlier this year.
From the standpoint of our balance of pay
ments position, too, the need for stronger aggregate demand restraint
seems clear.
Equilibrium in the U. S. payments balance is essential
to the strength of the dollar, its continuing status as a reserve
currency, and the accomplishment of international monetary reform.
And my own view is that some firming by means of the tax and expendi
ture sides of fiscal policy could also be of major assistance in
dealing with the current problems in the relationships among various
kinds of savings intermediaries in the United States,
Given this potential for policy interaction, the coordination
of monetary and fiscal policy is, in my judgment, invaluable.
such ideal coordination is not easy to achieve.
But
Judgments of
reasonable men can vary ae to where we are in the business cycle,
as to how "overheated11 the economy is.
Moreover, a whole panoply
of political judgments and social values must also be brought into
play.
The end result is that coordination of intra-government de
mand policy can be almost as tricky— and occasionally as unnerving-as such adjustment of aggregate demand policies attempted internationally.
- 18 But suppose our aggregate demand control isn't enough.
Then in
the immediate instance, movements toward equilibrium would probably
have to be made--as in fact they are being made--through depreciation
of the value of the currency in terms of goods.
Color this inflation--
it is an economic affliction that is well nigh inevitable when aggre
gate demands exceed supply by a greater margin that can, or is being
neutralized through the bite of tight fiscal and monetary policy.
To you so intimately involved in dealing in fixed-value claims, the
ills of inflation need no cataloging.
The distortions and inequitites
it can create suit few persons' social preferences.
But beyond these,
there is the hard fact that inflation typically proves to be unsustainable--and the eventual and subsequent recession is a painful
price that is extracted.
Some, worried about the damages threatened by inflation, would
turn to the third channel of control--direct controls.
This, for lack
of a better term, I would label the "cork-in-the-bottle” approach to
trying to hold down interest rates and effective demand.
If applied
at the right time and place, and with the right kind of public
support, direct control undeniably can serve some policy objectives.
There are times--like World War II or the Korean War--when such con
trols were obviously advantageous.
But fundamentally direct controls
have to be an anathema to anyone concerned with the market process.
This is because the very essence of a direct control is to override-to contr£dict--the ordinary thrust of market forces.
In the long run,
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human controllers are not wise enough, nor market participants docile
enough, to make a system of direct controls work well or indefinitely.
These kinds of positions can serve as reference marks in principle,
by which policymakers can plot their long-range course*
One cannot
deny, however, that we sometimes come across navigational hazards that
require some extra maneuvering to bypass without serious incident.
As much as anything, these trouble spots grow out of market imperfec
tions— including particularly the inability of private market partici
pants to moderate short-run fluctuations that are out of track with
longer run trends,
A number of such imperfections have become so
commonplace they are a part of our every-day language:
"sticky prices,"
"surplus labor areas," "cost-push," "wage-price spiral,11 f*market
congestion," "credit rationing," "destabilizing international capital
flows," and even that despairing moan that occasionally escapes the
lips of a money position manager:
"There's no more money anywhere!"
In such circumstances, public policy actions of a selective
nature can sometimes provide some pragmatic assistance to the adjust
ment process that is proceeding under the more general influence of
aggregate demand policies*
One of the programs of greatest social
benefit in this respect is the effort at basic education and vocational
training of pockets of our population where lack of the labor skills
most in demand in our automated society has given rise to long and
enervating periods of unemployment.
More in the headlines is the
Administration's effort, via price and wage guideposts, to encourage
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business and labor wage-price policies that would be conducive to
sustainable, noninflationary prosperity.
Minimum margin requirements
on stock market credit are perhaps the oldest of our selective policy
instruments.
And then there is the whole voluntary foreign credit
restraint program, designed to discourage excessive capital outflows
during the period needed for more basic adjustment forces to do their
work,
I cannot end my illustrative list without referring to the
kind of "jawbone" influence that is occasionally applied by officials—
not excluding my colleagues and myself on the Board--to encourage
an extra degree of prudence or consideration of long-run institutional
and national interest in the decisions being taken in the financial
marketplace,
In the last few months you have heard us cautioning
bankers to be prudent in bidding for time deposits, and to gird up
their loins and start saying, "No," to demands for loans that can
only be inflationary, even when it's a good customer that is doing
the asking.
And, given some snatches of casual market gossip I've
heard in the last few days, I'm tempted to call another area of jaw
boning to your attention.
To those of you who think you have figured
out just exactly the margin of the Federal funds rate, or the bill
rate over the discount rate that might impel the Federal Reserve to
raise its rate I say, "Don't underestimate our discount officersl"
Their administrative discipline on inappropriate bank borrowers
gives the Fed a good measure of flexibility in its rate decisions, and
you should not forget that.
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In focusing attention on this illustrative group of selective
instruments of adjustment— for both the balance of payments and the
domestic economy-1 want to emphasize the need to be wary of over
reliance upon them.
They are not substitutes for good policies as to
aggregate demands— indeed, they will break down unless supported by
appropriate demand policies*
But selective instruments of influence
can sometimes be extremely valuable supplements to general monetary and
fiscal policy--for they can smooth the adjustment process and save us
from having to push policies of general demand restraint too far.
Insofar as the choice of these selective influences is con
cerned, hard-pressed policymakers--and perhaps some battered market
participants--can sometimes come to regard them in a spirit very much
akin to that expressed by that aging but effervescent Frenchman,
Maurice Chevalier, when he was asked how it felt to reach the age
of 75*
He replied that, to be honest, it was distressing, un-
comfortable--and sometimes, when a girl passed by, downright frustrat
ing— but, considering the alternative, it was fine!
Considering the alternative, continuing to leaven a goodly
mixture of monetary and fiscal policy with a judicious sprinkling of
the selective instruments already at work may, in times like these,
well be the best alternative that we can manage,
@FedFRASER