The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Office C o r r e s p o n d e n c e Tn Frnm Chairman Eccles Date—May12,1947 Subject: Mr, Carpenter Among the topics suggested by the Board for discussion by the Federal Advisory Council at its next meeting were questions relating to (1) participation by American commercial banks in transactionsin^ gold against dollars at premium prices in foreign countries and ^2) what policy should be pursued by American commercial banks in making or participating in loans on foreign-owned gold. The Council was advised that informal, confidential memoranda with respect to these two topics would be sent to the members of the Council as soon as they were available* Copies of the memoranda sent to the Council in accordance with this arrangement are attached. Attachments CONFIDENTIAL Commercial Banks1 Gold Operations at Premium Prices Active speculative markets in gold exist in many financial centers throughout the world, some legally and others illegally, Under present circumstances, United States dollar prices for gold are quoted in many foreign centers at a premium over the official price of gold in the United States, The prices (in U. S. dollars) have ranged from only moderately above $35 an ounce in some countries up to around $80 in some Near Eastern centers. Hence private speculators, although unable to purchase gold in the United States, can make large profits by purchasing gold against dollars in one market and selling the gold for dollars in another, and American commercial banks, although not acting as principals, have apparently been actively engaged as agents for foreign buyers and sellers. In most of the countries where such gold is sold, payment is made in dollars which have been illegally acquired or held. The effect of these operations is that dollars are used up to purchase gold for private hoards rather than to acquire imported goods and equipment sorely needed in those countries. These operations seem to have been going on for some little time, but they first received public attention in articles appearing in our press last January dealing with purchases of gold at premium prices by American banks in Mexico at the rate of 30,000 ounces a day and the sale of such gold (at a considerable profit—50 per cent or more) particularly in China and Hongkong but also in the Near East. Not only Mexico but other countries (Chile, Brazil, etc*) are reported to have become sources of gold for this trade, presumably at times at the instigation of our banks. The latter have also turned to Switzerland and to Argentina, and it has been reported that gold has been acquired in Switzerland by an American bank in lots of around -230,000 ounces at the total cost of around $4.2 per ounce. Unexecuted orders in the hands of one of our banks alone were at one time reported to Federal Reserve Bank of New York at around 100,000 ounces, but several other New York banks are also involved in these transactions. It is difficult to estimate the volume of this kind of business so far put through but one bank has estimated that since January 194-6 at least $100,000,000 of gold has been sold to the Near East and Hongkong, much of it through our banks• While India, Hongkong, and China have recently taken action to restrict private gold imports, this action may not be completely effective and in any case markets continue to exist in certain other countries. One of the principal reasons why gold is quoted at a premium in terms of dollars, aside from the fact that gold is in many ways a more suitable hoarding medium than dollars, is the view that there may be an increase in the official dollar price of gold in the near future. Hence, when important American banking institutions participate ixx gold transactions against dollars at premium prices, they contribute to monetary instability by encouraging the belief that the dollar is at a discount and may soon suffer a reduction in gold content. Such suspicions would not be altogether eliminated by ending the participation of American banking institutions in these gold dealings, but such a step might do much to clear the air. Participation by our banks in this traffic also raises the question whether Americ£.n banking institutions should engage in practices inimical to the interests of foreign countries and to our own interests in promoting economic recovery abroad. CONFIDENTIAL Loans on Gold Loans to foreign central banks and governments against the security of gold were not unusual before 1933; they were made by many central banks and by the large commercial banks in New York and probably in London and other large financial centers abroad. Such loans were not frequent, however. Since 1933, the Federal Reserve Banks have been asked to make, and have made, such loans with increasing frequency, but the large American commercial banks made but one such loan* until February 1945, when a syndicate headed by the Chase National 3ank made a 100 million dollar loan to the Netherlands Government against gold earmarked at the Federal Reserve Bank of New York* Since then, a number of applications have been made by American commercial banks for Treasury licenses under which gold earmarked with the Federal Reserve Bank of New York would be set aside as collateral for loans to be made by them to various foreign banks. The increase since 1933 in the frequency of applications by foreign countries for dollar loans against gold appears to be dua in the main to two factors: (1) the fact that since the early thirties the world has not had an international monetary standard based on an unrestricted flow of gold between countries, even with respect to balance-of-payments settlements by central banks and governments; and (2) the need of various foreign countries for dollars for the reconstruction of their economies and the reestablishment of their foreign trade at a time of extreme unsettlefnent in their financial, economic, and political affairs* * A $300,000 loan on gold located in London, made in the early thirties• Although the Gold Reserve Act of 1934- restored convertibility of dollars into gold and of gold into dollars, it contains provisions for Treasury control (in the form of a licensing system) that give grounds for some uncertainty as to the ability of foreign countries to bxxy and sell gold freely in the United States. It also contains provi- sions, as yet unrepealed, which apparently have led to questions abroad as well as at home as to whether the price of gold in this country may be changed by administrative action•-* Furthermore, under Treasury regulations, a 1/4. per cent handling charge for purchases and sales of gold was imposed, which makes it cheaper for foreign countries to meet shortterm needs for dollars by borrowing from the Reserve Banks at present interest rates rather than by selling and subsequently repurchasing gold. These factors may have contributed to the tendency of foreign countries to borrow on their gold in preference to selling it. Most requests for short-term gold loans tend to come to the Federal Reserve Banks because the borrowers are monetary authorities with whom they have correspondent relations and because the Federal Reserve Bonks are prepared to make these loans at a favorable rate (at present, 1 per cent). Nevertheless there arise some cases in which a foreign central bank (or government) would prefer to obtain a short-term loan on gold from an American commercial bank, even though the cost were somewhat greater. (For example, such a loan might be sought in order to cultivate closer relations with the commercial bank.) i.e. because of the power of the Secretary of the Treasury to buy and sell gold at such prices as he may deem advantageous to the public interest (Sees. 8 and 9 of the Gold Reserve Act of 1934). -3In addition there are two types of loans on gold h£ld under earmark at the Federrl Reserve Bank of New York which might be made by private institutions in the United States but which would not be considered suitable for the Federal Reserve Banks• These are: (a) lo?-ns on gold to foreign central banks and governments for terms longer than those customarily extended by Federal Reserve Banks, and (b) ioans on gold (for any period) to foreign borrowers other than central banks and governments. In addition, comercial banks may lend against gold located outside the United States. Loans on gold are subject to certain abuses. Foraign central banks may at times engage in the improper practice of continuing to show gold in their reserve position even though it has been pledged against a loan, thereby in effect making use of the gold while giving their public the impression that the reserves remain intact. While the practice of including pledged gold in the monetary reserve should.certainly not receive any encouragement, the fact that some central banks engage in it should not be the determining element in any decision on the making of gold loans generally. A second more serious possibility of abuse arises, however, from the fact that any country which borrows dollars on gold rather than selling the gold outright is thereby placing itself in a position to profit from an increase in the dollar price of gold. It may appear from time to time that foreign countries are motivated simply (or mainly) by this consideration. In any case where the purpose of borrowing on gold seems predominantly speculative, it woulr1 seem desirable on grounds of public policy that the prospective borrower be refused access to lending facilities in the United States, It seems especially difficult to justify the making of loans on gold for periods of more than 12 months. It would always be much cheaper for the borrower to sell the gold and later repurchase it rather than to pay interest for any such extended period. Loans on gold ruining for more than one year may therefore appear as prima facie suspect; it might seem wise not to allow them to occur except through renewals which would permit each transaction to be scrutinized periodically for evidence of speculative intent. Even if a foreign country appears genuinely to seek a loan on gold for psychological purposes, i.e. in order to utilize the proceeds while still continuing to show the gold as an asset, there appears no reason why the loan should not be made on a relatively short-term basis so that the situation could be reviewed at frequent intervals. Any necessary control on loans against gold in this country could be imposed by the Treasury through its licensing powers. However, a recent long-term loan on gold by an American bank against gold on deposit in Switzerland (a %1 million loan from the Chase National Bank to the Roumanian Government for a term of four years) illustrates a method by which private lenders in this country could avoid any restrictions placed upon their activities through the Treasury's licensing procedure (which applies, of course, only to gold situated in the United States). Should a -5policy of confining Treasury licenses to loans of 12 months or less be adopted and should the making of longer-term loans against gold abroad reach significant proportions, it might prove necessary for the Government authorities to take further measures to dissuade American banks from making such loans*
@FedFRASER