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U. S. Foreign Exchange Operations: Needs and Methods
Introduction
The current international position of the United States c l e a r l y
demonstrates the advantages that would exist if the United States had at its
disposal the r e s o u r c e s and techniques for undertaking foreign exchange
operations a s a permanent feature of public policy.
The present later*
national financial structure, characterised by convertibility of the major
c u r r e n c i e s , relatively free short-term capital markets, and the existence
of large dollar holdings by foreigners (both public and private), has
greatly enhanced the possibility of large recurring movements of capital
out of and into the Halted States.
Such movements of short-term capital,
a s the Federal R e s e r v e System has learned from i t s experience of the
past y e a r , eaa greatly complicate the execution of aa appropriate dome stic
monetary policy.
Similar problems have been faced by monetary authori-
ties abroad, ia both the recent period aad ia e a r l i e r y e a r s .
Solutions to
problems relating to shifts ia capital flows aad their impact on national
balances of payments, together with the relationship of each international
flows to domestic monetary p o l i c i e s are perhaps best approached through
joint actioa by central banks.
It i s no accident that individual European
central banks have developed highly sophisticated techniques of operating
in the foreign exchange market, aad have supplemented individual operations by joiat m e a s u r e s of both a formal aad aa informal, ad hoe, character.
Monetary authorities ia the Plaited States, on the other hand,
have not, aatU recently, operated ia the foreign exchange market, bat have
• 2 -
maintained the stability (and primacy) of the dollar in the international
currency structure by standing ready to buy gold from* and s e l l it to,
foreign monetary authorities who either mm^4 or acquire dollars for exchange
purposes.
There can be little question that the intercon\ ertib lity of gold
and the dollar at a fixed price will have to remain the keystone of the
international currency structure.
At the s a m e time, foreign exchange
dealings by the United States monetary authorities, when judiciously
applied, can s e r v e to reduce capital flows, to dampen speculation, to
minimize potential rmm^T^m effects, and hence, to minimize the impact on
the United States gold stock.
The basic purpose of such operations would be to maintain confidence
in the dollar*
Foreign exchange operations would, of c o u r s e , not be a
substitute for other appropriate and basic actions to maintain the integrity
of the dollar* but would server as a highly useful and flexible addition to
other monetary and fiscal policy m e a s u r e s .
The continuation and expan*
sion of such operations a s have recently bm&n executed respecting the
German mark could make the United States an important factor in the
exchange market and thus help to enhance i t s bargaining position in any
international approach to currency problems.
Moreover, the holding of
foreign currencies by the Waited States might strengthen confidence in
such currencies and add to their usefulness in international trade and payments and hence contribute to an expansion of the movement of goods and
s e r v i c e s among countries.
• 3 •
I.
Federal R e s e r v e Operations for Its Own Account
Previous Experience
The Federal R e s e r v e Bask of Mew York has had a number of
accounts abroad, of which three with nominal sum s remain at present.
The three accounts are with the Bank of England, the Bank of France
and the Bank of Canada.
The r e a s o n s for opening the various accounts
differ somewhat but maintenance of the accounts over recent y e a r s has
been largely a matter of courtesy.
The account with the Bank of England was opened in 191? and s u b sequently need for a number of transactions involving exchange operations,
investments and the purchase and earmark of gold.
The account at the
Bank of France was opened in 1918 in order that we might establish a
sight account for possible nee in transactions for the stabilization of e x change rates.
The BIS account was opened in 1931 in the sum o f $ 1 0 million*
In
a letter from Mr. Harrison to Chairman E c c l e s in September 1936 it was
stated that f*The deposit was made for the s a m e purpose* essentially,
as the c r e d i t s which the Federal R e s e r v e Banks extended to foreign
central banks during 1931. It w a s made in lion of our having to respond
to requests for a s s i s t a n c e on behalf of various smaller European central
banks. w It w a s then msod for the purchases of prime c o m m e r c i a l bills
for our account and finally c l o s e d in 1946.
An account with the Bank of Canada was opened in 1943, almost
entirely as a courtesy m e a s n r o .
Other accounts included those with Iran,
. 4 £
gyp t »
aad
India which were opened in our name in order that the Treasury
would not be identified with certain transactions.
These latter accounts
have been c l o s e d .
Authority
Authorization for the opening of accounts abroad i t contained in
Section 14(e) of the Federal R e s e r v e Act.
Such accounts are subject to
Regulation N and to other rules prescribed by the Board of Governors a s
contained im the
M
Statement of Procedure With Respect to Foreign
Relationships of Federal R e s e r v e Banks. M Under Section 12A of the
Federal R e s e r v e Act, the investment of funds im the accounts are a l s o
subject to decision by the FOMC.
Basic authority was granted im a
November 13t 1936, resolution which authorized each Federal R e s e r v e
Bank to "purchase and s e l l at home and abroad cable transfers and Mils
of exchange and bankers acceptances payable in foreign currency to
the extent that such purchases and s a l e s a r e deemed n e c e s s a r y or
advisable im connection with the establishment, maintenance, operation*
i n c r e a s e , reduction or discontinuance of accounts of Federal R e s e r v e
B nks in foreign c o u n t r i e s - n Since at least 1944, the resolution has
been reviewed regularly by the FOMC and, in each instance, the basic
authority has not been rescinded.
Finally, it should be noted that n due
from" accounts with foreign banks may be participated among other
Federal R e s e r v e Banks; in the event of such participation, the operating
bank make weekly r&pmtt* to the participating banks.
Previous operation of the accounts has been carefully c i r c u m scribed.
Thus, in a tetter dated May 8, 1944* from Mr. Sproul to
- 5 ~
Mr. Peyton (President, Minneapolis R e s e r v e Bank), it was stated that
"The balances of the Bank of England, the Bank of France, and the BIS
w e r e approved by the Beard of Governors a* or near the figures shown;
they could not be increased (except for minor adjustments) without the
prior approval of the Board of Governors. I f
In substance, operations
by the Federal R e s e r v e Bank of Mew York are possible with the approval
of the Board of Governors, the FOMC, and after participation has been
offered to the other Federal R e s e r v e Banks.
A. Proposal
One approach would be for the Federal R e s e r v e Bank of New York
to purchase foreign exchange, either in the market or from the Treasury
in connection with the repayment of foreign official debt or a drawing on
the International Monetary Fund*
P u r c h a s e s of exchange in the market
would, in view of current p r e s s u r e on the dollar, be quite limited;
favorable balance-of-payments developments, however, would make such
operations possible in the future.
In the c a s e of transactions with the Treasury, the foreign exchange
could be acquired by the R e s e r v e Bank against the credit of dollars to
the T r e a s u r e s account with the Federal R e s e r v e Bank in a manner
similar to the current practice with regard to the acquisition of gold
certificates.
The r e s e r v e effects of such operations would be similar
to those involved in purchases of gold certificates and would require
coordination with System open market operations a s d i s c u s s e d below.
Arrangements for the conduct of operations would have to be worked out
~ 6~
among the FOMC, the Board of Governors, the Federal R e s e r v e Bank of
Mew Tork # and other participating R e s e r v e Banks.
Some mi thm technical
arrangements meed by the System i© the twenties and thirties might well
be adaptable to current needs.
In the immediate instance, for example,
the proposed German debt repayment of some $700 million could be made
partially in dollars and partially in Deutsche marks (DM).
The portion
received by the Treasury in DM could be sold immediately to the Federal
R e s e r v e Bank against dollar credit to the Treasury.
This procedure
might s e r v e to m e e t any requirement that the United States r e c e i v e
dollars in connection with the payment of foreign debt while, at the same
time, furnishing foreign exchange r e s o u r c e s for market operations and
adding leverage to the conduct of United States international
policy*
financial
The holdings of foreign money could then be need to operate in
the exchange market, or, a s occasion warranted, to "buy out? s o m e p o r tion of the Bundesbank dollar wmmmt^m9 or to m e e t other objectives.
If operations w e r e to be conducted by the Federal R e s e r v e Bank
on its own account, some provision would have to be made for protection
against changes in the value of the c u r r e n c i e s held, at l e a s t bntil such
time a s rmmmrvmm had been accumulated.
This could be provided by an
agreement under which the United States would hold the Federal R e s e r v e
Bank h a r m l e s s against l o s s arising out of devaluation of the foreign
currency; appropriate legislation might be required in this connection.
Federal R e s e r v e Coordination of Open Market Operations
Federal WLm&mwvm operations in foreign exchange would require the
c l o s e s t coordination with open market operations.
Indeed, they might
- ? -
become an integral part of such operations and could, in some c i r c u m stances* add desirable flexibility to System policy.
On other o c c a s i o n s ,
the r e s e r v e effects of foreign exchange transactions might have to be
offset by other open market operations in order to implement the Federal
Open Market Committee's policy.
Such offsetting operations would not
reprmmmmt an undue complication of System open market operations since
in most e a s e s the foreign exchange operations a r e likely to be alternatives
for exchange operations by foreign monetary authorities, the timing and
size of which have recently complicated the conduct of open market opera*
tions.
System operations in foreign exchange, by permitting c l o s e r
coordination a s to timing and amounts, could have beneficial effects on
o v e r - a l l System operations in relation to the money market.
To illustrate the effect on r e s e r v e s , a s s u m e , for example, a
German payment of $3®0 million in DM equivalent to the Treasury.
sale of these Deutsche m a r k s by the Treasury to the Federal
The
fteserve
Bank would increase the T r e a s u r y ' s balance at the R e s e r v e Bank and
perhaps reduce the need for calls upon tax and loam accounts, or n e c e s s i tate redeposits in H C n banks*
Expenditures (or redeposits) by the
Treasury would, of course* add r^mmr^m dollars to m e m b e r bank accounts.
Sales by the Federal R e s e r v e Bank of DM in the market for dollars would
directly reduce member bank r e s e r v e balances*
Even in a strictly inter-
central bank transaction important effects would be evident.
Thus, if
the f e d e r a l R e s e r v e Bank need DM 100 million to buy $25 million from
the Deutsche Bundesbank, simply by utilizing book e n t r i e s for the transaction, the account of the Deutsche Bundesbank on the books of the R e s e r v e
~ 8 -
Bank would be reduced by $25 million; the Deutsche Bundesbank might
have to e e l ! T r e a s u r y Mile from it* investment account in order to replen~
ish its deposit account with the R e s e r v e Bank.
A sale of Treasury b i l l s
in the market would immediately affect bank xmmmxvBB* Clearly, all
operations would require c l o s e and continuing coordination.
Meeting Requirements of S e c r e c y and Anonymity
It i s of fundamental importance that foreign exchange transactions
generally be subject to public analysis only with some delay.
It i s ,
therefore, n e c e s s a r y that published statements and data be appropriately
devised.
Some thoughts should first be given, however, to the question
of immediate publicity if foreign funds a r e acquired in connection with
official debt repayment.
In all probability, the paying country a s well
a s the United States will immediately announce the payment.
Perhaps,
however, no mention would need to be made of the fact that some part or
all of such repayments did not take the form of dollars.
On the other
hand, if circumstances warranted, it might be useful to let it be known
that a local currency repayment was made and that such funds w e r e available for use in the exchange market.
The immediate problem of publication involves the weekly s t a t e ment of the Federal Wimmmr^m Bank of New York.
At present, foreign
exchange holdings are included in "Other A s s e t s , " a category which
includes in addition to such * due from1* accounts, loans and s e c u r i t i e s
past due three months; a s s e t s acquired account (industrial loan and
c l o s e d banks); reimbursable expenses and other items; accrued interest;
premium on securities; overdrafts; deferred c h a r g e s ; currency and coin
- 9 ~
exhibits, e t c .
Generally, on the weekly statement of the Mew York
WLnmmrvm Bank, "Other A s s e t s " i s a relatively email item ranging between
$30 million and $100 million.
(On the consolidated statement for the
System, the item generally ranges between $125 million and $400 million. >
Substantial fluctuations in the item (say, $40 million or m e r e ) might lead
to rather immediate questioning and c l o s e analysis would probably reflect
foreign exchange dealings with perhaps embarrassing promptness.
should be some way to avoid title adverse result.
There
P o s s i b l y l , Other A s s e t s "
might be grouped into a broader category so that the net impact of foreign
exchange dealings would not he so readily evident.
Net operations would a l s o be reflected in the statements of condition published a s of month*end in the Federal R e s e r v e Bulletin with a
month delay f and in the statement on earnings and expenses (under the
i t e m s "other income" and "other expenses") reported in the February
Bulletin covering the previous year*
T h e s e data* however, a r e published
with some delay and pose no problem.
With respect to forward operations, d i s c l o s u r e could be avoided
if such commitments w e r e c a r r i e d simply a s memorandum accounts and
thus not be made available in any published data; before adopting such a
method, it would be n e c e s s a r y to consider to what extent a contingent
liability should be shown.
Evaluation o l Fed Operations For Its Own Account
A major advantage to be gained by Federal R e s e r v e operations on
i t s own account i s the foreign exchange market a r i s e s from the fact that
the Federal R e s e r v e Bank cam create dollars while the Treasury i s r e stricted to the use of fuads held by it.
This does not mean that there
a r e no l i m i t s on what the Federal R e s e r v e could or should do.
There
a r e very practical limitations upon such operations, the m o r e important
revolving about the need to m e e t other objectives of open market
policy, current p r e s s u r e s in the exchange market, and/or the willingn e s s of central banks to deal directly by providing local currency against
dollars {or "rice v e r s a ) .
l a substance, the creation and destruction of
Federal R e s e r v e credit would provide vast r e s o u r c e s for foreign exchange
operations and defense of the dollar.
If the decision should 1M made to conduct Federal R e s e r v e operations of this kind, there would be a vital need lor sufficient latitude s o
that operations could be conducted effectively and promptly under such
rules m&4 regulations a s the Board of Governors and the FOMC deemed
appropriate.
Finally, there la a subsidiary problem of arranging our
weekly statements so a s to avoid or delay publication of thm details of our
foreign exchange operations.
- 11 -
Be
Operations a s F i s c a l Agent for the T r e a s u r y
Federal R e s e r v e Sank of New York operations a s fiscal agent of
the Treasury operating through the Stabilisation Fund involve am a r e a in
which considerable experience has already been gained.
G r o s e r e s o u r c e s of the Stabilization Fund amount to about $336
million.
The composition of these r e s o u r c e s ami the amount that in
practice would be available a r e approximately a s follows:
(In Millions of Dollars)
""
Dollar*
Gold
Securities
Foreign Exefcaage
New York
% % ^ ^ ^ ^ /
'Total
17©.©
94.7
26.5
18.0
t.S
0
25. ©
0
171. 5
94. 7
SI. 5 » '
I f . <&>
3©§ • 2
26* 5
31Se ?
Total R e s o u r c e s
L e a s Argentine p e s o s currently held
335. ?
18.
31?.?
L e s s Stabilization Commitments (Argentina,
Mexico, Chile)
122. §£^
L e s s Working Balance for Fund
Met Available R e s o u r c e s
25.
170. 7
A? A s of January 31, 1961--little change since that date*
B/
An additional support order of $4$ million i s on hand--advance refunding.
C/
~
Argentina can draw am additional $32 million, thus making total drawings
$50 million. Mexico and Chile cam draw $75 million mmA $15 million,
respectively.
The above r e s o u r c e s provide s o m e latitude for operation, although
exchange purchases in the market face at present the obstacle of current
p r e s s u r e on the dollar.
Stabilisation Fund operations a r e provided for
* 12 under Section 10 of the Gold R e s e r v e Act which grants wide-ranging authority
to the Secretary of the Treasury, with the approval of the President.
Use
of the Stabilisation Fund, however, would ha limited to current rmmmutcm*
since it appears that permanent additions to f or reductions in, a s s e t s of
the Fund would require Congressional approval and appropriation.
There
would, for example* s e e m to ha considerable obstacles toward enlarging
the Stabilisation Fund by turning over to it, directly, official debt repayments
from abroad.
If, however, prepayments--particularly in local c u r r e n c i e s - -
are contemplated, such prepayments might ha sufficiently attractive s o that
Congress would approve allocation of those xmm&mxmmmtothe Stabilisation Fund.
Within the r e s o u r c e s , the holdings of (and operations ia> foreign
c u r r e n c i e s could he readily handled.
Operations could be either in the spot
or forward market, although there would ha some real advantage
in favor
of forward transactions since such operations tend to afford maximum u s e
of the Stabilisation Fund's r e s o u r c e s .
Insofar a s forward contracts involved
parallel operations with foreign central banks v it would be sufficient for the
Fund to hold a partial r e s e r v e adequate to c o v e r any possible l o s s in the event
of default.
Thus, for example, if the Bundesbank w e r e to fail to honor its
contracts with an under present arrangements* it would ha n e c e s s a r y far the
Fund actually to buy spot marks far delivery to meet the contract at maturity.
The Fund would have to have dollars to pay for tike spot m a r k s hat it would
immediately r e c e i v e dollars when it delivered the spot m a r k s to the purchaser
under its forward contract.
The possibility of l o s s would l i e in the difference
between the original contract price and the spot rata on the day the purchase
would have to ha made.
If the foreign central bank ware not under a parallel
• 13 *
commitment t then a partial reserve would need to be held to cover possible
lotaes in buying apot currencies for shorter forward currencies) to meet
contractual obligations. If parallel contracts were held, a reserve equal
to 19 per cent of total obligations would seem desirable, subject to the
proriso that the reserve would be adequate to cover total obligations undertaken lor any given day. If no parallel contract was involved, a rmwmrvm
somewhat larger than 1® per cent would probably lie needed. Use of Fund
resources would then actually be expounded by »ome multiple of the amount
currently available. Thus, under parallel contracts, the $179 million noted
aa available in the table above might cover forward contracts of up to, say,
$1 billion*
Spot operations would undoubtedly be necessary on occasion.
Obviously such purchases would deplete the ******* by the dollar equivalent.
Operations accordingly would be restricted to Hie amounts actually available
in the Fund no noted above.
Supplementing Stabilisation Fund Resources
Added foreign exchange resources might bo made available from a
drawing on the International Monetary Fund or foreign debt repayments if such
receipts were deposited in a special account of the Treasury which might be
called the "Special Foreign Exchange Account, H with transactions being channeled
through the Stabilisation Fund and with the Federal Reserve Bank of New York
acting an agent. Such a procedure might be feasible if—as seems likely--the
resources of the Stabilisation Fund could not readily bo supplemented by
direct allocation*
• 14 ~
Meeting Requirementsof Secrecy and Anonymity
Insofar as Treasury statements are concerned, details of tike
Stabilisation Fund are published «{uarterly with a delay of five months or
so. Published figures are fe* cnd-of-quartcr.
Operations during the
period are also shown on a net basis in the detailed statements of income and
expense contained la the Treasury Bulletin* Thus, there Mem* to be sufficient
publication delay from the Treasury aide to meet requirements.
With respect
to Stabilisation Fund assets in the form of securities or foreign exchange,
information in available only from the above sources with the noted delay;
these assets do not appear in data published by tibia Bank or the Board.
Cur rest statements by this Bank and the Board, however, do r e flect Stabilisation Fund holdings of dollars and gold. Dollar assets are
included in "Other Deposits" on our weekly statement and tike System f s consolidated statement. The over-all category includes a range o£ other items
each as nonmember bank clearing accounts, Regulation K reserves, deposit
accounts of the IADB, IBRJDf IDA, XFC# IMF, QHN No. 1, etc. There i» some
nominal variation in tibia amount over weekly periods, but if net transactions
in foreign exchange were of a substantial nature (eay, $§£ million or more),
fairly clone analysis of foreign exchange operations could be gained from
these figures. Again, some regrouping of categories or use of special accounts
would be necessary.
Hold holding s of the Stabilisation Fund may he obtained with about a
one-month delay from the Federal Reserve Bulletin, which shows tike total
gold stock and so-called Treasury stock. Moreover, a gold sale or purchase
~ 15 ~
would be reflected in earmarked gold, bat again with about a month to a eixweek delay (the February Federal Reserve Bulletin shews data for January
31, 1941).
Published data may be illustrated as follows, bearing in mind that
figures would be net, and hence any individual transaction might be offset.
For illustration, assume that the Stabilisation Fund purchases DM SO million
in the market with dollars currently in the account.
1. Effect on Fund's foreign exchange account: would not appear 1st
Federal Reserve Bank or System data but would be reflected in the quarterly
data of the Treasury, with a six to eight-month delay.
2. Fund's dollar account: the item MOther deposits" on our weekly
statement would show a decline, and the transaction also would be reflected
in the Treasury's quarterly report, but with delay.
3. Reserve accounts: would show an increase In member bank
reserves on the Federal Reserve Bank weekly statement.
Essentially, the only real problem related to the foreign exchange
position ol the Fund would tie in our weekly statement which would show a
direct Impact on the Fund*s dollar holdings, a s reflected in the item 'Other
Deposits* H In order to minimise immediate analysis ol operations over the
short-run, it would be desirable to include a wider range of items in these
categories. However, operations could under present conditions be masked
to some extent by careful supervision of the account and a selective nee of
"swaps."
* 16 *
III. Conclusion
The approaches discussed above to foreign exchange dealings are
suggested possibilities. Whatever the technique used, the United States
will run some risk of changes in currency values. To have effective protection of the dollar, such risks--minimised by careful management-would seem a relatively small price to pay* Once a basic choice is made
as between operations lor the account of the Federal Reserve Banks and
operations by the Reserve Bank for the Treasury a s fiscal agent* detailed
investigation of coordinating techniques and the requirements of secrecy
can be made. It may bo that fiscal agency operations offer some advantages
in the way of speed and simplicity. However, Aero are distinct benefits
to be gained from Federal Reserve operations for its own account.
Foreign
exchange operations by central banks are considered a normal part of their
activities* and there is much to bo said for utilising resources that are not
directly limited by a required cash position.
April 5, 1941
@FedFRASER