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F o r R e l e a s e on D e l i v e r y Wednesday, F e b r u a r y 11, 1970 6:00 p . m . , C.S.T. CAPITAL OUTFLOWS AND THE U . S . BALANCE OF PAYMENTS Review and O u t l o o k A Paper P r e s e n t e d by Andrew F . Brimmer Member Board o f G o v e r n o r s o f t h e F e d e r a l Reserve System At a Dinner Meeting of B a n k e r s , Businessmen and t h e B o a r d o f D i r e c t o r s o f t h e F e d e r a l Reserve Bank o f D a l l a s Fairmont H o t e l D a l l a s , Texas February 11, 1970 CAPITAL OUTFLOWS AND THE U.S. BALANCE OF PAYMENTS Review and O u t l o o k By Andrew F. B r i m m e r * Y e s t e r d a y , F e b r u a r y 1 0 , marked t h e f i f t h a n n i v e r s a r y o f a F e d e r a l Government p r o g r a m whose l o n g e v i t y was e x p e c t e d t o be much shorter: on t h a t day i n 1965, P r e s i d e n t Johnson announced, w i t h urgency, t h e e s t a b l i s h m e n t o f a s e r i e s o f programs t o m o d e r a t e o u t f l o w and i m p r o v e o u r b a l a n c e o f payments. programs were b o t h v o l u n t a r y and t e m p o r a r y . b a l a n c e o f payments i s still o f t h e programs i s m a n d a t o r y , have a c q u i r e d a l o o k o f Clearly, this great capital The m a i n e l e m e n t s i n Five years l a t e r , in substantial d e f i c i t , and t h e r e s t r a i n t s a major on c a p i t a l the the component outflow permanency. i s an outcome t h a t was u n a n t i c i p a t e d . k e y p a r t s o f t h e programs - - The a d m i n i s t e r e d s e p a r a t e l y by t h e U.S. D e p a r t m e n t o f Commerce and t h e F e d e r a l Reserve Board - - were launched against U.S. the background o f a dramatic r i s e funds abroad. However, it i n t h e movement o f was a l s o g e n e r a l l y assumed w i t h i n the ^Member, Board o f G o v e r n o r s o f t h e F e d e r a l Reserve System. I am g r a t e f u l t o s e v e r a l members o f t h e B o a r d ' s S t a f f f o r assistance i n the p r e p a r a t i o n o f these remarks. Messrs. B e r n a r d Norwood and Gordon B. Grimwood (who w o r k c l o s e l y w i t h me i n t h e a d m i n i s t r a t i o n o f t h e B o a r d ' s f o r e i g n c r e d i t r e s t r a i n t program) were m a i n l y r e s p o n s i b l e f o r t h e r e v i e w o f p r o g r a m developments. M r . Samuel P i z e r was v e r y h e l p f u l i n t h e a s s e s s ment o f t h e o u t l o o k f o r t h e U . S . b a l a n c e o f p a y m e n t s . M r . L y l e E. Gramley p r o v i d e d c o u n s e l on t h e p o s s i b l e use o f r e s e r v e r e q u i r e ments t o m o d e r a t e bank a c q u i s i t i o n o f f o r e i g n a s s e t s , and M r . James T. L y n c h made t h e p r e l i m i n a r y a n a l y s i s t o d e t e r m i n e t h e l e g a l b a s i s o f such a p o s s i b i l i t y . -2- F e d e r a l Government t h a t o u r e x t e r n a l m e n t a l l y s t r o n g and t h a t r e s t r a i n t s f i n a n c i a l p o s i t i o n was on c a p i t a l o u t f l o w s w e r e required only to provide short-term assistance u n t i l s t r e n g t h o f our t r a d e s u r p l u s , funda- the basic r i s i n g e a r n i n g s on d i r e c t investment, and o t h e r f a v o r a b l e elements could coalesce to r e s t o r e a l a s t i n g balance. To a c o n s i d e r a b l e e x t e n t , t h e b u s i n e s s and b a n k i n g community a c c e p t e d t h i s v i e w and c o o p e r a t e d w i t h t h e F e d e r a l Government i n an effort t o achieve the s t a t e d o b j e c t i v e s . But w i t h i n s i x months t h e programs were l a u n c h e d , U . S . m i l i t a r y accelerated, activity i n V i e t n a m was and t h e c o u n t r y became enmeshed i n a web o f that i s s t i l l w i t h us. have a c h i e v e d t h e i r still inflation The d e t r i m e n t a l e f f e c t s o f b o t h d e v e l o p m e n t s f o r o u r b a l a n c e o f payments a r e a l s o s t i l l w i t h u s . seems a p a r t i c u l a r l y after appropriate Thus, t i m e t o ask w h e t h e r t h e s e aims and w h e t h e r — f i v e y e a r s l a t e r -- the present programs they are needed. Sadly, I have c o n c l u d e d p e r s o n a l l y t h a t - - n o t o n l y i s f o r m o f r e s t r a i n t on c a p i t a l o u t f l o w r e q u i r e d a t t h i s t h a t t h e need w i l l t h i s prospect, exist time - - but f o r a number o f y e a r s t o come. some also I n view of I am a l s o c o n v i n c e d t h a t we s h o u l d t r y t o devise t e c h n i q u e s f o r m o d e r a t i n g c a p i t a l o u t f l o w w h i c h can r e m a i n v i a b l e over the long h a u l . firmly I n my j u d g m e n t , such t e c h n i q u e s s h o u l d be r o o t e d i n t h e m a r k e t p l a c e and s h o u l d depend as l i t t l e a d m i n i s t r a t i v e d e c i s i o n s o f Government officials. as p o s s i b l e on -3- I have r e a c h e d t h i s c o n v i c t i o n on t h e b a s i s o f an e x p e r i e n c e w i t h t h e e x i s t i n g programs w h i c h e x t e n d s back t o t h e d a t e o f inception. As A s s i s t a n t S e c r e t a r y f o r Economic A f f a i r s in their the D e p a r t m e n t o f Commerce, I h e l p e d t o f a s h i o n t h e v o l u n t a r y v e r s i o n t h e d i r e c t i n v e s t m e n t p r o g r a m and a d m i n i s t e r e d i t t o t h e F e d e r a l Reserve Board i n M a r c h , 1966. delegated a u t h o r i t y sibility until I was Since June, appointed 1968, f r o m t h e Board, I have had a d m i n i s t r a t i v e f o r the program (which i s s t i l l v o l u n t a r y ) During a l l of t h i s period, to r e s t r a i n as soon as institu- b a l a n c e o f payments and o f t h e p r e s s i n g need t o a c h i e v e - accounts. the possible. But I have been e q u a l l y c o n s c i o u s o f t h e c o n t i n u i n g weakness i n i n g f o r a course which w i l l the I have been e v e r c o n s c i o u s o f o r i g i n a l goal o f d i s m a n t l i n g the r e s t r i c t i o n s an e q u i l i b r i u m i n o u r i n t e r n a t i o n a l on respon- e x t e n s i o n o f f o r e i g n c r e d i t s by U.S. banks and o t h e r f i n a n c i a l tions. and m a i n t a i n Consequently, permit l i f t i n g a d m i n i s t r a t i v e our in search- restraints on c a p i t a l movements, we must assure t h a t t h i s more f u n d a m e n t a l is not put i n jeopardy. t i o n o f these competing At t h i s p o i n t , a r e my own. of - - o f payments. I I b e l i e v e - - would b r i n g about a r e c o n c l i a - goals. l e t me s t r e s s t h a t t h e v i e w s advanced h e r e The F e d e r a l Reserve Board as a w h o l e i s o b v i o u s l y and t r o u b l e d by - - target I n the c l o s i n g s e c t i o n o f these remarks, o u t l i n e an a p p r o a c h w h i c h - - of the c o n t i n u i n g serious d e f i c i t i n our The Board i s a l s o t r o u b l e d by t h e i n e q u i t i e s aware balance inherent -- -4- i n t h e p r e s e n t p r o g r a m and by i t s continued existence w e l l t h e p o i n t a t w h i c h i t was e x p e c t e d t o be t e r m i n a t e d . r e v i e w and assessment o f t h e program - - beyond However, the and a p o s s i b l e a l t e r n a t i v e -- p r e s e n t e d h e r e s h o u l d n o t be i n t e r p r e t e d as r e p r e s e n t i n g a p o s i t i o n a l r e a d y a d o p t e d by t h e Board. Before proceeding f u r t h e r , the s a l i e n t i t m i g h t be w e l l t o c o n c l u s i o n s emerging f r o m t h i s summarize assessment o f t h e Federal Reserve's v o l u n t a r y f o r e i g n c r e d i t r e s t r a i n t program over the five last years: The m a j o r o b j e c t i v e o f t h e p r o g r a m , t o r e s t r a i n t h e g r o w t h i n f o r e i g n l e n d i n g and i n v e s t m e n t o f U . S . f i n a n c i a l i n s t i t u t i o n s , has been a c h i e v e d . I n e v e r y y e a r s i n c e 1965, t h e amount o f f o r e i g n a s s e t s o u t s t a n d i n g has been l e s s t h a n t h e amount t h a t w o u l d have been p e r m i t t e d u n d e r t h e g u i d e l i n e s - - i n most y e a r s by s u b s t a n t i a l amounts. M o r e o v e r , t h e t o t a l amount o f such l e n d i n g and investment i s today lower than the t a r g e t s s e t i n the e a r l y years o f the program. W h i l e a c h i e v i n g t h i s m a i n o b j e c t i v e , t h e coope r a t i n g banks and o t h e r f i n a n c i a l i n s t i t u t i o n s have been m i n d f u l o f two o t h e r i m p o r t a n t n a t i o n a l goals: insuring that s u f f i c i e n t credit is a v a i l a b l e t o f i n a n c e U . S . e x p o r t s and t o h e l p meet t h e needs o f t h e d e v e l o p i n g c o u n t r i e s . The b a s i c d e s i g n o f t h e p r o g r a m has r e m a i n e d e s s e n t i a l l y unchanged o v e r t h e y e a r s : it r e m a i n s v o l u n t a r y , and i t e s t a b l i s h e s an o v e r a l l c e i l i n g w i t h i n which i n t e r f e r e n c e w i t h management d e c i s i o n s i s m i n i m i z e d . However, d u r i n g t h e l a s t two y e a r s , t h e p r o g r a m has become somewhat more s p e c i f i c . The p r o g r a m has a f f e c t e d t h e p a t t e r n o f U . S . i n t e r n a t i o n a l banking. Competitive i n e q u i t i e s -5- among banks have d e v e l o p e d , and a n e t w o r k o f f o r e i g n b r a n c h e s has been s t i m u l a t e d whose l o n g - r u n i m p a c t c a n n o t be seen c l e a r l y . Finally, as I m e n t i o n e d above, i n my j u d g m e n t o u r o f payments s i t u a t i o n s t i l l r e q u i r e s some k i n d o f r e s t r a i n t on t h e o u t f l o w o f U.S. p r i v a t e c a p i t a l . But I a l s o b e l i e v e that o t h e r t e c h n i q u e s h o u l d be s u b s t i t u t e d f o r t h e e x i s t i n g and a d m i n i s t r a t i v e balance some quantitative controls: T h u s , I t h i n k s e r i o u s a t t e n t i o n s h o u l d be given to the p o s s i b i l i t y of r e p l a c i n g the p r e s e n t p r o g r a m w i t h a system o f g r a d u a t e d reserve requirements against f o r e i g n assets. Such a s y s t e m w o u l d be c l o s e l y a l l i e d t o m a r k e t f o r c e s , and i t c o u l d be t a i l o r e d t o enhance - - o r d i s c o u r a g e — any t y p e o f f o r e i g n l e n d i n g or investment c o n s i s t e n t w i t h o u r o v e r a l l b a l a n c e o f payments o b j e c t i v e s . A p r e l i m i n a r y r e v i e w o f the F e d e r a l Reserve B o a r d ' s a u t h o r i t y s u g g e s t s t h a t t h e Board may a l r e a d y have an adequate l e g a l b a s i s on w h i c h t o r e s t such a system. O r i g i n s o f t h e B a l a n c e o f Payments Programs Before proceeding f u r t h e r , i t m i g h t be w e l l t o r e m i n d selves b r i e f l y of the circumstances which n e c e s s i t a t e d the of r e s t r i c t i o n s first on c a p i t a l o u t f l o w . E q u a l i z a t i o n Tax ( I E T ) later. adoption I t m i g h t be r e c a l l e d t h a t s t e p i n t h i s d i r e c t i o n was t h e p r o p o s a l o f t h e i n m i d - 1 9 6 3 , and i t s our- the Interest a d o p t i o n about a year The measure was d e s i g n e d t o l e s s e n t h e a t t r a c t i v e n e s s o f U . S . c a p i t a l m a r k e t t o b o r r o w e r s i n Europe and o t h e r d e v e l o p e d the countries. -6- This f i r s t s t e p i t s e l f was t a k e n a g a i n s t b a l a n c e o f payments d e f i c i t s the background o f to which a r i s i n g o u t f l o w of heavy private c a p i t a l was m a k i n g an i n c r e a s i n g l y l a r g e c o n t r i b u t i o n . For example, during the l a t e 1950fs, from t h e movement o f p r i v a t e c a p i t a l c o u n t r y a v e r a g e d about $ 2 - 1 / 2 b i l l i o n p e r y e a r ; b u t i n t h e period, t h e a n n u a l average was r o u g h l y $ 4 - 1 / 2 b i l l i o n . 1960-64 I n the y e a r 1964, t h e n e t o u t f l o w o f p r i v a t e f u n d s r e a c h e d $ 6 - 1 / 2 In contrast, d u r i n g these years, this billion. t h e U . S . had t h e advantage o f a l a r g e and g r o w i n g s u r p l u s i n e x p o r t s o f goods and s e r v i c e s - exceeded $ 8 - 1 / 2 b i l l i o n i n 1964. Nevertheless, abroad g r e a t l y outweighed our r e c e i p t s deficits single our t o t a l from abroad, so which payments substantial a p p e a r e d i n t h e l a t e 1 9 5 0 f s and p e r s i s t e d i n t o t h e early 1960's. The second move i n t h e e v o l u t i o n o f r e s t r i c t i o n s on p r i v a t e c a p i t a l o u t f l o w was t r i g g e r e d by a s h a r p d e t e r i o r a t i o n i n o u r o f payments i n t h e c l o s i n g months o f 1964. it d i d n o t c o v e r l o n g - t e r m bank l e n d i n g , f o r e i g n borrowers to s h i f t When t h e IET was a d o p t e d , and t h i s e x e m p t i o n e n c o u r a g e d f r o m t h e s a l e o f bonds i n t h e U . S . t o r e l i a n c e o n bank f i n a n c i n g . outflows Simultaneously, ( p a r t i c u l a r l y d i r e c t i n v e s t m e n t s and s h o r t - t e r m bank By t h e q u a r t e r o f 1 9 6 4 , t h e b a l a n c e o f payments (measured on t h e was i n d e f i c i t a t an a n n u a l r a t e o f $5 b i l l i o n , c a p i t a l o u t f l o w s were a t an a n n u a l r a t e i n excess o f $8 market other types of w h i c h were n o t s u b j e c t t o t h e IET a l s o r o s e r a p i d l y . basis) balance capital credits) last liquidity and p r i v a t e billion. -7- Out o f t h e s e d e v e l o p m e n t s came t h e v o l u n t a r y b a l a n c e o f payments programs announced i n F e b r u a r y , f u l l y realized that an i n n o v a t i o n . At the time, i t was t h e v o l u n t a r y r e s t r a i n t o f c a p i t a l o u t f l o w s was The c l a s s i c s o l u t i o n t o the balance of p r o b l e m w o u l d have c a l l e d f o r policy, 1965. payments a substantially restrictive c o n s i d e r a b l y reduced c r e d i t availability monetary and h i g h e r domestic interest rates. T h i s p o l i c y was a v o i d e d because i t w o u l d have hampered e f f o r t s t o e n c o u r a g e an e x p a n s i o n o f o u t p u t as a means o f r e d u c i n g t h e p r e v a i l i n g h i g h l e v e l o f unemployment and o f t h e b a c k l o g o f unused r e s o u r c e s . believe that higher i n t e r e s t Furthermore, shrinking t h e r e was r e a s o n t o r a t e s i n t h e U n i t e d S t a t e s w o u l d have been c o u n t e r e d b y h i g h e r r a t e s abroad - - w i t h no n e t b e n e f i t b a l a n c e o f payments. Under t h e s e c i r c u m s t a n c e s , t o t a c k l e the problem at i t s source — t h a t i s , t o our i t was t h o u g h t b e s t to l i m i t our capital o u t f l o w t o a f i g u r e more n e a r l y e q u a l t o our c u r r e n t a c c o u n t surplus, w h i l e a t t h e same t i m e p r e s s i n g v i g o r o u s l y t o w a r d a c h i e v i n g an optimum r a t e o f economic growth. The V o l u n t a r y F o r e i g n C r e d i t R e s t r a i n t Program: A Review I n a p p r a i s i n g the performance o f the V o l u n t a r y Foreign R e s t r a i n t Program (VFCR) r e l a t i n g t o f i n a n c i a l t o bear i n mind t h a t i t institutions, it is i s one component o f a c o m p r e h e n s i v e s e t of r e s t r i c t i o n s w h i c h b e a r on c a p i t a l o u t f l o w i n v a r y i n g d e g r e e s . t h e t i m e t h e VFCR was l a u n c h e d i n F e b r u a r y , Credit well At 1965, t h e IET was e x t e n d e d -8- t o c o v e r l o n g - t e r m bank l o a n s t o f o r e i g n e r s . v o l u n t a r y program t o moderate d i r e c t financial corporations f o r e i g n i n v e s t m e n t by n o n - ( a d m i n i s t e r e d by t h e U . S . D e p a r t m e n t Commerce) was p a r t o f t h e same announcement. that the l a t t e r Moreover, ( I t w i l l be of recalled program was made m a n d a t o r y by E x e c u t i v e Order as January 1, 1968). the others, As m e n t i o n e d a b o v e , a Each p a r t o f t h i s none set of r e s t r a i n t s reinforces o f them w o u l d be e f f e c t i v e w i t h o u t t h e the a d m i n i s t r a t i o n of the p a r t s t r u e o f t h e VFCR and t h e d i r e c t as much as p o s s i b l e . of (and t h i s i s others. especially investment r e g u l a t i o n s ) is coordinated I n t h e r e s t o f t h e s e r e m a r k s , however, most of my comments w i l l be r e s t r i c t e d t o t h e VFCR. The F e d e r a l Reserve p r o g r a m r e m a i n s v o l u n t a r y , although t h e Board has a u t h o r i t y u n d e r t h e J a n u a r y 1, 1968, E x e c u t i v e t o make i t m a n d a t o r y . it The g e n e r a l s t r u c t u r e has changed i n v o l v e s an o v e r a l l c e i l i n g Order little: ( w h i c h has been m o d i f i e d s e v e r a l based g e n e r a l l y on t h e h o l d i n g o f f o r e i g n a s s e t s a t t h e end o f W i t h i n t h i s c e i l i n g managers o f f i n a n c i a l institutions t o f i n a n c e U . S . e x p o r t s and t o m e e t i n g t h e needs o f countries. These p r i o r i t i e s 1964. are free make t h e i r own d e c i s i o n s , b u t t h e y a r e a s k e d t o g i v e p r i o r i t y credits times), to to developing have r e c e n t l y been g i v e n more e m p h a s i s . The g u i d e l i n e s f o r 1968 c o n t a i n e d a r e q u e s t t h a t f i n a n c i a l institutions r e f r a i n f r o m m a k i n g new n o n e x p o r t t e r m l o a n s t o d e v e l o p e d c o u n t r i e s of C o n t i n e n t a l W e s t e r n Europe (and i n t h e case o f banks t h a t t h e y r e d u c e their -9- c e i l i n g s by t h e amount o f repayment o f such l o a n s ) . lines The bank g u i d e - f o r 1970 e s t a b l i s h e d a s e p a r a t e c e i l i n g f o r e x p o r t t e r m l o a n s . Finally, on F e b r u a r y 2 8 , 1968, Canada was exempted f r o m a l l b a l a n c e o f payments programs a n d , on i t s side, undertook to t h a t Canada w o u l d n o t be u s e d as a " p a s s through 1 1 f o r U . S . flow to t h i r d countries. t h e U.S. ensure funds to The g e n e r a l s t r u c t u r e o f t h e VFCR a p p l i e s t o b o t h t h e bank and nonbank f i n a n c i a l i n s t i t u t i o n programs. However, because o f k e y d i f f e r e n c e s i n t h e f o r e i g n i n v e s t m e n t p o r t f o l i o o f t h e two t y p e s of i n s t i t u t i o n s , a few d i f f e r e n c e s The m a j o r d i f f e r e n c e o f the banks1 i n t r e a t m e n t have been n e c e s s a r y . i s t h a t o v e r 90 p e r c e n t o f t h e $ 1 0 . 2 billion f o r e i g n a s s e t s a r e c o v e r e d by t h e g u i d e l i n e s , whereas n e a r l y 90 p e r c e n t o f t h e $ 1 4 - 1 / 2 b i l l i o n o f f o r e i g n a s s e t s o f nonbank f i n a n c i a l i n s t i t u t i o n s a r e exempted. For banks, the the exceptions a r e more r e l a t e d t o i n s t i t u t i o n a l a r r a n g e m e n t s t h a n t o t y p e s o f F o r t h e nonbank i n s t i t u t i o n s , bonds o f i n t e r n a t i o n a l $1-1/2 b i l l i o n l o a n s t o Canada ( n e a r l y $ 1 0 - 1 / 2 institutions ( a b o u t $1 b i l l i o n ) , i n loans w i t h m a t u r i t i e s of r e f r a i n i n g banks. until Other aspects t h e emphasis on e x p o r t f i n a n c i n g and t h e f r o m new n o n e x p o r t l o a n s o r i n v e s t m e n t s t h e d e v e l o p e d c o u n t r i e s o f C o n t i n e n t a l W e s t e r n Europe — those f o r and a r o u n d (and i n Japan a few weeks ago) a r e n o t s u b j e c t t o g u i d e l i n e c e i l i n g s . desirability billion), o f t e n y e a r s o r l o n g e r and e q u i t y investments i n the developing c o u n t r i e s t h e nonbank g u i d e l i n e s - - assets. parallel in of -10- The c u r r e n t g u i d e l i n e s for t h e b a n k s , announced on December 17, 1969, i n c l u d e a m a j o r i n n o v a t i o n : for term c r e d i t s added. a separate ceiling f i n a n c i n g e x p o r t s o f U . S . goods and s e r v i c e s was The banks now have a G e n e r a l C e i l i n g o f $ 1 0 . 1 b i l l i o n e q u a l t o t h e i r a d j u s t e d c e i l i n g s u n d e r t h e 1969 g u i d e l i n e s . can be used f o r any p u r p o s e , a l t h o u g h t h e y a r e r e q u e s t e d t o t o observe the p r i o r i t i e s addition, -This continue i n the use o f t h i s General C e i l i n g . In t h e y have a c e i l i n g e q u a l t o o n e - h a l f o f one p e r c e n t t o t a l a s s e t s as o f December 3 1 , 1968, t o use f o r m a k i n g e x p o r t of loans w h i c h have m a t u r i t i e s o f one y e a r o r l o n g e r and w h i c h a r e i n amounts o f $ 2 5 0 , 0 0 0 o r more. T h i s p r o v i s i o n added a b o u t $ 1 . 5 b i l l i o n existing ceilings, b r i n g i n g the aggregate t o $11.6 Several troublesome issues on c o n t r o v e r s y ) ing. to billion. ( w h i c h a t t i m e s have b o r d e r e d have s u r r o u n d e d t h e VFCR a l m o s t f r o m i t s v e r y Undoubtedly, o u t o f Government) beginn- t h e most v i g o r o u s l y d e b a t e d o f t h o s e ( b o t h i n and is t h e a s s e r t i o n t h a t t h e p r o g r a m has hampered U . S . e x p o r t s and t h u s r e d u c e d ( i f n o t e r a s e d ) any b e n e f i t s i t have y i e l d e d f o r the balance o f payments. g u i d e l i n e s were f i r s t exclude export c r e d i t s drafted, been a c c e p t e d by t h e B o a r d . I n f a c t , when t h e VFCR t h e F e d e r a l R e s e r v e was u r g e d from the c e i l i n g . to T h i s a r g u m e n t has n e v e r I n s t e a d , we have a l w a y s t r i e d t o ample room f o r n e c e s s a r y f i n a n c i n g o f an e x p a n s i o n i n Throughout the l i f e may allow exports. o f t h e VFCR, t h e b a n k i n g s y s t e m as a w h o l e has -11- m a i n t a i r i e d a s u b s t a n t i a l leeway u n d e r w h i c h c r e d i t s c o u l d have been e x t e n d e d t o meet t h e needs o f U.S. e x p o r t e r s and t h e i r foreign customers. exports M o r e o v e r , no s t a t i s t i c a l study o f the trends i n s i n c e 1964 s u p p o r t s t h e p r o p o s i t i o n t h a t a d d i t i o n a l amounts o f bank c r e d i t e x t e n d e d t o f o r e i g n e r s w o u l d have i n c r e a s e d e x p o r t s by a l i k e amount. Yet, such a g r o w t h i n bank l e n d i n g a b r o a d certainly w o u l d have added some amount t o o u r b a l a n c e o f payments deficit. On t h e o t h e r hand, i n d i v i d u a l banks f r o m t i m e t o t i m e may have had t o r e l i n q u i s h t h i s c r e d i t b u s i n e s s t o o t h e r banks i n e a s i e r under the positions guidelines. N e v e r t h e l e s s , we d i d p r o v i d e a s e p a r a t e c e i l i n g c r e d i t s when we r e v i s e d t h e program l a s t December. s t e p , we w a n t e d t o g i v e renewed for In taking emphasis i n t h e p r o g r a m t o latitude f o r e x p o r t f i n a n c i n g w i t h i n an o v e r a l l The ceiling s h o u l d p r o v i d e even more a s s u r a n c e t h a t t h e r e s t r a i n t p r o g r a m not cost the country export sales. On t h e o t h e r h a n d , this the i m p o r t a n c e t h a t we a t t a c h t o i m p r o v i n g o u r b a l a n c e o f t r a d e . additional export will t o have exempted e x p o r t c r e d i t e n t i r e l y w o u l d have e n t a i l e d a r i s k of c a p i t a l o u t f l o w s o f unknown d i m e n s i o n s and t h u s w o u l d have made t h e restraints largely meaningless. A n o t h e r t r o u b l e s o m e i s s u e has a r i s e n b e c a u s e o f inequities inherent the i n a p r o g r a m w h i c h r e s t s so h e a v i l y on t h e -12- r e l a t i v e p o s i t i o n o f i n d i v i d u a l banks i n i n t e r n a t i o n a l as o f December 3 1 , 1964 - VFCR. finance t h e base d a t e f o r most banks u n d e r Of t h e 1 3 - 1 / 2 t h o u s a n d banks i n t h e U n i t e d S t a t e s , the about 160 ( l e s s t h a n 2 p e r c e n t ) have r e p o r t e d r e g u l a r l y u n d e r t h e p r o g r a m . The r e s t do n o t have even a t o k e n amount o f f o r e i g n a s s e t s . the r e l a t i v e l y s m a l l s i z e o f t h e a v e r a g e bank - - and t h e of foreign lending - - this s i t u a t i o n is not However, g i v e n complexities surprising. The r e a l p r o b l e m a r o s e because t h e l a u n c h i n g o f t h e VFCR c a u g h t a number o f banks o f s u b s t a n t i a l s i z e i n the m i d s t of starting new o r e x p a n d i n g e x i s t i n g b u t modest i n t e r n a t i o n a l d e p a r t m e n t s . the most p a r t , participating base. t h e s e i n s t i t u t i o n s were e s s e n t i a l l y frozen out i n f o r e i g n l e n d i n g because t h e y had v i r t u a l l y For of no The h i g h degree o f c o n c e n t r a t i o n o f f o r e i g n b u s i n e s s among a few banks can be seen i n t h e f a c t t h a t 20 o f t h e 160 banks r e p o r t i n g have c o n s i s t e n t l y a c c o u n t e d f o r 75 t o 80 p e r c e n t o f g e n e r a l c e i l i n g f i x e d u n d e r t h e VFCR. some o f t h e banks w i t h l a r g e c e i l i n g s Moreover, it the i s known t h a t (because t h e y a l r e a d y had a s u b s t a n t i a l amount o f f o r e i g n a s s e t s a t t h e end o f 1964) have u s e d s u c h c e i l i n g s as c o m p e t i t i v e l e v e r s i n s e e k i n g t h e b u s i n e s s i n g p u r e l y domestic business) accommodated b y t h e i r local (includ- o f f i r m s t h a t n o r m a l l y w o u l d be banks. -13- The F e d e r a l Reserve has a l w a y s been t r o u b l e d by t h e s e competitive inequalities Consequently, t h a t a r e d i r e c t l y r e l a t e d t o t h e VFCR. i n November, 1967, an a l t e r n a t i v e method o f i n g t h e c e i l i n g was p r o v i d e d . Under t h i s change, a bank had t h e o p t i o n of adopting a c e i l i n g equal t o 2 per cent of i t s a s s e t s as o f December 3 1 , 1966. more f l e x i b i l i t y Unfortunately, comput- total The change was i n t e n d e d t o give t o banks w i t h s m a l l - and m e d i u m - s i z e d b a s e s . t h i s n e w l y g r a n t e d leeway had t o be shaved d r a s t i c a l l y when t h e d e t e r i o r a t i o n i n t h e b a l a n c e o f payments made i t necessary t o t i g h t e n t h e v a r i o u s programs on New Years Day o f 1968. But each t i m e t h e Board has had an o p p o r t u n i t y , to reduce the i n e q u i t i e s . it has c o n t i n u e d i t s I n the s p r i n g o f l a s t y e a r , it t h e VFCR by r a i s i n g t h e c e i l i n g by a b o u t $400 m i l l i o n , efforts modified and p r o - p o r t i o n a t e l y more o f t h e i n c r e a s e went t o t h e s m a l l e r b a n k s . same was t r u e o f t h e E x p o r t Term l o a n c e i l i n g e s t a b l i s h e d December: last w h i l e t h e 20 l e a d i n g banks had a b o u t f o u r - f i f t h s general c e i l i n g , The of t h e y g o t o n l y s l i g h t l y more t h a n o n e - h a l f o f special export c e i l i n g . But d e s p i t e t h e s e changes, another s h o u l d be f o u n d . C o n t r i b u t i o n s o f t h e VFCR t o t h e Balance o f Payments There i s no need t o p r e s e n t h e r e a d e t a i l e d o f the c o n t r i b u t i o n s o f t h e VFCR t o t h e b a l a n c e o f the competitive i n e q u i t i e s r e m a i n a s e r i o u s p r o b l e m - - and t h e y p r o v i d e r e a s o n why a b e t t e r a l t e r n a t i v e the catalog payments. -14- (Furthermore, i t w o u l d be v i r t u a l l y unique assistance - - if o t h e r programs as w e l l . ) impossible to i d e n t i f y such any - - because o f t h e r o l e p l a y e d by However, t h e b r o a d c o n t o u r s can be sketched. I n 1965, b a n k s 1 f o r e i g n a s s e t s s u b j e c t t o t h e i n c r e a s e d by o n l y $150 m i l l i o n guidelines (compared w i t h an i n c r e a s e $ 2 - 1 / 2 b i l l i o n i n bank l e n d i n g t o f o r e i g n e r s i n 1964), of whereas t h e g u i d e l i n e c e i l i n g s w o u l d have p e r m i t t e d a n i n c r e a s e o f $500 m i l lion. T h i s " s w i n g " o f a b o u t $ 2 . 3 5 b i l l i o n was g r e a t e r than the improvement i n t h a t y e a r ' s b a l a n c e o f payments, as measured on t h e l i q u i d i t y basis. I n 1966, when m o n e t a r y p o l i c y became increasingly r e s t r i c t i v e as d o m e s t i c i n f l a t i o n a r y p r e s s u r e s i n t e n s i f i e d , the banks r e d u c e d t h e i r h o l d i n g s o f f o r e i g n a s s e t s by $150 m i l l i o n . a b s o l u t e t e r m s , t h i s r e p r e s e n t e d a b a l a n c e o f payments o f $300 m i l l i o n . Nevertheless, a t about $1.3 b i l l i o n In improvement t h e l i q u i d i t y d e f i c i t was m a i n t a i n e d f o r the year. Because o f t h e d e c r e a s e c o v e r e d a s s e t s and an i n c r e a s e i n t h e c e i l i n g , in t h e banks ended t h e y e a r w i t h a leeway u n d e r t h e p r o g r a m o f a l m o s t $1 b i l l i o n . I n 1967, m o n e t a r y p o l i c y e a s e d , and banks i n c r e a s e d h o l d i n g s o f c o v e r e d a s s e t s by $370 m i l l i o n , contributing $500 m i l l i o n t o t h e $ 2 . 3 b i l l i o n d e t e r i o r a t i o n i n t h e balance f o r t h a t year. about liquidity As m e n t i o n e d a b o v e , when i t became a p p a r e n t t h a t t h e b a l a n c e o f payments s i t u a t i o n was w o r s e n i n g , their the Administration -15- r e c o n s i d e r e d programs i t had announced i n November and s e t f o r t h new, more r e s t r i c t i v e programs on J a n u a r y 1 , 1968. A l t h o u g h t h e F e d e r a l Reserve p r o g r a m r e m a i n e d v o l u n t a r y , for the f i r s t t i m e t h e banks and nonbank f i n a n c i a l institutions were a s k e d t o a c h i e v e an a c t u a l r e d u c t i o n i n f o r e i g n c l a i m s the year - for during $400 m i l l i o n i n t h e case o f t h e b a n k s , and $100 m i l l i o n t h e nonbank f i n a n c i a l institutions. The a g g r e g a t e c e i l i n g banks was r e d u c e d f r o m $ 1 1 . 1 b i l l i o n t o $ 1 0 . 1 b i l l i o n , way f r o m $ 1 . 2 b i l l i o n t o a b o u t $200 m i l l i o n . t h e nonbank f i n a n c i a l institutions for and bank l e e - B o t h t h e banks and exceeded t h e r e q u e s t e d reductions. Bank h o l d i n g s o f c o v e r e d f o r e i g n a s s e t s d e c l i n e d by more t h a n $600 m i l l i o n , and t h e nonbank f i n a n c i a l institutions by $240 m i l l i o n . because o f t h i s good p e r f o r m a n c e - - and because o f o t h e r developments i n the c a p i t a l accounts - - Largely fortuitous t h e U n i t e d S t a t e s ended t h e y e a r w i t h a s m a l l s u r p l u s on t h e l i q u i d i t y b a s i s . The t r a d e surplus, h o w e v e r , d e c l i n e d t o o n l y $600 m i l l i o n . With respect t o 1969, p r e l i m i n a r y figures indicate that banks i n c r e a s e d t h e i r h o l d i n g s o f f o r e i g n a s s e t s l a s t y e a r b y a b o u t $150 m i l l i o n . T h i s f i g u r e i n c l u d e s a l a r g e o u t f l o w i n December. It a p p e a r s t h a t much o f t h a t m o n t h ' s o u t f l o w may have been r e l a t e d t o an e x t r e m e l y l a r g e volume o f t r a n s a c t i o n s w h i c h t o o k p l a c e n e a r t h e y e a r e n d , and i t may have been t e m p o r a r y i n n a t u r e . development, Prior to this t h e banks were showing a modest n e t i n f l o w o f f u n d s compared w i t h t h e l e v e l o f f o r e i g n c r e d i t s o u t s t a n d i n g a t t h e end o f year-end 1968. -16- S t i m u l a t i o n o f F o r e i g n Branches One b y - p r o d u c t o f t h e VFCR p r o g r a m may n o t be as to the long-run i n t e r n a t i o n a l may appear a t f i r s t glance. branches of U.S. banks. mately a s i x - f o l d heipful p o s i t i o n o f t h e U n i t e d S t a t e s as T h i s i s t h e enormous e x p a n s i o n o f it foreign S i n c e t h e p r o g r a m began, t h e r e has been a p p r o x i - r i s e i n number o f banks w i t h b r a n c h e s a b r o a d . It may be r e c a l l e d t h a t , when t h e VFCR g u i d e l i n e s were f o r m u l a t e d , a s s e t s on t h e books o f f o r e i g n b r a n c h e s were n o t c o u n t e d a g a i n s t institutions. Thus, s h i f t i n g o f f o r e i g n c r e d i t s the c e i l i n g s f r o m t h e head of offices t o such b r a n c h e s became a c o n v e n i e n t way f o r banks t o keep w i t h i n ceilings. B e f o r e l o n g , a number o f banks a p p l i e d f o r p e r m i s s i o n open b r a n c h e s a b r o a d - - u s u a l l y i n London. By t h e end o f last parent their to September, t h e t o t a l d o l l a r - d e n o m i n a t e d a s s e t s o f f o r e i g n b r a n c h e s amounted t o $ 2 8 . 9 billion. J u s t under h a l f i n the U . S . ; to U.S. of t h i s t o t a l had been p l a c e d w i t h head j u s t o v e r t w o - f i f t h s had been l e n t a b r o a d - - f i r m s and t h e i r foreign a f f i l i a t e s including to finance d i r e c t and t h e r e m a i n i n g 10 p e r c e n t r e p r e s e n t e d c l a i m s on o t h e r I n terms o f sources o f f u n d s , about t w o - t h i r d s redistributing Euro-dollar investment o f t h e t o t a l had been for mobiliz- deposits. But the r e a l l y dramatic s t o r y of the expansion o f branches i n p a r t i a l response t o the r e s t r i c t i o n s foreign imposed by t h e VFCR i s t o be f o u n d i n t h e s o - c a l l e d "Nassau 11 b r a n c h e s . loans foreigners. d e r i v e d f r o m f o r e i g n banks - - a c t i n g p r i m a r i l y as v e h i c l e s i n g and offices These a r e limited -- -17- M s e r v i c e or s h e l l ! f branches e s t a b l i s h e d i n t h e Bahamas. A t t h e end o f l a s t S e p t e m b e r , 22 U . S . banks ( 2 0 F e d e r a l Reserve members and 2 nonmembers) had opened such f a c i l i t i e s areas. Since e a r l y - - and t h e y had no b r a n c h e s i n o t h e r 1969 when t h e Board s t a r t e d a p p r o v i n g t h e o f Nassau b r a n c h e s ( a p o l i c y w h i c h I have p e r s o n a l l y n e v e r t h e y have grown r a p i d l y continuing. supported), liabilities, deposits. been p l a c e d w i t h t h e b r a n c h e s 1 U . S . a b o u t 80 p e r c e n t o f w h i c h Almost t h r e e - f i f t h s o f t h e f u n d s had parents. T h u s , w h i l e t h e d e s i r e t o escape t h e r e s t r i c t i o n s p r o g r a m was a m a j o r f a c t o r is l a s t S e p t e m b e r , t h e Nassau b r a n c h e s h e l d in total represented Euro-dollar creation i n b o t h number and s i z e — and t h e g r o w t h By t h e end o f j u s t over $1 b i l l i o n foreign o f t h e VFCR i n d u c i n g some banks t o open Nassau branches ( a n d a b o u t o n e - t h i r d o f t h e i r a s s e t s r e p r e s e n t e d c l a i m s on n o n - U . S . b o r r o w e r s ) , many o f them now seem t o be s e r v i n g p r i m a r i l y as a means o f p r o v i d i n g t h e i r head o f f i c e s w i t h E u r o - d o l l a r s . Because o f t h e low c o s t o f a t y p i c a l Nassau b r a n c h ( a m o u n t i n g t o o n l y a few t h o u s a n d and i n v o l v i n g f e w i f any f u l l - t i m e employees) compared w i t h a dollars full-scale b r a n c h i n London o r i n C o n t i n e n t a l W e s t e r n Europe ( w h i c h may r u n t o $400$500 t h o u s a n d ) , t h e s e banks have f o u n d t h e Bahamas an a t t r a c t i v e T h i s has been so d e s p i t e t h e f a c t t h a t t h e a d v a n t a g e s o f more location. traditional f o r e i g n f i n a n c i a l centers - - p a r t i c u l a r l y proximity to corporate c l i e n t s c a n n o t be f o u n d i n Nassau. Nevertheless, t h e Nassau b r a n c h e s a r e t o be m a i n t a i n e d , p e r h a p s on a m i n i m u m - l e v e l - o f - o p e r a t i o n s basis, likely even — -18- if t h e VFCR d i s a p p e a r s and t h e demand f o r E u r o - d o l l a r s p r e s s u r e s g e n e r a t e d by d o m e s t i c m o n e t a r y r e s t r a i n t But aside from these c o n s i d e r a t i o n s , to avoid the becomes l e s s intense. the r a p i d growth in t h e number and s c a l e o f f o r e i g n b r a n c h e s o f U . S . banks may h o l d implications f o r o u r b a l a n c e o f payments i n t h e l o n g - r u n . w e l l - e s t a b l i s h e d b r a n c h e s o f U . S . banks ( p a r t i c u l a r l y Undoubtedly, i n Europe) be e x p e c t e d t o expand i n any case t o accommodate t h e r i s i n g of t h e i r c l i e n t s abroad. banks1 f o r e i g n o p e r a t i o n s Yet, the d r a s t i c shift serious could activity i n emphasis o f the toward f o r e i g n branches could lead t o a lessening of the i n c e n t i v e f o r banks i n t h e U . S . t h a t might promote e x p o r t s . t o engage i n activities T h a t was one o f t h e c o n s i d e r a t i o n s l y i n g t h e d e c i s i o n t o p r o v i d e more leeway u n d e r t h e VFCR f o r under- export financing. Outlook f o r t h e U . S . B a l a n c e o f Payments As i s g e n e r a l l y known by now, t h e U . S . b a l a n c e o f r e g i s t e r e d an e x t r e m e l y l a r g e d e f i c i t For the f i r s t the d e f i c i t on t h e l i q u i d i t y b a s i s i n t h r e e q u a r t e r s o f t h e y e a r , on a r e a c h e d $8 b i l l i o n , but l a r g e c a p i t a l i n f l o w i n the I n the f i n a l the t r a d e s u r p l u s improved c o n s i d e r a b l y — r i s i n g annual r a t e of $1.7 b i l l i o n . But f o r s u r p l u s was j u s t o v e r $ 1 / 2 b i l l i o n , t h e y e a r as a w h o l e , the basis, last quarter t o an trade a b o u t t h e same as i n t h e p r e v i o u s A l t h o u g h t h e d e t a i l s on c a p i t a l movements d u r i n g t h e q u a r t e r o f 1969 w i l l 1969. seasonally adjusted q u a r t e r r e d u c e d t h e t o t a l f o r t h e y e a r somewhat. of the year, payments year. final n o t be known f o r a m o n t h o r s o , we do have a r o u g h -19i d e a a b o u t some o f t h e m a i n e l e m e n t s . The d o w n t r e n d i n s t o c k i n the U.S. market ( i n c o n t r a s t t o r i s i n g p r i c e s m a r k e t s a b r o a d ) and t h e c o n t i n u e d h i g h y i e l d s alternative i n some k e y prices equity on E u r o - d o l l a r and o t h e r i n v e s t m e n t s u n d o u b t e d l y dampened f o r e i g n a c q u i s i t i o n s U.S. c o r p o r a t e s t o c k s . On t h e o t h e r h a n d , t h e r e was p r o b a b l y a i n f l o w o f c o r p o r a t e f u n d s a r o u n d t h e y e a r - e n d as U . S . g e t u n d e r t h e t a r g e t s s e t by t h e d i r e c t i n f l o w o c c u r r e d a t t h e end o f 1968. investment program. o f f u n d s t h a t had been p l a c e d i n German mark a s s e t s p r i o r inflow to revaluation. t h e r e was an u n e x p e c t e d o u t f l o w p a r t o f t h i s was s e a s o n a l , and was soon r e v e r s e d . I n t h e f u l l y e a r 1969, t h e r i s e the fourth outflow in r e p o r t e d c l a i m s on f o r e i g n e r s amounted t o o v e r $ 1 / 2 b i l l i o n bank-- and t h i s was a c c o u n t e d f o r e n t i r e l y by t y p e s o f c l a i m s n o t s u b j e c t instance, collections o f t h e agencies of f o r e i g n banks. f o r customers o r f o r e i g n to assets However, as m e n t i o n e d a b o v e , banks u n d e r t h e p r o g r a m d i d i n c r e a s e t h e i r own f o r e i g n l e n d i n g i n December ( b y a l m o s t $320 m i l l i o n ) and t h u s c o n c l u d e d t h e f u l l y e a r w i t h a n e t o u t f l o w o f a b o u t $150 m i l l i o n . I f we p u l l t o g e t h e r t h e v a r i o u s , information, it is clear of though During the q u a r t e r as a w h o l e ( a n d on a s e a s o n a l l y a d j u s t e d b a s i s ) , t h e VFCR-- f o r to A similar bank f u n d s i n December, a m o u n t i n g t o more t h a n $ 1 / 2 b i l l i o n , was a r o u n d $350 m i l l i o n . large f i r m s sought There was a l s o a r e t u r n B u t , as m e n t i o n e d a b o v e , of incomplete threads t h a t t h e b a l a n c e o f payments d e f i c i t of for -20- 1969 as a w h o l e , on t h e l i q u i d i t y b a s i s , was w e l l under t h e o f n e a r l y $8 b i l l i o n r e c o r d e d f o r t h e f i r s t figure three quarters. Yet, s i n c e a modest s u r p l u s had been a c h i e v e d i n 1968 ( a l t h o u g h partly because o f a s i z a b l e amount o f s p e c i a l G o v e r n m e n t - a r r a n g e d trans- actions), official t h e d e t e r i o r a t i o n was o b v i o u s l y e x t r e m e l y l a r g e . settlements basis, t h e b a l a n c e o f payments was i n by a l m o s t $2 b i l l i o n d u r i n g t h e f i r s t and by a somewhat l a r g e r amount f o r Yet, little On t h e surplus three quarters of l a s t the f u l l year, year. i f we l o o k b e h i n d t h e s e s h o r t - r u n developments, c a n be seen t o encourage a f e e l i n g o f c o n f i d e n c e w i t h t o o u r b a l a n c e o f payments. On t h e c o n t r a r y , it is clearly respect evident t h a t we have made o n l y l i m i t e d p r o g r e s s t o w a r d t h e o b j e c t i v e s when t h e r e s t r a i n t s although at l e a s t p a r t o f our d i f f i c u l t y other m i l i t a r y It will on c a p i t a l o u t f l o w were a d o p t e d i n e a r l y 1965, r e l a t e s t o V i e t n a m and c o s t s r a t h e r t h a n u n d e r l y i n g economic imbalances. be r e c a l l e d t h a t t h e s e programs were c o n c e i v e d w i t h expectation that set t h e y w o u l d be s h o r t - l i v e d . They were the generally l o o k e d upon as t e m p o r a r y measures d e s i g n e d t o h o l d t h e s i z e o f deficits i n c h e c k w h i l e e f f o r t s were made t o a c h i e v e a f u n d a m e n t a l adjustment i n o u r payments p o s i t i o n . s e v e r a l i n t e r m e d i a t e g o a l s were the set: To a c h i e v e t h e latter, -21- - The m a i n t e n a n c e (and even e x p a n s i o n ) already large trade surplus. of an - Reductions wherever o u t l a y s abroad. - A r e v e r s a l o f t h e w i d e n i n g gap i n expenditures. - A r i s e i n income f r o m p r e v i o u s f o r e i g n ment. invest- - Encouragement o f e x p a n s i o n o f E u r o p e a n markets. capital p o s s i b l e i n Government travel O b v i o u s l y , we have f a l l e n c o n s i d e r a b l y s h o r t o f objectives. L a s t y e a r , o u r t r a d e s u r p l u s was o n l y $ 1 / 2 compared w i t h a r e c o r d o f $ 6 - 1 / 2 b i l l i o n i n 1964. extent, To a these billion considerable t h i s poor performance i s a r e f l e c t i o n o f our f a i l u r e s check i n f l a t i o n a t home. W i t h our p r i c e s r i s i n g faster than o f o u r c o m p e t i t o r s s i n c e 1964, we have l o s t a s i z a b l e s h a r e f o r e i g n markets. to those of W h i l e some o f t h i s r e d u c t i o n i n o u r r e l a t i v e o f t o t a l e x p o r t s may be a t t r i b u t e d t o b a r r i e r s our n e g o t i a t o r s are s t r u g g l i n g to l o w e r ) , shares of various kinds our b a s i c problem i s (which clearly one o f c o s t and p r i c e c o m p e t i t i o n . Some o f o u r c o m p e t i t o r s foreign a f f i l i a t e s have become i n c r e a s i n g l y a b l e out-sell of U.S. firms) (including some o f o u r f i r m s i n o u r own m a r k e t s as w e l l as a b r o a d . We have made s i g n i f i c a n t s t r i d e s i n r e d u c i n g some Government o u t l a y s a b r o a d and i n h o l d i n g o t h e r s . For e x a m p l e , d o l l a r payments t o f o r e i g n e r s u n d e r U . S . Government g r a n t and c r e d i t p r o g r a m s w e r e to -22- down t o a b o u t $650 m i l l i o n i n 1968, o u t o f a t o t a l p r o g r a m o f $5 b i l l i o n . sharp r i s e over However, such s a v i n g s had been more t h a n o f f s e t by in military 1964, m i l i t a r y the o u t l a y s abroad - - e s p e c i a l l y i n Vietnam. s p e n d i n g a b r o a d amounted t o $ 2 . 9 b i l l i o n ; had r i s e n t o $ 4 - 1 / 2 b i l l i o n , and t o d a y i t In by 1968, i s c l o s e t o a $5 it billion rate. Income r e c e i p t s s i n c e 1964. f r o m i n v e s t m e n t a b r o a d have c l i m b e d I n the l a t t e r year, p r i v a t e j u s t u n d e r $5 b i l l i o n ; sharply f o r e i g n i n v e s t m e n t income was t o d a y t h e r a t e i s a p p r o x i m a t e l y $8 b i l l i o n . t h e o t h e r h a n d , because i n t e r e s t r a t e s h e r e have r i s e n On dramatically s i n c e 1964 ( r e f l e c t i n g t o some e x t e n t t h e heavy r e l i a n c e on m o n e t a r y p o l i c y i n the f i g h t against i n f l a t i o n ) and p a r t l y because we have b e e n f i n a n c i n g o u r b a l a n c e o f payments d e f i c i t s huge v o l u m e o f s h o r t - t e r m d e b t - - by a c c u m u l a t i n g a t h e r e has a l s o been a i n c r e a s e i n o u r payments o f i n t e r e s t and o t h e r income t o sizable foreigners. Such payments r o s e f r o m $ 1 - 1 / 2 b i l l i o n i n 1964 t o a c u r r e n t r a t e r o u g h l y $5 b i l l i o n . of T h i s i n c r e a s e has more t h a n matched t h e g a i n o v e r t h e p e r i o d i n o u r r e c e i p t s o f income f r o m a b r o a d . W i t h r e s p e c t t o f o r e i g n t r a v e l , we seem t o have made no p r o g r e s s i n c l o s i n g t h e gap. I n 1968, A m e r i c a n s s p e n t a b o u t b i l l i o n a b r o a d , a n i n c r e a s e o f $800 m i l l i o n s i n c e 1964. $3.9 Spending by f o r e i g n e r s h e r e d u r i n g t h e same y e a r s r o s e by o n l y $560 m i l l i o n t o $ 2 . 0 lion. bil- T h u s , t h e m a r g i n o f t r a v e l e x p e n d i t u r e s a b r o a d b y A m e r i c a n s i n excess -23- o f what f o r e i g n e r s $1-1/2 b i l l i o n . spent here widened f r o m about $1 b i l l i o n t o almost The gap p r o b a b l y w i d e n e d f u r t h e r last year. I n t h e case o f European c a p i t a l m a r k e t s , we have w i t n e s s e d a d e v e l o p m e n t t h a t has b r o u g h t c o n s i d e r a b l e b e n e f i t s o f payments. direct t o our balance Even two y e a r s ago (when t h e m a n d a t o r y r e g u l a t i o n i n v e s t m e n t was a d o p t e d ) few — i f any - - observers for clearly f o r e s a w t h e enormous e x p a n s i o n w h i c h has o c c u r r e d s i n c e t h e n i n t h e volume o f f u n d s r a i s e d by t h e s e m a r k e t s . T h i s has h e l p e d t o t h e f i n a n c i n g p r o b l e m s o f U . S . c o r p o r a t i o n s whose e f f o r t s lessen to carry out p r o j e c t s a b r o a d w o u l d have g e n e r a t e d even more p r e s s u r e s on c a p i t a l o u t f l o w from t h i s country. I t has a l s o c o n t r i b u t e d t o a much g r e a t e r f l o w o f f o r e i g n c a p i t a l i n t o U.S. Nevertheless, equities. s i n c e we a r e s t i l l a l o n g way f r o m a c h i e v i n g a v i a b l e e q u i l i b r i u m i n our balance of payments, I t h i n k t h e t i m e has come t o s e a r c h f o r a b e t t e r way t o a c h i e v e an a d j u s t m e n t . An A l t e r n a t i v e t o t h e VFCR,: Against Foreign Assets A p p l i c a t i o n o f Reserve R e q u i r e m e n t s I n b r o a d t e r m s , t h e a l t e r n a t i v e I have i n mind t o o u r restraints on U . S . bank l e n d i n g t o f o r e i g n e r s w o u l d be t h e o f a cash r e s e r v e r e q u i r e m e n t against foreign assets. present application This reserve w o u l d be i n a d d i t i o n t o t h e c u s t o m a r y r e s e r v e t h a t a bank m a i n t a i n s against deposits. as a s u p p l e m e n t a l For convenient r e f e r e n c e , reserve. it m i g h t be d e s c r i b e d -24- The o b j e c t i v e o f t h i s s u p p l e m e n t a l r e s e r v e w o u l d be t o raise t h e c o s t o f f o r e i g n l e n d i n g by r e d u c i n g t h e m a r g i n a l r a t e o f r e t u r n t h e bank making t h e f o r e i g n l o a n — and t h e r e b y dampen t h e o u t f l o w U.S. c a p i t a l . to of The b a s i c p u r p o s e o f t h e s u p p l e m e n t a l r e s e r v e w o u l d n o t be t o l e v y new r e s e r v e r e q u i r e m e n t s on t h e b a n k i n g s y s t e m as a w h o l e ; nor would i t be t o r a i s e t h e average l e v e l o f r e s e r v e s r e q u i r e d for i n d i v i d u a l banks t h a t do n o t choose t o engage i n f o r e i g n l e n d i n g investing. credit T h u s , i t w o u l d n o t be r e l a t e d d i r e c t l y conditions - - as a r e r e g u l a r to general or domestic reserve requirements a p p l i c a b l e to a l l member banks o f t h e F e d e r a l Reserve System. I n f o c u s i n g on t h i s a p p r o a c h , I p u t a m a r k e t f o r c e a t t h e t o p o f my l i s t of desirable c h a r a c t e r i s t i c s . t h e VFCR, I am k e e n l y aware o f t h e d e s i r a b i l i t y as much as p o s s i b l e — i t minimize i n t e r f e r e n c e In administering of assuring that w i t h normal d e c i s i o n s and t h e economic f o r c e s o f t h e m a r k e t p l a c e . community, w i t h i n whatever o u t e r technique l i m i t s are considered -- business The b u s i n e s s absolutely necessary, can b e s t a l l o c a t e f i n a n c i a l and r e a l r e s o u r c e s . Business, therefore, s h o u l d be a s s u r e d as much f r e e d o m o f c h o i c e as t h e basic o b j e c t i v e s o f an o f f i c i a l p r o g r a m p e r m i t . S i n c e t h e o b j e c t w o u l d c o n t i n u e t o be t o r e s t r a i n t h e in foreign lending, rather by some d a t e i n t h e p a s t , t h a n t o b u r d e n t h e amount o f l e n d i n g achieved t h e r e s e r v e s m i g h t a p p l y o n l y t o t h e amount o f l e n d i n g above some d e t e r m i n e d v o l u m e . would c o n s t i t u t e m a r g i n a l , growth That i s , t h e cash rather than average, required reserves reserves. -25- Solely for t h e sake o f illustration, l e t us t a k e $10 billion as t h e amount o f U . S . bank l e n d i n g e x i s t i n g a t t h e i n c e p t i o n o f program. Suppose f u r t h e r t h a t a bank were r e q u i r e d t o s e t a s i d e cash r e s e r v e s e q u a l t o 20 p e r c e n t o f t h e amount by w h i c h i t s loans t o f o r e i g n e r s the exceeded t h e amount o f b e f o r e t h e r e s e r v e p r o g r a m went i n t o outstanding such l o a n s o u t s t a n d i n g just force. T h i s f o r m u l a t i o n m i g h t be v a r i e d so t h a t a cash r e s e r v e re^ q u i r e m e n t m i g h t be a p p l i e d a g a i n s t w h a t e v e r new f o r e i g n l o a n s t h e bank might extend r a t h e r than apply a marginal reserve against of l o a n s above t h e amount o u t s t a n d i n g on a p a r t i c u l a r To i l l u s t r a t e , after, t h e amount date. a bank t h a t e x t e n d e d a l o a n t o a f o r e i g n e r s a y , t h e end o f F e b r u a r y 1970, m i g h t be r e q u i r e d t o s e t cash r e s e r v e s o f 20 p e r c e n t o f t h e amount o f t h a t loan. aside Loans to f o r e i g n e r s a l r e a d y o u t s t a n d i n g as o f t h a t d a t e w o u l d r e q u i r e no r e s e r v e s n o r be u n d e r any q u a n t i t a t i v e restraint. Any e x t e n s i o n o f t h o s e s t a n d i n g l o a n s , as w e l l as any drawdowns o f t h e n - e x i s t i n g lines c r e d i t , w o u l d be t r e a t e d as new l o a n s and w o u l d be s u b j e c t reserve requirement. This v a r i a n t f r e e o f any r e l a t i o n s h i p to is especially attractive r e p r e s e n t e d by d i f f e r i n g volumes o f outof the i n being foreign l o a n s o u t s t a n d i n g among i n d i v i d u a l banks a t a g i v e n base d a t e - - a weakness o f t h e e x i s t i n g VFCR. Under e i t h e r v a r i a n t the percentage of t h i s a l t e r n a t i v e system, r e s e r v e r e q u i r e m e n t w o u l d be s e t on t h e b a s i s o f an o f f i - c i a l d e t e r m i n a t i o n o f the degree o f i n f l u e n c e t o our p r e s e n t t o be a p p l i e d , for balance -26- o f payments r e a s o n s , a g a i n s t u n l i m i t e d c a p i t a l o u t f l o w . w o u l d be l e v i e d i n p r o p o r t i o n t o t h e l e n d i n g . The restraint Contrary to the present situation, i t w o u l d n o t r e q u i r e i m m e d i a t e a s s e t a d j u s t m e n t s by each b a n k ; instead i t w o u l d l e a v e t h e d e c i s i o n t o i n d i v i d u a l banks t o a d a p t l e n d i n g t o the circumstances a t the their time. The l o a n s t h a t w o u l d be s u b j e c t to the supplemental reserve r e q u i r e m e n t c o u l d be d e f i n e d i n a way t h a t w o u l d t a k e a c c o u n t o f priorities and e x e m p t i o n s u n d e r t o d a y ' s p r o g r a m . present request t h a t banks g i v e p r i o r i t y developing countries For example: the t o l o a n s t o meet t h e needs c o u l d be g i v e n e f f e c t through a reserve a g a i n s t such l o a n s s m a l l e r t h a n t h e r a t i o f o r o t h e r loans; Export loans - - loans including term loans r e c e n t l y accorded a separate set o f c e i l i n g s -- to restraints, export- c o u l d be s u b j e c t e d t o a cash r e s e r v e r e q u i r e m e n t o n l y when t h e y exceeded a u l a t e d percentage of a bankfs end-of-1968 t o t a l assets, f o r the present c e i l i n g f o r t h i s category of the basing foreigners, b u t i t w o u l d do so i n a more s u p p l e and e c o n o m i c a l l y j u s t i f i a b l e The new r e s e r v e way require- ment f o r f o r e i g n a s s e t s o f b a n k s , b e i n g a v e r y m i n o r f r a c t i o n o f r e s e r v e s now r e q u i r e d a g a i n s t d e p o s i t point system sketched o f r e s t r a i n i n g bank l e n d i n g t o t h a n i s t h e case w i t h o u r e x i s t i n g t e c h n i q u e . stip- loans. Such a s u p p l e m e n t a l cash r e s e r v e r e q u i r e m e n t above w o u l d have t h e e f f e c t of ratio r e s i d e n t s o f Canada c o u l d be e x e m p t e d , as t h e y a r e f r o m p r e s e n t by s e t t i n g t h e r e q u i r e m e n t a t z e r o . the liabilities, the w o u l d n o t cause a -27- significant d i s t u r b a n c e o f domestic monetary p o l i c y . While there would be a modest i m p a c t on t h e r e q u i r e d r e s e r v e s o f member b a n k s , t h i s be e a s i l y o f f s e t by o p e n - m a r k e t operations. From t h e p o i n t o f a d m i n i s t r a t i o n , l e s s e r degree o f c e r t a i n t y a shift to a p r o h i b i t i v e could t h e s y s t e m w o u l d have a t h a n t h e p r e s e n t s y s t e m , because - - reserve r a t i o — it barring would a l l o w f o r e i g n t o i n c r e a s e , whereas t h e p r e s e n t s y s t e m p r o v i d e s a f a i r l y rigid loans limit t o t h e volume o f f o r e i g n l e n d i n g by U . S . b a n k s . But the reduced tainty t h e many a d v a n t a g e s seems t o me a r e a s o n a b l e p r i c e t o pay f o r such a s y s t e m w o u l d offer. As I m e n t i o n e d e a r l i e r , r e a d y possess a u t h o r i t y amount o f c r e d i t With respect cer- t h e F e d e r a l Reserve S y s t e m may a l - t o e s t a b l i s h a reserve program r e l a t e d extended t o p a r t i c u l a r categories of f o r e i g n t o f o r e i g n l o a n s by member banks o f t h e F e d e r a l System ( w h i c h h o l d over f o u r - f i f t h s to borrowers. Reserve of our banking resources but 90 p e r c e n t o f t o t a l f o r e i g n a s s e t s ) , it seems t h a t the the reserve over pro- v i s i o n s o f t h e F e d e r a l Reserve A c t p r o v i d e such a u t h o r i t y . For a b r o a d e r - b a s e p r o g r a m - one a p p l y i n g t o a l l banks and o t h e r financial institutions— E x e c u t i v e O r d e r 11387, i s s u e d i n J a n u a r y 1968, authorizes t h e B o a r d t o " r e g u l a t e o r p r o h i b i t any t r a n s a c t i o n by any bank o r financial institution11 involving credit to f o r e i g n e r s , " d e t e r m i n e s such a c t i o n t o be n e c e s s a r y o r d e s i r a b l e b a l a n c e o f payments p o s i t i o n o f t h e U n i t e d States.11 if the other Board to strengthen the -28- A p o s s i b l e a d d i t i o n a l source of a u t h o r i t y i s the recently- e n a c t e d C r e d i t C o n t r o l A c t , w h i c h empowers t h e F e d e r a l Reserve Board t o p r e s c r i b e maximum r a t i o s o f l o a n s o f p a r t i c u l a r particular types such l o a n s . ( s u c h as r e s e r v e b a l a n c e s ) , types to assets or to p r o h i b i t or However, t h i s power can be e x e r c i s e d o n l y a f t e r limit a P r e s i d e n t i a l d e t e r m i n a t i o n t h a t r e g u l a t i o n and c o n t r o l o f c r e d i t the Board i s called for sion of c r e d i t t o c o n t r o l " i n f l a t i o n g e n e r a t e d by t h e i n an e x c e s s i v e efficient by exten- volume." I n o u t l i n i n g a possible a l t e r n a t i v e program, I of t o o u r f i v e y e a r o l d VFCR do so t o encourage an a c t i v e q u e s t f o r a more a t t r a c t i v e - - a n d - - means o f l i m i t i n g c a p i t a l o u t f l o w . W h i l e I have n o t t h e F e d e r a l Reserve Board t o adopt i t (and i n f a c t the Board's agenda), i t t h e d i r e c t i o n o f my own t h o u g h t s as t h e a d m i n i s t r a t o r does i n d i c a t e it urged o f t h e VFCR - - and as a b e l i e v e r i s n o t even on i n market techniques. In closing, techniques we s h o u l d n o t e t h a t a s i m i l a r t o replace the d i r e c t nonfinancial corporations quest f o r market investment r e g u l a t i o n s applying s h o u l d a l s o be e n c o u r a g e d . to
@FedFRASER