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A review by the Federal Reserve B a n k of Chicago



The trend of business


Trends in banking and finance—
negotiable certificates of deposit


Monetary policy and
international payments


Federal Reserve Ba nk o f Chicago


R etail sales rose vigorously in the closing
months of 1962 while employment and pro­
duction continued at the levels that had pre­
vailed during most of the summer and fall.
If consumer purchases were to remain strong,
as was the case in the early weeks of 1963,
business inventories and spending for new
plant and equipment might soon begin to rise,
thereby reversing the recent declines in these
Developments have been sufficiently
favorable to cause a revision in the widely
accepted forecast of business activity some
months ago which had hinted at a mild
recession in the first half of 1963. Recently,
the view expressed most commonly has called
for a flat or mildly rising trend in the first half
of the year followed by a stronger upswing in
the second half, often predicated upon stimu­
lation expected from a cut in Federal income
C a p ita l e x p e n d itu re p la n s stre n g th e n


A mild decline in the rate of spending on
new plant and equipment between the fourth
quarter of 1962 and the first quarter of 1963
was indicated in a Government survey re­
leased in December. This has played an im­
portant role in current estimates of future
business activity.
Declines in such outlays almost invariably
have been accompanied by downturns in
general business activity. However, there is
evidence that capital expenditure plans have
been raised by many business firms since the


survey mentioned above was taken. For ex­
ample, the railroads had been expected to
reduce their capital outlays 12 per cent in
1963. A more recent survey by Railway Age
indicates an increase of 20 per cent. The
petroleum industry had been expected to re­
duce outlays 13 per cent in 1963, but industry
sources now anticipate that outlays will be
maintained at last year’s level.
Plans also appear to have been revised up­
ward in the textile, automotive and steel in­
dustries. While capital outlays in steel were
indicated to rise 13 per cent in 1963, the
largest gain for any major industry, a number
of projects announced since that time suggest
an even greater rise. In the Chicago area
virtually all of the producers have reported
plans for important new facilities, and Beth­
lehem has stated that work soon will begin on
its first midwestern plant at Burns Ditch,
Although there is evidence of large
amounts of “excess capacity” in the steel in­
dustry, new facilities often are designed to
produce new products or to achieve substan­
tially lower costs. For example, most steel
companies are contemplating the installation
of oxygen converters to take the place of open
hearth furnaces in the production of steel
ingots. These converters have much lower
initial capital investment per ton of capacity
and somewhat lower operating costs than
existing facilities. The smaller batches of steel
produced in these units permits greater flexi­
bility in scheduling output than has been

B u sin e ss C o n d itio n s, Fe b ru a ry 1963

possible with the open hearths. Meanwhile,
finishing capacity is being expanded rapidly
for a number of steel products, especially
“thin tin” plate which competes with other
materials in the lightweight can market. Ex­
isting mills are not capable of rolling the new
Buyers and sellers of capital goods have
shown growing interest in the tax credit
which lowers the cost of certain types of new
equipment as much as 7 per cent and the
more liberal depreciation guidelines which
may be used in calculating income tax liabili­
ties for 1962 and subsequent years. Both of
these programs increase the profit potential
to be expected from new capital goods by re­
ducing or postponing tax liabilities. It appears
that a “second look” has caused many busi­
ness firms to value these incentives more
highly than was indicated earlier. The com­
bination of the tax credit and more rapid de­
preciation is credited with much of the
increase in capital expenditures now indi­
cated in the railroad industry.
However, tax credits and accelerated de­
preciation work “on the margin”, by reducing
capital costs and increasing cash flow, and
can do little to encourage capital outlays
which do not appear advantageous on other
grounds. New capital goods are purchased in
the expectation that they will increase profits
by creating capacity to produce new products,
cutting operating costs, improving quality and
in some instances expanding capacity to pro­
duce existing products. The programs will be
most effective in an atmosphere of confidence
based upon rising sales and order backlogs.
In v e n t o r y g r o w t h slo w s

Business inventories may have a more im­
portant impact upon total activity in the
months immediately ahead than any changes
in plant and equipment outlays. In the second

D urable g o o d s manufacturers' new
orders edged above sales in late
1962 after lagging most of the year

half of 1962, business inventories increased
very little despite rising sales and according
to most estimates are low relative to current
sales. Important swings in the United States
economy during the past decade usually have
been accompanied by substantial changes in
At the end of November the book value of
total business inventories was 3.5 per cent
higher than a year earlier. Over the same
period total business sales had increased 5.1
per cent. As a result, the ratio of inventories
to sales declined to the lowest level since the
spring of 1959.
Sluggish sales during the past spring and
summer help explain the slow rise of inven­
tories. This trend was aided also by the ample
capacity in virtually all lines, the absence of
expectations of price increases and a reduc­
tion in the proportion of production repre­
sented by military and industrial equipment
with a long “lead time” between order and


Federal Reserve Ba nk o f Chicago

At the end of 1962 steel inventories were
“back to normal” and in some cases, ex­
tremely low, according to some analysts.
Steel production was at an annual rate of
just under 100 million tons and was believed
to be close to consumption. But the outlook
is complicated by the possibility of a strike.
Under the terms of the labor-management
contract, wage negotiations can be reopened
May 1 and a work stoppage could be called
for August 1. Some steel consumers already
are making plans to increase their stocks in
the months ahead. Steel buyers have been
told to “stay on top of your suppliers’ situa­
tion and required lead times for your prod­
ucts.” In early January the majority of fabri­
cators contacted by Iron Age planned to
increase steel inventories 50 to 100 per cent
above “normal” in the months ahead.
A great deal has been done to improve
inventory management in most industries in
recent years through the use of computers,
air transport and other techniques. Neverthe­
less, it is apparent that a sharp rise in orders
could upset plans based upon very rapid de­
liveries from suppliers. In this case inventory
accumulation to assure uninterrupted produc­
tion schedules and adequate supplies at retail
could become once again the most expan­
sionary force in the economy.
The b ig g e s t C h ristm a s e v e r


Normally about 28 per cent of a year’s re­
tail sales occur in the fourth quarter, more
than in any other quarter. This reflects, of
course, the influence of Christmas buying.
Stores which emphasize gift merchandise may
make a third or more of their sales in the
fourth quarter. For many of these merchants
the margin of profit or loss for the year is
largely determined by holiday trade.
Total retail sales in the fourth quarter of
1962 were at a record annual rate of over

240 billion dollars. Sales of auto dealers in­
creased sharply between the third and fourth
quarters while sales of other stores rose
slightly, seasonally adjusted, as shown in the
following table:

Auto dealers .
Other stores .
Total retail

Third quarter Fourth quarter
1962 to
1961 to
fourth quarter fourth quarter
(per cent increase)

In the four weeks ending December 29,
which included the bulk of the Christmas
trade, department store sales in the nation
were 5 per cent above the record 1961 period.
For the Seventh Federal Reserve District the
gain was 8 per cent with increases ranging
from 4 per cent in Indianapolis and Milwau­
kee to 12 per cent for the Chicago area.

Sales of auto dealers and general
merchandise stores led the rise
in retail trade in fourth quarter
billion dollars

B u sin e ss C o n d itio n s, Fe b ru a ry

The strong trend in auto sales in the fourth
quarter brought the total number of new cars
sold to American purchasers last year to 7.1
million including imports—a level projected
only by the most optimistic forecasts at the
start of the year. This number was 19 per
cent above the 1961 total and was exceeded
only in 1955. In dollar terms, car sales were
substantially above any previous year as the
rise in sales was accompanied by a trend
toward larger, more powerful and more elab­
orately equipped cars.
Consumers have recently increased their
use of instalment credit as their purchases of
durables have risen. The November expan­
sion in such credit outstanding—almost 600
million dollars, seasonally adjusted—was the
largest since 1959. Extensions of credit
amounted to almost 5 billion dollars, the
highest on record. Automobile paper ac­
counted for 36 per cent of the extensions of
instalment credit during November and 41
per cent of the outstandings at the end of the
month. During 1962, 59 per cent of all new
cars purchased were financed, about the same
as in 1961, but a smaller proportion than in


any of the years in the 1955-60 period.
While consumer expenditures have shown
greater strength in recent months, Govern­
ment purchases of goods and services con­
tinued to rise steadily and current estimates
indicate that this trend will continue in 1963.
These developments have encouraged a spirit
of optimism among many business groups
which contrasts with the cold weather “blues”
often characteristic of the early weeks of a
new year. Substantial gains in business have
been forecast by polls of purchasing agents,
construction contractors and manufacturers
of appliances, carpets and furniture. Pro­
ducers of autos and TV expect, at worst, mild
reductions from the high levels of 1962.
Views of businessmen can shift markedly
in short periods of time. Last year optimism
early in the year gave way to bearishness in
the summer and early fall. The recent surge
in confidence, of course, can melt away if in­
coming business proves disappointing. How­
ever, for the period immediately ahead busi­
ness decisions apparently will be made in an
atmosphere much improved from that which
prevailed a few months ago.

in banking and finance
Negotiable time certificates of deposit

T„ sharp rise in time and savings deposits
was probably the outstanding development in
commercial banking in 1962. At the end of
the year, these deposits at commercial banks
totaled 97 billion dollars, almost 20 per cent
higher than at the end of 1961. Furthermore,

the increase was the greatest for any year in
the postwar period. The rise was sharpest at
large banks in major cities with the weekly
reporting banks in Chicago, for example,
showing an increase of almost 30 per cent.
Among the various types of time deposit


Federal Reserve Ba nk o f Chicago

services offered by banks, time certificates of
deposit in denominations of 100,000 dollars
or over expanded most rapidly. These cer­
tificates, popularly known as CDs, are gen­
erally in negotiable form and readily market­
able, enabling them to be sold at any time.
They are, of course, redeemable upon matur­
ity at the banks issuing them.
Over 800 million dollars of these large
certificates of deposit were outstanding at
Seventh District banks at the end of 1962,
more than twice the volume at the end of the
preceding year. Large New York City banks
experienced a similar rate of growth and had
about 1.8 billion dollars in these CDs out­

time by selling their certificates. The breadth
of the market along with the short maturity of
most CDs assured depositors that certificates
could be sold at any time for approximately
their face value thereby giving them many of
the characteristics of such short-term money
market instruments as Treasury bills, com­
mercial paper and bankers acceptances, and
were soon accepted as such by an increasing
number of investors.

C D - a sample certificate
T h e \in K N u ii> N U .£ u K
TC c & V Q O H l i s n » x

o r


D e v e lo p m e n t o f se c o n d a ry m a rk e t


The very rapid expansion of CDs in 1962
is attributed both to the increase in interest
rates offered by banks and the development
of a secondary market in these certificates.
CDs are not new; some banks have issued
them for many years. Before 1961, however,
they were traded infrequently since there was
no organized secondary market. This meant
that depositors were unable to reacquire their
funds prior to the maturity date. The volume
of funds available for investment in CDs
under these conditions was quite limited.
In order to gain greater access to the vast
national market for short-term funds, a large
New York City bank arranged in early 1961
for a Government securities dealer to provide
a market for the certificates issued by the
bank. Soon afterward other large banks
stepped up their sales of CDs and more deal­
ers commenced trading in them. The devel­
opment of a viable secondary market for
CDs substantially altered the nature of the
On the one hand, depositors could now
obtain the use of their time deposits at any


® 340da, kan


"" '


On the other hand, the broadened market
enabled banks to tap the vast national pool
of short-term funds much more effectively.
Possibly the most revolutionary feature of
CDs is that for the first time banks were able
to compete for funds on an equal footing with
other borrowers, limited only by creditworthiness and their willingness and ability to
pay for the funds.1
Prior to 1961, banks were generally able
to attract additional deposits from large busi­
ness firms only by entering into loan agree­
ments. Banks whose service areas were
limited to a particular metropolitan area or
region were further restricted in their quest
’While individual banks can increase deposits in
this way, all banks cannot do so simultaneously.
Expansion of total bank deposits is limited by the
volume of reserves provided by the Federal Reserve
System and the legal reserve requirements on de­
posits set by the System.

B u sin e ss C o n d itio n s, Fe b ru a ry

for additional deposits by geographical con­
siderations. Since 1961, with the develop­
ment of an active secondary market for CDs,
any bank which has a national reputation can
bid for deposits from any part of the country
and without an accompanying obligation to
extend loans concurrently.
Although holders of CDs can sell them at
any time, the bank retains the deposit at least
until the stated maturity date. Thus, while the
development of the secondary market effec­
tively removed the maturity date for deposi­
tors, it did not alter the length of time banks
have the use of the funds.
F a v o ra b le fo r la r g e b a n k s

on certificates of comparable maturities
issued by a few of the country’s most promi­
nent banks.
The standard unit of trade in CDs is 1
million dollars and multiples thereof. This
also tends to orient the market toward cer­
tificates issued by large banks whose financial
strength enables them to accommodate the
higher denominations. A limited volume of
transactions is conducted in denominations of
less than 1 million dollars, mostly 500,000
dollars and on occasion as small as 100,000,
but these are not common and the certificates
sell at lower prices (higher yields).
Because of the financial strength and
reputation of large money market banks, CDs
issued by them yield only slightly higher rates
than Treasury bills—the money market in­
strument generally considered to have the
least risk of default and to be the most readily
marketable. The spread between interest
yields on CDs issued by large banks and on
Treasury bills of comparable maturities fluc­
tuates between 2/10 and 4/10 of a per cent,
widening as the time to maturity lengthens.
Rates on CDs approximate those on prime

Interest rates on CDs, like those on other
money market instruments, are determined in
part by the size and financial reputation of
the issuing bank. Therefore, interest rates
tend to be lower on certificates issued by
large and well-known banks than on those
issued by smaller or less widely known banks.
This is the case with respect to both the rate
stated on the CD at time of issue and the
yield at which the certificates sell in the sec­
ondary market.
Certificates issued by only two
banks with deposits of less than
100 million dollars and 12 banks
M o st CDs have been issued
with deposits of less than 500 mil­
by large banks in the District
lion have appeared on the semi­
C D s issu e d by d e n o m in a tio n s
weekly quote sheet issued by one
$ 5 0 0 ,0 0 0 o r o ve r
$ 1 0 0 ,0 0 0 - $ 4 9 9 ,9 9 9
of the leading dealers. These
D o lla r
N um ber of
D o lla r
d e p o sit
sheets list the amounts and effec­
Num ber
am ount Num ber
am ount
tive yields of CDs offered for sale
(m illio n s )
(m illio n s)
( m illio n s )
by the dealer according to issuing
Under $100
bank. In all, CDs issued by 36
$100 - 200
different banks have been listed
13 6
$200 - 500
by this dealer during 1962. Those
Over $500
issued by smaller banks have been
priced to yield a premium of up
to 2/10 of a per cent over yields



Federal Reserve Ba nk o f Chicago

commercial paper and bankers acceptances.
Interest rates offered by banks on certifi­
cates, similar to rates offered by banks on
most other types of time and savings deposits,
are subject to control under Regulation Q.2
Present regulations prohibit banks from offer­
ing rates higher than:

Deposit payable in:
30 - 89 days
90 days but under 6 months
6 months but under 1 year
1 year or more

interest rate
(per cent)

These ceilings apply only to the interest
rates paid by the banks, not the effective
yields at which the certificates trade. While
banks are prohibited from paying more than
2 Vi per cent on certificates maturing in less
than six months, CDs with less than six
months remaining to maturity currently trade
at yields above that ceiling. This is possible
because market yields have not declined very
rapidly as the CDs approach maturity, and a
CD issued at, say, 3X per cent for seven
months may yield an effective rate of 3 per
cent two months later.

these banks had issued certificates in denomi­
nations of 500,000 dollars or over.
Most CDs were issued by banks in the
major District financial centers. Chicago and
Detroit alone accounted for almost 90 per
cent of the dollar volume. Other District cities
with more than 5 million dollars in certificates
outstanding included, in order of importance,
Milwaukee, Grand Rapids, Flint, Bay City
and Indianapolis. The relatively small volume
reported by Indianapolis banks may be attrib­
uted in part to the 3 per cent interest rate
ceiling on time deposits provided by state
regulation in Indiana.
Business firms were the largest initial pur­
chasers of CDs, having purchased 87 per cent
of the amount outstanding on the survey date.
State and political subdivisions were next, but
accounted for only 7 per cent of the total.
Over 90 per cent of CDs outstanding were
issued with maturities of between six and 12
months—only 7 per cent had maturities of
over one year and 2 per cent, maturities
under six months. Forty-seven per cent were
issued with maturities of between six and
nine months; 16 per cent, nine months to a
year and 28 per cent, exactly one year. The

CD s in th e S e v e n th District

A recent survey of large Seventh District
banks helps to round out the current picture.
The banks were requested to report on their
outstanding negotiable certificates of deposit
in denominations of 100,000 dollars or larger.
Of the 62 banks surveyed, 32 reported that
they had such CDs outstanding on December
5, the survey date, in a total amount in ex­
cess of 800 million dollars. Twenty-two of


zIn October 1962, time deposits of international
agencies and foreign governments and central banks
were excluded from interest rate ceilings for a
period of three years.

B an ks in Illinois and Michigan have
issued the greatest amounts of C D s*
Decem ber Decem ber
3 1 ,1 9 6 0

3 1 ,1 9 6 1

Decem ber
5 ,1 9 6 2

( m illio n d o lla rs )





















W isconsin












* ln d e n o m in a tio n s o f $ 1 0 0 ,0 0 0 o r o ve r.

B u sin e ss C o n d itio n s, Fe b ru a ry

negligible volume issued with maturities of
less than six months is explained by the
tendency during the past two years for the
Treasury bill rate to fluctuate above the 2 Vi
per cent interest rate ceiling that banks are
permitted to offer for time deposits of less
than six months.
While the larger banks accounted for a
high proportion of the total volume of CDs
outstanding, the proportion of their total time
deposits in the form of CDs was no greater
than the proportion for the smaller banks in­
cluded in the survey. Five District banks had
CDs outstanding in excess of 20 per cent of
their total time deposits and these were of
varying deposit size. Eleven banks, again of
varying deposit size, held less than 5 per cent
of their total time deposits in the form of CDs.


For all 32 banks, CDs accounted for 13 per
cent of total time deposits and 54 per cent of
time deposits excluding savings deposits.
In their brief period of existence, negoti­
able certificates of deposit have achieved an
important place both in the deposits of com­
mercial banks and as a money market instru­
ment. Because they enable banks to effec­
tively tap the national money market while
providing investors with a highly regarded
interest yielding liquid asset, the dollar
amount of CDs outstanding may be expected
to expand at a rapid pace until either banks
no longer wish to attract additional deposits
or market interest rates rise to a level where
banks are effectively precluded by legal inter­
est rate ceilings from offering competitive
rates. Neither condition seems imminent.

Monetary policy and
international payments
William McChesney Martin, Jr., Chairman,
Board of Governors of the Federal Reserve System*

TJLhe task of the Federal Reserve, like that
of all parts of our Government, is (in the
words of the Employment Act of 1946) “to
foster and promote free competitive enter­
prise” as well as “to promote maximum
employment, production, and purchasing
power.” These four purposes may well be
summarized under the single heading of
orderly and vigorous economic growth.
*A statement before the joint meeting of the
American Economic Association and the American
Finance Association, Pittsburgh, Pennsylvania,
December 28, 1962.

The Federal Reserve has recently been
criticized for neglecting these goals in favor
of another—the achievement of balance in
our international payments. Other critics of
the Federal Reserve, however, charge us with
neglecting the international payments prob­
lem and with concentrating too much on
domestic goals. Both criticisms overlook what
seems to me an obvious fact, namely, that
our domestic and international objectives are
inextricably interrelated. We simply do not
have a choice of pursuing one to the virtual
exclusion of the other. Both must be achieved


Federal Reserve Ba nk o f Chicago


together, or we risk achieving neither.
Thus, our domestic economic growth will
be stimulated when our external payments
problem is resolved. And our payments situ­
ation will be eased when the pace of our
domestic growth has been accelerated. With
more rapid growth, the United States will
become more attractive to foreign and do­
mestic investors, and this will improve our
payments balance by reducing the large net
outflow of investment funds.
In particular, accelerated growth will pre­
sumably lead to larger internal investment
and credit demand, and so to some gradual
rise in interest rates, not through the fiat of
restrictive monetary policy, but through the
influence of market forces. With rising credit
demand pressing on the availability of credit
and saving, the flow of funds from the United
States to foreign money markets will be more
limited. In addition, a closer alignment of
interest rates internationally can be expected
to result and this will help to reduce the risk
of disturbing flows of volatile funds between
major markets.
Similarly, the maintenance of reasonable
stability in average prices, with progressive
gains in productivity, is more than a basis for
sustained domestic growth. It is also a neces­
sary prerequisite for improving the interna­
tional competitive position of our export
industries and our industries competing with
imports, and thus for increasing our trade
surplus so that it can cover a larger part of
our international commitments. This is not
to deny that prices and costs of some of our
individual industries may be out of line with
those of foreign producers. There are doubt­
less industries where grievous competitive
problems exist for international reasons, and
in these cases a strong enterprise economy
expects the necessary adjustments to be made
through the efforts of such industries.

Even if our country did not suffer from an
international payments deficit, our Govern­
ment would still have to pursue the twin goals
of orderly and vigorous economic growth and
over-all price stability. The payments deficit
provides merely another circumstance that
the Federal Reserve must consider if it is to
make an effective contribution to the fulfill­
ment of the goals set by the Employment Act.
In t e r n a t io n a l r o le o f th e d o l la r

In reaching our decisions on domestic
monetary policy then, the Federal Reserve
cannot ignore our international financial
problems. There might be countries or times
in which there could be enough leeway to do
so. But the United States is not such a coun­
try and the present is not such a time.
The United States at present is the finan­
cial leader of the free world, and the United
States dollar is the main international cur­
rency of the free world. As long as this leader­
ship exists, we are obliged to keep our poli­
cies compatible with the maintenance of the
existing international payments system.
The increase in the volume of world trade
and finance since World War II has led to an
unprecedented integration of the world econ­
omy. This economy has become ever more
closely bound together by ties of trade, in­
vestment, communication, transport, science
and literature. Financially, the world econ­
omy has become coordinated by an inter­
national payments system in which the dollar
serves both as a major monetary reserve asset
and as the most important international
means of payment. And the reliance that the
world has come to place on the dollar requires
that the dollar be always convertible into all
major currencies, without restriction and at
stable rates, based on a fixed gold parity.
It is in the light of the special international
role of the United States and its currency,

B u sin e ss C o n d itio n s, Fe b ru a ry

and therefore of the responsibilities of the
Federal Reserve, that a Federal Reserve con­
cern with maintenance of our gold stock, our
balance of payments and stability of the dol­
lar exchange rate must be understood.
Above all, we must always have in mind
that the role of the dollar in the international
payments system is founded upon freedom
from exchange restrictions. Whatever tempo­
rary advantage might be gained for our pay­
ments deficit by controls over capital move­
ment or other international transactions
would be more than offset by the damage
such controls would do to the use of the
dollar internationally.
R o le o f t h e U. S. g o ld s to c k

A persistent decline in our gold stock is
harmful to the United States economy for
two reasons: First, it endangers our interna­
tional liquidity position, i.e., our continuing
ability to convert on demand any amount of
dollars held either by foreigners or by United
States residents into any other currency they
may need to settle international transactions.
Second, because of our long-established
domestic reserve requirements, a declining
gold stock fosters uneasiness about a cur­
tailed Federal Reserve flexibility to pursue
domestic monetary policies otherwise re­
garded as appropriate and desirable.
Sometimes it is suggested that the decline
in our gold stock could be avoided if we gave
up our policy of selling gold freely to foreign
monetary authorities for monetary or inter­
national settlement purposes. But a decline in
our gold stock stems from the deficit in our
international payments, not our gold policy.
A payments deficit initially means an accu­
mulation of dollars in the hands of foreign­
ers, as virtually all of their commercial or
financial transactions with residents of the
United States are settled in dollars. If foreign

corporations or individuals choose not to hold
dollars, they convert them into their own or
into other foreign currencies; in either case,
the dollars fall eventually into the hands of
one foreign central bank or another.
If in turn the foreign central bank acquir­
ing dollars chose not to enlarge its dollar
holdings and if it could not convert its dollar
receipts into gold, it would present dollars to
us for redemption into its own currency. Once
United States holdings of that currency, in­
cluding credit availabilities, were exhausted,
we could acquire the currency only by selling
gold. If the United States declined to sell gold
in such circumstances, foreign private recipi­
ents of dollars could no longer count on con­
verting dollars at par into their own or other
foreign currencies.
Thus, a gold embargo would terminate the
convertibility of the dollar at fixed values, not
just into gold, but into any foreign currency.
This would obviously be the end of the dollar
as a currency that bankers, merchants or in­
vestors could freely use to settle their inter­
national obligations.
Since there is a statutory linkage between
gold and our domestic money supply, through
the minimum gold certificate reserve require­
ments of the Federal Reserve Act, considera­
tion must also be given to the effect of
changes in the United States gold stock on the
gold certificate reserve ratio of the Federal
Reserve Banks. At present, this ratio still ex­
ceeds the required minimum of 25 per cent
both against Federal Reserve Bank deposits
and against Federal Reserve notes. Should it
fall below that minimum, the Board of Gov­
ernors would have full authority to suspend
the Reserve Bank gold certificate reserve
Some interest has been expressed in the
mechanics of suspending these requirements.
Let me summarize them at this point in brief-



Federal Reserve Ba nk o f Chicago


est form. Upon action to suspend require­
ments, the Board of Governors would have
to establish a tax on the Reserve Banks grad­
uated upward with the size of their reserve
deficiencies. The tax could be very small for
as long as the reserve deficiencies were con­
fined to the reserves against deposits and the
first five percentage points of any deficiencies
against Federal Reserve notes. If the reserve
deficiencies should penetrate below 20 per
cent of Federal Reserve notes outstanding,
the tax would undergo a fairly steep gradua­
tion in accordance with statutory specifica­
The Federal Reserve Act further specifies
that, should the reserve deficiencies fall below
the 25 per cent requirement against notes, the
amount of the tax must be added to Reserve
Bank discount rates. But if the reserve de­
ficiencies were confined to reserves against
Reserve Bank deposits, the required penalty
tax could be nominal and no addition to dis­
count rates would be necessary.
It is perhaps easier to talk about this sub­
ject just now when the gold stock has shown
no change for two months. But our progress
this year in rectifying our international pay­
ments disequilibrium has fallen short of our
target, in part because of a rise in our imports
of IVi billion dollars. Hence, we must now
intensify our efforts to re-establish payments
balance. And until we have regained equili­
brium, we shall have to be prepared to settle
some part of any deficits experienced through
sales of gold.
Nevertheless, any decline in our gold stock
large enough to bring its level significantly
below the gold certificate reserve requirement
of the Federal Reserve could raise further
questions about maintenance of dollar con­
vertibility. And it could also lead to heavy
pressures on the United States monetary
authorities to take strong deflationary action

that might be adverse to the domestic econ­
omy, or, alternatively, to pressures on Con­
gress to devalue the dollar, a subject to which
I return later. It is of utmost importance,
therefore, to shorten as much as possible the
period in which further large decline in our
gold stock will occur and to hasten the arrival
of a period in which our gold stock may from
time to time increase.
The point I should like most to emphasize
here is the following: No question exists or
can arise as to whether we shall pay for the
debts or liabilities we have incurred in the
form of foreign dollar holdings, for that we
most certainly must do— down through the
last bar of gold, if that be necessary. What is
in question is how we best manage our affairs
so that we shall not incur debts or liabilities
that we could not pay.
B a la n c e o f p a y m e n t s

To maintain the credit-worthiness of the
United States, to support confidence in the
dollar, to check the decline in our gold stock,
to bring our international payments and re­
ceipts into balance without interfering with
the convertibility of the dollar—these objec­
tives are all synonymous one with another.
We in the Federal Reserve are concerned
about the balance of payments because it is

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B u sin e ss C o n d itio n s, Fe b ru a ry

vital that the full faith and credit of the
United States not be questioned.
Our international payments deficit this
year was less than Vi of 1 per cent of our
gross national product. That deficit did not
represent a decline in our international wealth
because the rise in our foreign assets ex­
ceeded the drop in our net monetary reserves.
Yet the deficit was of vital concern in that it
extended by one more a series of large defi­
cits, a series that has now persisted for five
A payments deficit means either a decline
in United States gold or foreign exchange re­
serves, or an increase in United States short­
term liabilities to foreigners. In either case, it
worsens the ratio of reserves to liabilities; in
other words, it weakens the nation’s interna­
tional liquidity position.
The United States, as the free world’s lead­
ing international banker, can fulfill its role
only if it keeps the confidence of its deposi­
tors. No banker can suffer a continuous de­
cline in his cash-deposit ratio without court­
ing danger of a run.
The best method to combat a payments
deficit is to improve the competitive position
of our export industries and our industries
competing with imports. This method can be
effective only in the long run, but in the long
run it is bound to be effective. And its accom­
plishment will have an expansive rather than
contractive influence on our domestic econ­
omy as a whole.
D o lla r e x c h a n g e r a t e

Some economists have argued forcefully
that as a general principle a country, suffer­
ing at the same time from external deficit and
from domestic unemployment, should de­
value its currency, either by a shift to a float­
ing rate or by a change in its gold parity. But
if there ever is any merit to that argument, say


in the case of countries whose currencies are
not extensively used in international transac­
tions, it is not applicable to the United States.
This is so because the United States, as the
world’s leading banker, is responsible for a
large part of the monetary reserves of foreign
countries and for the great bulk of the inter­
national working balances of foreign bank­
ers, traders and investors. We have accepted
these balances in good faith and as I said
earlier, we must stand behind them.
Whatever other consequences would fol­
low from a devaluation of the dollar, I am
convinced that it would immediately spell the
end of the dollar as an international currency
and the beginning of a retreat from the pres­
ent world role of the United States that would
produce far-reaching political as well as eco­
nomic effects. It would, in my judgment, in­
vite the disintegration of existing relation­
ships among the free nations that are essential
for the maintenance and extension of world
prosperity and even world peace.
It has sometimes been suggested that we
could maintain the dollar as an international
currency simply by giving a gold value guar­
antee to some or all foreign holders of liquid
dollar assets. At first glance, it might seem a
good idea for a foreign central bank or a
foreign investor to own an asset that would
be not only as good as, but actually better
than gold: a kind of interest-bearing gold. But
I do not think that the suggestion for a gold
value guarantee is realistic.
First, if foreign holders of dollars did not
trust our repeated assurance that we would
not devalue the dollar, they would hardly
trust our assurance that, if we devalued the
dollar contrary to our previous assurance, we
would do it in such a way that some or all
foreign holders would be treated better than
domestic holders.
Second, I do not think it would be possible


Federal Reserve Ba nk o f Chicago

to limit effectively a gold value guarantee to
the dollars held by some or all foreign hold­
ers; and if it were possible to make an effec­
tive distinction between foreign and domestic
holders, this would amount to unjustified dis­
crimination against domestic holders. In my
judgment, neither Congress nor public opin­
ion would tolerate any such discrimination.
In spite of our international payments
deficit, the United States has refrained from
drastically cutting Government expenditures
abroad for defense or for economic aid and
from curtailing the freedom of capital move­
ments. To have done otherwise would have
undermined our position of economic and
political leadership of the free world. So
would any failure on our part to maintain the
established par value of the dollar.
R o le o f t h e F e d e r a l R e s e r v e


Within the limitations set by the interna­
tional role of the dollar, what can the Fed­
eral Reserve do to achieve its domestic policy
goals together with contributing to the
achievement of international balance?
My friends sometimes accuse me of being
a chronic optimist. But I believe that we can
find ways of furthering our domestic eco­
nomic aims while, at the same time, we are
making progress in overcoming our payments
problem internationally. And I believe that
these ways will contribute better to sustain­
able economic growth than would flooding
the economy with money.
Indeed, my present feeling is that the
domestic liquidity of our banks and our
economy in general is now so high that still
further monetary stimulus would do little if
any good—and might do actual harm—even
if we did not have to consider our payments
situation at all. This means that if any addi­
tional governmental action is needed in the
financial field in order to give fresh expansive

impulse to the economy, it would probably
have to come from the fiscal side. The part
played by monetary policy, from both an in­
ternal and an external point of view, would
then be mainly supplementary and defensive.
In this context, monetary policy would
have to be on guard against two dangers:
First, the danger that too rapid domestic
monetary expansion would eventually pro­
duce rising domestic costs and prices as well
as unwise speculation and in this way curtail
exports and over-stimulate imports; Second,
the danger that too easy domestic credit avail­
ability and too low borrowing costs would
encourage capital outflows.
For the past few years, monetary policy
has already contributed to the needed sta­
bility of the domestic price level, while prices
in some other important industrial nations
have been under steady upward pressure. In
specific terms, Federal Reserve policy has
been seeking to maintain a condition of credit
availability that would be adequate for do­
mestic needs while avoiding any serious
deterioration of credit standards or any wide­
spread speculative reliance on credit financ­
ing and at the same time limiting the spillover
of credit funds—short-term and long-term—
into foreign markets.
Nevertheless, our monetary policy has re­
mained easier through this economic cycle
than during previous cycles because that has
seemed to be needed in a domestic situation
of lagging longer-term growth and a lessthan-robust cyclical expansion. In balancing
the scope and the limitations of our monetary
policy, however, I am convinced that, within
limits imposed by human imperfection, the
Federal Reserve has paid neither too much
nor too little attention to our international
payments problem.
As I mentioned at the outset, criticism of
our policy through this economic cycle has

B u sin e ss C o n d itio n s, Fe b ru a ry

been about equally divided between two
groups. The first complains that we have vio­
lated the classical principle of an interna­
tional payments standard based on fixed ex­
change rates by failing to contract our money
supply in the wake of a decline in our gold
reserves. The second complains that we have
neglected our duties to the domestic economy
by permitting the decline in our monetary
reserves to have some impact on our money
markets, especially on short-term interest
If all criticism had come from one side
only, I would still believe it unjustified. But
the very fact that criticism comes from both
sides inclines me even more strongly to the
comforting thought that we have been keep­
ing to the golden mean.
F o r e ig n c u r r e n c y o p e r a t io n s

The Federal Reserve has not been content
to limit its participation in solving the coun­
try’s payments problem to its traditional
tools of monetary policy. It has felt a par­
ticular need to set up defenses against specu­
lative attacks on the dollar pending an orderly
correction of our payments disequilibrium.
And it has felt a more general need to co­
operate directly with foreign central banks in
efforts to reinforce the international payments
structure. Recognition of these needs under­
lies the decision that we took just a year ago
to participate on Federal Reserve account in
foreign currency operations.
Since the Treasury also engages in similar
operations, Federal Reserve activities have
had to be, and will continue to be, conducted
in cooperation with those of the Treasury.
Smooth coordination has been facilitated by
the fact that the instructions of both agencies
are carried out through the same staff mem­
bers of the Federal Reserve Bank of New
York, headed by Mr. Charles A. Coombs,

Vice President in charge of the Foreign De­
partment of that Bank and Special Manager
for Foreign Currency Operations of the Fed­
eral Open Market Committee. At the same
time, both the Board of Governors and the
Federal Reserve Bank of New York have en­
deavored to maintain close contact with the
central banks of foreign countries, bilaterally
as well as through regular meetings of the
Organization for Economic Cooperation and
Development in Paris and the Bank for In­
ternational Settlements in Basle.
The most important foreign currency ac­
tivity of the System thus far has been the
conclusion of reciprocal currency arrange­
ments with leading foreign central banks and
the Bank for International Settlements. Un­
der these arrangements, the System acquires,
or reaches agreement that it can acquire on
call, specified amounts of foreign currencies
against a resale contract, usually for three
months. Concurrently, the foreign central
bank acquires, or can acquire on call, an
equivalent amount of dollars under resale
contract for the same period.
In these contracts, both parties are pro­
tected during the active period of a swap
arrangement against loss in terms of its own
currency from any devaluation or revaluation
of the other party’s currency. These arrange­
ments, of course, are subject to extension or
renewal by agreement. Interest rates paid on
the deposit or investment of funds acquired
through swaps are set at equal levels for both
parties, in the neighborhood of the current
rate for U.S. Treasury bills, so that, as long as
neither party utilizes any of its currency
holdings, there is no gain or loss of income
for either.
So far, agreements have involved a total
approximating 1 billion dollars. For the most
part, they are stand-by arrangements. Only a
small fraction of actual currency drawings



Federal Reserve Ba nk o f Chicago

has been utilized for market operations. And
a large part of amounts so utilized has been
reacquired and used for repayment of the
swap drawings.
In entering into swap arrangements, the
Federal Reserve has had three needs in view.
First, in the short run, swap arrangements can
provide the System with foreign exchange
that can be sold in the market to counter
speculative attacks on the dollar or to cushion
market disturbances that threaten to become
Second, swap arrangements can provide
the Federal Reserve with resources for avoid­
ing undesired changes in our gold stock that
may result when foreign central banks accu­
mulate dollars in excess of the amounts they
wish to hold, especially if these accumula­
tions seem likely to reverse themselves in a
foreseeable period.
Third, when the United States balance of
payments has returned to equilibrium, swap
arrangements with other central banks may
be mutually advantageous as a supplement to
outright foreign currency holdings in further­
ing a longer-run increase in world liquidity,
should this be needed to accommodate future
expansion of the volume of world trade and

velopment could be modified, of course, by
further changes in the institutional frame­
work of our international payments system.
For this reason, the Board’s staff, in coopera­
tion with the staffs of the Treasury and other
interested agencies of the Government, is
carefully scrutinizing the various recent pro­
posals designed to adapt, strengthen or re­
form this framework.
Whatever the fate of these reform propo­
sals, it seems likely that Federal Reserve
operations in the international field will need
to be continued for the foreseeable future.
The Federal Reserve’s involvement in foreign
exchange problems is the inevitable conse­
quence of its role as the central bank respon­
sible for the stability of the world’s leading
currency. Such a responsibility necessarily
carries with it the responsibility for helping
to preserve and improve the existing interna­
tional monetary system, thus to contribute to
the stability and prosperity of the free world.

1962 A n n ual Report
T h e 1 9 6 2 A n n u a l R e p o rt o f th e F e d e ra l
R e se rve B a n k o f C h ic a g o fe a tu re s a stu d y
o f the c o n stru c tio n in d u s try a s w e ll a s th e

C o n c lu d in g r e m a r k s


As long as the United States balance of
payments is in over-all deficit, and we are
therefore losing rather than gaining monetary
reserves, on balance, the Federal Reserve
cannot expect to accumulate outright large
amounts of foreign exchange. Meanwhile,
System holdings of foreign currencies will
necessarily be limited to relatively small
amounts, swollen on occasion by swaps.
But over the longer run, the System may
find it useful to increase gradually its foreign
currency holdings and operations. This de­

B a n k 's fin a n c ia l s ta te m e n ts a n d b r ie f re ­
v ie w s


la s t

y e a r's

d e v e lo p m e n ts


S e v e n th D is tric t b u sin e ss, a g ric u ltu re a n d
b a n k in g . T h e c o n stru c tio n a n a ly s is tra c e s
a c tiv ity


h o m e b u ild in g ,

n o n re s id e n tia l

p riv a te c o n stru c tio n a n d p u b lic w o rk s d u r ­
in g th e

1 9 4 6 - 6 2 p e rio d . C h a n g e s in the

stock o f s tru c tu re s , fin a n c ia l a n d te c h n ic a l
d e v e lo p m e n ts a n d th e s ta b ility o f th e in ­
d u s try re la tiv e to g e n e ra l b u sin e ss a re em ­
p h a siz e d .

C o p ie s

o f th e

A n n u a l R e p o rt

m a y be o b ta in e d b y w ritin g to th e B a n k .

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102