Full text of Business Conditions (Federal Reserve Bank of Chicago) : March 1964

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A review by the Federal Reserve Bank o f Chicago

Business
Conditions
1 9 6 4 March

Contents

The state of the economy
— the problems before us

Gold in the world's
monetary machinery

Federal Reserve Bank of Chicago

The state of the economy
— the problems before us
A s man continues his quest for more and
better goods and services, he inevitably en
counters the restraints imposed by limited
resources, including his own limited ability to
use these resources efficiently. There is hope,
of course, that by studying how resources are
used, ways can be found to produce greater
supplies of useful products and thereby pro
vide higher standards of living for more
people.
The Employment Act of 1946 provides for
a Council of Economic Advisers to assist the
President in maintaining a continuous study
of the performance of the economy and in
proposing changes in laws and Government
programs to improve performance in both
private and public sectors of activity. Each
year the Council prepares an Annual Report
to the President that is made available to the
public in January.
In its Report for 1964 the Council noted
that the “American economy has recorded
nearly three years of solid expansion” since
the current rise in activity began in the first
quarter of 1961. The Council concluded that
there was no evidence to indicate an early
recession but contended that the tax cut, then

pending before Congress and subsequently
signed into law by the President on February
26, was “urgently needed” to accelerate eco
nomic growth toward “full employment.”
Big pro blem s

The major function of the Council is to
call attention to conditions that are hamper
ing or are likely to hamper the optimum use
of resources and to propose possible reme
dies. The current report, therefore, comments
upon a number of major problems which the
Council believes are retarding achievement of
maximum output and efficiency of the na
tion’s economy.
These problems include (1) reducing un
employment of men and facilities to accepta
ble levels; (2) reducing the proportion of the
nation’s population with family income below
the amount needed to provide a decent mini
mum standard of living; (3) accelerating
advances in technology—the basis for all
economic progress— and cushioning the hard
ships created for some individuals and com
munities as a result of this progress; (4)
restraining any tendency toward excessive
price and wage increases as activity rises in

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Business Conditions, March 1964

1964, and (5) reducing the deficit in the
nation’s international balance of payments
and maintaining the value of the dollar in
world trade.
Id le re so u rce s

Almost everyone agrees that the United
States economy could produce goods and
services in greater volume than it is at pres
ent. Unemployment is relatively large com
pared with past periods of prosperity and
surveys of manufacturing firms indicate that
most industries have unused capacity.
How large is the difference between actual
and potential output? At best, this must be
a fairly rough estimate and this theoretical
“gap” will vary depending upon judgments of
achievable minimum unemployment levels,
rate of gain in efficiency and the ability to
adapt the idle resources to production of
needed goods and services and for other rea
sons. Judgments differ also on the extent to
which output could be raised from present
levels without reawakening excessive infla
tionary pressures. In fact, some believe that
these pressures were undesirably strong in
1963 when the Bureau of Labor Statistics’
consumer price index rose 1.5 per cent
although its index of wholesale prices con
tinued relatively stable.
The Council estimates that there was an
output gap in the fourth quarter of 1963
equal to an annual production of 30 billion
dollars of goods and services. In other words,
had the actual performance during the quar
ter matched the potential envisaged by the
Council, output would have been at an
annual rate of 630 billion dollars or 5 per
cent above the actual rate of 600 billion.
Even if there were no margin of unused
capacity, output could be increased by elim
ination of impediments to efficiency. For
example, any monopolistic practices of busi

ness and organized labor would come under
this heading as would Government programs
that help to maintain prices above competi
tive levels or to promote investment that
tends to maintain production of certain kinds
of goods in excess of current requirements.
Production also can be stimulated under
most circumstances by expanding the supply
of money and credit, by stepping up Gov
ernment spending without a corresponding
boost in tax revenues or by reducing taxes
without an offsetting reduction in Govern
ment spending. The Council endorses tax cuts
as the most important means of stimulating
faster growth of production in the current
circumstances to boost both consumer de
mand and private investment.
The tax cut is expected to reduce Govern
ment revenues about 8 billion dollars in 1964.
There can be no serious question that the
effect will be expansionary. Consumers and
business will tend to spend and invest more
if their after-tax incomes rise. But increased
dollar income is not translated automatically
into increased production.
Many analysts are apprehensive that the
most serious economic problems are misallocation of capital investments and lack of
proper training of the unemployed and that
these may not yield readily to measures de
signed primarily to increase aggregate dollar
income. To the extent this may be the situa
tion, with the economy already in an upswing,
the stimulation provided by the tax reduction
could cause additional upward pressure on
prices well before full employment is reached.
To help guard against this possibility the
Council reiterates its earlier proposal for
wage and price restraint.
P ric e -w a g e “ g u id e p o sts”

Although “the price stability of 1961-63
has resulted in part from persistent slack in

Federal Reserve Bank of Chicago

In setting prices individual industries are
the economy . . . the Council states, “an
asked to compare their own changes in trend
other major factor has been the responsible
productivity with that of the entire private
action of most union and business leaders in
making noninflationary wage and price deci
economy. It is appropriate, the Council be
sions.” Since the tax cut and other current or
lieves, to raise prices to accommodate defi
pending Government programs are intended
ciencies between an industry’s and the econ
omy’s trend productivity. On the other hand,
to largely eliminate the “slack” in the econ
omy, continued price stability during 1964
if an industry’s trend productivity exceeds the
presumably will depend even more heavily
national average, “product prices should be
than in the recent past on “responsible
lowered enough to distribute to the industry’s
action” by union and business leaders.
customers the labor cost savings it would
make under the general wage guidepost.”
It is argued that in a competitive society
an “unseen hand” guides economic decisions
For the entire period 1947-63, the annual
average increase in output per man-hour for
toward the general good even though particu
lar actions are motivated .by the hope of pri
the entire private economy is estimated to
have been 3.2 per cent. Trend productivity
vate gain. Many observers believe, however,
for the five years ending in 1963 also aver
that this condition no longer holds as a result
aged 3.2 per cent compared with 2.3 per cent
of the great market power wielded by large
in 1960.
business firms and industrywide unions. In
the words of the Council: “Either manage
Despite difficulties in measurement, esti
ment or labor, by unrestrained pursuit of its
mates of trend productivity constitute a useful
own near-term advan
tage, could reactivate
Th e impacts of earlier postwar tax cuts varied . . .
the price-wage spiral
that has remained qui
escent for several
years.” The Council
unem ploym ent ra te
disposable personal income
considers wage in
creases to be noninfla
tionary if the annual
percentage increase in
total compensation per
man-hour does not ex
ceed the national trend
output per man-hour,
calculated as the aver
age rise in output per
man-hour of all goods
and services produced
in the private sector of
the. economy during
.2
4
.6
the most recent fiveyear period.
W M m HHHS9SS I Si
1st quarter 1 9 4 8 *

effective tax cuts

■
^
quarters before and after tax cuts became effective

Business Conditions, March 1964

yardstick for judging whether or not private
decisions on wages and prices are noninflationary according to the Council. If wage
increases exceed trend productivity, prices
will tend to rise.
Individuals involved in decisions that will
result in changes in prices or wages clearly
are confronted with considerable difficulty if
they attempt to apply the Council’s sugges
tions to specific cases. Nevertheless, the
Council believes adherence to the price-wage
guideposts “not only would make for overall
price stability but would be generally consist
ent with the tendencies of competitive labor
and product markets.”
Thus, where wages and prices are set in
competitive markets, it would appear that
wage-price decisions will automatically ap
proximate the guideposts. Where competition
does not bring this result, wage and price
negotiators are asked to police themselves

much as public utilities are policed by regu
latory commissions.
Widespread differences of opinion exist
about the extent to which the present Amer
ican economy offers buyers and sellers truly
competitive markets. It can be maintained
that the failure of prices and wages to decline
in the period since 1957 despite significant
amounts of unused resources implies the
existence of rigidities associated with exces
sive concentration of market power. If it is
desired that conditions more nearly approxi
mate those of competition and if those who
determine prices and wages do not respond to
the suggestion that they make decisions simi
lar to those that would be made in a com
petitive environment, a reduction in the ex
tent of such market power may be the only
remedy.
There are a number of ways in which Gov
ernment reduces market competition and
substitutes administrative decrees for the de
as indicated by general economic measures
cisions of many buyers
and sellers. Examples
are found in the agri
cultural programs, tar
in d u stria l production
nona g ricultural employm ent
iffs and import quotas,
regulation of transpor
tation, price mainte
nance laws and quotas
restricting production
of crude petroleum.
F o r the most p art
these programs reflect
successful attempts of
interested groups to
obtain legislation that
helps insulate them
from competitive mar
ket forces. Elimination
or reduction of such
governmental aids to

per cent, 1957-59 =100

Federal Reserve Bank of Chicago

monopoly clearly would allow competitive
forces to operate in a broader area and would
lead to more efficient use of resources and
larger total production. But such improve
ments may be purchased at the expense of
some other objectives of public policy.
C h a lle n g e of tech n o lo g ica l ch an g e

Innovation, which can help reduce costs or
pave the way for new or improved goods and
services, is looked upon by the Council as
“the great reconciler.” Technological change
permits the satisfaction of apparently con
flicting desires—higher wages and larger out
put along with increased leisure and stable
prices. It also improves the nation’s competi
tive position in world markets.
Last year the nation’s output was seven
times as great as in 1900. This gain was ac
complished with a rise of only 80 per cent in
man-hours worked while output per man
hour increased 300 per cent.
The tax credit on the purchase of new ma
chinery and equipment and the accelerated
depreciation permitted in 1962 are helping
to encourage investment. The tax cut is ex
pected to further stimulate investment by in
creasing profit potential through increases in
sales, reduction in corporate tax rates and
rates on the upper brackets of personal in
come and a broadening of the investment tax
credit.
These factors encourage business to make
additional investments in new equipment al
ready developed by producers of capital
goods. Government and business also are
stimulating technological change by making
large expenditures for research and develop
ment. In 1963 total expenditures on research
and development exceeded 16 billion dollars,
more than three times the total of 1954.
“Growing sophistication in the use of economic policy, particularly fiscal and monetary

policy,” the Council maintains, “is capable
of righting the balance whenever job-destroy
ing effects of technological progress outweigh
its job-creating effects.” Nevertheless, addi
tional Federal aids are advocated to help
retrain or relocate workers displaced by
changes in technique.
The degree to which technological change
is accelerating and the extent to which, on
balance, it may be eliminating or creating
jobs is unknown. But it is clear that the pro
cess called “automation” is really a continua
tion of the centuries old process formerly
known as “mechanization.” It will be aided
and the impact upon men and capital will be
eased by a maximum flexibility of movement
and utilization of workers and other re
sources. Future problems will be aggravated
by any attempts to impede this development.
If employment can be boosted and tech
nological progress maintained at a high or
even accelerating rate, average income will
continue to rise. In 1947 the incomes of
United States families ranged above and be
low a midpoint of $4,117 in terms of 1962
prices. By 1962 the midpoint had risen to
$5,956. During this period the proportion of
families with current incomes of less than
$3,000 declined from 32 per cent to 20 per
cent. Despite this substantial progress, about
9.3 million American families, including 30
million persons still had incomes of $3,000
or below in 1962 and were classified by the
Council as “poor.”
In general, measures that improve the effi
ciency of the economy and enable it to oper
ate closer to optimum capacity will improve
the environment in which the poor as well as
others find jobs. But measures that help to
increase the flexibility and skills of the labor
force could have a more direct effect in boost
ing incomes at the lower levels. Measures to
reduce discrimination in employment, cut

Business Conditions, March 1964

Since 1961 productivity gains
have been close to increases
in worker compensation

down the incidence of illness, expand educa
tional and job training facilities and strength
en job placement services could help many
persons of ability and determination to raise
their status. Programs to accomplish these
goals exist. The need is to improve and ex
pand activities that are insufficient.
B alan cin g th e b a la n ce of p a ym en ts

In recent years no broad survey of the
national economy has been complete without
a commentary on the deficit in this country’s
balance of payments. The Council points out
that the nation has continued to have a sur
plus of exports as compared with imports of
goods and services and this “favorable” bal
ance appears to be improving. (The difficulty
in balancing the totals relates largely to capi
tal, aid and defense transactions.) Moreover,
total United States assets in other countries

probably have been increasing
faster than total liabilities to for
eigners. Nevertheless, the “defi
cit,” defined as the increase in
foreign short-term liabilities plus
the outflow of gold, has averaged
more than 3 billion dollars per
year since 1957 and rose from 2.2
billion dollars in 1962 to an esti
mated 2.6 billion dollars in 1963.
The United States balance of
payments deficit worsened sub
stantially in the first half of 1963
mainly because of an increased
outflow of long-term capital. A
number of steps were proposed or
taken to deal with this develop
ment, of which the following were
most important: (1) higher short
term interest rates to reduce the
incentive to purchase higher yield
ing foreign obligations; (2) re
duced military spending abroad;
(3) further “tying” of foreign aid to United
States exports; (4) arrange for borrowing
from the International Monetary Fund; (5)
an interest equalization tax to be made effec
tive retroactive to the day following the
President’s July 18 message, and (6) an
intensified campaign to expand exports and
promote tourism in the United States.
No one believes that the balance of pay
ments problem will be resolved permanently
in the immediate future. Nevertheless, there
is ground for hope along the lines set forth
by a Brookings Institution study undertaken
at the request of the Council, the Treasury
and the Bureau of the Budget. Assuming an
acceleration in the nation’s rate of economic
growth, the study projected that the nation
would have a basic payments surplus (exclu
sive of short-term capital flows, unrecorded
transactions and special Government trans-

Federal Reserve Bank of Chicago

ment declined sharply and total capital spend
ing did not exceed the 1956-57 level (in
constant dollars) until last year. Meanwhile,
capacity to produce these goods had been
increased. As a result, prices were relatively
stable and were reduced in many cases. Of
equal importance, especially in international
competition, delivery times on new orders
for capital goods were shortened substan
tially.
Examination of the nation’s balance of
payments position, therefore, reveals the
close relationship between developments in
international trade and the domestic econ
omy. Can the nation achieve “full employ
ment” and an increase in the proportion of
total spending channeled to plant and equip
ment without a renewal of general price infla
tion and a lengthening of lead-times on new
orders? Would enhancement of the forces of
competition hold the greatest promise of re
alizing these desired goals or must there be
resort to greater dependence upon Govern-

actions) of 1.9 billion dollars in 1968 com
pared with a basic deficit of 2.1 billion dollars
in 1962. The Council states that:
A principal factor in the projected im
provement in the U. S. payments balance
was the assumption that the United States
would be better able to maintain internal
cost and price stability than the countries
of Europe . . . .

Since 1958 this nation has been holding
the price line more effectively than most other
industrialized nations. Between 1953 and
1958, however, prices of some of our most
important exports, especially steel and ma
chinery and equipment, increased much more
than prices charged for similar items by our
principal competitors abroad.
Prices for American machinery and equip
ment rose in the 1953-58 period in response
to heavy demand associated with the capital
goods boom that commenced in 1954 and
continued into 1957. In the following year
domestic demand for machinery and equip

U nite d Sta te s balance of payments
GoodIs and services
Exports’

Imports2

Balance

Net govt.
grants and
capital

Net U. S.
private
capital

Net
all
other

Overall
balance3

(billion dollars)

1947
1948
1949

19.7
16.8
15.8

10.3
9.6

1960
1961
1962
1963

27.0
28.3
29.8
31.7

23.2
22.9
25.0
26.1

8.2

11.5
6.4
6.1

3.8
5.4
4.8
5.6

-6.1
-4 .9
-5 .6
- 2 .8
- 2 .8

-3 .0
-3 .5

4.6

- 1 .0

0.1

-0 .9

0.4

1.0

- 0 .6

0 .2

-3 .9
-4 .2
-3 .3
-4 .0

- 1 .0

-0 .9
- 0 .7
-0 .7

-3 .9
-2 .4
- 2 .2
— 2 .6 4

’Includes income on investments,
includes military expenditures abroad.
3Changes in U. S. gold, convertible currencies and liquid liabilities to foreigners.
*The deficit declined sharply in the second half of 1963 from a high annual rate of about 4.2 billion in the first half.

Business Conditions, March 1964

ment for the direction and control of eco
nomic activity?
The foregoing discussion is presented here
to indicate the nature of the basic economic
problems that business, labor and Govern
ment leaders must resolve. The problems are
not unique or even solvable in the sense that
an adequate corrective today will remain

effective tomorrow. Instead, these and similar
problems are inherent parts of the environ
ment in which man seeks to raise his standard
of living. There is fairly wide agreement on
the ends, but a great diversity of views on the
most effective means of achieving these de
sired ends, reflecting our imperfect knowl
edge of the world in which we live.

Gold in the world s
monetary machinery
T L role that gold plays in the world’s
monetary arrangements gradually has be
come more specialized and probably less im
portant overall. Nevertheless, gold retains a
position of prestige: many people automatic
ally think of gold—and its erstwhile com
panion, silver—whenever the word “money”
is mentioned.
Although important, these metals provide
only a small part of the world’s money; the
proportion is especially small in countries
where most payments are made by check.
For example, probably no more than 2 per
cent of all financial transactions in the United
States are made with coins—and gold is not
included in these at all.
While gold and silver have a variety of
uses in industry and arts, these are largely
irrelevant to their use as money. Instead,
these metals came into widespread use as
money centuries ago because of their par
ticular characteristics: durable, easily shaped
and resistant to corrosion. But most impor

tant, these “noble” metals are relatively
scarce and the total supply does not vary
greatly from year to year as do supplies of
many other commodities that might other
wise be satisfactory as monetary mediums.
Because of these characteristics, they can
serve as a combination “yardstick and ware
house”—that is, a measure of relative value
and store of wealth.
In a country with a stable government and
established customs, however, these functions
can be provided better by “paper and ink.”
The weight is less; the flexibility is greater.
Paper money, checks and various accounting
arrangements that minimize actual transfers
of money or in some instances avoid them
altogether have gained popularity.
The supply of money in most of the indus
trially advanced countries has long been de
tached from, and largely unrelated to, the
amount of available gold. Thus, it has been
insulated against the effects of shifts in the
stock of gold available for monetary use as

Federal Reserve Bank of Chicago

well as shifts in private demand for gold to
serve as a store of wealth. In the United
States, for example, the private holding of
monetary gold has been prohibited since
1933 and the holding of gold abroad by
American citizens has been prohibited since
1961.
For international financial transactions,
too, it is more convenient and efficient to use
paper and ink and associated “promises to
pay” than to incur the expense and nuisance
of constantly moving monetary metals around
the world and providing for their security
against loss or theft. Thus in the international
as well as the domestic financial arena, the
allure of the yellow metal may be less strong
than in some former periods.
Currently gold’s major role is that of pro
viding one form of linkage between the vari
ous national currencies and the economies of
the countries that engage extensively in world
commerce. It is largely because of this inter
national linkage that developments such as
the following attract widespread attention:
In 1963, the monetary gold stock of the
United States declined an additional 461 mil

lion dollars—about half as much as each of the
two preceding years.
Soviet sales of gold in European markets rose
to more than 400 million dollars—up from
about 200 million in 1962.
Estimated free world production of gold in
1963 amounted to 1,365 million dollars, 75
million above 1962. The increase of production
has been relatively large since about 1958 even
though inflationary pressures have continued in
evidence through much of the world.
The gold stocks held by central banks and
governments in Western Europe and the Inter
national Monetary Fund rose between 700 and
800 million dollars last year, more than twice
the increase in 1962. The relatively large rise
reflects the lessened demand for private hoard
ing, increased sales of gold by Russia to obtain
exchange used to purchase wheat and other
commodities and sales by the United States.
G o ld in th e U. S. m o n e ta ry m echanism

The U. S. Treasury stands ready to pur
chase and sell gold at the official price of
$35 an ounce, thereby fixing the value of
the dollar in terms of gold. But since banks
and the public in this country are not per
mitted to hold monetary gold or
gold certificates, it is not possible
for shifts in domestic private de
Gold and d o lla r re se rv e s of foreign
mands for gold to cause fluctua
central banks and governments
tions in bank reserves and money
Per cent
supply.
Short-term
gold in
YearThe par value of most curren
total reserves
Gold
dollar claims
Total
end
(million dollars)
cies that are not themselves de
66.8
17,448
8,665
26,113
1958
fined by statute in terms of gold
66.7
18,373
9,154
27,527
1959
are stated to have a par value rela
66.4
10,212
30,438
1960
20,226
tive to the United States dollar of
10,940
32,848
66.7
21,908
1961
1944 gold content. In this way
66.0
11,958
35,136
23,178
1962
most of the world’s currencies are
12,359
36,275
65.9
1963*
23,916
anchored to gold.
So long as foreign monetary
*September
authorities have confidence that
Source: IMF, International Financial Statistics
the United States will be willing

Business Conditions, March 1964

ment is obsolete since
p riv ate holding of
Required reserves
monetary gold is pro
Liabilities requiring
Gold or
foreign
gold or foreign
hibited in this country.
Gold
exchange
exchange reserves
Central Bank
Moreover, the Presi
(per cent)
dent has declared that
In effect
Belgium
Notes and demand liabilities
3 3 '/3
—
this nation’s entire
None
Canada
—
—
—
stock of gold is avail
Suspended since
Notes and other demand
France
35
—
September 1, 1939
able, if needed, to re
deposits
Suspended
deem foreign dollar
40
Italy
Notes and other demand
—
since 1935
liabilities
claims. Many of the
Japan
None
—
—
—
advocates of abolition
In effect
50
Notes, drafts, deposits and
Netherlands
—
of the gold reserve re
other current account balances
quirement believe that
In effect
40
Switzerland
Notes
—
such action should
In effect
United Kingdom Notes in excess of 2.35
100
—
only be taken at such
billion pounds sterling
time as the United
In effect
Notes and deposit liabilities
25
United States
—
States balance of pay
West Germany
None
ments deficit has been
g reatly reduced or
eliminated.
While flows of gold
into and out of United States monetary re
and able to continue to maintain the official
serves still increase and decrease bank re
dollar price for gold, countries can treat dol
serves, the effects on domestic money supply
lars as the equivalent of gold. It is stipulated
and credit conditions can be offset by appro
in the Bretton Woods Agreements Act of
priate action of the Federal Reserve System
1945, through which the United States be
and is offset if this is deemed advisable from
came a member of the International Mone
the standpoint of the System’s overall policy
tary Fund, that any change in the value of
goals. Through purchases and sales of securi
the dollar relative to gold shall require legis
ties in the open market, changes in Federal
lative action by Congress.
Federal Reserve Banks are required to
Reserve Bank discount rates and changes in
member bank reserve requirements, the Fed
maintain reserves in gold certificates (repre
senting gold held by the U. S. Treasury) of
eral Reserve System can control the supply of
reserves available to commercial banks and
not less than 25 per cent of their deposit lia
hence the amount of bank deposits and credit
bilities and of their notes in circulation. This
in the United States. The potentially infla
requirement can be changed by Congress, as
tionary or deflationary effects of gold inflows
it was in 1945, and it may be suspended by
the Federal Reserve Board provided that the
or outflows can thus be offset.
deficient Reserve Banks pay a tax graduated
G o ld in o th e r co u n tries
according to the amount of the deficiency.
The role of gold as a reserve currency and
There has been widespread discussion for
as a part of domestic money supply varies
some years whether the gold reserve require
Re q uire d h o ld in g s of gold and foreign exchange

—

Federal Reserve Bank of Chicago

widely among countries. There are only a
few (not all are shown in the table on page
11) where the statutory reserves must be held
exclusively in gold; elsewhere reserves con
sist of gold and foreign exchange. Neverthe
less, the desire of monetary authorities to
hold gold is still generally strong. This is true
even of central banks whose statutory re
quirements have been suspended or which
have never been subject to such requirements.
Most countries allow the private domestic
holding of gold, but nowhere do the monetary
authorities undertake to sell gold to their
nationals at a fixed price or in unlimited
quantity for this purpose. Practically all
countries buy gold freely from individuals
and banks at a fixed price, paying the seller
in currency or check, but Switzerland also
mints some gold coins. In some countries, for
instance the United States, the buying rate is
specified by law while in others it is set by
administrative decision. Many permit pri
vate trading of gold, a smaller number permit
free import and fewer still permit free export.
London is the world’s most important bar
gold market while coin markets are domi
nated by Paris and Zurich. Quoted prices in
gold markets tend to reflect the public moods
of optimism or pessimism about the economic
or political future to the extent they are not
offset by official transactions. In addition to
France and Switzerland, Germany, Italy,
Belgium, the Netherlands, Greece and Tur
key have played a rather important role in
European gold dealings.
On the Asiatic Continent, Bombay despite
prohibition against gold imports played a
leading role as a gold importer until Novem
ber 1962, when the Indian government made
gold transactions illegal and called in the
metal. Since then, trading in black markets is
reported to have developed. Bombay’s decline allowed Beirut (Lebanon) to become

Asia’s ranking gold trading center, followed
by Kuwait, Hong Kong, Macao, Bangkok,
Singapore, Rangoon, Tokyo, Manila, Taipei
and Seoul. In Africa, Dakar, Djibouti and
Casablanca are the leading centers, and
in the Western Hemisphere, Mexico City,
Toronto, Montevideo, Panama City and Rio
de Janeiro are of some importance.
No precise measure of the amount of pri
vate dealings in gold in recent years is avail
able but it probably totaled several billion
dollars annually. When confidence in certain
currencies declines, some wealthy persons
may shift a portion of their assets into gold
bars while the “little man” under similar
circumstances may seek refuge in gold coins.
Among the most popular coins are the
French napoleon, once equal to 20 francs;
the British sovereign, once equal to 20 shill
ings; and the United States double eagle, once
equal to $20. These and other popular coins
trade at a substantial premium above the
value of their gold content, but premiums
vary sharply from time to time reflecting
changes in demand and the limited supply of
these coins. Some of the popular gold coins
are reported to command premiums about 25
per cent above the gold content.
Although Paris and Zurich are the chief
centers for gold coin trading, there is no
single marketplace for them in either city.
Instead, the major commercial banks act as
agents for buyers of gold coins and do much
of the trading, storage and shipping.
Demand from collectors has come to play
an increasingly important role in the goldcoin market. Another source of demand is
from jewelers, who use gold coins to make
pendants, cuff links and other objects of per
sonal adornment. The pre-Christmas demand
from both of these sources causes a seasonal
variation in gold-coin prices.
While gold continues to have a limited

Business Conditions, March 1964

circulation throughout much of the world, its
role in national money mechanisms clearly
cannot be described as a dominant one and
there is a growing tendency to consider gold
as primarily, if not exclusively, an “interna
tional money.”
G o ld in th e In te rn a tio n a l m echanism

Most international commercial transac
tions are “cleared” in the exchange markets
through offsetting entries on the books of
commercial banks and private traders. The
balances remaining are for the most part
settled by the use of United States dollars and
British pounds sterling. Reflecting the impor
tance of these currencies in international
transactions, the central banks and treasuries
of many countries keep a part of their mone
tary reserves in these so-called reserve cur
rencies. Most or all of their remaining re
serves are held in the form of gold bullion at
home or abroad.
Gold re se rv e s
of central banks and governments
billion dollars

The non-gold portion of international re
serves is held largely in the form of dollar
balances with American banks or in short
term investments, for example, Treasury bills.
Second in importance as a supplement to gold
holdings are balances in sterling in the Lon
don market.
There are wide variations between coun
tries in the composition of the non-gold por
tions of their international reserves. The
United States carries its reserves entirely in
the form of gold. Western European nations
generally hold much larger amounts in gold
than in dollars while Japan has followed the
opposite practice.
Since the end of 1958—the year of the
largest gold outflow from the United States—
foreign central banks and governments have
maintained an almost constant ratio of gold
to dollar reserves (about 2:1), using only a
portion of newly acquired dollars to purchase
gold from the U. S. Treasury. From Decem
ber 1957 to September 1963, foreign gold
reserves increased about 9.5 billion dollars
while the United States monetary gold stock
decreased about 7.2 billion dollars—from
22.8 to 15.6 billion. The remainder came
from other sources—Russian gold sales and
new production.
G o ld ou tflo w re d u ce d

Declines in the United States stock of
monetary gold were smaller in 1961 and
1962 than in each of the preceding three
years and the drain was reduced further in
1963. This welcome change reflects in part
new forms of international cooperation, in
particular the sale by the Treasury of special
securities denominated in foreign currency.1
The willingness of foreign central and com
mercial banks and individuals to increase
*Excludes holdings of the USSR, other Eastern Euro
pean countries and China Mainland.

’See Business C ondition s, July 1963.

Federal Reserve Bank of Chicago

monetary reserves and working balances in
the form of dollars depends largely on confi
dence in the ability and determination of the
United States to maintain the exchange value
of the dollar in terms of their domestic cur
rencies. This in turn is closely related to the
success in achieving and maintaining an ap
proximate balance in the United States inter
national payments.
The United States in recent years has been
more successful than most of its trading part
ners in arresting domestic inflation; there also
is some indication that this country’s mer
chandise export surplus is being further en
larged and will contribute even more to a
reduction in the deficit in the international
balance of payments than it has in the past.
Meanwhile, the dollar, as some of the other
major currencies, is likely to be in large sup
ply in the foreign exchange markets from
time to time, with resulting pressures on the
exchange rate. In order to moderate such
temporary pressures, the Federal Reserve
System since early 1962 has entered into a
number of currency swap arrangements with
foreign central banks and the Bank for Inter
national Settlements. It also expects to derive
continuing benefit from the “gold pool,” an
arrangement closely connected with the
operation of the London gold market.
London gold m a rk e t

The London gold market was reopened in
1954 after being closed for about 15 years.
There are two principal differences between
the London market and the purchase and
sale of gold by the U. S. Treasury: 1) Any
nonresident of the sterling area can buy gold
in London from bullion dealers, but only
monetary authorities can buy gold from the
U. S. Treasury. 2) The London price is al
lowed to fluctuate in response to supply and
demand while the U. S. Treasury’s buying

and selling prices do not change.
The arrangements for gold purchases and
sales in London and New York are integral
parts of the international payments mechan
ism, with central banks, treasuries and sta
bilization funds channeling their gold trans
actions mostly through London and New
York. Gold traded in other places is related
predominantly to private supply and de
mand, although Russia is known to have fre
quently sold gold in these markets in recent
years.
Five men representing firms which together
constitute the London bullion market meet
every weekday morning in the offices of one
of their members. The first order of business
is to “marry,” as far as possible, the buy and
sell orders for gold previously received and
arrive at a “fixing price.” These dealers are
in telephone contact with the Bank of Eng
land, which largely controls the supply of
newly offered gold.
While the fixing price is quoted as the
official price for the day, business is often
done later between banks and dealers at dif
ferent prices. At the fixing the bullion dealers
are normally acting as brokers (agents) only
but later may be buying or selling also as
principals.
During the first five years of operations
since the reopening of the market in 1954,
dealers were authorized to conduct only spot
transactions (delivery and payment within
two working days). The restriction on for
ward dealing was removed in 1959, but fu
ture prices may not be made public and thus
forward deals are of minor importance.
South Africa, traditionally the world’s
largest gold producer, is a major factor in the
market, but the basis on which the Bank of
England sells South African gold and the
amount it actually handles are not published.
Important sources of demand in the London

Business Conditions, March 1964

R a tio o f gold in official holdings of gold and convertible
foreign currencies of selected countries
Belgium

Canada

France

W e st
Germany

1958

1959

1960

1961

1962

1963

Year-end

N e th e r
lands

Sw itzer
land

100

15°

93
92b

Japan

Italy

United
Kingdom

United
States

(per cent)

a June

^September

Source: IMF, International Financial Statistics

market are European commercial banks and
Eastern dealers buying metal for resale in the
Middle and Far East.
The basic trading unit is a gold bar of ap
proximately 400 ounces, equivalent to some
thing over $14,000 at recent prices. There
may be a surplus of buy orders at the fixing,
in which case the Bank of England will be
informed of the excess demand. The Bank
then decides whether to supply gold and in
what amount and whether the dealers’ bids
are acceptable. In general, the bank’s objec
tive is to maintain a relatively stable price for
gold, but if private supplies are large or pri
vate demand is exceptionally strong, the bank
may permit sizable price swings. In order to
maintain relatively stable prices, it may at
times have to draw on its Exchange Equalisa
tion Account—in which all of Britain’s gold
and foreign exchange reserves are held—and
purchase gold from the United States.
London “ gold p o o l”

A gold pool was formed among the West’s
leading central bankers toward the end of
1961 for the purpose of providing joint action
and support to the Bank of England in its

efforts to stabilize the London gold market.
The pool is managed by the Bank of Eng
land and includes as additional members the
United States, Germany, France, Italy, Switz
erland, Belgium, and the Netherlands. Its
monthly surpluses or deficits are settled at the
close of the following month according to
each member’s quota, but activities are not
publicized.
Relatively small fluctuations in the Lon
don market price of gold since the inception
of the pool suggest that it has been quite
successful in checking potentially large spe
culative price movements. The willingness of
member central banks to channel their own
demands through the pool and to refrain
from buying in the market at certain times
may also have helped to prevent wide swings
in the market price of gold with resulting
speculation against certain currencies.
Conclusion

The current international monetary ar
rangements are often described as the gold
exchange standard. While their origin ante
dates World War I, their main features were
set forth at the end of World War II in the

Federal Reserve Bank of Chicago

Articles of Agreement of the In
ternational Monetary Fund.
Gold production
/xunougn me roie oi gold in tne
W o rld
South
United
All
Ausproduction* Africa
States
other
Canada
tralia
world’s monetary machinery has
(million dollars at $35 a fine ounce)
gradually diminished, gold still
1954
895
462
153
39
65
176
appears to many people as the
1958
1,050
159
618
62
39
212
essence of wealth. This popular
1959
1,125
702
157
57
38
171
preference for a commodity that
1960
1,175
748
16
1
59
38
169
has tended to remain stable or to
1961
1,215
803
157
55
38
162
increase in value relative to the
1962
1,290
893
146
55
37
159
world’s major currencies— though
1963p
1,365
962
140
50
37
176
its purchasing power relative to
goods and services has declined—
*Estimated; excludes U.S.S.R., other Eastern European countries, China
is reflected in many of the world’s
Mainland, and North Korea. It is estimated that the Sino-Soviet bloc has
produced about $350 million of gold annually in the last 10 years.
markets in which gold in one form
’’Preliminary estimates.
or another is still actively traded.
As a determinant of the domestic
money supply, however, gold
plays a minor role at best in eco
nomically advanced countries.
gold’s position as an international reserve
currency.
On the other hand, there are few indica
At the annual meeting in September of the
tions so far that gold will soon lose its im
International Monetary Fund, two compre
portance as a medium in which most nations
hensive studies of the international payments
carry at least a portion of their international
system were initiated. One is being conducted
reserves. Although gold’s share in total re
by the IMF staff, the other by Treasury
serves has declined in the postwar period of
representatives of the 10 major IMF mem
rapidly expanding world trade, it still consti
bers that participate in the Fund’s General
tutes the hard core of international liquidity.
Whether it will continue to do so for a long
Arrangements to Borrow. The latter study
group includes the United States, Britain,
time to come depends on many factors—gold
France, West Germany, Italy, Belgium, the
production, the price at which gold is bought
Netherlands, Sweden, Canada and Japan,
and sold by monetary authorities, the bal
with combined holdings of about two-thirds
anced (or unbalanced) growth of world
of the world’s reserves of gold and foreign
trade and coordination of national economic
exchange. The only ideas ruled out from the
policies, to name just a few. For years, pri
agenda of the meetings are a change in the
vate economists have offered proposals for
present gold price of $35 an ounce and freely
reform of the international monetary system.
fluctuating exchange rates among currencies.
Some of these envisage a freeing of the inter
Results from these studies are expected dur
national payments mechanism from depend
ing the latter part of this year.
ence on gold, while others would strengthen

Full text of Business Conditions (Federal Reserve Bank of Chicago) : March 1964

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