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DECEMBER 1962 FEDERAL RESERVE BANK OF PHILADELPHIA BUSINESS R EVIEW is produced in the Department of Research. Lawrence C. Murdoch, Jr., was primarily responsible for the article “ The Compact House” and Clay J. Anderson for “ Defend ing the Dollar.” The authors will be glad to receive comments on their articles. Requests for additional copies should be addressed to the Department of Public In formation, Federal Reserve Bank of Phila delphia, Philadelphia 1, Pennsylvania. THE COMPACT HOUSE The “ dinosaur in the driveway,” as George Romney called the standard-sized American car, FEWER D O LLA R S PER U N IT It takes considerably less steel, glass, rubber, lost much of its appeal in the late 1950’s. As a and other materials to build a compact car. result many drivers changed to the new com Thus its manufacture is less stimulating than a pacts. standard-sized car would be. The same thing ap plies to operation because a compact uses less gas, A similar trend developed in housing at about the same time. Disenchanted with the standard suburban house at the end of the driveway a oil, and anti-freeze and is cheaper to repair. number of people began switching to more unit uses less concrete, wood and other materials compact apartments. than the standard house. In most cases less Last year apartments accounted for almost 25 per cent of all housing starts, up from labor is required because apartments are mass only 9 per cent in 1956. In Philadelphia more specialized machinery while single homes often building permits were issued for apartments in are constructed by hand on scattered sites. So it is with the compact house. An apartment produced and benefit from the use of much In 1961 the average construction cost for 1961 than for single-family homes. The increased popularity of compact cars and single homes was $13,900 and for apartment to units it was $10,400. With apartments making much the same causes. Both are simplified and up a larger proportion of housing starts the easy to maintain; both can satisfy a desire for average expenditure per start declined almost economy. 5 per cent from 1960 to 1961. apartments— compact The wide houses— is acceptance traceable of smaller cars and apartments stems in part from basic Furthermore, high-rise apartments do not re aspirations and status quire so extensive a network of roads, sewers, symbols. Last but not least, both may be reasons and utility services as housing developments do. why the present rate of economic growth seems Since apartments are likely to be constructed in disappointing. built-up areas they usually do not touch off a changes in American 3 business review THE EFFECT OF THE C O M P A C T HO USE apartment or other rented quarters. Often the Average expenditure per nonfarm housing unit. wife works for a few years and they set aside some money that becomes a down payment on their first house. As children grow older and the husband’s earning power increases, the typi cal family often moves to a larger house. Then after the children grow up and go out on their own the parents frequently move back to a more compact, convenient apartment. The depression of the 1930’s, postwar pros perity, medical advances, and other factors have skewed our population mix. The adult popula tion is growing faster at both ends— young people just starting out and older people near ing retirement. A significant part of the increase wave of secondary construction— schools, shop in apartment construction is a response to the ping centers, etc. strong demand— both present and anticipated— The compact house, like the compact car, costs less to operate. Apartment dwellers don’t from these two groups. In addition these factors are important: have to buy lawnmowers or invest in blue spruce Increased mobility. The average family trees to plant by their doorstep. They need fewer now changes its residence every 5 years. appliances; one washer and drier in the base When the breadwinner works for a large ment often serves dozens of families. Less furni national concern moving-day may be even ture and furnishings are required in apartments more frequent. Many people hesitate to buy because of their smaller size. Most high-rise a home when they might have to move units are centrally located and apartment people again in a few years. Each purchase can often find they can get along without a car. involve a broker’s commission of 6 per The high proportion of compact cars and cent or more and settlement charges that apartments is one reason why the numerical rise run as high as $500. In order to avoid the in auto sales and housing starts this year has trouble and expense of frequently buying not given the economy a more vigorous tone. and selling homes many families prefer to The present popularity of apartments also has rent an apartment. other implications, but before we discuss them Playing safe. A home owner’s investment we shall explain some of the reasons why more can be threatened when something unde people are “ living it up.” sirable— people, factories, highways, etc.— comes into the neighborhood. Some fami W H Y A P A R T M EN T S ARE S O P O P U LA R lies hesitate to take the risk and lease an The housing needs of the typical family change apartment instead. in a regular pattern as its members grow older. Available money. Mortgage money is rela After the wedding many couples move into an tively easy to get nowadays and this has 4 business review spurred all types of residential construc breaking up the old gang. Government mortgage tion. Remembering past shortages, some programs and increasing income made suburban builders feel “ better take it while I can home ownership possible for millions. A number get it.” Changes in tax and zoning laws and of things made it seem desirable. the end of rent control have encouraged apartment building in certain areas. The soaring postwar birth rate was a factor. Most suburbanites say “ we moved because we Suburban slowdown. The flood tide of mi wanted better schools and a safe place for the gration to the suburbs has slowed some kids to play.” what in recent years. Some families are Apparent economic advantages of home own electing to remain in the city and others ership also were important considerations. Local are returning to more central locations. taxes and mortgage interest were (and still are) We don’t mean to imply that people are no deductible for Federal Income Tax purposes. longer moving to the suburbs. They are, cer Since most houses were appreciating in value it tainly, and the total suburban population con seemed living was “ for free.” Real estate owner tinues to grow but in some areas this growth ship also was considered a good way to hedge has begun to slow. Edmund N. Bacon, Executive against the inflation of the early postwar period. Director of the Philadelphia City Planning Com mission, speaks of Some families felt they were forced to the . . the beginning of a suburbs by the migration of rural job seekers to marked trend toward a return to city living both the city. Others moved because the old neighbor on the part of older people and of families with hood had deteriorated in appearance and was no children.” This may come as a surprise to those of us accustomed to thinking of suburban life as longer considered safe at night. Still others moved an unshakeable American institution. because most of their old friends had gone. Finally there was the desire for status and prestige. Americans have a deep-rooted desire to The v in e -co v e re d -co tta g e sy n d ro m e own land which traces back to their European Until World War II the suburbs were the prov origins. In days long past land was practically ince of the wealthy and socially elite. Along the only source of wealth. Royalty and a few Philadelphia’s Main Line gracious stone man sions bobbed in undulating seas of blue grass favored families owned all the land and every body else was forced to work it in a form of and it was the same outside most large cities. semi-bondage. This heritage helps explain why The average man lived within city limits in detached homes with land around them are so row houses, “ brownstones,” or tenements. The old city neighborhood could be a pleasant place, popular. In order to create a supply to fill the fast however. It usually was a friendly, cohesive unit. growing People with similar ethnic and religious back swatches across suburbia. Asphalt was poured on grounds tended to live together. Boys married land that yesterday grewTalfalfa and utility poles girls next door and families remained within a replaced stately old trees. Row after row of few blocks of each other. Most residents had an ranch intimate, informal feeling of group identity. “ ranches.” Armies of split levels and colonials Then after World War II the suburbs began demand, houses bulldozers sprung up on made 70' broad by 100' were drawn up in parade ranks. Picture windows 5 business review stared each other down across narrow lawns. ity of the people involved, an unstable social It was a new and exciting way of life for order and a fluid set of values grew up in this many first-time home owners. Take the case of case. The Gardners wanted status and respect the Gardners, a family we know and maybe you but they didn’t know exactly how to achieve do too. They moved to a small suburban house them. For a while they tried fancy, high-powered in the early 1950’s. In the beginning there was cars, then it was velvet-carpet lawns and hi-fi, much to learn and much to do. Yard care was and “ look what I built with my own hands.” fun. Bailing out the basement was good exercise. Painting and repairing were creative. Shoveling snow was invigorating in the crisp country air. Nothing seemed to work the way it should. The initial throw-out-your-chest pride of being a land owner diminished as the Gardners grew The Gardners were united with their new older and performed the duties of home owner neighbors by a kind of frontier spirit. Brought ship again and again. Yard care became a chore. together by the chance reading of a real estate Home ad, they faced common problems in making a just-finished development into a living com drudgery and snow shoveling was a good way repair and maintenance turned into to strain your back. munity. A certain intimacy developed between Some of the economic advantage of suburban these pioneers as they exchanged tools, ideas, home ownership proved to be more illusion than and cups of coffee. The majority of developments remained popu fact. The Gardners found that taxes rose year lar, pleasant communities. We heard it was dif the ferent for the Gardners, however. Commuting became more expensive and time- after year as more and more families moved into area demanding governmental services. After a time, the initial camaraderie they en consuming. Service and repair men were un joyed with their neighbors began to disappear. available except at exorbitant prices. The used Developments are often thought to be full of home market weakened and this diminished the people who are just as similar as their box-like “ living-for-free” feeling. Real estate ownership houses. This notion is based on the fact that became less desirable as a hedge against infla- most couples are around the same age, have children, and enjoy roughly the same income. In the Gardners’ case these were only surface similarities that hid more basic differences. A wide range of religions, tastes, interests, political THE APARTMENT M IX Multifamily units as a percentage of nonfarm starts. PER CENT persuasions, and educational and regional back grounds existed in this development. Finding they had little in common, the Gardners and their neighbors began to drift apart. The Gardners longed for the solid friendships and family con tacts they had known in the city. What satisfying attachments they did make in suburbia usually were broken up by job transfers to another city. Perhaps because of the diversity and insecur 6 * N ew series. business review tion because the cost of living seemed relatively legal title to his condominium apartment which stable. may be mortgaged, sold, rented, given away or Such considerations led the Gardners and bequeathed. It is almost the same as buying a families like them to reassess the advantages and house in the sky. Condominium owners must pay disadvantages ownership. property taxes but they and mortgage interest Some, particularly those with older children, or are deductible for Federal Income Tax purposes. of suburban home working wives, decided that the promised land Condominiums require enabling legislation of a decade ago now was going back on its prom and are now available in only a handful of ises. As we pointed out, the suburbs continue to states. Many experts, however, expect their use grow just as people continue to buy standard to spread rapidly in the next decade— “ the new sized cars but enough people have become disen frontier in housing,” they have been called. chanted with the vine-covered cottage to swell the demand for apartments both in more central THE P EN D U L U M EFFECT suburban locations and near the cores of large A previous apartment boom of major propor cities. tions occurred in the 1920’s. At its peak in 1927, A number of people choose to live in downtown one-third of all housing units started were areas because they claim the social life in the city apartments. In the 1930’s, 1940’s, and much of is more interesting and stimulating. It is easier the 1950’s the pendulum of preference had to find friends with similar tastes and interests— swung to single-family units. Now, of course, probably because there are so many people in a it’s moving back to apartments again. Each time the pendulum swings it picks up something from given area. Cultural activities are more accessible to city residents and so is a wide selection of stores, one side and carries it to the other. For example, the apartment boom of the restaurants, and amusements. Father’s office may 1920’s had an important influence on the design be a short walk from the city apartment and this of houses during the following generation. As can mean two or more extra hours a day for House and Home, the builders’ magazine points pleasure and relaxation. Mother finds that car out, people who lived in apartments during the Jazz Age learned to like small, well-planned ing for an apartment is easier and less expensive tic help is readily available in the city. Urban living space all on one level. When they later became home owners they wanted much the renewal has removed a number of slums, created same thing— smaller, more functional homes— parks and playgrounds, and generally made many of them without stairs. than for a house and, even if it were not, domes cities more appealing. Rising industrial unem Home owners of the postwar period in turn ployment has slowed the immigration of rural are influencing present apartment construction. workers and relieved the overcrowding that Suburban living whetted the appetite for sun forced many to the suburbs in the 1950’s. shine, greenery, play areas, and convenient parking, and ex-homeowners want at least a A house in the sk y taste of these things with their new apartments. The condominium is a new idea in apartments The present emphasis on apartments no doubt that is stimulating demand. A person buys a will affect single homes of the future. Probably 7 business review tomorrow’s home owner will demand the over all airconditioning he has grown accustomed R O O M TO SPARE Rental vacancies as a percentage of all rental units. PER CENT to in his modern apartment. Future housing de velopments may offer less private yard area and more community space and facilities. Possibly double homes and row houses which economize on construction and land cost will be more popular. Tomorrow’s homes may come with more built-in and convertible furniture to make efficient use of limited space. More extras such as carpeting and refrigerator-freezers probably will be included. Quite possibly community washer-dryer-dry cleaner units will be set up. Apartment dwellers have learned such an ar rangement is practical. Garages also could be 1957 and 2.5 per cent in 1950. Stories of con centralized or they may disappear entirely. The cessions that landlords are forced to make to feeling is spreading that it is a waste to devote lure tenants are becoming commonplace. In sev so much indoor space to “ just a car.” Modern eral instances we heard about, the first months paints and construction enable cars to better of a lease are rent free. No-charge extras such withstand the elements and automobiles are no as pools, tennis courts, putting greens, dishwash longer the love-objects they once were. ers, and babysitting often are used as bait. On the other hand, many experts maintain TOO M A N Y APARTM EN TS? Like most things in that frantic decade, the that a “ vast, untapped reservoir of demand” still exists. Vacancy rates may be high but they apartment boom of the 1920’s was overdone. actually declined during 1962. Furthermore, it After a few years, supply outraced demand and is claimed most of the vacancies are either in considerable excess capacity developed. Rents new luxury units— a small segment of the market softened and apartment starts dropped 45 per — or in dilapidated units that should be torn cent from 1927 to 1929. The roller-coaster ride down anyway. The huge, middle-income market in apartment construction in the 1920’s, if not a is far from saturated and should support more cause, undoubtedly aggravated the depression of the 1930’s. construction. If, in fact, the present apartment boom results Many experts now have begun to wonder about the present boom. Are we again building in considerable excess capacity, this is partly in the nature of the industry. It takes a good many too many apartments too fast so that future years from the time an apartment building is construction will have to mark time while the planned until they finally hand out keys. Thus nation digests its supply? supply cannot be finely tuned to demand and the Indeed, some claim apartments already are overbuilt. Almost 7.5 per cent of all rental units now are vacant compared with 5 per cent in 8 momentum behind a wave of construction may carry it too far. But there are many important differences be- business review tween the present apartment boom and the last swell the ranks of apartment seekers in the late major one. Here, briefly, are a few of them. 1960’s and 1970’s. From the 1920 low to the 1927 peak, 1.3 million If excess capacity develops in apartments, apartment units were begun. Since 1956, when therefore, most of it could be absorbed within a the present boom got under way only 1.2 million relatively short time. This assumes, of course, that units have been started. Today, however, the total prosperity will prevail. A sound, healthy econ population is almost twice as large as it was in the omy, in the last analysis, is most important 1920’s and 70 per cent of the present population lives in urban areas now compared with 50 per cent then. In other words, this boom is relatively puny compared with the previous one. THEN A N D N O W Apartment starts and various demand factors compared for -year periods after both world wars. 16 APARTMENT STARTS THOUSANDS to sustain the demand for apart ments. C O N C L U S IO N By the year 2000 it is estimated we New household formation is a key will need more than 40 million addi demand factor because, as we men tional housing units. This means we tioned, people starting out on their will have to increase the present sup own usually rent apartments. House- 200 ply at least 75 per cent in the short” hold formation is now edging up 150 space of 38 years. In addition, we after making a trough in the 1950’s will have to replace tens of millions and it is almost certain that the io o 50 of units that are now, or will become, general rise will continue through substandard. It will be a staggering the remainder of this decade and beyond. In contrast, household for building task. mation hit its top in 1923 and NET HOUSEHOLD FORMATION trended downward for ten years INDEX 1919=100 1946 = 100 Whether or not an oversupply of apartments may be troublesome for the next few years, looking further ahead the major need will be for thereafter. The number of births increased more housing. We must construct rapidly after both World Wars. The enough units to house an exploding first time was a flash-in-the-pan, adult population in decent fashion; however; by 1922, births had en but where will the necessary capital tered a long-run decline. On the come from— and the land? Suburbs other hand, births continued to in BIRTHS crease during most of the period MILLIONS already sprawl 20 to 30 miles be from World War II to the present. open space is extremely expensive. yond our major cities and remaining Already the first bumper crop of The suburban housing development postwar babies is 16 years old and in may be a luxury that we will be forced a few more years they will be getting to stint in the future. Apartments are married (average age: girls, 20; cheaper and more efficient to build and looking for apart than individual homes and they econ boys, 22) younger omize on land and utilities. The brothers and sisters will continue to compact house may be the answer. ments themselves. Their 9 DEFENDING THE DOLLAR “ Defending the dollar” has recently become a of dollars. To conserve limited supplies of dol topic of lively discussion. Only a decade ago a lars, many countries imposed special controls dollar shortage was of widespread concern. against imports of goods from the United States. This article deals briefly with two main prob In that environment there was an acute shortage lems: defending a country’s currency against of dollars— not a problem of defending the dollar short-term outflows of funds, and achieving and against depreciation markets. maintaining equilibrium in its balance of inter in foreign exchange national payments. The emphasis is on the gen Significant changes have occurred in the past eral principles involved, with some recent United few years. The dollar shortage began to vanish States policies being used as illustrations. The over a decade ago. A continuing deficit in the article does not attempt to give a complete de United States balance of payments has put a scription of recent steps taken to defend the growing volume of dollars in the hands of for dollar and remedy the deficit in the United eigners. Foreign holdings of dollars are cur States balance of payments. rently at an all-time peak. Productive capacity As background, it may be helpful to note some of the principal countries has been restored, of the marked changes that have occurred in the even increased, and most of the countries have international financial mechanism in the past rebuilt their international monetary reserves. three decades. The Great Depression of the early Confidence in the major currencies has been thirties brought the final collapse of the interna reestablished. Restrictions on trade and capital tional gold standard which had been relied on flows have been relaxed, and once again the to maintain stable exchange rates. The depres world’s leading currencies are convertible into sion was also accompanied by financial crises, each other on current and on some capital rumors, and massive flights from one currency transactions. then another. In the chaotic environment that The dollar remains the key currency in the developed, currencies were devalued and many international payments mechanism. Except for countries established exchange controls as a gold, the dollar constitutes the largest portion of means of keeping foreign payments and foreign the free world’s international monetary reserves. receipts in balance. Members of the International Monetary Fund In World War II, exchange controls and trade have declared the par values of their currencies restrictions were tightened. Wartime damage in terms of gold or the dollar, and have agreed and destruction of productive capacity in many to maintain the market values of their cur of the major industrial countries left the United rencies within a range of not more than 1 per States as the principal source of supply in world cent above or below par. Most of the West markets. An urgent need for United States goods European countries maintain the value of their for reconstruction and development, together currencies within the agreed limits by selling or with seriously impaired capacity and ability to buying dollars in foreign exchange markets. The produce for export, led to a widespread shortage United States maintains the foreign exchange 10 business review value of the dollar by agreeing to buy or sell 90 days hence at a price of $2.79. His forward gold to foreign official institutions for legitimate sale of the sterling he will receive when his monetary purposes at a fixed price of $35 an British bills mature protects him against loss ounce. from converting his sterling back into dollars should the price of sterling decline. The cost of DEFENSES A G A IN S T S H O R T -R U N hedging by selling forward sterling would Establishing defenses against temporary disturb amount to 1.43 per cent at an annual rate in.BO - n .7 9 x a Allowing for the cost of cover- ances in foreign exchange markets and against ing the exchange risk, the United States in outflows of short-term funds is an essential part of vestor would get more than % Per cent higher D IST U R B A N C E S an over-all program to defend a nation’s currency. Short-term funds may flow abroad for several reasons. yield from Treasury British than from United States bills. An increase in the cost of Extending short-term credit to for cover—-widening the spread between the spot eigners purchasing United States goods is a com and forward rates— would diminish the attrac mon Higher tiveness of British bills, while a narrower spread interest rates in foreign countries may stimulate would increase the inducement to invest abroad. an outflow of funds both by encouraging for A premium on forward sterling would provide eigners to borrow in the United States and induc a strong inducement for short-term funds to flow ing holders of dollars, both domestic and foreign, to England, the investor receiving in addition to to invest abroad. Higher rates were one of the the higher yield on British bills a profit from covering the exchange risk. method of financing exports. factors in the outflow of about $2 billion of private short-term capital from the United States in both 1960 and 1961. Another cause of an outflow of funds is un certainty or fear about the future value of a The inducement to shift short-term funds from currency. Upward revaluations of the mark and one international financial center to another is guilder in the spring of 1961 sparked a large- influenced by the spread between spot and for scale outflow of funds from London, especially ward rates of exchange as well as by differentials in interest rates. To illustrate: if the current to Germany and Switzerland. Political develop ments and international tension may also touch yield on three-month British Treasury bills is 2 off substantial short-term capital movements. The per cent above the yield on similar United States Berlin crisis, for example, generated an outflow bills and if the price of spot sterling is $2.80 of funds from Germany. and the rate for sterling for 90 days future deliv Outflows of short-term funds, although a ery is $2.79, an investor could cover the ex natural consequence of currency convertibility change risk and still get a higher return on and greater freedom of capital movements, may British bills. Investors placing funds abroad in at times cause difficulties. A substantial outflow short-term earning assets usually like to cover during a period of economic slack, especially if the exchange risk involved. The United States long continued, may hamper monetary authori investor could buy sterling at $2.80 to pay for ties in fostering as much ease as might otherwise his three-month British bill and simultaneously seem appropriate to domestic economic condi could enter* into a contract to sell his sterling tions. Also, an outflow of short-term funds may 11 business review at times become disruptive and cumulative. An would soon follow. As a result, some foreign outflow of funds from the United States, for central banks, notably those of Germany and example, tends to push up prices of foreign Switzerland, had a heavy inflow of funds and currencies. If the capital outflow induces ex in the process accumulated large holdings of pectations of a further loss of funds and de dollars. preciation of the dollar in foreign exchange future contracts to pay marks tried to anticipate markets, speculative transactions may accelerate their payments because of the expected rise in both the outflow of funds and depreciation of the dollar. If the rate on dollars abroad drops too Individuals and business firms with the price of marks in terms of other currencies. much, foreign stabilization authorities buy dol The forward mark rose to a substantial pre mium, and in Germany there was a sharp dis lars to keep the rate from falling below the limit count on forward agreed upon with the International Monetary forward marks encouraged an outflow of funds Fund. As dollar holdings rise, stabilization au from the United States, and the discount on thorities may decide to convert some of their forward dollars made it expensive for Germans growing supply of dollars into gold by buying to cover funds placed temporarily in the United gold from the United States. States. O p e ra tio n s in fo re ig n e x c h a n g e United States and to cushion the impact of An important link in the defenses established to speculative transactions deal with temporary disturbances and imbal rates, the Treasury intervened in the forward ances is official intervention to prevent or at least exchange market. Under an arrangement worked mitigate sharp swings in exchange rates and out with the Bundesbank, the Treasury sold large movements of short-term funds which, by forward marks in the New York market. These creating become sales helped reduce the premium on marks for cumulative. The Treasury, through the Exchange future delivery which in turn diminished the Stabilization Fund established in 1934, inter incentive to shift short-term funds to Germany. vened in the foreign exchange market in the When the forward sales contracts began to spring of 1961, and the Federal Reserve System mature, the purchasers had to buy dollars to began operations in the market in the spring of pay the United States Treasury. Such purchases 1962. The principal tended to raise the price of dollars abroad and dollars. The premium on To help check the outflow of funds from the fear and uncertainty, objectives may of Treasury- on foreign exchange Federal Reserve operations are to protect the reduce the volume of central bank purchases to external value of the dollar, prevent disorderly prevent the rate on dollars from dropping below conditions in the foreign exchange market, and the support level. avoid excessive outflows of short-term capital Substantial official sales of forward marks by the Treasury helped restore confidence in the and gold. Treasury operations have been mostly in the foreign exchange markets, cushion the outflow forward exchange market. Revaluation of the of short-term funds from the United States, and German guilder diminish the accumulation of dollars in some of touched off large speculative flows of funds by the foreign central banks. As conditions im creating expectations proved, the Treasury was able to discontinue 12 mark and the that Netherlands other revaluations business review its forward sales and by the end of 1961, all of of the specified period at the same rate of ex its forward mark contracts had been liquidated. change. This agreement affords mutual protec The Treasury also intervened in the forward market for Swiss francs and Netherlands guil ders. Both countries experienced tion against fluctuations in exchange rates between the two currencies. substantial Swap transactions negotiated by the Federal inflows of short-term funds, and the premiums Reserve have varied somewhat as to purpose. on three-month forward francs and guilders rose Those with the Swiss National Bank and the (or the discount on forward dollars increased). Netherlands Bank were soon activated and part In these cases also, the Treasury offered Swiss of the funds used to absorb dollars these insti francs and guilders for future delivery. These tutions were acquiring in keeping their exchange sales helped reduce the forward premiums on rates with the dollar within the agreed limits. francs and guilders, thus diminishing the incen Had these surplus dollars not been absorbed tive for short-term funds to continue to flow into these banks probably would have converted them Switzerland and the Netherlands. into gold in the United States, resulting in a Federal Reserve operations in foreign ex drain on our gold stock. change facilitate System cooperation with foreign The System’s swap of $250 million with the central banks and supplement the limited re Bank of Canada was part of a large-scale mobil sources of the Stabilization Fund operated by ization of credit to help defend the Canadian dol the Treasury. System operations have been care lar in mid-1962, when the Canadian Government fully coordinated with those of the Treasury. declared a par value for its currency and insti Thus far most Federal Reserve operations have been directly with foreign central banks. As yet tuted a broad stabilization program to protect it. the System has not executed any transactions in Bank of England, swaps have been negotiated the own and put on a standby basis. Should they be The bulk of the Fed’s operations has been by promptly and the proceeds used in foreign forward exchange market for its account. means of swap arrangements negotiated with In other cases, such as the Bank of France and the needed, these standby credits can be activated exchange operations. foreign central banks. The initial step in these Official intervention in foreign exchange, it swaps usually is a standby credit in which each should be noted, may also discourage specula central bank agrees to exchange on request its tion. If, for example, the prices of foreign own currency for the currency of the other coun currencies in the United States are expected to try, up to a maximum amount for a certain rise, speculators may buy expecting to be able period of time, commonly 90 days. If the standby to sell later at a profit. Speculators abroad credit is actually used, the Federal Reserve might be induced to sell dollars forward expect credits the account of the foreign central bank ing to profit by buying them back later at a with a given amount of dollars and in exchange lower price. Official operations such as those receives a credit on the books of the foreign conducted in the spring of 1961 helped to restore central bank for an equivalent amount of that confidence and thus temper speculative activity. country’s currency. Simultaneously, both central The very fact that Treasuries and central banks banks agree to reverse the transaction at the end have substantial foreign exchange resources at 13 business review their command which may be used to thwart balance-of-payments problems. Meetings of the expected rate changes increases the risk and group bring together top financial officials and tends to discourage speculative activity. afford an opportunity to explore current finan cial and balance-of-payments problems of the O th er fo rm s o f in te rn a tio n a l coope ratio n participating countries. The chain of defenses forged to protect the tribute to a better understanding of each other’s The discussions con dollar, as well as other currencies, includes in problems and facilitate coordination of national addition to intervention in foreign exchange markets other types of international cooperation possible, adding to the difficulties and pressures among Treasuries and central banks. Mobiliza on other countries. programs and policies so as to avoid, insofar as tion of credits to assist countries whose curren cies are under heavy pressure, cooperative efforts Special b o rro w in g a rra n g e m e n ts to counteract speculative activity and to stabilize Cooperation the price of gold in the London market, and credit arrangements, and intervention in foreign regular meetings to discuss mutual balance-of- exchange markets are lines of defense that can among central banks, including payments problems and policies are among the be brought into operation quickly. These de recent developments in this field. fenses may be adequate except in serious situa When the German mark and Dutch guilder tions in which a currency is put under heavy were revalued in the spring of 1961, there was pressure. Another part of the defense line against a large-scale speculative attack on sterling and temporary pressures is the International Mone a substantial loss of reserves by the Bank of tary Fund. Heavy drawings in recent years left England. At one of the monthly meetings of the the Fund with limited resources in some of the Bank for major currencies, especially now that these cur International Settlements in Basle (which brings together governors of the leading rencies are convertible; European central banks and, in recent years, a recently adopted, to enlarge the resources avail senior representative of the Federal Reserve able to the I.M.F. hence the proposal, Basle Agreement was The new supplementary borrowing arrange worked out to help cope with the capital flows ment adds $6 billion to the resources of the Fund. System) the so-called generated by the revaluations. Leading central Under this arrangement, ten of the major indus banks put total credit facilities of nearly $1 bil trial countries stand ready to lend up to specified lion at the disposal of the Bank of England. One maximum advantage of central bank credit arrangements maximum for the United States is $2 billion, amounts of their currencies. The is that they can be organized and put into effect and the total for the other nine nations is $4 bil quickly. lion. Another important development in the area The purpose of the new arrangement is to of cooperation was the establishment in the establish facilities spring of 1961 of a special working group under gaining reserves can lend their currencies to the the Organization for Economic Cooperation and Fund which in turn can lend these currencies to Development. This particular working group deficit countries needing them. Such loans to the deals primarily with monetary, financial, and Fund mature in five years but can be repaid 14 whereby surplus countries business review sooner if the borrowing country pays its draw cit arising from a fundamental imbalance, how ing before maturity. Should a lending country ever, the only remedy is effective action to correct experience balance-of-payments problems, it can the deficit. The function of a reserve in such cases obtain prompt repayment from the Fund even is not to enable a country to avoid action but to though the loan has not matured. afford reasonable time for a sound remedial pro By enlarging the resources that can be mobil gram to be established and become effective. ized in support of the ten leading currencies, the Unless remedial action is taken, a continuing new borrowing deficit would eventually exhaust any reserve. arrangement puts the Inter national Monetary Fund in a much stronger position to meet the heavy pressures that may M A IN T A IN IN G B A S IC BA LAN CE arise in the current international environment. The defense line erected against temporary dis The very fact that such large resources are avail turbances and deficiencies, although helpful, is able should serve as a strong deterrent to specu not a remedy in any sense for the longer-run lative activities in foreign exchange markets. problem of a persistent deficit in a nation’s basic balance of payments, as United States authorities R ole of liqu id ity have stressed repeatedly. The root of the prob A nation’s international monetary reserve influ lem of defending the dollar is the continuing ences its ability to withstand external pressures deficit in the international transactions of the on its currency. The function of an international United States. It is the deficit that has built monetary reserve is similar to that of a working foreign holdings of dollars to an all-time peak, balance or reserve of a bank or business insti increased potential claims on our gold reserve, tution. It is to tide over periods when payments are temporarily larger than receipts. Even exchange markets. Deficits year after year are and at times put a strain on the dollar in foreign though its international transactions are basically bound to arouse doubts as to the ability of a in balance, a nation may have seasonal and other country to maintain the value of its currency, temporary deficits. It needs a reserve of gold or and may lead to rumors of devaluation which currencies acceptable in international payments in turn may touch off massive shifts of funds to meet such temporary deficits, just as a bank into currencies that are considered stronger. or business firm needs a cash reserve or working The foundation of any effective program to balance to bridge short-term gaps between its defend the dollar or any other currency is some payments and receipts. method of keeping foreign earnings and foreign In addition to covering temporary shortages, payments in balance over a period of time. A a reserve gives a nation some time to take brief look at various approaches to maintaining the necessary steps to remedy a basic imbalance balance between foreign receipts and payments in international transactions. The size of the will help put this problem in better perspective. reserve cushion needed depends significantly on how promptly effective corrective measures are S e lf-a d ju stin g devices taken. An international reserve should be suffi A significant feature of a free market economy cient to meet seasonal and other temporary defi is that if some segment gets out of balance, cits in the balance of payments. In case of a defi forces tend to be set in operation to restore 15 business review equilibrium. One of the great advantages claimed for the international gold standard was that in case of sizable balance-of-payments sur market forces which would restore balance between foreign receipts and payments. Even in its heyday the gold standard never pluses or deficits, forces were automatically set worked so smoothly as the above summary of into operation to restore balance. Experience the theory indicates. Adjustments in reserves, revealed, however, that this automaticity was prices, and incomes brought about by gold flows less than often claimed. often hampered achievement of domestic eco A feature of the gold standard was that for nomic objectives. For example, an outflow of eign exchange rates were pegged within narrow gold and contraction of credit in a period of limits by the cost of shipping gold between recession conflict directly with policies needed international money centers. To illustrate: in to promote recovery. It was largely such conflicts the days of the gold standard when the par that led to the so-called managed gold standard value of the English pound sterling was $4.8665, in which the central bank offset insofar as the gold export and import points were about possible those gold flows that interfered with 4.8865 and 4.8465, respectively, because the cost policies needed to achieve domestic objectives. of shipping gold between New York and London Foreign exchange rates are prices— prices of was about 2 cents per pound sterling. If a foreign currencies. Fluctuations in foreign ex deficit pushed the price of a foreign currency change rates may also initiate forces to restore to the gold export point or slightly above, it balance between foreign earnings and payments. became cheaper to use gold in making payments A net deficit, for example, would put upward than to buy foreign exchange. As a result, gold pressure on prices of foreign currencies, which flowed out and the country’s gold reserve was in turn would make foreign goods and services reduced. When the price of foreign currencies more expensive; dropped to the import point it was profitable to become less expensive to foreigners. A reduction buy foreign exchange and import gold. in payments for imports and an increase in Under the gold standard, gold flows were the principal means of keeping foreign receipts and payments in balance. An outflow of gold and reduced reserves in deficit countries United States goods would would receipts from exports would operate to eliminate the deficit and restore balance. Although operating to maintain equilibrium between foreign receipts and payments, fluctuat tend to tighten credit, push up interest rates, ing exchange rates have a number of undesirable and put downward pressure on prices, income, consequences. Only a few of the major disad and production. Countries receiving gold would vantages can be touched on here. gain reserves which in turn would encourage an A serious disadvantage is that wide swings in expansion of credit and the money supply and exchange rates increase risk and therefore dis increases in prices and production. Lower prices courage international trade and financial trans and income in deficit countries would encourage actions. Diminished trade in turn hampers inter exports and discourage imports; rising prices national and income in surplus countries would reduce times, rate changes may induce speculation and specialization and productivity. At foreign receipts and increase payments. In short, aggravate rather than mitigate balance-of-pay- gold flows were supposed to set into operation ments problems. Fluctuating exchange rates also 16 business review increase the risk of holding foreign currencies a as part of international monetary reserves, and deprives the country of the benefits of inter as a result might impair international liquidity. national Disadvantages such as these led to the provision efficiency that comes from competing in the for stable exchange rates in the establishment world market. In addition, a harness of controls of the International Monetary Fund. stifles initiative and flexibility which are so nation’s economy specialization against external and the forces stimulus to essential for economic progress and growth. E x ch an ge control The disadvantages are such that this method of At the opposite extreme from relying on free maintaining international balance should be used market forces to correct imbalances in a coun only in time of war or some other national try’s balance of international transactions is emergency. direct controls imposed by Government. Severe and protracted imbalances created by the depres The m id d le w a y sion of the thirties and later by World War II The United States approach to the problem of and its aftermath led to widespread imposition maintaining balance between foreign receipts of exchange controls. Although objectives and and payments is an attempt to avert both ex methods varied among countries, the essence of tremes— sole reliance on free market forces or a exchange control is to achieve balance between blanket of controls over foreign receipts and payments and receipts by channeling foreign payments. Foreign exchange rates, as already earnings into the exchange control authority mentioned, which, in turn, rations the available supply narrow limits by countries that are members of among those desiring to make foreign payments. the are International maintained Monetary within Fund. relatively Monetary The exchange control authority, through ration policy is determined mainly in terms of domestic ing foreign exchange, limits payments to the economic and credit conditions instead of in amount of foreign exchange available. relation to gold reserve increases or decreases. In an emergency such as a war, disparities in The United States has never relied on direct economic conditions among countries may be exchange controls, and the trend in other coun so serious for an extended period that exchange tries has been toward their elimination or re control is about the only feasible method of laxation. bringing foreign with United States officials are fully aware that our receipts. Direct control also makes it possible balance-of-payments deficit cannot be expected to ration scarce foreign exchange in accordance to correct itself. Without going into detail, the with program thus far developed embraces a number domestic payments needs for into line reconstruction and development. of measures designed to increase receipts and to Exchange control has serious disadvantages, reduce the foreign exchange drain of Govern however. Exchange control restricts the con ment payments abroad. The foundation of the vertibility of the nation’s currency. Such re program is maintaining a stable cost-price struc strictions, major ture so that United States producers can compete countries, are a serious impediment to world in world markets. In addition, the Government trade and international specialization. Insulating is sponsoring a drive to increase exports, includ especially if imposed by 17 business review ing an expanded program credit Monetary and fiscal policies directed toward insurance and more information about sales of export maintaining cpst-price stability are integral parts opportunities abroad. of any program to defend the dollar. A rising Measures have also been taken to reduce cost-price spiral would seriously impair the foreign payments and hold down their impact ability of United States producers to compete in on the deficit. The net drain of military expendi world markets and, by reducing exports and tures in foreign countries, a large deficit item increasing imports, would aggravate the deficit. in our balance of payments, is being reduced Monetary and fiscal policies, even though by persuading foreign countries involved to use essential, should not be our sole reliance for some of the dollars to buy more of their military eliminating our balance-of-payments deficit. As equipment and supplies in the United States. pointed out in the first article, Government pay Another large deficit item, foreign economic ments to other countries are an important fac aid, is being tied more closely to the purchase tor in the deficit. Even if domestic policies are of United States goods and services. The goal successful in maintaining price stability, it is this year is for 80 per cent of such aid to be in unlikely that private international transactions the form of United States goods and services. will usually generate a surplus sufficient to cover In addition, efforts have been made to get net Government payments abroad, which are foreign countries with continuing balance-of- necessarily determined largely on noneconomic payments surpluses to assume a larger share of grounds. It is appropriate, therefore, that mone foreign aid to underdeveloped countries. tary and other economic policies which exercise their influence on the private sector of the C O N C L U S IO N S economy through the market place be supple Deficits and surpluses in international trans mented by measures to assist in bringing our actions are inevitable in a world in which money international transactions into balance. and goods can move freely among countries. Even though eliminating the deficit is the Balance-of-payments deficits and surpluses may basic remedy, measures that are helpful in deal result from seasonal and other temporary fac ing with temporary disturbances are a valuable tors, or they may arise from more deep-seated part of an over-all program for defending a causes. nation’s currency. Whether provided The fundamental problem by the in defending a I.M.F. or central banks, credit facilities may be nation’s currency from speculative pressures and a suitable means of meeting temporary deficits. depreciation in foreign exchange markets is to A subsequent surplus can then be used to repay avoid a long-continued deficit in the balance of the funds borrowed. Credit facilities also pro payments. Such a deficit results in a substantial vide time for putting into operation effective build-up in foreign holdings of the currency, measures to correct a basic deficit. Foreign depresses its value in foreign exchange markets, exchange intervention may be used to help and renders the currency susceptible to specu stabilize foreign exchange rates, temper specu lative forays. lative activity, and diminish an outflow of gold. 18 b u s i n e s s r e v ie w F E D E R A L R E S E R V E B A N K OF P H I L A D E L P H I A TABLE OF CONTENTS -1 9 6 2 JANUARY (A n n u a l R e p o r t Issue) T h e G r e a t C o r p o r a t e P ro fits M y s t e r y R e c o v e ry , M a r k e t In te re st R a tes, a n d M o n e t a r y P o lic y B u sin e ss a n d B a n k in g in 1961 FEBRUARY S ilv e r: P h y sic s a n d F olk lo re C a p i t a l S p e n d i n g — G r e e n L ig h t U n d e r Y e llo w T h e N e w F o u r P e rc e n te rs R o u n d in g th e H o r n o f P le n ty MARCH S . R . O . a n d S O S : T h e P e r fo r m in g A r t s P a r a d o x Bank P ro fits in th e W a k e o f R e c e s s io n A P R IL B a la n c e o f P a y m e n ts a n d M o n e t a r y P o lic y T h e L o n g a n d th e S h o r t o f It: B a n k e rs a re R e a c h in g O u t f o r L o n g e r -T e r m S e c u rit ie s A g a i n MAY C o r p o r a t e C o u r t in g , a n d A f t e r C a p i t a l S p e n d in g R e v iv e s on S c h e d u le E le c tro n ic B a n k in g JUNE A d v e r t i s in g a n d C h a r lie B ro w n A u t o D e a le rs A r e H a p p y JULY T h e F o r e ig n E x c h a n g e M a r k e t R e s to ra tio n in V a c a t io n la n d AU G U ST M o r e C a s h F low — A n d X E xce ss C a p a c i t y SEPTEM BER H o w R e c e s s io n s H i t P h ila d e lp h ia N e w J e r s e y 's F if t y - M illio n - D o lla r V e g e t a b le G a r d e n OCTOBER M a s s M e d i a a n d th e G u lliv e r F a lla c y 1 9 6 2 — A R o u g h Y e a r f o r F a rm e rs NOVEM BER F o r e ig n B o r ro w in g in th e U .S. C a p i t a l S p e n d e r s P la y It S a f e DECEM BER The C o m p a c t H o u se D e f e n d in g th e D o lla r M a y b e N e w M a c h in e s F O R TH E R E C O R D • • • BILLIONS INDEX Third Federal Reserve District United States Per cent change Per cent change $ MEMBER BANKS 3RD F.R.D. Department Storef Factory* Employment Payrolls Sales Stocks Check Payments Per cent change Oct. 1962 from Per cent change Oct. 1962 from Per cent change Oct. 1962 from Per cent change Oct. 1962 from Per cent change Oct. 1962 from mo. ago mo. ago SU M M ARY Oct. 1962 from mo. ago year ago 10 mos. 1962 year ago 10 mos. 1962 Oct. 1962 from mo. ago year ago LOCAL year ago mo. ago M ANUFACTURING + Electric power consumed...... Man-hours, total*................ Employment, total.................. W age income*..................... C O N S T R U C T IO N ** COAL PRODUCTION 5 1 0 - 1 + 11 + 5 + 4 0 0 + 2 - 2 - 3 + 8 + 3 + 1 + ^ +17 + 5 TRADE*** Department store sales........... Department store stocks......... + + + B A N K IN G (All member banks) Deposits............................. Loans................................. Investments.......................... U.S. Govt, securities............. Other............................... Check payments.................... + - 2 6 5 + 5 + 5 + 7 + 5 + 3 + 7 - 3 + 6 +18 + 9 + 2 0 t +11+ +14+ + PRICES W holesale.......................... Consumer............................ •Production workers only. ••Value of contracts. •••Adjusted for seasonal variation. 6 2 1 0 0 0 ot + It + It 2 6 + 3 + 9 + 3 - year ago mo. ago year ago year ago year ago 1 0 - 2 0 +15 + 8 2 — 1 + 6 +18 - 1 5 3 ’+ 4 0 + 11 + 7 Lancaster........ 0 + 7 0 +10 - 6 + 6 2 + + 1 8 + 5 Philadelphia. . . . 0 1 - 1 + - 4 Reading.......... + 1 + 2 + 1 + 1 - 9 - 2 + 4 +21 + 7 + 8 + 7 + 2 +22 + 11 Scranton......... - 2 2 - 4 - -1 0 - 6 0 + Trenton.......... + 3 0 + 3 - 2 - 9 -1 0 0 + 1 - 1 + 9 - 9 - 1 + 2 -1 1 1 0 -1 5 0 0 + 8 + 11 + 4 - 4 +26 +12 + + 1 1 + 0 1 f20 Cities IPhiladelphia Wilkes-Barre. . . year ago 0 + + + + 3 + 1 + 2 + 2 + 1 + 17 mo. ago - - Wilmington...... - 1 - 3 York.............. - 1 - 2 + - 3 4 - 1 + 2 + 1 + 16 + 15 0 + 2 + 8 +24 + + 9 + 3 +18 + 8 9 5 - 2 + 3 +43 +26 2 + 3 + 3 +11 + - 4 - 2 + 3 + - 2 + 1 + 8 6 8 +33 + 10 + 7 •Not restricted to corporate limits of cities but covers areas of one or more counties. tAdjusted for seasonal variation.
@FedFRASER