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The U.S. Balance of Payments—Present and Future
How the Fed Helps Checks to “Hurry Back”


is produced in the Department of Research. Evan B. Alderfer and James V. Vergari were
primarily responsible for the article, "How the Fed Helps Checks to ‘Hurry Back’.” The authors will be glad to receive comments
on the article.
Requests for additional copies should be addressed to Bank and Public Relations, Federal Reserve Bank of Philadelphia,
Philadelphia, Pennsylvania 19101.

by Robert N. Hllkert*
No meeting of bankers is complete these days

if these were the so-called “ good old days.”

without some discussion of what Banking Mag­

In 1863, the National Banking Act brought

azine has called “ the bewildering divergencies

a degree of uniformity to American banking.

in the policies of regulatory authorities.” Freely

In theory the Act created the dual banking sys­

translated into English this refers to the “ mud­

tem but in practice there were at least 24 sys­

dle” in bank supervision.

tems— one National and 23 in the Union states,

Actually, the situation is not new. The super­

and 11 more in the Confederacy.

vision of American banking has always been

The passage of the Federal Reserve Act in 1913

muddled to some extent. We have a tendency

provided for a three-tiered system: National mem­

to forget history. Sometimes it pays to look

bers, State members and State non-members.

back in order to gain the perspective which just

Since both classes of members were subject to

possibly might be helpful in the way we look

many of the same regulations, the Federal Re­

at a present problem.

serve System added further uniformity.

The several states largely regulated banking
until the Civil War, and conditions varied

The need for still more uniformity and co­
ordination in banking supervision was fully

widely. At one extreme, states merely granted

recognized in the 1930’s. The Banking Act of

charters and then faded into the background or

1933 provided that no State bank could be

out of the picture entirely. At the other extreme,

insured after July 1, 1936 if it were not a mem­

states actually owned and operated commercial

ber of the Federal Reserve System. This was

banks. Certain states demanded large sums for

modified in the Banking Act of 1935 so that

the privilege of banking; others charged noth­

no State bank with deposits of $1,000,000 or

ing at all. In some jurisdictions, banks were

more could be insured if it were not a member

chartered only if they agreed to lend stipulated

of the Federal Reserve System by 1942. Thus

amounts to railroads, canal companies or other

it was never intended by the architects of the

favored enterprises.

modern banking system that the present wide

Competition under such conditions was grossly

differences in rules should exist. If this provi­

inequitable and banking, in general, was chaotic.

sion had taken effect most banks today would

Lending practices were lax. As many as 50 per

be operating under substantially the same reg­

cent of the notes of certain banks were counter­


feit. Failures were commonplace. One wonders

The provision was repealed in 1939, how­
ever, and the banking system, for its supervi­

* Mr. Hilkert, First Vice President of the Federal Reserve
B ank of Philadelphia, gave this talk at ten m eetings of
bankers and bu sin e ssm e n sponsored by the Federal Reserve
B a n k durin g the sp rin g of 1964.

sion, was left to three regulatory bodies in
Washington— the Comptroller of the Currency,


business review

the Federal Reserve and the F.D.I.C. Things

Saxon, in contrast, has stated “ . . . actual ex­

worked well enough so long as the regulatory

perience does not support the assertion that

authorities agreed on basic principles.

there has been a deterioration in the quality of

As you all know, a series of conflicts recently
has flared up between the regulatory agencies.

bank credit.”

The Comptroller and the Federal Reserve

The disputes are principally between the Comp­

have significantly different views on System

troller and the Federal Reserve. The points of

membership, foreign branches, window dress­

controversy are numerous and I won’t attempt

ing, the content of call reports, loans on real

to give you a chronological catalogue— only an
idea of their nature and extent.

estate, the underwriting of revenue bonds, limits
on business loans, among other things.

1. The Comptroller rules that National banks

As you can see, the disputes cover almost the

may issue debentures and consider them as

entire range of commercial bank operation. But

capital. As far as the Federal Reserve is con­

there is a consistent thread running through

cerned, debentures aren’t capital or surplus and

them. The Federal Reserve’s basic disagreement

thus cant be counted in such things as the limit

with the Comptroller seems to boil down to

on loans to one borrower.

whether bank supervision should be substan­

2. The Comptroller wants all call reports on

tially relaxed at this time. Mr. Saxon seems to

surprise dates and the Federal Reserve dis­

be saying it should, and the System is saying


that it shouldn’t. I realize that opposing the

3. The Comptroller redefined savings accounts

siren-song of reduced regulation may make us

to include deposits of profit corporations. The

unpopular with some people, but the Federal

Federal Reserve

Reserve, with its long experience in “ leaning




pointed out that “ failure of a National bank to

against the wind,” tries to place the interests of

comply with provisions of the Federal Reserve

the Nation and the banking system above its

Act constitutes grounds for instituting legal pro­

own popularity.

ceedings to close the bank.”

For my part, I believe that if one thinks a

4. The Comptroller ruled that the sale of

certain law is inequitable or outmoded he should

Federal funds is not a loan and not subject to

try to get it changed through the regular legal

lending limits. The Federal Reserve holds the

or legislative process. The Federal Reserve did

transaction is a loan on the part of the selling

this with vault cash and now it is working hard

bank and, therefore, comes under the limits.

for legislation to lift or liberalize the restric­

5. The Comptroller claims the limit on loans

tions on loans to member banks. The proposed

to “ executive officers” applies only to the Pres­

legislation, already introduced in the House by

ident, principal Vice President and Cashier.

Rep. Kilburn and in the Senate by Senator

The Federal Reserve, on the other hand, defines

Robertson, would do away with the technical

an executive officer as any officer who partici­

requirements regarding “ eligibility” of collat­

pates in management.

eral for such borrowings that have become out­

6. Federal Reserve Chairman Martin has said,

moded since the enactment of the Federal Re­

“ / am impressed with the indications that the

serve Act. Emphasis would be placed primarily

quality of credit has deteriorated.” Comptroller

on the soundness of the paper offered as se­


business review

curity and the appropriateness of the purpose
for which credit is sought.

new services, ranging from lock boxes to jo b ­



mortgages, con­

Still other changes are highly desirable. For

sumer loans and personal savings has intensified

example, I feel nonmember banks, which do

in recent years. Banks, both large and small, are

essentially the same kind of business as mem­

seeking, but not always finding, the avenue to

bers, should be required to operate under sim­

automation that suits them best. The sum of

ilar, if not identical, rules and regulations. It

these changes, in addition to their overall un­

does not make sense to me that certain prac­

settling effect, is pressure to reach for higher

tices are considered safe for one class of bank

yields, longer maturities and increased risk.

and not for another. To be specific, I think that

It’s always nicer (and easier) to compliment

all commerical banks should be subject to sim­

than criticize and for a regulatory agency it’s

ilar reserve requirements and, when the time

always more pleasant to trust than restrain. But

is right, the Federal Reserve and the States

we must not forget the lessons of history. Time

should take appropriate steps to initiate changes

and time again it has been shown that reason­

and compromises toward this end.

able restraint is necessary for democracy to

I am in favor of making bank regulation as

function properly. Thomas Jefferson, who be­

uniform and equitable as possible, but I don’t

lieved wholeheartedly in the freedom of indi­

believe this is the moment for a general relax­

vidual action, said “ a wise and frugal Govern­

ation of bank supervision. I must emphasize

ment must restrain men from

that the Federal Reserve has confidence in the

another . . .”

ability of bank managements to operate with
safety and prudence under conditions as they

money, have a magnified capacity to “ injure”

are right now. But will conditions remain the

their customers and their communities. The

same? Automation is revolutionizing the pro­

greater freedom to operate in this fiduciary ca­

duction of goods and information and imposing

pacity requires foregoing some lesser opera­

Banks, since


deal in

injuring one
other people’s

sweeping changes on business, labor and gov­

tional freedoms, such as accepting savings de­

ernment. The late Norbert Weiner, an M.I.T.

posits from profit corporations.

professor, said that fast-accelerating automation
will bring a depression that will make the 1930’s

table. It has caused us concern and embarrass­

seem like a joke. I don’t agree with him but I

ment and it has made your job as commercial

can’t completely ignore the thought. At the

bankers more difficult. The present confusion

very least the coming years will be an unsettled

seems to point up the need for a single super­

period for the Nation as a whole.

visory agency in Washington.

The “ muddle” in bank supervision is regret­

Banking, for its part, is already undergoing

I have no doubt a single supervisory agency

rapid changes. The traditional mainstay— the

would be more efficient. But is more efficiency

short-term business loan— has diminished in im­

all we really want? Mussolini made the no­

portance as firms have come to rely more on

toriously tardy Italian trains run on time but

internal financing, trade credit and commercial

he achieved such efficiencies only through a

paper. The practice of compensating balances is

massive denial of important values.

under fire. Many banks are experimenting with

Some of us believe that greater efficiency in


business review

bank supervision would not be worth the sac­

When all the considerations have been prop­

rifice of many values and concepts we hold im­

erly time-tested and evaluated, a single agency

portant. I speak, for example, of the democratic

could well turn out to be the best solution. Or

type of supervision that is possible when sev­

the muddle may be solved satisfactorily by

eral specialized agencies can discover the needs

other, less drastic means.

of banks and bank customers, each in their

Many disputes, this one included, seem to

own way. I speak of fundamental concepts such

go through two phases. The first is what I call

as the dual banking system. I speak of the sound

the pawing-the-ground-and-snorting stage. Here

compromises that can be welded out of dis­

both parties growl accusations and make a lot
of noise. Before long, the commotion attracts a

putes in good faith.
Would a single monolithic agency require

number of interested observers. Their presence,

sacrificing these and other valuable features of

and sometimes their active intervention, often

the present system? And, if it did, would the

brings about the second stage where the par­

efficiency and coordination achieved be worth

ties shake hands and quietly talk things over.

this price? I just don’t know and I doubt if

The dispute with the Comptroller rose to a

anyone else does right now. We need more

crescendo this year as the issues I mentioned

time— more serious thought and dispassionate

earlier were thrashed out in the public press.

discussion— before such decisions can be made.

The commotion attracted observers such as Bill

After all, it has only been a short time since the

Kelly, of the A.B.A., Secretary Dillon and even

present controversy with the Comptroller came

President Johnson himself.

to a head and trident supervision had previ­
ously worked well for decades.

In large measure through their efforts, the
three regulatory agencies recently entered the

Governor Robertson, a man of keen discern­

second stage of their dispute— the stage where

ment, feels that we have come to the end of the

they are meeting regularly at the conference

road in trying to cooperate and coordinate.

table. The Federal Reserve welcomes this op­

More important, even if cooperation is once

portunity. We have always felt that much more


present system has the

can be accomplished by negotiation at the table

built-in risk that today’s problems may be re­



than by fighting in the streets. For one thing,

peated in the future. He may indeed be right.

there is less need to save face and thus com­

Nevertheless, there is something that is built-in

promises come easier.

in my own personal fiber— a great tendency

I won’t bet on it but I have a feeling that

toward faith in the possibilities of human beings

regular interagency conferences-—with the Ad­

eventually to resolve their differences. I want

ministration, the A.B.A. and the entire banking

to try a bit longer. I know that the term “ ac­

industry watching the results— will usher in a

cord” is not new in our history. I like to believe

new era of supervisory cooperation. If this hap­

that this is not lack of courage on my part, but

pens I don’t think you will be hearing much

an expression of faith. It may indeed turn out

more about the need for a single agency. But

to be misplaced faith. The boundary between

I am not by any means sure of this.

idealism and realism is seldom clearly deline­

I have a banker friend who said he would

ated, and its location varies with individuals.

like to be for the Fed but he doesn’t know


business review

where it stands. Tonight I’ve tried to tell you

changes in bank supervision. We are for face-to-

where I stand and, insofar as I can gauge its

face negotiation and cooperation. If we finally

policies, where the Federal Reserve Bank of

find this does not work— then we may have to

Philadelphia stands. We are for observing the

turn to some other solution, perhaps the one

law until it is changed. We are for similar

suggested by Governor Robertson, or some var­

rules-of-the-game for all banks. By similar, I

iant of his proposal. I hope this doesn’t be­

do not mean that they necessarily be identical.

come necessary.

There is room for differences in a dual bank­

At this time and under present circumstances

ing system, and examination and evaluation of

we oppose a wholesale loosening of restrictions on

differences is often the very thing which leads

the way banks operate with other people’s money.

to progress. I agree, however, with Governor

To some this opposition may seem about as popu­

Robertson that “ Special privilege has no place

lar as being against motherhood. And, indeed, we

in the supervisory process.” We are for the

are against motherhood— except at the proper

most careful consideration of basic structural

time and under the right circumstances.

In celebration of its 50th anniversary, the Federal Reserve
Bank of Philadelphia announces publication of a commem­
orative pamphlet, "Fifty Years On Chestnut Street." A limited
number of complimentary copies is available to the public.
Requests should be addressed to Bank and Public Relations
Department, Federal Reserve Bank of Philadelphia, Phila­
delphia, Pennsylvania 19101.


by «l. Herbert Furth*
The dramatic improvement in the U.S. payments
balance since mid-1963 has become a matter of

P erm an e n t a n d te m p o r a ry causes
o f im p ro ve m e n t

general knowledge. The seasonally adjusted an­

The factors making for the improvement in our

nual rate of the deficit, as conventionally cal­

payments balance are partly permanent and

culated, has declined from $5 billion in the first

partly temporary.

half of 1963 and $1% billion in the second half

Our trade surplus has no doubt been en­

to as little as $500 million in the first quarter
of 1964.

hanced by the success of the United States in
keeping costs and prices relatively stable, and

The improvement from the first to the second

indeed far more stable than they have recently

half of 1963 was due mainly to a decline in net

been in most other industrial countries. Thanks

capital outflows. This decline in turn may be

to the moderation of business and labor leaders

attributed in part to the mid-July proposal of

as well as to public policies, including the mon­

the interest equalization tax, which greatly cur­

etary policies of the Federal Reserve, U.S. in­

tailed net purchases of foreign securities by

dustry appears to have regained some of the

U.S. investors; and in part to the mid-July ac­

competitiveness it had lost as a consequence of

tions of the Federal Reserve on the discount

the devaluation of the most important foreign

rate and on interest rates on time deposits,

currencies between 1949 and 1958, and of the

which greatly reduced and at times actually re­

creeping inflation of the ’forties and the early

versed outflows of money market funds into

and middle ’fifties.

Euro-dollars and into paper denominated in for­
eign currencies.

But the trade surplus has recently been fur­
ther increased by temporary factors, including

While complete details for the first quarter of

food sales to the Soviet area and, more impor­

1964 are not yet available, it seems that the

tantly, the fortuitous concurrence of an eco­

further improvement in that quarter was due pri­

nomic expansion in virtually all foreign indus­

marily to a further increase in our trade surplus,

trial countries and a hitherto rather modest

which in turn reflected a strong expansion in ex­

increase in U.S. production. The boom in Eu­

ports together with relative stability in imports.

rope, Canada, and Japan has not only stimulated

* Mr. Furth, A dviser on the staff of the Board of Governors
of the Federal Reserve System , presented this paper before
the Philadelphia E co n o m ists’ D isc u ssio n Group, Philadel­
phia, Pa., on M a y 19, 1964, at the Federal Reserve B an k of
Philadelphia. The paper reflects exclusively the author’s
personal views and m ust not be regarded as representing
the opinion of the Board of Governors of the Federal Reserve
System .


our exports to those areas but also improved
export earnings of raw material producing na­
tions, and thus helped to raise or maintain our
exports to less-developed countries as well. At

business review

the same time, the failure of our industrial pro­

But some of the recent improvements in cap­

duction to rise more rapidly has kept our raw

ital movements must be considered temporary.

material imports from increasing as fast as

As soon as the interest equalization tax is en­

would otherwise have been expected in a pe­

acted, U.S. investors will no doubt take advan­

riod of continued economic upswing.

tage of whatever loopholes may be found in the

Similarly, some of the reasons for the decline

bill. The recent expansion of bank loans to for­

in our net capital outflow are likely to prove

eigners may, to some extent, have already been

permanent. The measures taken in mid-1963

connected with an effort of foreign borrowers

have, I hope for good, dispelled any notion

to substitute bank loans for security issues.

that the United States did not care about its

These efforts may well become bolder, unless the

payments deficit, and was either unable or un­

banks themselves show some restraint in ac­

willing to do anything decisive about it. Today,

cepting such business. Moreover, the mainte­

little is heard about the alleged weakness of the

nance of ready credit availability in this coun­

dollar, about the danger of a dollar devaluation,

try, designed to sustain the impetus of expansion

about the need for an increase in the dollar

under conditions of persistent high unemploy­

price of gold or for flexible dollar exchange

ment of manpower and capital resources, may


well continue to encourage some spill-over of

Beyond this, a complete reassessment of the

funds into those foreign markets where profit

economic prospects of Europe and the United

and interest rates are likely to remain higher

States seems slowly to be taking place. Recent

than in the United States.

inflationary developments in Italy, France, the
Netherlands, and even Switzerland have raised

P a y m e n ts prospects fo r 1 9 6 4

doubts as to the basic economic stability of

In view of the temporary nature of many of the

these countries. Political prospects in Britain

factors responsible for the recent improvement

and some Continental European countries may

in our payments balance, few observers expect

appear uncertain. Even in Germany, action to

much further improvement for the rest of the

curtail the country’s persistent and excessive

year, and most of them expect some backsliding.

payments surplus may make the placement of
foreign funds less profitable.
Both short-term financial and long-range eco­

On trade account, any strong expansionary
effect of the tax cut on domestic economic ac­
tivity would almost certainly lead to a sharper

nomic considerations make it therefore less at­

increase in imports, even if we managed to pre­

tractive to shift U.S. funds to Europe. At the

vent prices and wages from rising faster than

same time it is to be hoped that the effects of

in recent years. At the same time, the anti-

domestic expansionary policies, and especially

inflationary measures now being taken in Japan,

of the recent tax cut, will make investments at

France, Italy, and the Netherlands, and to a

home more attractive. In this way, the seepage

lesser degree in Britain, may well prevent our

abroad of funds not only for short-term and

exports from expanding further, or at worst

portfolio placement but also for direct invest­

actually depress them. These measures may af­

ments may be permanently reduced from the

fect not only our direct exports to these coun­

unusually high levels of recent years.

tries but also our exports to the less-developed


business review

areas whose import capacity depends consider­

cates that despite the recent improvement our

ably on their raw-material sales to other in­

payments problem is probably far from having

dustrial countries. Needless to say, if our prices

been solved for good. Thus, we are confronted

and costs were to get out of control, our entire

with two basic policy questions:

trade and payments position would deteriorate

should be the goal of our payments policy? And

much more seriously.
On capital account, the main problem may

first, what

second, how should we try to achieve its pur­

well be the future course of European monetary
P ay m e n ts equilibrium

policy. The Ministerial Council of the Common
Market has recently advised its members to give

Surely, the goal of payments policy is long-run

price stability for the time being priority over

payments equilibrium. The Review Committee

all other policy goals. Should the member coun­

for Balance of Payments Statistics (chaired by

tries decide to follow this advice, they might

Mr. E. M. Bernstein), whose report is expected

well take harsh restrictive measures that could

to be published within the next few weeks, will

disturb the international money and capital mar­

presumably solve the problems of the proper

kets as badly as the German and the Netherlands

statistical definition and presentation of our

revaluations did in 1961. Sharply restrictive

payments balance. But whatever definition the

monetary policies could raise interest rates in

Committee chooses to recommend for our Sta­

those countries so much that the United States

tistics, the problem will remain of what kind of

might be compelled to choose between three al­

payments equilibrium should be the objective of

ternatives: to raise its interest rates to levels

our policies.

that would be higher than considered desirable

One such objective might be just to avoid a

in view of the needs of our domestic economy;

decline in our gross monetary reserves, espe­

or to take more drastic measures than the pro­

cially in the U.S. gold stock. This was a main

posed IET to isolate domestic interest rates and

policy goal under the so-called classical gold

money and capital markets from developments

standard. But even today European observers

abroad; or to permit a substantial rise in the

assure us that the typical European banker bases

outflow of U.S. funds into foreign money market

his views of the U.S. economy primarily on the

instruments, loans, and securities. Each of these

weekly figures of changes in the U.S. gold stock.

alternatives could interfere either with further

On the other extreme it might be contended

economic growth at home, or with the smooth

that we should be satisfied with maintaining the

working of the international payments system,

international wealth of the United States intact.

or with both.

If this were all that was needed, we would have

While the newly developed instruments of in­

reached our goal long ago. For the past six

ternational monetary consultation and coopera­

years, the international wealth of the United

tion, together with the common sense of the

States has actually increased, as our net for­

Europeans themselves, should make impossible

eign investments (including reinvested earnings

any such return to the beggar-my-neighbor pol­

of U.S. subsidiaries that do not appear in U.S.

icies of the Great Depression, this survey of pay­

payments statistics) have substantially exceeded

ments prospects for the rest of the year indi­

the cumulative payments deficit.


business review

The third and most generally accepted view

ally as the equal of foreign official holdings.

is that payments equilibrium refers neither to a

This consideration would lead to measuring

country’s gold reserve alone nor to its interna­

our payments position on the so-called “ official

tional wealth but to its international net liquid­

settlement” basis, i.e., by the changes in gross

ity position. Any individual enterprise would

reserves minus liquid claims of foreign mon­

get into payments difficulties if it concentrated

etary authorities on us. There is only one draw­

either purely on its cash assets or on its total

back to using this concept in determining our

net asset position, and neglected the relation

policy goal. While foreign private holdings are

between liquid assets and liabilities. In the same

in general genuine working balances, there still

way, a country gets into payments difficulties if

are important cases in which a central bank, for

it concentrates either on its gold stock or on its

good or bad reasons, may increase or decrease

total net international assets, and neglects its

its dollar reserves by acquiring the dollar hold­

net international liquidity.

ings of the country’s commercial banks or by

But which of the various methods of com­

shifting its own dollar holdings to the commer­

puting our net liquidity position seems to pro­

cial banks. On the “ official settlement” basis,

vide the best guideline for policy? We are ac­

such purely internal transactions of a foreign

customed to deduct from our gross reserves the

central bank would affect U.S. payments pol­

liquid claims of all foreigners, official and non­

icies, although they may have obviously nothing

official alike. This method was appropriate at a

whatsoever to do with U.S. international transac­

time when most important foreign countries had


exchange controls so that dollar holdings of for­
eign bankers or businessmen were hardly any­

at stabilizing U.S. international net liquidity on

thing but official holdings, temporarily shifted

the broadest possible basis: considering on the

into private hands. But today this is not the

liability side changes in liquid claims on the

For these reasons it may be preferable to aim

case. Foreigners usually hold balances not as

U.S. financial system of both foreign monetary

formal or material agents of their central banks

authorities and foreign non-official holders; but

but because they decide that they need these bal­

similarly on the asset side changes not merely

ances as investments and for working purposes.

in U.S. official reserves but also in liquid claims

Thus, their liquid dollar holdings are more

on foreigners of U.S. private financial institu­

similar to the holdings of domestic merchants,

tions. As long as foreign private dollar holdings

bankers, or individual investors. They might in­

rise in harmony with an increase in U.S. liquid

deed become a drain on U.S. reserves, if their

claims on foreigners— say, because a U.S. bank

holders transfer them one day to a foreign mon­

and a foreign bank establish mutual accounts;

etary authority. But, since we have full do­

or because a U.S. investor acquires a foreign

mestic convertibility, U.S. holders of dollars are

money-market instrument or a deposit with a

also free at any time to transfer their holdings

foreign bank; or because a U.S. bank makes a

to a foreign central bank and thus to create a

short-term loan to a foreigner— the U.S. net

potential drain on U.S. reserves. We have, there­

liquidity position is not substantially altered,

fore, no longer a compelling policy reason for

and there is usually no reason for such a trans­

treating foreign private dollar holdings gener­

action to influence U.S. payments policy. Sim-


business review

U.S. BALANCE OF PAYMENTS, 1963/1 - 1964/1
(Millions of dollars)
1st Qtr.
Decline in U.S. reserves


(foreign convertible currencies)
(IMF gold-tranche position)
Increase in bank-reported liquid
liabilities to foreigners
Sales of non-marketable Government bonds
Special government receipts
Seasonal adjustment

equals (1) Conventional Deficit
(1) minus Increase in bank-reported liquid
liabilities to non-official foreigners
equals (2) "Official Settlement" Deficit


2nd Qtr.


3rd Qtr.

4th Qtr.

1st Qtr.



( 111)
(-3 3 )
(-4 6 )

( 6)
( 2)

( 196)
(-2 8 )
( 59)

( 38)
(-5 8 )
( 15)

(-2 2 8 )
( 131)



-4 4 5


-1 5 5
- 55










-1 3 7




(1) minus Increase in bank-reported shortterm claims on foreigners
(seasonally adjusted)

-6 3





equals (3) " Total Net Liquidity" Deficit





-2 9 8

Sources: Departm ent of Comm erce, Business News Reports, released M ay 15, 1964; Federal Reserve Bulletin, M a y 1964 (for
liquid liabilities to non-official foreigners).

ilarly, if a foreign central bank shifts some of

method, U.S. policy has perhaps— unconsciously

its dollar holdings to a commercial bank, or

— recognized the validity of the broader basis.

vice versa, the U.S. net position has not changed

Ever since the successful tightening measures

and U.S. payments policy should not usually

taken in July 1963, both fiscal and monetary

be affected. In contrast, if aggregate foreign

policies have returned to an expansionary rather

liquid dollar holdings rise without a comparable

than restrictive posture. Thus it might be argued

rise in U.S. liquid claims on foreigners— say, as

that the authorities have in fact acknowledged

a result of a U.S. deficit on current account, or

the virtual disappearance of a disruptive pay­

because U.S. public and private long-term invest­

ments deficit.

ments abroad exceed our surplus on current ac­
count— then the U.S. payments position seems

Tools o f p a y m e n ts policy

indeed to suffer from a disturbance which, if

Still, as long as we must face the possibility of

large or presistent, would require correction.

a renewed deterioration of our payments bal­

It is interesting to note that the cumulative

ance, and thus the reappearance of a deficit also

payments defict for the period from mid-1963

on the “ total net liquidity” basis, the question

to the spring of 1964 has remained substantial

of the best way to correct such a defict remains

both on the conventional and the “ official set­

important. Barring changes in government ex­

tlement” basis but has nearly vanished on the

penditures abroad— which should be reduced to

“ total net liquidity” basis.* And whereas U.S.

the minimum compatible with the requirements

payments statistics have adhered to an outdated
* See the appended table.


of U.S. military and diplomatic goals, regard­
less of our payments balance— there are only

business review

two ways in which our payments deficit can be

guised form of exchange controls and as a bar­

corrected: by increasing our surplus on cur­

rier to free international commerce. The first

rent account, and/or by decreasing our deficit

criticism seems unwarranted. Taxes differ from

on capital account.

direct controls in that they keep the market

Obviously, a necessary but not sufficient con­

mechanism in force. If a foreigner is willing to

dition for an adequate surplus on current ac­

borrow in the United States at an effective in­

count is a stabilizing domestic policy, designed

terest rate one per cent higher than he would

to maintain or improve our international com­

have to pay otherwise, he remains free to do so.

petitiveness. Assuming such a policy, however,

The proposed tax is, in substance, a tariff rather

our imports will depend basically on the pace of

than an import quota.

our domestic economic expansion; and our ex­

It is true, however, that the tax tends to cur­

ports on the level of economic activity abroad.

tail international capital movements— in fact, it

Surely, nobody would recommend policy meas­

is purposely designed to do so. But this cur­

ures that would seriously hamper sustainable

tailment seems to be less objectionable than a


curtailment of the free movements of goods.



and there is

hardly any way for domestic policy to raise the

Import duties or export subsidies are harm­

level of economic activity abroad. Hence— al­

ful because they impair not only the optimum

ways taking generally stabilizing policies and of

international division of labor but also the op­

course the maintenance of the dollar’s par value

timum distribution of domestic resources. Im­

for granted— our current accounts are not easily

port duties, for instance, protect some less ef­

susceptible to rapid improvement by specific pol­
icy action.

ficient domestic industries by raising the costs of
the other more efficient industries, including those

Thus, the main burden of measures seeking

of the most efficient export industries. Thus, they

rapidly to correct the payments balance may

tend to reduce domestic national production and

well, at least in the short run, fall on capital

income below their potential maximum.

movements. If the preceding analysis is correct,

A tax on capital exports may impinge upon

short-term capital movements, which create liq­

the optimum international allocation of capital

uid assets as well as liquid liabilities, are of

but it does not substantially discriminate among

little longer-run importance. Adverse short-run

domestic industries. To the (negligible) extent

effects, including disturbances in the exchange

that it might lower the costs of capital-intensive

markets and losses of gold reserves, can be

industries more than those of labor-intensive

averted by policies affecting interest-rate differ­

industries, it would usually favor the more mod­

entials, and especially by such instruments of

ern and more rapidly expanding and thus prob­

international financial cooperation as the Fed­

ably more efficient industries. And even interna­

eral Reserve swaps. Longer-run policy may well

tionally, such a tax need not hamper the opti­

focus mainly on avoiding excessive outflows of

mum division of labor in those cases in which

long-term credits and investments.

capital may be attracted to foreign countries

The proposed interest equalization tax may

not because of higher productivity but on ac­

be considered as a tool of such a type of policy.

count of a higher degree of domestic protection,

The proposal has been attacked both as a dis­

a less equitable tax system, or a distribution of


business review

the national income favoring capital over labor.

fiscal and monetary policy.

But if policies designed to speed adjustment

Any attempt at such policy reorientation may

to payments imbalance were to shift their em­

well prove impracticable. But if ways could be

phasis from current account to capital account,

found to make such a policy operative, it might

many problems would have to be solved. In fact,

become possible not only to hasten the restora­

virtually no effort has yet been made to deter­

tion of our international balance but also to free

mine under what conditions such policies would

our domestic policy, and especially our mone­

seem to be necessary or advisable; under what

tary policy, from some of the restraints imposed

conditions they might be expected to be suc­
cessful; how they could be made administra­

by a payments deficit. Thus, we might be better
able to pursue the main task of monetary policy,

tively effective; and what side-effects they might

to promote, under conditions of price stability,

have on domestic and international economic

“ maximum employment, production, and pur­

activities, and especially on the relation between

chasing power.”

In a series o f articles entitled “ How Banking Tames Its Paper Tiger ” beginning with the
May, 1 9 6 0 issue o f the B u s in e s s R e vie w , we reported on electronic banking. W e said that we
were going to be a guinea pig by installing electronic check-clearing machinery; herewith
a follow-up progress report.

Scads of sitting money and slews of flitting

A pretty girl touches a button on a machine,

money are the two most amazing sights seen

called a reader-sorter, not much larger than a

by visitors touring through the Federal Reserve

commercial food freezer. A starry constellation

Bank of Philadelphia. The sitting money— coins

of little lights begins to twinkle to the accom­

and currency— is heavily vaulted and guarded

paniment of a muffled electronic chatter. Behind

in the cellar, awaiting the call of business. The

a clear plastic shield, checks begin cascading

flitting money— checks and money orders— is

into rows of pockets. Racing through the ma­

never at rest, is forever in motion on the third

chine at a prodigious speed in excess of 1,000

floor. The mounds of money in the vault be­

a minute, the checks have the appearance of a

token solidarity. The ever-flowing cataracts of

continuous ribbon of paper. The machine spouts

checks upstairs reflect the vigor of a pulsating

simultaneously eight paper tapes of meaningful

economy. This article is about all the commotion

numbers, each tape emerging at a rate of 1,300

on the third floor.

lines a minute. The entire process is directed


business review

and controlled by an electronic brain built and

country’s millions of checking accounts are ge­

trained for the job. The mechanism— called


Check handling


more than 13,000 commercial banks. With mil­

Systems (CHIPS, for short)— enabled the Bank

lions of people writing checks daily, directing

to process 260 million checks and money or­

thousands of banks to pay their bills for them

and /nformation





ders last year. That was at the rate of three-

and with millions of recipients of checks daily

quarters of a million checks daily.

calling on their banks to collect the funds of

Time was when coins and currency performed

checks deposited, there is a tremendous amount

the biggest share of the country’s money work,

of behind-the-scenes clerical work required in

but no longer. Coin and currency are now only

the use of checkbook money. In the parlance of

pocket-and-purse stuff; the heavy-duty money

the trade, this function of commercial banking

function of the economy is performed by check­

is known as clearing and collection.

ing accounts, with checks as their emissaries.

In numerous local communities this clearing

The country’s commercial banks boast of more

and collection is simplified by means of a clear­

than 60 million checking accounts, and the num­

ing house. The members of the Philadelphia

ber is steadily rising. Checkbook money runs

Clearing House, for example, meet daily at an

into the billions, and the dollar value it per­

appointed hour to exchange checks drawn on

forms runs into the trillions.

each other and make settlement for net balances
only. That eliminates needless transfer of funds,

“ P a y to the o rd e r o f ”

and saves much time and trouble.

The easiest way to pay a bill left by the postman
is to write a check and dispatch it by return

Out-of-town checks, however, present a dif­
ferent problem. Collection of these is made

mail to the creditor. When you drop the letter

through intermediate collecting banks, such as

in the mailbox, you consider the bill paid. But

correspondent banks and Federal Reserve Banks.

the process of paying the bill has only begun,

Here at the Fed of Philadelphia, checks in bun­

because you have merely ordered your bank

dles, batches, and packets from our member

to pay the bill for you. When your creditor re­

banks arrive at all hours of the day and night

ceives your check, he will deposit it in his bank,

for collection. Each bundle is accompanied by

whereupon he also considers the bill paid. But

a statement listing the amount of each check

the transaction is not completed until the check

in the group together with the total.

comes home to roost.
Completion of such a transaction initiated by

M a n u a l c le arin g a n d collection

the drawer of a check would be comparatively

Octogenarian bankers remember when they as

simple if there were only one big bank with

young clerks sat on high chairs, wore green

regional branches in every community through­

eyeshades, dipped their steel penpoints into ink

out the country. Theoretically, the bank could

bottles, and sorted checks by hand. To add the

finish the job with an elementary bookkeeping

columns they had to be nimble with numbers.

transaction— crediting the account of the de­

The arrival of adding machines, which pre­

positor and debiting the account of the drawer.

ceded sorting machines, eased the wear and

Alas, it is not so simple as that because the

tear of the head but not of the hands. Let us


business review

begin with a short and quick flashback to the

significant reduction from the four to six passes

adding-machine era.

required under the old manual check-handling

In clearing and collecting at the Fed, the first
step was to list the checks on an adding machine


in order to prove that the checks enclosed were
equal to the amount indicated on the accom­
panying deposit slip. The next operation was
to sort the checks by hand. Four to six separate
sorting steps were necessary before placing the
checks into the bank-of-origin group. After each

system. The average proof-machine

of these sorting steps, the checks were relisted

could do both sorting and listing of 1,300 checks

on an adding machine to keep the checks

an hour, which resulted in a material reduction
in cost.

in proof during the operation. Finally, a list of
the amounts of the individual checks was prepared to accompany the



Electronic c le arin g a n d collection
So great was the increase in volume o f checks

batch of checks when AND SO RTIN G RACK
they were presented to

flowing into this Bank that proof machines soon

the bank on which they

became tinged with obsolescence. Thereupon a


still more efficient mechanism was devised—

worker under this sys­

namely, automation with the help of electronics.

tem would be able to

These machines, as already mentioned, are not

sort about 2,000 checks

very big but they are “ fantabulous.” Their cost,




an hour on a rack, or

whether bought or rented, is fantastic and their

list about 1,800 checks

performance on the job is fabulous. The mech­

an hour on an adding machine.

anism has a highly sensitive nervous system

With the passing of time, the volume of

which is plainly discernible by the unbelievably

checks coming into the Fed steadily increased;

high speed with which the check-sorting opera­

so that more efficient means of clearing and

tion is performed. The most amazing part of

collecting had to be devised.

the machine, however, is the computer which
supervises the sorting as well as the listing, and

M e ch a n iz e d cle arin g a n d collection

adding of subtotals and grand totals— in fact,

A major improvement was achieved with the


introduction of proof machines. A proof ma­

The computer is often referred to as the

chine is a combination of an adding machine,

brain, which is a bit of poetic license. The com­

an endorsing dial, and a rotor device with mul­

puter is brainy only in the sense that it has a

tiple pockets to speed the sorting. The keyboard

prodigious memory on which it can call for

enabled the operator to make a tape listing and

useful information with the speed of lightning;

to drop each check automatically into the des­

and when we say “ with the speed of lightning”

ignated pocket. The proof machine reduced the

we are not indulging in hyperbole— it is the

listing and sorting of checks to two passes— a

naked truth. Lack of imagination is the com-


business review

puter’s greatest shortcoming in its frequent anal­

dashes, colons, and stuttering quotation marks.

ogy to the human brain; but it will perform
most magnificently when given specific instruc­


tions by people experienced in the job to be done.

All of the Arabic numerals and symbols are

The first thing that must be done in teaching

clearing and collection instructions in language

CHIPS to assist in
, ,
the clearing and col­

that the computer

lection of checks is

can understand —
called MICR (Mag­


to give instructions

netic 7nk Character

in its own language.

Recognition) .Mag­



netic ink is just

English and it can’t

what it says; you

even think in Eng­

can’t see the mag­

lish; it thinks and


speaks in numbers

there, and all the

and symbols.




The chances are



that sometimes since

something. For ex­

the 60’s you have

ample, in the group
to the extreme left




grotesque numerals
and arabesque sym­

is the routing symbol-transit number— that is

bols in the lower-left

group of symbols contains, among other things,

border of the checks
supplied by your

the account number of the person who drew the


is reproduced

to say, the bank’s electronic address. The middle

check. The group of symbols on the lower-right
o u t g o in g to payor banks

include the dollar amount of the check in plain


English, which you can read, and also in symbols

memory. You will note that the numerals all

which the computer can read. The amount of the

have a characteristic angularity and some of

check obviously cannot be preprinted because

them are heavy in the hips. When the bank

only the drawer of the check knows what it will


be. After the check has been issued the amount











must be encoded in


magnetic ink by the

statement there may
also be some mystic

first bank in bank-


numbers and symbols


^ £ _ 19£ 2



Some of the symbols



collection channels if
the check is to be


border of the checks,

5 6 -7 8 9 0




• :i2m « 78R0 i:


processed by a reader-


/oooo iqsqotv

Now for a slow-motion picture of what


business review

happens when the girl on the third floor at the
Fed feeds checks to CHIPS. She places a pile of
checks into the feed-box of the reader-sorter and


as the first check in the parade passes under the
electronic reading head the first character of
the MICR generates an electric impulse which
is transmitted to the computer. Scratching his
head, the electronic computer is heard to mur­
mur to himself (electronically of course), “ Oh
oh, here is a piece of paper; what’ll I do with
it?” Quick as a flash, his infallible memory
comes to his aid and directs the reader-sorter
to place the check in the proper pocket. At
intervals in millionths of a second the other
magnetized characters flashing by call for yet


While the computer-controlled, reader-sorter is

upon it records the dollar amount of the check





the Collection Department’s wunderkind which

in its memory and directs the lister-printer to

attracts all the attention and admiration, its

print the amount of the check on a master list

magic performance relies heavily upon other

and the bank’s electronic address, together with

machines in the Department.

a running total of the dollar amounts of the

In the southwest bay of the third floor is a

checks dropped in each of the pockets and

squadron of about 40 neat little machines, some­

a grand total of all of the checks in all the



music but they perform the necessary orches­






CHIPS does its work with ever so much

tration for the reader-sorter. From midnight

greater efficiency than its predecessor proof ma­

until 8 o’clock in the morning, members of the

chine. This electronic marvel processes 63,000

night force operate these machines, which in­

checks an hour versus 1,300 an hour by the

scribe electronic characters on the checks so

proof machine. And the machine has never re­

that they can be processed electronically when

quested a stop for a coffee break.

people on the day shift take over. Check col­

Installed in January, 1961, CHIPS has pre­
vented the Bank from being inundated by the

lection never stops; it is a round-the-clock op­

ever-increasing volume of check clearing. Checks

The recently installed power file is another ex­

which are not machineable, either because they

ample of a supporting mechanism. A file for

are not MICR qualified or are wrongly encoded

storing papers is no glamor gadget, but it is an

or are rejected by CHIPS for any other reason,

indispensable part of the check-clearing mech­

continue to be processed through the proof ma­

anism. Into its cavernous interior, trays of

chines. Now, however, electronic machines proc­

checks are constantly deposited for storage while

ess daily 85 per cent of the checks going through

awaiting their turn for passage through the

the shop.

reader-sorter. When a specific tray of checks is


business review

needed for further processing, it is called forth

So soon old

to the delivery window of the power file by the

The Pennsylvania Dutch have a saying, “ You

mere pressing of a button. But for the power

get so soon old and yet so late smart.” This

file the electronic crew would be floundering

earthy aphorism is even more applicable to elec­

knee-deep in checks.


W o m e n a n d m achines

Smart as these machines are, they are soon out­

Much has been written about men and machines,

smarted by their successors.

but here at the Fed most of the machine opera­






A few paragraphs ago it was pointed out


that the computer-controlled, reader-sorter began

proved themselves particularly adept to the elec­

working here in January, 1961. That machine,

tronic age. Complicated and sensitive as some

known as 1412, was replaced by an improved

of these machines are, the women acquire the

model (1419) in April, 1963 and it has already

necessary competence and skill in a compara­

attained old age and is about to be replaced by



women— young



1421— the latest design. The new 1421 has a

tively short time.
Contrary to what might be expected, the

vastly improved memory; it has the capacity to

of check

memorize 8,000 characters, in contrast with the

clearing has brought no displacement of work­

4,000 capacity of the incumbent. To install the

ers. Current employment in the Check Depart­

new machine without interrupting the flow of

ment is virtually at the same level which pre­

work requires a prodigious amount of detailed

vailed at the time of installation of CHIPS three

planning in advance. Upon completion of the

years ago. What has happened is that a much
larger volume of checks is now handled more

installation, the new machine will probably serve

expeditiously than formerly. Throughout the en­

still brainier model. Of the growth in check­

tire day the processed checks, in bundles of all

book money and the ever-changing technologi­

sizes, leave the Fed on rigidly maintained sched­

cal improvements to handle it there appears to

ules— hurrying back to their banks of origin.

be no end.

mechanization and


for a year or two before being replaced by a


F O R THE R E C O R D . . .

Third Federal
Reserve District

United States

Per cent change

Per cent change






Per cent
April 1964

Per cent
April 1964

Per cent
April 1964

Per cent
April 1964

Apr. 1964



Apr. 1964







+ 6

+ 6


+ 11

-1 8

-1 1









+ 16




Philadelphia. . . .








+ 12











+ 14

+ 11

+ 7
+ 12





+ 13



+ 10


- 8
+ 17
+ 11






+ 14



+ 13






Lehigh Valley. . .







+ 7
- 2
+ 2




+ 3

+ 9

+ 14

+ 8

+ 3

+ 4

+ 4


+ 2


+ 11

+ 8

Electric power consumed.......



Employment, total..................
W a ge income*.....................
C O N S T R U C T IO N **................
CO AL PR O D U C T IO N ..............
Department store sales..........
(All member banks)
U.S. Govt, securities.............
Check payments....................






+ 2

+ 5
+ 9
+ 2




+ 5



— 1



+ 1 + 19 + 2 0
+ 7t + 5t + st



+ 2


+ 7
+ 14
- 1
- 8
+ 14

•Production workers only.
••Value of contracts.
•••Adjusted for seasonal variation.




+ 2J


+ 1
+ 2


f20 Cities
























+ 1


+ 11

-1 0



+ 1



+ 10




+ 16


Y o rk ...............





+ 13






Wilkes-Barre. . .






*N o t restricted to corporate limits of cities but covers areas of one or more
tAdjusted for seasonal variation.