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The U.S. Balance of Payments—Present and Future How the Fed Helps Checks to “Hurry Back” BUSINESS REVIEW 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. THE MUDDLE IN BANK SUPERVISION 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 ulations. 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, 3 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.” 7. 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 agrees. 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 disagreed emphatically and 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 4 business review curity and the appropriateness of the purpose for which credit is sought. new services, ranging from lock boxes to jo b accounting. Competition for 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 they 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 5 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 again present system has the can be accomplished by negotiation at the table built-in risk that today’s problems may be re resumed, the 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 6 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. 7 THE U. S. BALANCE OF PAYMENTS - PRESENT AND FUTURE 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 . 8 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 rates. 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 9 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 pose? 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. 10 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 tions. 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- 11 business review U.S. BALANCE OF PAYMENTS, 1963/1 - 1964/1 (Millions of dollars) 1963 1st Qtr. Decline in U.S. reserves plus plus plus plus (gold) (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 32 2nd Qtr. 1964 3rd Qtr. 4th Qtr. - 1st Qtr. 124 227 ( 111) (-3 3 ) (-4 6 ) (116) ( 6) ( 2) ( 196) (-2 8 ) ( 59) ( 38) (-5 8 ) ( 15) ( 46) (-2 2 8 ) ( 131) 320 413 45 339 918 142 29 89 187 80 346 -4 4 5 155 24 264 17 -1 5 5 - 55 150 247 1,149 1,302 395 455 136 394 755 142 1,160 38 357 29 426 273 -1 3 7 5 - 51 (1) minus Increase in bank-reported shortterm claims on foreigners (seasonally adjusted) -6 3 488 8 267 434 equals (3) " Total Net Liquidity" Deficit 1,212 814 387 188 -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. 12 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 domestic curtailment of the free movements of goods. economic expansion; 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 13 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. HOW THE FED HELPS CHECKS T O “HURRY BACK” 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 14 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 ographically Check handling Processing 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 scattered among the country’s 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 15 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 P R O C ESSIN G CHECKS BY PROOF M A C H IN ES 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 MACH|NE operator 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 good 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, were drawn. A 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 everything. 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- 16 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 M IC R 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 ELECTRONIC CHECK H A N D LIN G SYSTEM lection of checks is can understand — called MICR (Mag INCOMING CHECKS to give instructions netic 7nk Character in its own language. Recognition) .Mag It speak 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 netism speaks in numbers there, and all the and symbols. characters doesn’t numbers The chances are but it’s and mean that sometimes since something. For ex the 60’s you have ample, in the group to the extreme left become aware of 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 bank. check A sample 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 your 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 returns be. After the check has been issued the amount an your here cancelled end-of-the-month to checks refresh along with must be encoded in M)CR CHECK magnetic ink by the statement there may also be some mystic first bank in bank- CITY, STATE numbers and symbols on the ^ £ _ 19£ 2 illustrated here. Some of the symbols look like upended collection channels if the check is to be lower-right Dollars border of the checks, as 5 6 -7 8 9 0 1234 NAME OF YOUR BANK sorter. C ITY, STATE • :i2m « 78R0 i: i2aa«i.&s?»* processed by a reader- a«.t /oooo iqsqotv Now for a slow-motion picture of what 17 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 AVERAG E DAILY VOLUME OF CHECKS PROCESSED, 1963 THOUSANDS 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 more where While the computer-controlled, reader-sorter is upon it records the dollar amount of the check decisions from the computer, 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 what pockets. music but they perform the necessary orches resembling spinets. They produce no 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 eration. 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 18 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. tronic 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 mechanisms than to their operators. A few paragraphs ago it was pointed out have 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 tors are women— young women who 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 electronification for a year or two before being replaced by a 19 F O R THE R E C O R D . . . Third Federal Reserve District United States Per cent change Per cent change Department Storef Factory* Employ ment Payrolls Sales Check Payments Per cent change April 1964 from Per cent change April 1964 from Per cent change April 1964 from Per cent change April 1964 from SU M M ARY Apr. 1964 from mo. ago year ago 4 mos. 1964 from year ago 4 Apr. 1964 from LO CAL W nMNUBd mo. ago year ago mos. 1964 from year ago + 1 + 6 + 6 1 + 11 -1 8 -1 1 Lancaster......... 0 -1 0 + 8 + 4 + 16 + 5 +17 Philadelphia. . . . 0 -1 0 + 1 - 4 + 12 + 3 + Reading.......... 0 +2 1 +13 + 2 + 14 + 11 + 7 + 12 Scranton.......... 0 +2 0 + 13 - 3 + 10 0 0 - 8 + 17 + 11 Trenton........... 0 +2 + 2 + 14 - 6 + 13 +45 2 - mo. ago year ago Lehigh Valley. . . +i Harrisburg....... -i M ANU FA C T U RING i 5 + 7 - 2 0 + 2 +10 +54 +23 + 3 + 9 + 14 + 8 + 3 + 4 + 4 - + 2 - + 11 + 8 Electric power consumed....... 0 0 0 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 .............. TRADE*** Department store sales.......... B A N K IN G (All member banks) Deposits.............................. Loons.................................. Investments.......................... U.S. Govt, securities............. Other............................... Check payments.................... + 3 + + + + 6 1 1 + 2 + 5 + 9 + 2 - - 0 + 5 1 +10 0 — 1 6 6 + 1 + 19 + 2 0 + 7t + 5t + st + - 0 1 1 3 1 + + 2 3 + 7 + 14 - 1 - 8 +15 + 14 PRICES Consumer............................ •Production workers only. ••Value of contracts. •••Adjusted for seasonal variation. ot + n + 2J 0 0 + 1 + 2 + f20 Cities ^Philadelphia 0 1 year ago +2 + + +2 + + 2 mo. ago year ago 4 2 mo. ago year ago + + 8 7 4 +22 0 + 7 2 + 1 - + 11 -1 0 Wilmington...... 0 + 1 + 1 + 10 + 1 +25 + 16 + Y o rk ............... 0 +4 + 1 + 13 + 7 +13 +29 +41 Wilkes-Barre. . . -1 mo. ago - 2 0 *N o t restricted to corporate limits of cities but covers areas of one or more counties. tAdjusted for seasonal variation.