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38 MONTHLY REVIEW, MARCH 1968 T r e a su r y an d F e d e r a l R e s e r v e F o reig n E x c h a n g e O p e r a tio n s* By C h arles A. C o o m bs The shock effects on international financial markets of clear that no other major currency would follow. the cut in the sterling parity from $2.80 to $2.40 on No As expected, however, the sterling devaluation triggered vember 18, 1967 dramatically illustrated some of the rea heavy speculative buying on the London gold market and sons why the British government, the Bank of England, and massive flows of funds across the exchanges. To deal with monetary authorities throughout the world had fought for these problems, the governors of the central banks of Bel the previous three years to stave off such a devaluation of gium, Germany, Italy, the Netherlands, Switzerland, the the pound. Without the strenuous effort made by the Labor United Kingdom, and the United States convened in Frank Government to defend the $2.80 parity by severe domestic furt on November 26, 1967. As noted in their subsequent restraint programs, reinforced by foreign financial support, communique, they “took decisions on specific measures to sterling might have collapsed in disorder long before, with ensure by coordinated action orderly conditions in the ex far more damaging repercussions on world trade and finance. change markets and to support the present pattern of ex As it was, the decision of the British government last change rates based on the fixed price of $35 per ounce November to reinforce its program of shifting resources of gold”. from domestic to export uses by a moderate devaluation of In addition to continuing operations in the London gold sterling was a deliberate, careful judgment based on pro market, the Frankfurt meeting approved a number of spective balance-of-payments trends. The very choice of specific new measures designed to deal with the danger the new $2.40 parity, a rate cut which provided a fully ade ously heavy flows of funds into central bank reserves quate stimulus to British overseas trade without simulta that had been set off by the sterling devaluation. These neously forcing any other major currency into a competitive included agreement on a massive expansion of the Federal depreciation, was in itself evidence of the remarkable Reserve swap network, from $5,030 million to $7,080 development of international financial cooperation in re million. Most of the increases in individual swap lines were negotiated and announced within a few days’ time. cent years. Much advance thinking had, of course, been done on Thus strengthened, the Federal Reserve swap network the damage-control measures that would be required in readily accommodated sizable additional drawings by the the event of a devaluation of sterling, and there was an Federal Reserve in order to absorb flows of “hot” money immediate closing of the ranks among the major industrial into the reserves of member central banks in the network. countries. By the end of the first week after the devaluation By late December 1967, such Federal Reserve drawings had of sterling, a series of official announcements had made it risen to a record level of $1,791 million, of which $650 million was in Swiss francs drawn from the Swiss National Bank and the Bank for International Settlements (BIS), $500 million was in Italian lire, $350 million in German marks, $170 million in Dutch guilders, and $121 million in * This report, covering the period October 1967 to March 1968, Belgian francs. These drawings were made in the expecta is the twelfth in a series of reports by the Vice President in charge of the Foreign function of the Federal Reserve Bank of New York tion that much of the heavy flow of funds to continental and Special Manager, System Open Market Account. The Bank European central banks would be reversed, as the shock acts as agent for both the Treasury and Federal Reserve System in effects of the British devaluation began to wear off and the conduct of foreign exchange operations. FEDERAL RESERVE BANK OF NEW YORK the United States took measures to protect the dollar. On January 1, President Johnson announced a drastic program to improve the United States payments balance. Reflows of funds out of continental European currencies subsequently developed in heavy volume, enabling the United States authorities to make very sizable paydowns on their short-term commitments. In addition to such re flows, the United States Treasury drew $200 million of continental European currencies from the International Monetary Fund (IMF) and issued $166 million of foreign currency securities. As a result, by early March the debt to foreign central banks incurred by the Federal Reserve had been reduced by $1,234 million to a currently outstanding level of $557 million. As noted in Table I, Federal Reserve swap commitments outstanding as of March 8 consisted of $325 million in Italian lire, $132 million in Swiss francs, $65 million in Dutch guilders, and $34.5 million in Belgian francs. Among the increases in the Federal Reserve swap net work announced shortly after the British devaluation was a rise in the swap line with the Bank of England from Table I FED ER AL RESERVE RECIPROCAL CUR R EN C Y ARR A NG EM EN TS A N D COMMITMENTS Institution Amount of facility March 8, 1968 Federal Reserve commitments September 1, December 27, March 8, 1967 1967 j I 1968 Millions of dollars A ustrian N atio n al B an k .............. N atio n al B ank of B elgium .......... 100 225 B ank o f C an a d a ............................. 750 N atio n al B ank of D e n m a r k ...... Millions of dollars equivalent 100 1,500 B ank of E n g lan d............................ B ank o f F ra n c e ............................. 750 B ank of I t a l y ................................. 750 B ank of J a p a n ................................ B ank of M e x ic o ............................. N etherlands B an k .......................... 225 34.5 750 130 B ank of N orw ay............................ 120.8* 100 G erm an F ed eral B an k ................. 120.0 100 350.0 500.0 325.0 20.0 170.0f 65.0 B ank of Sw eden............................. 200 Swiss N ational B an k ................... 1 400 173.0 250.0 77.0 400 200.0 400.0 55.0 513.0 1,790.8 556.5 Bank for In tern atio n al Settlem ents: Swiss fr a n c s /d o lla rs ................ A uthorized E u ropean c u rre n c ie s/d o lla rs ................... T o ta l......................................... 1 600 7,080 ! * P eak com m itm ent of $150 m illion reached on N ovem ber 13, 1967. Peak com m itm ent of $185 m illion reached on Jan u ary 4, 1968. * 39 $1,350 million to $1,500 million. In addition to this $150 million increase in the Federal Reserve credit line, new facilities totaling over $1,350 million were also secured by the Bank of England from the United States Treasury and various foreign central banks. Such reinforcement of the defenses of the new sterling parity was deemed desirable in view of the heavy Bank of England recourse to the Fed eral Reserve and other credit lines (including temporary accommodation from time to time by the United States Treasury) to cope with reserve drains prior to devaluation. In the case of the Federal Reserve swap line, sizable Bank of England drawings had been necessary from the Middle East war until the final speculative onslaught on the Friday preceding devaluation. During this period, the entire $1,350 million then available was used, with a large drawing on the last day of the $2.80 parity. Since then, the Bank of England has repaid $300 million, thus leaving available $450 million under the Federal Reserve swap line. There were no other foreign central bank drawings on the Federal Reserve swap network during the period under review ex cept for a $250 million drawing made by the Bank of Can ada at the end of January in order to offset the effects of speculation primarily engendered by the announcement on January 1 of the United States balance-of-payments program. Other major developments during the period under review included sizable operations in the forward markets by the German Federal Bank, the Swiss National Bank, the Netherlands Bank, and the National Bank of Belgium, in a number of instances acting on behalf of the Federal Reserve and United States Treasury. In fact, one of the major decisions at the Frankfurt meeting was a coordinated 7 launching of central bank operations in the forward market, specifically designed to induce reflows into the Euro-dollar market of hot money which had gone into continental European financial markets in the wake of the sterling de valuation. During November and December, such forward operations by the German Federal Bank rose to a total of $850 million, while similar forward operations by the central banks of Switzerland, the Netherlands, and Belgium, on behalf of the Federal Reserve System and the United States Treasury, not only helped to arrest speculative in flows to these markets, but also provided cover for roughly $115 million of placements abroad. Even as the rush of speculative capital flows was sub siding, however, the approach of the year-end windowdressing period produced new, heavy inflows of short-term funds to continental European markets. As in previous years, however, a joint central bank effort was undertaken to maintain orderly conditions in the Euro-dollar market by rechanneling such funds back to the market. Reinforcing MONTHLY REVIEW, MARCH 1968 40 Table II OUTSTANDING UNITED STATES TREASURY SECURITIES FOREIGN CURRENCY SERIES M illions o f dollars equivalent Issues or redemptions (—) Issued to Amount outstanding on December 31, 1966 1967 January 1March S, 1968 II 1 Austrian N ational Bank ...................................... 50.3 ! National Bank of Belgium .................................. 30.2 ! ! IV "> 1 50.3 - 30.2 German Federal Bank .......................................... 350.7 Bank o f Italy ............................................................ -0- Swiss National Bank ............................................ 210.9 92.6 ! 60.2 Total ........................................................................ 859.5 | 30.0 60.4 ! Bank for International Settlem ents*................ | 60.4 124.8 Netherlands Bank ................................................... Amount outstanding on March 8 ,1968 125.5 124.9 124.9 726.1 124.8 65.7 j -0- 65.7 100.1 j 310.7 290.7 1,489.8 151.8 i 125.5 185.3 Note: Discrepancies in amounts are due to valuation adjustments, refundings, and rounding. * Denominated in Swiss francs. these efforts by the European central banks to avoid undue year-end pressure in the Euro-dollar market, the BIS, at the suggestion of the Federal Reserve, drew dollars on its swap line with the System for placement in the market. By the year-end, BIS drawings stood at $346 million. In re sponse to such smoothing operations, the Euro-dollar mar ket continued to function efficiently, with no more than a normal seasonal rise in rates. In the aggregate, such central bank operations designed to avert potentially disruptive strains in the Euro-dollar market during the devaluation and pre-year-end period totaled approximately $1.4 billion. By March 8, the Federal Reserve and the Treasury had re duced their forward currency liabilities in connection with these various operations from $115 million to $60.4 million equivalent. During the period under review, the Treasury increased its foreign-currency securities indebtedness by $476.0 million, to $1,489.8 million equivalent (see Table II). In order to fund some of the short-term Treasury and Sys tem commitments, the Treasury sold a two-year $60.4 mil lion note to the National Bank of Belgium, a twelve-month $65.7 million certificate of indebtedness to the Netherlands Bank, and a fifteen-month $100 million note to the Swiss National Bank. The Treasury used most of the Dutch guilders to help meet special swap commitments with the Netherlands Bank, maturing in January, and sold the Bel gian franc, Swiss franc, and the residual Dutch guilder proceeds to the System for System liquidations of swap commitments in those currencies between November and March. In addition, the Treasury issued to the German Federal Bank the second and third of four scheduled 4Viyear $125 million notes denominated in German marks. These notes have been issued quarterly since last July to the German Federal Bank in conjunction with the agree ment between the United States and German governments regarding the offsetting of $500 million of United States military expenditures in Germany. Apart from the issuance of foreign currency securities, the United States acquired certain Continental cur rencies in connection with drawings on the IMF. When Canada drew $426 million equivalent of convertible cur rencies from the IMF in late February, arrangements were made among the respective Canadian, American, and Euro pean authorities so that the German marks, Italian lire, Belgian francs, and Dutch guilders (together the equiva lent of $150 million) in the package could be employed to reduce United States official foreign currency commitments. On March 8, the United States Treasury itself drew $200 million of continental European currencies from the IMF, and the balances so acquired were used to make further liquidations of existing commitments. ST E R L IN G During the first quarter of 1967, sterling staged a strong recovery from the speculative onslaught suffered during the summer of 1966. Unexpectedly good balance-of-payments figures for the fourth quarter of 1966 encouraged hopes FEDERAL RESERVE BANK OF NEW YORK that the progressive curbing of inflationary pressure during the preceding two years might finally enable the Labor Government to close the payments deficit. The London money market regained a competitive edge in attracting international short-term funds as credit conditions in for eign financial centers eased considerably. Spurred by these favorable developments on both trade and capital account, a surge of short covering heavily swelled market demand for sterling, and the Bank of England made exceptional reserve gains. By the end of March, the exchange inflow had enabled the Bank of England to liquidate completely $1.3 billion of international credits previously received from the Federal Reserve and other foreign financial authorities, while remaining central bank credits linked specifically to changes in sterling overseas balances were paid off early in the second quarter. After this auspicious beginning, unfortunately, the tide began to swing against sterling with gradually cumulative force. Shortly after the announcement on May 4 of the third cut in the bank rate since the beginning of the year, from 6 per cent to 5 Vi per cent, Euro-dollar rates began to firm and covered interest rate comparisons which had tended to favor London earlier in the year started to turn adverse. Even more disturbing were indications that Brit ain’s foreign trade account was lapsing into new diffi culties. The announcement on May 11 that the British trade deficit had jumped from $36 million in March to $115 million in April was followed a few days later by President de Gaulle’s sharply negative comments at a press conference on Britain’s application to join the Com mon Market. By mid-May these and other adverse devel opments had eroded the earlier recovery of confidence and brought the influx of exchange to a standstill. In this vulnerable situation, new heavy burdens were suddenly thrust upon sterling by the Middle East war that flared up in the week of June 4. On June 1, market expectations of an imminent outbreak of hostilities in the Middle East sparked a burst of selling of sterling. Such apprehension of war affected sterling not only directly but also indirectly through the Euro-dollar market, where pre cautionary withdrawals of funds and the usual pressures associated with midyear window dressing combined to cre ate a sudden squeeze and a sharp hike in rates. These dual pressures were immediately met by a coordinated central bank response in both the exchange and Euro-currency markets. On June 1 the United States authorities, in con sultation with the Bank of England, purchased a total of $92.9 million of sterling in the New York market on a swap basis, buying spot against forward sales. That same day the BIS began placing in the Euro-dollar market new dollar funds drawn under its swap arrangement with the 41 Federal Reserve. (See section on Euro-dollar market for details.) As war broke out, the United States authorities temporarily took another $20 million of sterling out of private hands through additional swap purchases in New York. With the cessation of actual hostilities, covering by the market of short positions in sterling boosted the spot rate from a low of $2.7900 on June 6 to $2.7932 on June 7 while permitting the Bank of England to recoup its losses of the preceding few days. As the month progressed, however, market anxieties were aggravated by rumors of major withdrawals of ster ling by Arab countries. In the latter part of June, reports of shifts of Arab-held sterling balances to Paris triggered heavy selling of sterling, and the Bank of England ex tended substantial support in holding the rate at just under $2.7900. The market had also become concerned over the probable adverse consequences for the British balance of payments of the Suez Canal closure, and the announce ment at midmonth of disappointing trade figures for May created still more apprehension. Finally, the pull of foreign interest rates, particularly during a brief squeeze in the Euro-dollar market at the end of June, exerted further pressure. To cushion the reserve impact of these develop ments, the Bank of England drew $225 million during June under its $1,350 million swap arrangement with the Federal Reserve. This swap drawing enabled the Bank of England to cut its June reserve loss to $120.4 million, but announcement of this figure early in July nevertheless confirmed to the market that sterling had once more come under pressure. During the month, outflows of short-term funds continued for reasons of confidence and for higher yields abroad. At midmonth, announcement of a further widening of the trade deficit in June touched off heavy sales of sterling, and by the end of July the spot rate had declined to $2.7858. The mid-August announcement of a sharp swing in the United Kingdom trade balance in July—to a small sur plus from a large deficit the month before—provided a brief respite from the continuing pressures on the pound. Moreover, market concern over the risk of a breakdown in intergovernmental discussions of international liquidity was relieved after it was announced on August 26 that an agreement along general lines had been reached by the Group of Ten, and that a plan to strengthen the interna tional monetary system would be ready for submission to the IMF at its annual meeting in September. Nevertheless, short-term outflows persisted on balance, and the Bank of England drew a further $425 million on the Federal Re serve during the third quarter, bringing its commitments under the swap line to $650 million. The rearguard action being fought by Bank of England 42 MONTHLY REVIEW, MARCH 1968 officials in the exchange markets became progressively more difficult and costly in October and November. In midOctober, it was reported that Britain’s September trade bal ance had deteriorated sharply to a deficit of $146 million, the largest in fifteen months. As expected, the Suez Canal closing had raised the cost of fuel oil imports, but the trade figures also appeared to indicate a weakening trend in ex ports. The outbreak in late September of a strike on the Liverpool docks, which subsequently spread to London, raised justifiable fears that exports might show even sharper declines in October, and market confidence in sterling de teriorated sharply. Even more important, the unremitting selling pressure on sterling since the Middle East war had fanned into lively debate long-smoldering doubts held by many responsible publications and private individuals, both in the United Kingdom and abroad, as to whether the $2.80 parity was economically viable. In this debate, the basic government policy of seeking to shift domestic resources into exports by restraining domestic demand came increas ingly under attack. In the eyes of the market, the lagging recovery of exports, the rise in unemployment, and the decision of the British government to ease instalment credit controls in late August increasingly suggested that a policy impasse had been reached. These market fears were translated into a heavy wave of selling of sterling, in both the spot and forward mar kets, during the first two weeks in October. Despite heavy intervention by the Bank of England, the sterling rate by October 12 had dropped to $2.7824. In an effort to reassert official determination to hold the parity and to reduce the still-continuing covered incentive in favor of the Euro-dollar market, the Bank of England raised its discount rate by Vi percentage point to 6 per cent on October 19. The British rate action was immediately supported by the BIS which, in agreement with the Federal Reserve, made placements of funds in the Euro-dollar market by drawing on its swap facility with the System, in an effort to prevent a rise in Euro-dollar rates from off setting rate increases on sterling money market instruments. But market reaction was one of disappointment that the British bank rate had not been raised a full percentage point, and heavy sales of sterling resumed, requiring very sizable intervention by the Bank of England in both the spot and forward markets that same day. In an effort to stabilize ster ling quotations in New York, the United States Treasury initiated purchases of sterling at rates just under $2.7830. These operations, eventually involving total purchases of $47.1 million equivalent, continued through Monday, Oc tober 23, and seemed to help calm the market somewhat during the final week of October. The announcement on November 2 of a $75.6 million reserve gain for October, after taking credit for a loan of $103 million equivalent from Swiss commercial banks, was brushed aside by a market which had become in creasingly persuaded that a devaluation of sterling was imminent. Sales of sterling in pre-weekend trading were heavy, and on November 9 the Bank of England, for the second time in three weeks, raised its discount rate by an other Vi percentage point to 6 V2 per cent. Once again the BIS backed up this move with operations in the Euro dollar market by additional drawings on the Federal Re serve swap line. The announcement on November 14 that the trade deficit in October had jumped to $300 million equivalent, the largest ever recorded, dramatized the disastrous effects of the dock strike and very nearly extinguished any remain ing hopes in the market that the $2.80 parity could be held. At this critical juncture, however, rumors began to circulate that negotiations were in progress for sizable new inter national credits to tide the United Kingdom over its dif ficulties once more. If a new credit package had in fact materialized, the grossly oversold position of sterling might have led to massive short covering such as had occurred in late 1965 and again in early 1967. Accordingly, traders began to hedge their exposed positions in sterling, and on Thursday, November 16, short covering pushed the sterling rate to $2.7848. That afternoon in London, however, Chancellor Callaghan refused in Parliament to confirm or deny that such negotiations were in progress. Financial mar kets throughout the world immediately concluded that the last hope of a turnaround in the sterling situation had dis appeared. On the next day, Friday, the market was inun dated by offers of sterling in the expectation that a decision to devalue that weekend had already been taken. To help meet the avalanche of offerings of sterling, the Bank of England, which had already made further use of the Federal Reserve swap line, drew the remainder available under this arrangement, bringing the total amount outstanding to $1,350 million. On Saturday, November 18, Chancellor Callaghan an nounced the British government’s decision to devalue the pound by 14.3 per cent to $2.40. In order to stiffen the defense of the new parity, the Bank of England raised its discount rate to 8 per cent per annum (the highest level in fifty-three years) and redirected bank credit toward exports, while the government announced curbs on con sumer instalment credit and programmed cuts in govern ment spending and an increase in the corporation tax. The Prime Minister set as the target of his government’s policy a major improvement in the country’s balance of payments designed to bring the external accounts into substantial surplus by the second half of 1968. A $1.4 billion standby FEDERAL RESERVE BANK OF NEW YORK agreement with the IMF was formally requested. In addi tion, the British government reported that negotiations for an additional $1.5 billion of central bank credits were in progress. When markets in London reopened on Tuesday, Novem ber 21, after a special bank holiday on Monday, trading was hectic as banks and commercial interests scrambled to purchase or borrow sterling to meet immediate- and near-term requirements, including maturing forward sales undertaken earlier. The demand for pounds pushed ster ling firmly against its new upper limit ($2.4200), and the Bank of England made large dollar gains. Such abnor mally heavy demand for sterling to meet immediate cash commitments soon faded, but the Bank of England contin ued to buy dollars on a moderate scale. As in earlier periods of recovery the Bank of England used its gains to reduce short-term debts, repaying $300 million to the Federal Reserve. Bank of England commit ments under the $1,350 million credit line, which had been fully utilized to help meet pressures prior to devalu ation, were thereby reduced by the end of November to $1,050 million. On November 30 the reciprocal currency arrangement with the Bank of England was increased to $1.5 billion, along with the other increases in the System’s swap network. Market atmosphere changed abruptly in early Decem ber—in view of a British railway labor dispute and higher United States interest rates— and the spot rate for sterling declined sharply. The market took no special notice of the announcement of a $127.2 million reserve gain during No vember, reflecting incorporation into the reserves of the $490 million remainder of the United Kingdom dollar port folio. (In November, the authorities also announced that the $250 million debt repayment falling due on Britain’s 1964 IMF drawing had been repaid, with the reserve impact offset by a new credit from central banks and the United States Treasury.) Despite subsequent mediation of the railway difficulties, the market remained uneasy, and by December 7 the spot rate had moved below $2.4100. Prior to the Christmas holi days, however, the market quieted and sterling took on a firmer tone. After the long Christmas holiday, there were re ports that the British government was planning sizable cuts in welfare and defense-spending programs to backstop its devaluation package, with details scheduled for release in mid-January 1968. These cuts were duly announced on Jan uary 16, and although their major impact was not to take effect until 1969-70, as Britain would phase out its military operations east of Suez, a significant reduction in pro grammed spending—by some .£300 million—was sched uled for this year. The trade figures for both December and 43 January showed major improvements over the pre devaluation deficits while export orders were reported to be on an encouraging uptrend. Toward the end of January the sterling rate moved firmly above $2.4100, and during that month and February there was a steady demand for sterling that enabled the Bank of England to liquidate a large volume of maturing forward commitments. Reviewing the sterling devaluation and its aftermath in an address to the Overseas Bankers Club in early February, Governor O’Brien of the Bank of England noted: Those who so readily advocated devaluation before we had made any attempt to apply other correctives had scant regard for our obligations abroad, for the risks entailed for ourselves and others, and for the harsh medicine which must be taken to make devalu ation work. All these things are now being made abundantly clear. Those who thought devaluation was a soft alternative to strict internal policies have been disabused. SW ISS FRANC The Swiss National Bank’s dollar holdings rose sharply in May and early June, as funds poured into Switzerland prior to and during the crisis in the Middle East. In order to absorb these heavy inflows, and further moderate gains by the National Bank near the end of June, the Federal Reserve took on commitments of $390 million under its Swiss franc swap facilities— $190 million from the Swiss National Bank and $200 million from the BIS—out of credit facilities then totaling $400 million. The heavy inflows to Switzerland left Swiss commer cial banks in a highly liquid position, and after midyear there was an easing in Swiss interest rates. To reinforce this trend, the National Bank reduced its discount rate from 3 V2 per cent to 3 per cent on July 10. Although there was some immediate outflow of funds from Switzer land, there were no sizable offerings of Swiss francs as the exchange market atmosphere remained highly un certain. Under the circumstances, with the System’s Swiss franc lines almost fully utilized, it was agreed in mid-July that these swap facilities with the National Bank and the BIS should each be expanded by $50 million to $250 million. By the end of July, the only repayment made on the System’s Swiss franc swap drawings was $10 million equivalent acquired by the Federal Reserve as a result of Swiss official needs for dollars; thus, outstanding commit ments stood at $380 million equivalent. As the exchanges settled down in August, there was some further shifting of funds out of Switzerland into the 44 MONTHLY REVIEW, MARCH 1968 Euro-dollar market, and by late August the rate for the franc had eased considerably. Short-term outflows from Switzerland continued through early November and kept the spot Swiss franc close to the low for 1967 ($0.2301Vi) reached on September 12. Although the Swiss National Bank did not have to supply any dollars to the market during this period, the Federal Reserve was able to make some progress in liquidating its Swiss franc swap commit ments, as a substantial amount of dollars was required by Swiss official agencies during the fall. In order to replenish dollar balances sold to the Swiss Government, the National Bank purchased a total of $57 million from the Federal Re serve. The System used the francs so acquired to reduce its outstanding swap commitments to the Swiss National Bank to $123 million by mid-November. The growing pressures on sterling in early November were quickly reflected in an increase in the rate for spot francs. In addition, the Swiss money market was tightened by the payment of the $103 million equivalent Swiss franc loan granted to the United Kingdom government by three large Swiss commercial banks. With continuing interna tional uncertainties and the approach of the year-end, the franc rate advanced further. Despite the turbulence in the exchanges in connection with the devaluation of the pound on November 18, the Swiss National Bank purchased only a small amount of dollars in market intervention dur ing the rest of the month. As a consequence of unrest in the exchange market, however, the premium on the forward Swiss franc then widened, and following the Frankfurt meeting of Gold Pool members the Swiss National Bank, as part of the general cooperative effort, indicated to the mar ket its willingness to sell forward francs on behalf of the United States authorities. This move helped restore a calmer atmosphere and the premium on three-month forward Swiss francs dropped substantially below 2 per cent per annum, the premium prevailing just before the Swiss National Bank’s offer to sell forward francs. In November, the System purchased from the Bank of England $80.1 million equivalent of the Swiss franc pro ceeds of the one-year loan by Swiss commercial banks. (The United States Treasury also purchased $14.3 mil lion equivalent of the loan proceeds and used the francs to pay off the remainder of an earlier sterling-Swiss franc swap with the BIS.) The System used the francs, together with a small amount in balances and $4 million equivalent purchased from the National Bank in connection with Swiss government needs, to reduce swap drawings from the BIS to $115 million by November 30. By the end of that month, total Federal Reserve commitments under its Swiss franc swap lines were thus reduced to $238 million. Heavy inflows to Switzerland resumed on December 1, and during the first half of the month the Swiss Na tional Bank purchased about $350 million as the Swiss financial community prepared for its year-end liquidity needs. In past years these inflows had been accommodated on a swap basis by the National Bank, but in view of the tense international monetary situation the Swiss banks were reluctant to enter into such swap transactions. In deed, not only was the spot franc in demand but the pre mium on the forward franc again widened, especially dur ing the midmonth flare-up in the gold market. To deal with this pressure, on December 14 the Swiss National Bank initiated forward sales of Swiss francs jointly for Federal Reserve and United States Treasury accounts. A total of $65.5 million equivalent of forward francs was sold by December 19, before the market responded to this evidence of official reassurance and the demand for both spot and forward francs eased. Thereafter, a more normal trading pattern emerged, and Swiss commercial banks began to make use of the usual year-end swap facilities offered by the National Bank to obtain additional Swiss franc liquidity. In order to increase its capacity to deal with the heavy inflows to the Swiss National Bank, the Federal Reserve, after discussions with the Swiss National Bank and the BIS, increased its Swiss franc swap facilities by $150 mil lion equivalent each on December 15, bringing each credit line to $400 million. The Federal Reserve subsequently drew $127 million on the Swiss National Bank, raising Swiss franc commitments to that institution to $250 million equivalent. The System also drew $285 million on the BIS, thus fully utilizing that $400 million Swiss franc credit line. After the turn of the year, and following the President’s balance-of-payments message on New Year’s Day, there was a sharp reversal in the market as Swiss commercial banks moved to rebuild their dollar investments. By midJanuary outflows from Switzerland had become quite large. The spot rate dropped sharply, and the National Bank ex tended sizable support in the spot market. The bank covered its losses from exchange market intervention by purchasing dollars from the Federal Reserve, which used the Swiss francs, together with moderate amounts purchased in the market and obtained in special transactions, to reduce its swap obligations in Swiss francs by $343 million. Moreover, early in March the Federal Reserve was able to pay off an additional $175 million of its drawings on the BIS and the Swiss National Bank through Treasury issuance of a $100 million equivalent Swiss franc security and the purchase of $75 million equivalent of Swiss francs from the Swiss National Bank. The Swiss National Bank simultaneously purchased $25 million of gold from the United States Trea sury. These transactions brought the System’s outstanding FEDERAL RESERVE BANK OF NEW YORK Swiss franc commitments to $132 million, a reduction of $518 million from the peak at the end of 1967. In addition, the United States authorities were able to pay off at maturity the first $10 million of forward sales of Swiss francs concluded by the Swiss National Bank for the accounts of the System and the United States Treasury late in 1967, leaving $55.5 million still outstanding, di vided evenly between System and Treasury accounts. GERMAN MARK Germany’s international position maintained in the second half of 1967 the strength that had characterized the first six months of the year. With relatively slack do mestic demand continuing through most of the year, the trade account remained in surplus, and for the year as a whole the current-account surplus reached $2.4 bil lion. Had the foreign exchange earned as a result of this surplus flowed into official reserves rather than remaining in private hands, the stresses in the international credit markets and the exchanges during the summer and fall months would have been immeasurably greater. The huge surplus was not permitted to put pressure on international financial markets, however, as the German authorities acted throughout the year to avoid any massive increase in official reserves. By maintaining an easy monetary pol icy, the German Federal Bank not only stimulated the regeneration of domestic economic growth during the latter part of the year but also facilitated very large outflows of capital, both long- and short-term funds, into the Euro dollar and other markets. During the early fall months, Euro-dollar rates firmed up, and there was some refinancing in German marks of maturing Euro-dollar credits. But the principal result of easier monetary conditions in Germany continued to be further placements of funds abroad by commercial banks. As a result, the spot mark traded narrowly just below par through October. The Federal Reserve took advantage of occasional offers of spot marks in New York to build up balances, and between August and early November pur chased $20.1 million equivalent of marks. On November 3, the growing uneasiness in the sterling market and a tightening in the German money market were reflected in repatriation of funds by German interests and a consequent sharp strengthening in the spot quotation for marks. The demand for marks intensified on Novem ber 7, as growing speculation in the gold and exchange markets spawned wide-ranging rumors of imminent changes in currency arrangements, including an upward revaluation of the mark. In the ensuing heavy buying of marks the German Federal Bank purchased a total of $57 45 million as the spot rate advanced to $0.2512^. A flat denial by the German authorities of any intention to revalue led some speculators to cover their positions, and the spot mark eased slightly. This burst of demand for marks had no sooner died down than another wave of buying developed, partly reflecting the massive selling of sterling on Friday, Novem ber 17. The heavy demand was repeated the following Fri day, when the intense pressures in the London gold market led to further precautionary repatriations of German funds from abroad. During this period the German Federal Bank took in nearly $300 million. The market atmosphere changed abruptly, however, when on November 26 the active members of the Gold Pool met in Frankfurt and pledged concerted support of the existing exchange parities based on the $35 gold price. As part of the coordinated central bank effort to calm the exchange markets follow ing the Frankfurt meeting, the German Federal Bank acted to return dollars to the market on a swap basis in trans actions with German commercial banks, selling dollars spot against repurchase at a later date. These operations relieved the developing stringency in the Euro-dollar mar ket resulting from the earlier heavy withdrawals of funds and helped cut the covered incentive to move additional funds out of dollars as a result of the wide premiums then being quoted on the forward mark (nearly 3 per cent per annum for three-month maturity, by November 24). Ini tially, the swap facilities were offered to the German com mercial banks at rates representing a premium on the forward mark of 1% per cent per annum; this rate pro vided an incentive of close to 1 per cent per annum to switch funds into Euro-dollar investments. By November 30, about $600 million had been shifted from official reserves to private holders at premiums on the mark ranging up to 2Va per cent. Euro-dollar rates responded immediately by moving sharply lower. The Federal Re serve participated in this operation by drawing $300 million equivalent of German marks on its swap line with the German Federal Bank, to this extent providing cover for part of the dollars purchased forward by that bank. Apart from these operations, at the end of November the Federal Reserve drew $50 million equivalent of marks under the swap line and held the marks for possible direct market intervention related to prevailing uncertainties and expected year-end pressures. (On November 30, as part of a general strengthening of the swap network, the swap facility with the German Federal Bank was increased by $350 million to $750 million.) Demand for marks began to grow in mid-December, as heavy speculative pressures again struck the London gold market and there was a re newed heavy inflow of funds to the German Federal Bank. 46 MONTHLY REVIEW, MARCH 1968 When the backwash of these demands spilled over into the New York exchange market on December 15, the Federal Reserve sold some $7 million equivalent of the marks drawn for market operations. The heavy inflows into Germany resulting from market uncertainties proved considerably larger than necessary to meet German commercial banks’ usual year-end needs, in good part because the German Federal Bank had as sisted the banks in arranging for such mark liquidity in advance by selling them a large amount of money market paper scheduled to mature in mid-December. Moreover, it also became apparent that the earlier heavy selling of dollars had depleted the German banks’ investment port folios. By December 21, with the German money market becoming quite liquid and the exchanges returning to a more normal atmosphere, funds began to flow back into Euro-dollar investments. As German commercial banks bid strongly for dollars on a covered basis, the German authorities sold an addi tional $250 million on a swap basis, before raising the swap rates offered to the banks, and permitted the spot mark to move lower. By the end of the year, outflows from Ger many had offset the German Federal Bank’s dollar gains earlier in December. In the last few trading days of the year the spot mark moved still lower, and the Federal Reserve began buying to replace the small amount of marks sold from the earlier $50 million swap drawing. By January 5, 1968 the System’s balances had been fully reconstituted and the swap was repaid in advance of maturity. Demand for dollars in Germany continued through the first two months of 1968. Part of the outflow of funds reflected the usual seasonal pattern, but more significant was the fact that the German economy still was not absorb ing all the liquidity available in the domestic market, and the German commercial banks again were invest ing very sizable excess funds in the Euro-currency and other markets. As a result, the supply of German marks in the exchange market increased substantially and the Federal Reserve purchased marks in New York almost continuously through January and February, using them to reduce its swap drawings on the German Federal Bank. By the end of February the System had purchased sufficient marks to repay fully its $300 million swap commitment, thereby restoring the full $750 million facility to a standby basis. In the currency packages put together by the IMF for the Canadian and United States drawings late in February and early March, Germany supplied a total of $100 mil lion equivalent of marks. Under arrangements worked out with the various parties, the Federal Reserve purchased these marks and sold them to the Bank of Italy, against lire (using the lire to repay part of the System’s swap obligations in that currency). During the period under review, the German Federal Bank continued its purchases of special United States Trea sury medium-term securities denominated in German marks, in conjunction with the German government’s agree ment to offset part of the cost of stationing United States troops in Germany. The first of four equal quarterly pur chases of $125 million was made on July 3, the second on October 2, and the third on January 5, 1968, bringing the outstanding total of such special United States Treasury notes denominated in German marks to $375 million equivalent. As a result the total of all mark-denominated Treasury securities rose to $726.1 million equivalent. I T A L I A N L IR A In 1967, the Italian balance of payments was in surplus by some $325 million, representing a further reduction from surpluses of $700 million in 1966 and $1.6 bil lion in 1965. During the course of 1967, however, this trend was reversed, perhaps only temporarily, as the surplus widened significantly in the second half. Thus, for the first six months through June, the accounts were actually in deficit by $220 million (compared with a $280 million surplus for the first half of 1966). This deficit—which in part reflected unusually heavy Italian investments in the Euro-bond market—was financed largely by a runningdown of Italian commercial bank net short-term assets abroad rather than by a reduction in official reserves. Over the course of the summer, when tourist receipts are a strong factor for Italy, there emerged an official reserve buildup well in excess of usual seasonal gains. Even after seasonal demands receded, Italian official reserves con tinued to increase in October and early November, and the gain for the second half of the year amounted to nearly $500 million. This renewed surplus was largely unexpected, given the buoyant demand in Italy that had been swelling imports and the sluggish rate of expansion in northern European economies that had been exerting a drag on Italian exports. Indeed, the impressive trade performance may indicate that Italy’s recent strong record of relative price stability is beginning to show through in increased competitiveness in European and other markets. In addition to a stronger than expected trade account, Italian long-term capital out flows tapered off in the second half of the year and, like other countries, Italy was affected by developments in the sterling market through a sizable repatriation of funds. Under the circumstances, between September 19 and November 30, the Federal Reserve drew a total of $500 FEDERAL RESERVE BANK OF NEW YORK 47 Further inflows to the Netherlands continued inter million equivalent of lire, using the lire to absorb dollars from the Italian official reserves. (With the $600 million mittently through the fall months, reflecting firmness in swap facility almost fully utilized, the System and the the Amsterdam money market, an improvement in the Bank of Italy agreed in late November to increase their Dutch balance of payments, and repatriations of Dutch arrangement by $150 million to $750 million; this was part money from London. The resulting increases in the dollar reserves of the Netherlands Bank were taken over by a of the general move to strengthen the swap network.) Late in the year, delayed seasonal outflows finally began series of Federal Reserve drawings on the swap facility to emerge. The lira rate declined somewhat in December until the full $150 million line had been utilized by Novem and even further in early January 1968, when adverse sea ber 13. The exchange market turbulence arising out of the de sonal influences were reinforced by market concern over possible reductions in United States tourist and other valuation of sterling and subsequent speculation in the gold expenditures in Italy as a result of the United States pay market was accompanied by further heavy inflows of funds ments program. Nevertheless, the spot rate remained above into the Netherlands. These speculative influences also par, and outflows from Italy were insufficient to permit were reflected in the forward market, where the premium liquidation of United States commitments in lire. In late on the guilder reached nearly 2 per cent per annum for February-early March, the Federal Reserve purchased three-month maturities. Joining in a concerted central bank some $75 million equivalent of lire from the Bank of effort to restrain such speculation, on November 23 the Canada and from the United States Treasury in connection Netherlands Bank initiated forward sales of guilders on with the Canadian and United States drawings from the behalf of the Federal Reserve and the United States Trea IMF. From the same drawings, the Federal Reserve was sury. Most of these forward sales were part of swap trans able to acquire $100 million equivalent of German marks actions—i.e., spot purchases of guilders against resale at which it converted into lire. These transactions enabled a later date— designed to return dollars to the inter the System to reduce its swap obligations to the Italian national markets while at the same time curbing the risk authorities by $175 million equivalent to $325 million that the wide forward premium on guilders might stimulate further inflows. By November 29, when $37.5 million equivalent. Federal Reserve and Treasury commitments in for equivalent of forward guilders had been sold, speculative ward lire, which had arisen in connection with dollar-lira pressures eased sufficiently for operations to be discon swaps the Bank of Italy has extended to its commercial tinued. Meanwhile, in order to absorb the heavy inflows banks, were rolled over during the period in review; in addi to the Netherlands Bank during November, the Federal tion, the Treasury added a moderate amount to its forward Reserve Bank of New York executed temporary swap lira commitments. drawings of guilders on behalf of the United States Trea sury, and by the end of November Treasury commitments under these ad hoc arrangements were $126 million. Such D U T C H GUELDER swap drawings by the United States Treasury, combined Relatively tight money market conditions in Amsterdam with already outstanding Federal Reserve drawings of $150 during the spring of 1967 induced Dutch commercial million under the regular swap line, lifted the United States banks to repatriate funds from abroad in order to swap debt in guilders to $276 million equivalent. strengthen their liquidity in guilders. The Netherlands Buying of guilders was small and sporadic during early Bank dealt with this inflow by purchasing a substantial December, but a tightening of the money market in amount of dollars on a swap basis (i.e., against resale for Amsterdam in the latter part of the month produced ward), thus avoiding a large buildup in its net dollar hold more substantial inflows. Just before the year-end, com ings. These operations built up rapidly in May and rose to mercial demand for guilders boosted the spot rate to a peak of $150 million in early June. $0.2782^ and the Netherlands Bank purchased a further At that point, the Middle East crisis and related pres sizable amount of dollars. The Federal Reserve swap line sures on sterling generated further demand for guilders. with the Netherlands Bank meanwhile had been increased As funds flowed into the Netherlands the spot rate rose to $225 million, and by January 4 an additional $35 mil sharply and the central bank took in dollars outright as lion equivalent had been drawn, raising the System’s draw well as on a swap basis. To cushion these pressures, the ings to a peak of $185 million. Federal Reserve reactivated its swap facility with the Shortly after the year-end, the money market in Amster Netherlands Bank, drawing $10 million of guilders on July dam began to ease and the spot guilder softened as Dutch 26 and $10 million more before the end of the month. commercial banks started to move excess funds back into 48 MONTHLY REVIEW, MARCH 1968 the Euro-dollar market. In mid-January, outflows from Demand for Belgian francs intensified in July and Amsterdam were sufficiently large for the Netherlands August, partly as a consequence of the continuing Middle Bank to provide support for the guilder. The Netherlands East crisis and the growing pressure on sterling. In order Bank then restored its dollar position through purchases to absorb dollars purchased by the National Bank of from the Federal Reserve Bank of New York acting for Belgium through early September, the Federal Reserve account of the United States Treasury. Through these drew $97.5 million equivalent of francs under its swap transactions the Treasury obtained $23 million equivalent facility, bringing commitments in Belgian francs to $125 of guilders, which were used to reduce Treasury commit million equivalent. Later in the month, Belgian govern ments under its swap with the Netherlands Bank to ment requirements for dollars again enabled the Federal $103 million. Reserve to purchase francs from the National Bank and These outflows from the Netherlands were short-lived, reduce its swap commitments in Belgian francs to $115 however, and the Federal Reserve was able to make only a million equivalent by the end of September. modest start in repaying its commitments outstanding under The Belgian balance of payments on current account the swap with the Netherlands Bank. Accordingly, on Janu strengthened in October. In addition, the money market ary 29 the United States Treasury issued to the Netherlands tightened, following the flotation of a large government Bank a twelve-month certificate of indebtedness denomi bond issue. The resulting demand for francs pushed the nated in guilders equivalent to $65.7 million. The Treasury spot rate to the ceiling, and the National Bank acquired used $55.7 million equivalent plus a small amount in bal still more dollars. The surplus on current payments per ances to reduce its swap commitments to $47 million. sisted as the Belgian economy remained sluggish. The The Federal Reserve purchased the balance of the guilders Federal Reserve continued to use its swap facility to cover and used them to reduce its swap indebtedness to the the National Bank’s dollar gains, and by November 13 Netherlands Bank to $165 million. the full $150 million had been employed. On February 21 the Treasury repaid its remaining $47 During the period immediately preceding the British million equivalent of swap commitments to the Nether devaluation, and in the days of heavy speculative activity lands Bank with guilders purchased from that bank. The afterward, the Belgian authorities took in further substan Netherlands Bank in turn then purchased $23.5 million tial amounts of dollars. With the Federal Reserve swap in gold from the Treasury. Shortly afterward, Canada line fully utilized, on November 24 the United States made its drawing from the IMF; included was $30 mil Treasury issued a $60.4 million equivalent 24-month lion equivalent of guilders, which the Bank of Canada Belgian franc-denominated Treasury note in order to fund converted to United States dollars through the Netherlands a portion of outstanding System commitments. The Federal Bank. This reduced the Dutch dollar position enough for Reserve purchased these francs and used them to repay the United States authorities to purchase sufficient guilders outstanding swap drawings. Then, at the month end, the to liquidate the $37.5 million in forward contracts (entered System absorbed a total of $41.2 million from the National into last November) maturing in late February and early Bank by drawing once again on the swap line. Thus Federal March. Finally, the United States Treasury drawing from Reserve commitments in Belgian francs under the line the IMF included $100 million equivalent of guilders, with the National Bank stood at $130.8 million equivalent which were used by the Federal Reserve to make a further at the end of November. (On November 30, as part of reduction on its swap obligation with the Netherlands the general strengthening in the swap network, the total Bank. As of March 8, the swap debt of the Federal Reserve Belgian swap line was raised by $75 million to $225 mil to the Netherlands Bank was thus reduced to $65 million. lion equivalent.) The National Bank of Belgium, in cooperation with United States authorities, also took action to keep the forward BEL G IA N F R A N C market calm in the aftermath of the sterling devaluation. During the early part of 1967, the surplus in Belgium’s On December 4, the National Bank initiated forward sales current international payments kept the franc at or near of Belgian francs on behalf of the United States authorities its upper intervention point. To absorb these inflows, (divided equally between System and Treasury accounts) the Federal Reserve reactivated its swap line and by early to reduce the large premium on forward francs and dis June had drawn a total of $37.5 million. Shortly afterward, courage further shifts of funds from dollars. Pressures however, Belgian government dollar needs enabled the subsided almost immediately, and few additional forward System to purchase francs and reduce its swap commit sales were necessary through the end of December. These ment to $27.5 million as of the end of June. were the first operations conducted in forward Belgian FEDERAL RESERVE BANK OF NEW YORK francs and involved only a modest commitment of $11.8 million equivalent. The spot Belgian franc eased somewhat below its ceiling during the month of December, and the National Bank of Belgium lost a moderate amount of dollars in market support operations as the Belgian economy showed signs of revived growth and import demand picked up. The Federal Reserve, therefore, was able to acquire Belgian francs as the Belgian authorities required dollar balances to meet market needs; the System also obtained some francs from conversion of part of the proceeds of an IMF member’s drawing. These francs were used to reduce Federal Reserve commitments under the swap line with the National Bank of Belgium to $105.8 million equiva lent by the year-end. In late January, the National Bank purchased $25 mil lion from the System to cover moderate losses in market support and to meet anticipated dollar requirements of the Belgian government. The Federal Reserve used the franc proceeds to reduce further its swap indebtedness to $80.8 million. In February, however, the tendency was briefly reversed, and the National Bank once again pur chased dollars which the System covered by drawing $7.5 million equivalent of francs on the swap. Subsequently, the System was able to make further reductions in its Belgian franc commitments. Late in February, the Federal Re serve acquired $13.5 million of francs from the National Bank, when that bank needed dollars, and $30.2 million equivalent following Canada’s IMF drawing. Moreover, the System acquired $10 million of Belgian francs in con nection with the United States Treasury’s Fund drawing. These francs were used to make swap repayments, and by March 8 such commitments had been reduced to $34.5 million equivalent. The remainder of the Treasury’s $15 million Belgian franc drawing was used in the liquidation of System and Treasury forward contracts and, on March 8, $5 million equivalent remained outstanding. C A N A D IA N DOLLAR Canada’s balance of payments was in sizable surplus in 1967, with a strong export performance during the last quarter of the year contributing significantly to the year’s overall results. In the exchange markets, there was substantial demand for Canadian dollars during most of the year. During the summer months, the success of e x p o 67 attracted an exceptional number of visitors to Canada and stimulated an unusually large volume of tourist receipts which helped keep the spot Canadian dollar close to $0.9300. In late summer, the Canadian banks sought to 49 relieve domestic liquidity pressures through conversion of United States dollar assets, and such conversions intensified with the approach of the end of their fiscal year on Octo ber 31. Demand from this quarter converged with buying of Canadian dollars during the last minute rush to e x p o and with the increased movement of shipping prior to the winter closing of the St. Lawrence Seaway. As a result, the spot rate rose to its effective ceiling of $0.9324 by October 11 and held at about that level through the end of the month. In the three months to the end of October, Canadian holdings of gold and United States dollars (in cluding Canada’s net creditor position with the IMF) increased by $121.5 million to $2,570 million. This gain more than offset the modest losses sustained during the first half of 1967. The Canadian dollar remained strong until the devalua tion of sterling on November 18, after which it began to decline. Some Canadian funds joined the general reflow into sterling, but there was also a sizable movement of short term Canadian capital into Euro-dollars. These outflows might have been larger except for the 1 percentage point rise in the Bank of Canada’s discount rate to 6 per cent, which followed discount rate increases by the Bank of England (by IV2 per cent to 8 per cent) and the Federal Reserve (by V2 per cent to AV2 per cent). The sterling devaluation came at a time when the market was in any case assessing the likely impact on the Canadian dollar of e x p o ’s closing and the sizable grain crops abroad that might limit Canadian wheat sales over the near term. More over, with winter coming on, the Canadian payments posi tion was moving into its seasonally weak period. Against this background, the announcement of the United States balance-of-payments program had a fur ther disturbing effect on market operations. Despite the fact that the new program did not restrict Canada’s ac cess to the United States bond market, there was apprehen sion that the program might adversely affect United States direct investment in Canada and the balance of short-term capital flows between the two countries. With exchange markets still unsettled following sterling’s devaluation and the subsequent rush into gold, the new uncertainties created by the United States program had a grossly ex aggerated impact on Canadian dollar trading. By the third week of January, sales of Canadian dollars reached heavy proportions and the Bank of Canada was required to pro vide substantial support in the market. To counter these speculative pressures, which became particularly severe on Friday, January 19, the Bank of Canada announced on January 21 a 1 percentage point increase in its discount rate to 7 per cent. In addition, it obtained the agreement of Canadian banks to discourage the use of bank credit for 50 MONTHLY REVIEW, MARCH 1968 abnormal transfers of funds abroad. At the same time, the United States Treasury issued a statement emphasizing that: “The United States balance-of-payments program does not call for and is not intended to have the effect of causing abnormal transfers of earnings or withdrawals of capital by United States companies having investments in Canada.” The selling diminished considerably following these measures, but the market remained uneasy and was put off stride by political developments in Canada during February. The impact on Canadian reserves of the selling pressures of January and February was cushioned by the use of some of Canada’s credit facilities. In January the Bank of Canada drew $250 million under its $750 million swap facility with the Federal Reserve, thereby reducing the January reserve loss to slightly less than $100 million. And, in February, the Canadian government made a $426 million drawing on the IMF. Of this drawing, some $241 million represented Canada’s creditor position in the Fund and was already included in published reserve figures. Consequently, the drawing improved Canada’s reported reserves by some $185 million. This increase was substantially greater than the amounts that had been used in support operations in the market in February with the result that, for the month, Canada reported a reserve gain of $71.6 million. When market uncertainties continued in early March, the Canadian government responded by announcing a new series of fiscal measures designed to restrain domestic de mand and reinforce the defense of the Canadian dollar. These steps were then backed up by a major bolstering of Canada’s international credit lines, with $900 million of new facilities—over and above the $500 million still avail able under the Federal Reserve swap line—made available by the United States Export-Import Bank, the German Federal Bank, the Bank of Italy, and the BIS. At the same time the United States authorities made clear their whole hearted support for Canada’s determination to defend the $0.9250 parity by announcing the complete exemption of Canada from the restraints on capital flows announced in the President’s January 1 program. EURO-DOLLAR M A R K ET During 1967 the Euro-dollar market was subjected to major strains, first during the spring and early summer as the Middle East crisis triggered heavy withdrawals of funds and again later in the year when speculation in the gold and exchange markets generated massive repatria tions into Continental centers. These sudden shifts of funds out of the Euro-dollar market not only threatened to disrupt the normal continuity of credit and deposit trans actions in that market, but—given the close links between the Euro-currency and foreign exchange markets—also had destabilizing effects on the exchange markets as well. Whereas central banks are accustomed to dealing with periods of temporary stress in their own national money markets, there is no comparable international institution responsible for the smooth functioning of the Euro-currency market. Nevertheless, as the experience of the last year indicates, the Euro-currency market itself is surprisingly resilient in the face of fairly severe shocks and, so long as national central banks are prepared to cooperate in tem pering the pressures to which the market is subjected, the risk of serious repercussions being transmitted by and through the market can be minimized. As noted in the March 1967 article of this series, The Euro-dollar market, which has become a multi billion dollar operation, functions as a truly interna tional money market and consequently cannot rely, as can a national money market, on the support of any single central bank to relieve temporary stringen cies or knots in the market. There is a great deal which the central banks whose nationals use the Euro-dollar market can do in an ad hoc, informal way, however, to alleviate undesirable strains on the market. Prospective developments in the Euro-dollar market are regularly discussed at the monthly meetings of central banks in Basle, with central banks increasingly prepared to under take operations of various sorts to reduce the impact on the Euro-currency market of shifts of liquid funds by their own commercial banks. In fact, such operations have be come more or less routine during periods of seasonal pres sures, such as midyear and at the year-end when banks in some countries repatriate very sizable amounts to meet their own liquidity needs as well as those of their customers. The particular measures taken at any given time have been tailored to the prevailing circumstances and to the institutional requirements of the central banks involved. For example, the Swiss National Bank has normally re channeled funds to the Euro-dollar market either directly or through the BIS. For its part, the Federal Reserve has also placed funds in the market, via the BIS, to mitigate year-end strains. Other central banks, such as the German Federal Bank, have sought to minimize seasonal pressures of this sort by providing special domestic paper timed to mature in December. Similarly, during periods of speculative—as distin guished from seasonal—pressures, central banks have acted to rechannel funds to the international markets, frequently by providing forward cover to their banks FEDERAL RESERVE BANK OF NEW YORK (either for their own account or in cooperation with the United States authorities) at rates that make profitable a covered outflow. In a somewhat different case, the Italian authorities have provided forward cover on a sustained basis to regulate domestic liquidity and at the same time provide funds to the Euro-dollar market during a period of payments surplus. Another important form of central bank intervention in the Euro-dollar market has been the Federal Reserve swap line with the BIS. Under this arrange ment the BIS can draw dollars from the System for place ment in the Euro-dollar market, and in a number of operations since late 1966 such short-term placements have amounted to $700 million. This facility was expanded to a total of $600 million during the past year, both because of the unprecedented stresses encountered during this period and because experience had demonstrated the usefulness of this facility in meeting such pressures. The outbreak of hostilities in the Middle East early last June set off a sharp rise in Euro-dollar rates, as pre cautionary withdrawals of funds added to stresses asso ciated with usual preparations for the midyear by con tinental European banks. These pressures were quickly countered, however, by BIS placements of dollars drawn on the swap line with the Federal Reserve or obtained from other central banks. As a result, the market calmed and, with the cessation of fighting, the rapid rise in rates was halted. Interest rates on three-month deposits eased A from about 53 per cent per annum to about 5 V4 per cent by June 9 and, with ample liquidity available in the Euro-dollar market by the end of June, the BIS began to withdraw the funds placed earlier in that market. By July 17, all outstanding drawings on the Federal Reserve by the BIS—which had reached a total of $143 million— had been repaid and the swap facility reverted fully to a standby basis. Although the Euro-dollar market remained quite liquid during the summer months, covered interest arbitrage in centives continued to favor Euro-dollars over sterling. Some of the funds moving out of sterling were absorbed by United States banks’ foreign branches along with additional dollars coming into the market from the Continent. In late Sep tember, however, Euro-dollar rates began to move up as interest rates in the United States rose and as Conti nental interests, faced with increasing uncertainties, began to anticipate requirements for the approaching year-end. Interest rates on three-month Euro-dollar deposits reached 53 per cent per annum at the end of September and re A mained at or above 5 Vi per cent during the early weeks of October. Confidence in sterling was steadily deterio rating and, when the Bank of England raised its discount rate by V2 percentage point to 6 per cent on October 19, 51 the BIS, at the suggestion of the Federal Reserve, re activated its swap line and placed a small amount of dol lars in the Euro-dollar market to help forestall an offsetting rise in rates. Additional placements on a more substantial scale were made on November 9 to reinforce the second V2 point rise in the British bank rate in three weeks to 6 V2 per cent. Once again these operations—which raised BIS drawings on the System to $68 million—helped steady the market. The November 18 devaluation of the pound and the accompanying increase in the Bank of England’s discount rate by IV2 percentage points to 8 per cent, followed immediately by the V2 point rise in the Federal Reserve discount rate to AV2 per cent, caused a sharp jump in Euro-dollar rates. Speculation against the dollar and gen eral uncertainties in the exchanges generated large with drawals of funds from the Euro-dollar market, thus adding to the stringencies associated with normal year-end repatri ations. It was clear that coordinated central bank action was imperative if the speculation erupting in the gold and exchange markets and the corresponding heavy pressures being generated in the Euro-dollar market were to be held in check. Among the various measures agreed upon by the active members of the Gold Pool who met in Frankfurt on the weekend following sterling’s devaluation, the central banks of Belgium, the Netherlands, and Switzerland agreed to sell their currencies forward in cooperation with United States authorities, with a sizable amount of the sales conducted on the basis of market swaps (forward purchase of United States dollars against spot sale) so that dollars simulta neously were pumped out into the Euro-dollar market by the central banks. Even more important in terms of size was the very large volume of swaps entered into by the German Federal Bank at the end of November (in which the Federal Reserve participated through a $300 million drawing on its reciprocal currency arrangement with the German Federal Bank). The $600 million channeled into the Euro-dollar market by these German operations was especially effective in bringing down Euro-dollar rates—from nearly 7 per cent per annum for three months to about 6 V4 per cent by early December—and in cutting the forward premium on the German mark. In addition, at the end of November, the BIS placed $38 million in the market, using dollars drawn under its swap line with the System, to reinforce the effects of the outflow generated by the German Federal Bank. Such operations through the BIS continued during much of December, bringing the total amount of BIS draw ings outstanding to $346 million at the year-end. Moreover, the German Federal Bank swapped out a further $250 mil lion before the end of the year. As a result, interest rates 52 MONTHLY REVIEW, MARCH 1968 held in a narrow range, and the market generally remained steady despite the considerable stresses and uncertainties in the exchanges near the year-end. After the turn of the year, Euro-dollar rates moved sharply lower, despite widespread expectations in the mar ket that there would be a further rise following the an nouncement of the President’s new balance-of-payments program. Yet the fall in rates should not have been sur prising. Money markets in most of the major Continental centers remained highly liquid, and there were substantial outflows into the Euro-dollar market from Germany, France, and Switzerland as well as more modest flows from the Netherlands and Belgium. Much of this shift of funds was, of course, of a normal seasonal nature. More over, the spate of longer term Euro-bond issues undoubt edly resulted in the temporary accumulation of excess funds by some of the borrowers, who then placed the pro ceeds in short-term deposits. At the same time, the heavy pressures on the Canadian dollar during January undoubt edly resulted in a shift of short-term money from Canada into the Euro-dollar market. Thus, by the end of January, interest rates on three-month deposits had declined to about 5V2 per cent, and they held at that level through February. Under these circumstances the BIS was able to reverse its earlier placements in the Euro-dollar market made from the proceeds of drawings on the Federal Reserve swap line. By the end of January the $346 million outstanding at the end of 1967 was fully repaid. P e r J a c o b s s o n F o u n d a tio n L e c tu r e The Per Jacobsson Foundation in Washington, D. C., has made available to the Federal Re serve Bank of New York a limited number of copies of the 1967 lecture on international mone tary affairs. In sponsoring and publishing annual lectures on this topic by recognized authorities, the Foundation continues to honor the late Managing Director of the International Monetary Fund. The fourth in this lecture series was held on September 22, 1967 in Rio de Janeiro, Brazil. David Rockefeller, President of The Chase Manhattan Bank, N.A., gave the only lecture on that date, under the title of “Economic Development—The Banking Aspects”. Supplementary comments were made by Felipe Herrera, President of the Inter-American Development Bank, and Shigeo Horie, Chairman of the Committee on International Finance, Federation of Economic Organiza tions of Japan. Since many readers of this Review have expressed an interest in international monetary affairs and in view of this Bank’s sympathy with the Foundation’s aims, we will distribute copies of the lecture upon request. Requests should be addressed to the Public Information Department, Federal Reserve Bank of New York, 33 Liberty Street, New York, N. Y. 10045. Requests for French and Spanish ver sions of the lecture can also be filled. FEDERAL RESERVE BANK OF NEW YORK 53 T h e B u s in e s s S itu a tio n The domestic economy has shown continued strength so far in the new year, though some indicators have been unable to sustain the extraordinary advances posted late in 1967. In January, both industrial production and new orders for durable goods declined after very large Decem ber increases. January gains in personal income and pay roll employment were relatively modest, but various nonrecurring special factors exerted a restraining influence. Over the balance of the quarter, personal income should get a strong boost from the February increase in the mini mum hourly wage and the March step-up in social security benefit payments. The unemployment rate edged down to a fourteen-year low of 3.5 per cent in January, and retail sales apparently showed the first sizable gain in many months. Overall, the likelihood that the economy is ex panding at an excessively rapid rate in the current quarter remains high. Moreover, prospects are that demand and cost pressures on prices will remain substantial over the balance of the year. Indeed, if the recent events in Asia lead to a step-up in defense spending beyond currently budgeted levels, these pressures will intensify, unless ap propriate measures are taken to restrain aggregate demand. P R O D U C T IO N , O R D E R S , A N D C O N ST R U C T IO N The Federal Reserve Board’s index of industrial pro duction declined in January by 0.6 percentage point, to 161.2 per cent of the 1957-59 average, after having jumped 2.3 percentage points from November to December (see Chart I). The largest January declines occurred in consumer durable goods and industrial materials. Auto assemblies fell by 6.1 per cent to an annual rate of 8.4 million units in January, at least in part reflecting local work stoppages. The assembly rate declined further in Feb ruary while labor disturbances continued, but production schedules call for output to rebound to an annual rate of 9 million units in March. Business equipment production was largely unchanged in January, as some further decline in industrial machinery production was offset by a recovery in output of farm equipment following a late-December strike settlement. The output of iron and steel dropped slightly in January from its recent high level, but produc tion stabilized in February as strike-hedge demand re mained steady. Not surprisingly, new orders for durable goods fell back in January after jumping HV 2 per cent in December. At a seasonally adjusted rate of $24.6 billion, January’s order inflow was below the December pace but was still the second highest since September 1966. More than half of the decline was accounted for by a drop in orders for con struction materials, and another third was due to a drop in 54 MONTHLY REVIEW, MARCH 1968 defense orders. Small reductions were also fairly widespread throughout the remainder of the durables manufacturing sector. While durable goods shipments edged off in January, shipments nevertheless exceeded the volume of new orders, and the backlog of unfilled orders declined for the first time since last April. Indicators of residential construction activity, which have behaved erratically in recent months, reversed their sharp December movements in January. Private nonfarm housing starts recovered strongly in January, following December’s precipitous decline, and climbed by 16 per cent to reach a seasonally adjusted annual rate of 1.4 million units. On the other hand, building permits for new private housing units declined 16 per cent in January after a 14 per cent jump in December. The changes put housing starts and permits in January more nearly in line with their recent levels than they had been after December’s wide swings. Although residential construction outlays were un changed in January, total private construction spending increased substantially, largely reflecting a surge in com mercial construction. E M P L O Y M E N T , P E R S O N A L IN C O M E, AND CONSUM ER DEM AND Following three months of sharp increases, nonfarm payroll employment rose again in January but at a more moderate pace. The major gains were registered in trade, services, and state and local government employment. There was a rise of about 43,000 in the number of per sons on manufacturers’ payrolls, with about two fifths of the increase due to the settlement of strikes. January’s growth in payroll employment was limited by a decline in construction employment, caused by unusually cold and snowy weather. Had construction employment remained at its December level, total January payroll employment would have risen by an amount about equal to 1967’s monthly average. The continued strength of the employment situation was evidenced by the 0.2 percentage point January decline in the overall unemployment rate to 3.5 per cent (see Chart II), the lowest level since November 1953. While much of this decline was accounted for by a greater than seasonal decrease in the number of adult women in the labor force, the key unemployment rate for married men also dropped to 1.6 per cent from its already low November-December level of 1.7 per cent. At the same time, the unemployment rate for teen-agers continued to move lower from the high levels of mid-1967. Reflecting in part the growth of employment, personal income rose by $1.9 billion during January to a seasonally adjusted annual rate of $651.2 billion. The gain would have been larger had it not been for special nonrecurring factors. The personal income figure is calculated net of social insurance tax payments and expressed each month at a seasonally adjusted annual rate. Thus, since the taxable earnings base for social security taxes was raised as of January, the deduction for such taxes made in com puting personal income was raised in January by $1.0 billion at a seasonally adjusted annual rate. In terms of a worker’s actual take-home pay, the present 4.4 per cent deduction from gross pay will be made for more weeks this year than was the case last year. The wage and salary component of personal income edged down in January, as a drop of $2.3 billion in Fed eral Government payrolls more than offset the $1% billion gain in private wages and salaries. The decline in Govern ment payrolls simply reflected the fact that the figure was inflated in December by $2.7 billion as a result of pay ment of a retroactive pay increase to Federal employees. Excluding the effects of these factors, and an abnormally large rise in dividend payments in January which merely FEDERAL RESERVE BANK OF NEW YORK 55 recouped most of December’s unusual decline, the Com tax payments and a modest decline in output per manmerce Department estimates that personal income rose hour resulted in a very large 1.4 per cent increase in by a healthy $3% billion in January, the same as the labor costs per unit of output. In January, the index of average monthly gain throughout 1967. Personal income unit labor costs in manufacturing stood at 108.8 per cent is expected to be boosted in February by the rise in the of the 1957-59 average, 3.8 per cent above the January minimum hourly wage from $1.40 to $1.60, which went 1967 level. Rising demand and cost pressures have already caused into effect on February 1, and in March by a 13 per cent rapid increases in wholesale prices. In January, the whole average rise in social security benefit payments. One of the more noteworthy January developments was sale price index jumped 0.4 percentage point to 107.2 the apparent sharp increase in consumer retail buying, per cent of the 1957-59 average, with all the major com after many months of sluggishness. Retail sales reached a ponents rising. Preliminary figures for February indicate record high in January, according to preliminary data, as an acceleration of wholesale price increases. The total in sales climbed 2.9 per cent above the December level. dex surged another 0.6 percentage point, as farm products January retail sales were bolstered in particular by a 7.3 and processed foods and feeds climbed 1.3 percentage per cent increase in auto sales to an annual rate of 8.0 points after falling throughout most of the second half of 1967. The evidence now available indicates that the in million units. The Commerce Department’s most recent survey of dustrial commodity index showed an annual rate rise of consumer buying expectations, taken in January, indicates 4.5 per cent in the first two months of 1968, up substan that households are more optimistic about the likelihood tially from the 2.6 per cent rate of the second half of 1967. Consumer prices rose sharply again in January. At of income gains than they were when the survey was last taken in October 1967. On the other hand, the indexes of 118.6 per cent of the 1957-59 average, the January con expected purchases of new and used cars and of expendi sumer price index was 0.4 percentage point above the tures on houses and household durables over the next two December level. A large part of the January increase was quarters showed no significant change from the levels due to a substantial advance in food prices. This increase reported in October 1967. However, the survey in its followed a sharp advance in December which, in turn, had present form was inaugurated only a year ago, and it is ended three months of declines. Prices of services rose difficult to assess its reliability in such a short period. rapidly again in January. However, prices of nonfood commodities increased at a relatively modest rate for the second consecutive month. Declines in apparel and new C O ST A N D P R IC E P R E S S U R E S car prices, probably partly seasonal, helped to account for Labor costs accelerated sharply in January. The com the small size of the overall rise in nonfood commodity bination of a sizable increase in employers’ social security prices. T h e M o n e y an d B o n d M a r k e ts in F eb ru a ry Money market rates edged higher on balance during February, as nationwide net reserve availability contracted and member bank borrowings at the Reserve Banks in creased. The effective rate for Federal funds was gen erally Vb percentage point higher than in January, and other short-term rates rebounded from late-January lows early in the month and rose irregularly thereafter. An out flow of funds from maturing certificates of deposit (C /D ’s) early in February was subsequently reversed, and short term C /D rates remained below earlier ceiling levels, al though some increases were posted in these maturities. The movement of yields in the Treasury bill sector was greatest in the six-month area, where rates moved up as much as 20 basis points, while three-month bills rose 14 MONTHLY REVIEW, MARCH 1968 56 Table I Table H FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, FEBRUARY 1968 RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS FEBRUARY 1968 In millions o f dollars; (+ ) denotes increase, (—) decrease in excess reserves In m illions of dollars Daily averages—week ended on Factors affecting basic reserve positions Changes in daily average* week ended on Feb. Feb. 14 Feb. 7 Feb. 28 21 Total “ market’* factors ................... — 441 + 145 - f 537 — 458 — 184 — 141 — 67 — 109 4- 42 — 290 4- — 205 — 85 + 2 + 221 10 — 4-1 2 5 4-519 4-467 4- 34 — 3 4 - 168 — 148 — 4— -f 406 36 178 47 4 - 51 12 4 -1 0 7 4 -1 6 1 4 -188 — 15 — 194 - f 24 —6 + — 86 — — 11 3 — + 110 1 4-380 — 25 + 5 4- 25 — 1 4- 143 Total ................................................... 4- 346 4- 56 2 4- 281 — 4 21 4 131 119 99 410 161 25 229 44 931 610 1,026 616 953 792 849 824 — 304 -4 2 1 — 264 — 140 — 284 1,252 878 985 966 1,020 Gross purchases ............................. Gross sales ...................................... Equals net basic reserve surplus or deficit (—) .......................................... N et loans to Government securities d e a le r s.................................... Reserve excess or deficiency (—) t Less borrowings from Reserve B a n k s ........................................ Less net interbank Federal funds purchases or sales(—) ......................... 940 711 23 4 - 37 — 212 8 Gross purchases ............................. Gross sales ....................................... Equals net basic reserve surplus or deficit (—) .......................................... Net loans to Government securities d ea lers.................................... 72 7 54 39 54 — 34 — 25 — 391 — 25 — 4 + 28 144 321 — 67 110 75 77 668 1,692 1,025 782 600 1,858 1,076 1,558 958 1,770 1,230 1,720 1,072 540 648 — 698 -7 7 8 — 703 — 561 -6 8 5 792 680 673 719 716 4 - 201 N o te : Because of rounding, figures do not necessarily add to totals. * Estimated reserve figures have not been adjusted for so-called “as o f” debits and credits. These items are taken into account in final data, t Reserves held after all adjustments applicable to the reporting period less required reserves and carry-over reserve deficiencies. 4- 34 Excess reserves* .................................... — 372 — 127 1 Thirty-eight banks outside New York City Direct Federal Reserve credit transactions Open market instruments Outright holdings: Government securities ....................... Bankers’ acceptances........................ . Repurchase agreements: Government securities ....................... Bankers' acceptances........................ Federal agency obligations............... Member bank borrowings........................ Other loans, discounts, and advances... Feb. 28* Feb. 21 18 Reserve excess or deficiency (—) t Less borrowings from Reserve B a n k s ..................................... Less net interbank Federal funds purchases or sales ( —) ......................... - 644 79 Feb. 14 Eight banks in New York City “ Market” factors Member bank required reserves* ........... Operating transactions (subtotal) .......... Federal Reserve flo a t............................ . Treasury operations! ............................ Gold and foreign account..................... Currency outside banks* ..................... Other Federal Reserve accounts (n e t)t Feb. 7 Net changes Factors Averages of four weeks ended on Feb. 28* 4- 113 Table III Daily average levels AVERAGE ISSUING RATES* AT REGULAR TREASURY BILL AUCTIONS In per cent Member bank: Total reserves, including vault cash* Required reserves* .............................. Excess reserves* .................................. Borrowings ........................................... Free reserves* ..................................... Nonborrowed reserves* ....................... 25,953 25,575 378 241 137 25,712 25,529 25,038 491 384 107 25,145 25,275 24,913 362 405 — 43 24,870 25,625 25,319 306 442 — 136 25,183 25,595§ 25,211§ 384§ 368§ 16 § 25,227§ Weekly auction dates— Feb. 196S Maturities Feb. 5 Feb. 9 Feb. 19 Feb. 26 Three-month...................................... 4.957 5.040 4.940 5.063 Six-month........................................... 5.119 5.275 5.133 5.236 Changes in Wednesday levels Monthly auction dates— Dec. 1967-Feb. 1968 System Account holdings of Government securities maturing in: - 235 Total ................................................. 4- 235 -878 4-7,697 —7,658 4 - 297 4- 4-297 Note: Because of rounding, figures do not necessarily add to totals. * These figures are estimated, t Includes changes in Treasury currency and cash. $ Includes assets denominated in foreign currencies. § Average of four weeks ended on February 28. 39 Dec. 26 Jan. 25 Feb. Nine-month.. 5.555 5.254 5.239 One-year...... Less than one y e a r .................................. More than one y e a r ................................ 5.544 5.267 5.281 4-7,351 —7,658 21 * Interest rates on bills are quoted in terms of a 360-day year, with the discounts from par as the return on the face amount of the bills payable at maturity. Bond yield equivalents, related to the amount actually invested, would be slightly higher. FEDERAL RESERVE BANK OF NEW YORK basis points over the month. The three-month Euro-dollar rate was generally quoted in a narrow range around 5.50 per cent. The principal feature of the markets for intermediateand longer term securities was the Treasury exchange offering (including a prerefunding) involving a 53 per A cent seven-year note and the subsequent cash offering of $4 billion of a 5s per cent fifteen-month note. Both were /s well received. Federal agency offerings of $1.4 billion of short- and intermediate-term securities in mid- and late February were quite successful. Over the month, yields on coupon issues were generally steady to somewhat higher. Prices were supported by a growing conviction among market participants that capital market pressures arising from greater expenditures in the event of further escalation in Asia would be mitigated by stringent fiscal measures. 57 In such an event, consensus born of crisis would be ex pected to offset the legislative stalemate now plaguing the proposed tax increase. BANK RESERVES A N D THE M ONEY M ARKET On balance, money market rates were slightly higher in February than in January. The effective rate for Federal funds was generally 4% per cent, Vs percentage point above the most frequently prevailing rate a month earlier, and trading at 4% per cent was not uncommon. Rates on commercial paper were generally unchanged during the month, but early in February rates on bankers’ acceptances were raised Vs percentage point to 5Va per cent (offered) and rates on 60- to 89-day finance company paper declined by a similar amount to 5 Vs per cent. Treasury bill rates SELECTED INTEREST RATES Per cent 7.50 MONEY MARKET RATES Decemberl967-February 1968 Per cent BOND MARKET YIELDS 6.50 5.50 4.50 3.50 3.00 December January 1967 February 1968 December 1967 January February 1968 Note: Data are shown for b usine ss d a y s only. M O N EY MARKET RATES Q UO TED: D a ily ra n ge of rates posted by major New Yo rk C ity b anks point from underw riting syn d ica te reo fferin g yield on a given issue to market yield on the on new call loans (in Fed eral funds) secured by United States G overnm ent securities (a point sam e issue im m ediately after it has been rele ased from syn d icate restrictions); d a ily ind icates the ab sen ce of any ran ge); offering rates for directly p la ce d finance co m p an y p ap er; a v e ra g e s of yield s on long -term Governm ent securities (bonds due or ca lla b le in ten years the effective rate on Fed eral funds (the rate most representative of the transaction s executed); or more) and of G overnm en t securities due in three to five years, computed on the b a sis of c lo sing bid rates (quoted in terms of rate of discount) on newest outstanding three- and six-month clo sin g bid prices; T hursday av e rage s of yields on twenty seaso n ed twenty-ye ar tax-exem pt T rea sury b ills . B O N D MARKET Y IELD S Q UO TED: Y ie ld s on new A a a - and A a-rated p ub lic utility bonds are plotted around a line show ing d a ily a v e ra g e y ield s on seasoned A aa-ra te d co rp o rate bon d s (arrows bonds (carrying M oody’s ratings of A a a , A a , A , and Baa). Sources: Fe d e ra l Reserve Bank of N ew Yo rk, Board of G overno rs of the Federal Reserve System, M oody’s Investors Service, and The W eekly Bond Buyer. 58 MONTHLY REVIEW, MARCH 1968 F ifty-th ird A n n u al R e p o r t The Federal Reserve Bank of New York has published its fifty-third Annual Report, which reviews the major economic and financial developments of 1967. The Report notes that 1967 was a trying year for the economy, and that the country was plagued by a variety of economic ills in the midst of unprecedented prosperity. Delay in the ap plication of fiscal restraint in the face of a large budget deficit and of inflationary pressures in the latter part of the year posed a serious dilemma for monetary policy; partly as a result, the policy of monetary ease was continued until late in the year, when the Federal Reserve System shifted its stance toward somewhat firmer credit conditions. The devaluation of sterling rocked the inter national financial system in November, but the threat to the dollar was countered as 1968 opened by the President’s unprecedentedly stringent balance-of-payments program. In his letter transmitting the Report to the member banks in the Second Federal Reserve Dis trict, Alfred Hayes, President of the Bank, stated: “In 1968, economic policy must seek a reduction in inflationary pressures and a significant improvement in the balance of payments, both in the context of a growing economy. An appropriate mix of monetary and fiscal policies, including en actment of the long-needed tax increase, can make a major contribution to this effort.” Copies of the Annual Report may be requested from the Public Information Department, Fed eral Reserve Bank of New York, 33 Liberty Street, New York, N. Y. 10045. rose sharply in early February from the lows of the pre vious month, and rates were fairly steady—particularly in shorter maturities—throughout the balance of the month. Increases early in the month, which generally ranged from 10 to 30 basis points, reflected adjustments in dealer posi tions emanating from smaller than anticipated reinvestment demand associated with the Treasury refunding operations and higher dealer financing costs. The principal increase in the cost of financing occurred in the first week, when rates quoted by New York City banks on call loans to Government securities dealers rose as much as Va per centage point. These rates fluctuated narrowly for the bal ance of the month. At banks in New York City, rates posted on C /D ’s in the 90- to 179-day maturity range fluctuated mostly be tween 5 Vs per cent and 5Vi per cent, Vs to V percentage 4 point higher than at the end of January. Rates for other maturities were generally steady: 60 to 89 days at 5 per cent and over 180 days at the 5Vz per cent Regulation Q ceiling. Although on balance New York City banks experi enced a decline in the volume of outstanding C /D ’s in February, much of this outflow was offset by gains in funds drawn from their own foreign branches. These funds, which are not subject to reserve requirements and deposit insurance assessments, became attractive as the threemonth Euro-dollar rate declined about 1 percentage point during January and then stabilized between 5.40 per cent and 5.60 per cent for most of February. Indeed, the avail ability of these funds reduced upward pressure on do mestic money market rates. Aggregate daily average free reserves declined on bal ance during February, and borrowings from Federal Reserve Banks increased markedly after the first week. Although over the first two statement weeks free reserves were little changed from average January levels, there was a sharp contraction in the last two weeks, when net bor rowed reserves averaged $43 million and $136 million, respectively (see Table I). The shift from free to net bor rowed reserves during the third week was strongly influ enced by a decline of $794 million (on a daily average basis) in System holdings of open market instruments, which more than offset an increase in float of $467 million. “Country” banks were responsible for most of the gain in borrowings from Federal Reserve Banks in February, when their daily average borrowings reached the highest level since October 1966. Moreover, borrowings by New York City banks for the month were the largest in a year, and this resort to the discount window was evidence of increased money market pressure. Reserve stringency at reserve city banks mounted in the first half of February after some easing in the final two weeks of January. Al though nationwide net reserve availability contracted in FEDERAL RESERVE BANK OF NEW YORK the last half of February, reserve distribution was more favorable to money market banks, particularly those in New York City, than earlier in the month (see Table II). THE G O V E R N M E N T SE C U R IT IE S M AR K ET Prices of Treasury notes and bonds fluctuated irreg ularly during February, and at the month end yields on both intermediate- and longer term coupon issues were little changed from levels a month earlier. In part, the firmness of prices during the month reflected an attitude that the worsening Asian situation would not significantly affect fixed-income securities. It was believed that an aggravation of hostilities which stimulated greater defense expenditures would at the same time result in the impo sition of fiscal measures which would relieve market pressures. Two sizable Treasury financing operations were con ducted in February. In the first, a new 53 per cent sevenA year note was offered in exchange for a maturing note and, as a prerefunding, for issues maturing in August and November 1968. Subscription books were open for three days beginning February 5. Although initial enthusiasm waned somewhat, the exchange was regarded as very suc cessful. About 72 per cent of the $1.7 billion in February maturities held outside Federal Reserve and Government accounts was exchanged, and 25 per cent of the $10.3 billion in other maturities was tendered. On February 13 the Treasury received subscriptions for a $4 billion offer ing of a 55 per cent fifteen-month note. Banks were /s allowed full Tax and Loan Account credit, and settlement was made on February 21. Allotments of 39 per cent on subscriptions in excess of $200,000 were within the range of market expectations, and the new note was generally quoted around par in subsequent trading. Treasury bill rates moved higher in early February, influenced partially by higher dealer financing costs, which stimulated aggressive selling. Rates for bills due in two to six months rose from 6 to 22 basis points during the first week, while rates on longer maturities were only slightly higher. At the higher yield levels interest emerged at mid month, when demand by banks and state funds—particu larly for shorter maturities—moved rates lower. Rates rebounded somewhat thereafter as these influences abated, and there was little reaction to the expected Treasury an nouncement that an additional $100 million would be of fered in the regular three-month bill auctions, probably for a full thirteen-week cycle. Interest in the monthly auction of nine- and twelve-month bills favored the shorter issue, and accepted bids covered a wide range of prices. The average issuing rates of 5.239 per cent and 5.281 per cent, 59 respectively (see Table III), were little changed from those a month earlier. Prices of Federal agency securities fluctuated narrowly during February. On February 14 the Federal Home Loan Banks offered $400 million of a 5.70 per cent note matur ing on September 25, 1968 at par and $200 million in a 6 per cent note due March 25, 1970, priced at lOOVs. The next day the Federal Intermediate Credit Banks offered $453.5 million of a 5.75 per cent nine-month debenture at par. At the month end the Federal National Mortgage Association offered $350 million of a 6 per cent three-year debenture, priced to yield 6.02 per cent. All issues were very well received, and the earlier offerings subsequently traded at premiums. O THER SE C U R IT IE S M A R K E T S Prices in the market for corporate bonds were generally steady throughout February, although some weakness de veloped toward the end of the month. While the volume of new offerings was light, investor resistance was fairly pervasive—especially to issues priced aggressively by underwriters. The successful conclusion of Treasury financ ing operations during the first half of the month did not trigger a renewal of demand for new issues, nor did the prospect of a relatively low volume of offerings in March stimulate buying. As a result, dealer inventories rose dur ing the month. At the same time, spreads between new and seasoned high-grade issues were slightly wider on bal ance than during January (see chart). On February 28 four underwriting syndicates were disbanded, and unsold issues were released to trade at yields about 10 basis points higher than originally offered. The Moody index of yields on Aaa seasoned corporate bonds changed little during February and closed at 6.08 per cent. Prices in the market for tax-exempt bonds drifted steadily lower during February. Late in the month the prospect of a revival in industrial revenue bond financing added further pressure to prices. Buying by commercial banks favored is sues with short maturities. As a rule, longer maturities of new issues moved slowly throughout the month, and the Blue List of dealer-advertised inventories rose from $443.8 million at the end of January to $488.8 million a month later. This swing about offset the decline in inventories during January, and the resultant market congestion con tributed to the postponement of a major offering scheduled for late February. Over the month, The Weekly Bond Buy er's series of twenty seasoned tax-exempt issues (carrying ratings from Aaa to Baa) rose by 19 basis points to 4.44 per cent, only slightly below the 1967 peak reached last December.