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Treasury and Federal Reserve Foreign Exchange Operations*
B y C h a r le s A . C oom bs

Bonn of the finance ministers and central bank governors
of the Group of Ten.
While the Bonn conference in itself did not fully clear
the air, market apprehension was immediately relieved by
the categorical assertion by all elements of the German
coalition government that the mark would not be revalued
and that adjustment of the foreign trade balance would in­
stead be sought via tax measures. Similarly, market fears
of a devaluation of the French franc also receded as the
French government, on the day after the Bonn conference,
equally categorically asserted its determination to hold to
the present parity and to introduce changes in taxation and
stringent exchange controls to protect the franc until more
basic policy measures restored a natural equilibrium. The
British government simultaneously took forceful action to
restrain internal demand which had been eroding much
of the benefit anticipated from the November 1967 de­
valuation of sterling. Finally, during the Bonn conference,
the central bank governors quickly put together a new
package of credits totaling $2 billion on behalf of the
Bank of France, thus providing further convincing evi­
dence of the solidarity of the major trading countries
against any threat of breakdown in the existing interna­
tional financial system.
With this clarification of official intentions, the specula­
tive fever abruptly subsided. Encouraged by unusually high
rates in the Euro-dollar market, favorable terms on market
swaps provided by the German Federal Bank, and out­
right forward mark cover initially offered by both the
German Federal Bank and the Federal Reserve, massive
return flows of funds from Germany continued throughout
the winter months, and by early March 1969 all the funds
This report, covering the period September 1968 to March taken in by the German Federal Bank between late
1969, is the fourteenth in a series of reports by the Senior Vice
August and the Bonn conference had been withdrawn or
President in charge of the Foreign function of the Federal Reserve
Bank of New York and Special Manager, System Open Market
recycled into the international money markets. The Bank
Account. The Bank acts as agent for both the Treasury and Fed­
of France succeeded in recovering a substantial portion of
eral Reserve System in the conduct of foreign exchange operations.

The major development in the exchange markets during
the period under review was the surging wave of specula­
tion last fall on a simultaneous revaluation of the German
mark and devaluation of the French franc and pos­
sibly other currencies. Between late August and the Bonn
conference in November, the German Federal Bank was
swamped by record gross market purchases of more than
$4 billion. Over the same period, the Bank of France and
the Bank of England suffered reserve losses, largely attribut­
able to speculation, of over $2 billion. The flood of money
across the exchanges, probably the largest in international
financial history, was rooted in national currency problems
rather than basic flaws in the international financial system.
The extraordinary competitive strength of German exports,
the struggle of France to restabilize the franc after the
“events of May”, the lagging recovery of sterling after the
devaluation of November 1967, and, more generally, con­
cern over the erosion by inflation of the value of the dol­
lar—these and other fears had kept the exchange markets in
a state of continuous anxiety and vulnerability to any per­
suasive rumor. Thus the speculative rush into marks in late
August and again in November 1968 seems to have been
triggered not by any special event, but rather by a sudden
boiling-up of rumors of an imminent intergovernmental
agreement on a realignment of the mark and other currency
parities. The market accordingly rushed to hedge against
what seemed to be a near-term risk until a number of major
markets were closed during the emergency conference at



the reserves lost during the fall months, while the pound
sterling showed a healthier tone with sizable dollar gains
by the Bank of England appearing after the turn of
the year.
Since the end of the last war, the monetary authorities
of the major industrial countries have been confronted
with a number of speculative storms which may well recur
over the years to come as one country or another drifts
into disequilibrium. But there is no reason why trouble at
any one point in the network of currency parities should
trigger a chain reaction of competitive devaluations or re­
sort to floating rates. The Bonn communique noted that
. . international monetary stability is the joint respon­
sibility of all countries in the international economic com­
munity”. The rules of the game agreed upon at Bretton
Woods were designed to provide, and do provide, an effec­
tive safeguard against the competitive devaluations of the
thirties, while the development of central bank and inter­
governmental cooperation at Basle and in the Group of
Ten has further strongly reinforced the ability of the major
trading nations to prevent any accidental collapse of exist-

Table I
March 10, 1969
In millions of dollars

Amount of facility

Austrian National Bank................................................


National Bank of Belgium...........................................


Bank of Canada.............................................................


National Bank of Denmark..........................................


Bank of England............................................................


Bank of France..............................................................


German Federal Bank..................................................


Bank of Italy



Bank of Japan .............................................................


Bank of Mexico..............................................................


Netherlands Bank...........................................................


Bank of Norway........................................... .................


Bank of Sweden.............................................................


Swiss National Bank.....................................................


Bank for International Settlements:
Other authorized European currencies-dollars.....



•T h e facility with the Bank of France was increased by $300 million effec­
tive November 25, 1968.
t The facility with the Bank of Italy was increased by $250 million effective
October 10, 1968.

ing monetary arrangements. These countries have in their
hands all the authority, the financial resources, and the
facilities for immediate communication and consultation
required to protect the international financial system
against the risk of a national currency crisis escalating
into a worldwide financial explosion.
Illustrative of the determination of the central banks
to deal with the speculative risks inherent in all free
markets was the response of the central bank governors
meeting at Basle to their undertaking, as noted in the
Bonn communique, to “. . . examine new central bank
arrangements to alleviate the impact on reserves of specu­
lative movements”. The conclusions of the governors’
study, as communicated to Minister Schiller, Chairman of
the Ministers and Governors of the Group of Ten, noted
. . facilities between central banks, or with the BIS,
have been established extremely quickly in case of need.
If, at any time in the future, it appears that new arrange­
ments are needed in order to cope with an unusually large
movement of speculative funds, the central banks of the
group declare themselves ready to meet together immedi­
ately, at the request of the President of the BIS, to arrange
such additional facilities as the group may judge appropri­
ate.” The governors further expressed their belief that
“. . . in any new group arrangement designed to recycle
speculative flows, both the shares of the participants and
the timing of drawings should reflect the direction of the
flows involved. Thus, central banks that were receiving
funds at the time could accept proportionately larger
shares in the arrangement and/or they could agree to be
drawn on first. Central banks that were drawn on and were
not gaining reserves at the time should be afforded refinanc­
ing facilities for the period of the drawing from other cen­
tral banks that were gaining reserves at the time.”
Among other important developments, the Federal Re­
serve swap network was further increased to $10,505 mil­
lion (see Table I). The System’s swap line with the Bank
of France was raised by $600 million in July and by a fur­
ther $300 million in November, to a total of $1 billion, as
the Federal Reserve participated in international credit
packages for France. In October, the facility with the
Bank of Italy was also raised to $1 billion, an increase of
$250 million, bringing it into line with other major
reciprocal currency arrangements.
By midsummer 1968, the Federal Reserve had liquidated
its $1.8 billion of swap commitments outstanding at the
beginning of the year, and shortly thereafter the System
and the Treasury had cleared away all forward market
commitments originally undertaken in late 1967 and March
1968. (See Table II for the System’s swap operations since
the beginning of 1968.) In late August this Bank, act­


Table n
In millions of dollars equivalent
Drawings (+ ) or repayments (—)

System swap
commitments on
January 1,

National Bank of Belgium..............................
German Federal Bank......................................
Bank of Italy......................................................
Netherlands Bank.............................................
Swiss National Bank.........................................
Bank for International Settlements................
T otal...................................................................






} -




f + 175.0
1 — 311.0


1 -








January 1M
arch 10


— 112.1

j — 160.0

( + 145.0

f 4- 280.0
I — 80.0

- 280.0


( + 145.0
} — 349.0

I — 80.0

— 392.1


- 300.0




f + 54.0
I — 124.1


System swap
commitments on
arch 10,

J + 368.1
i -1,251.8




) '+ 73.0
1 — 15.0

- 189.0


f 4- 302.0
I - 870.1

* System drawings in Swiss francs.

ing for the Federal Reserve and the Treasury, reentered
the forward market in German marks for the first time
since 1961, supplying $33.8 million of forward marks
to the New York market in support of much larger
market swap operations by the German Federal Bank
in Frankfurt; the forward commitments of the United
States to the market were fully liquidated by the end
of the year. In November, during the phase of acute
speculative demand for marks, the Federal Reserve re­
activated its swap line with the German Federal Bank to
finance $40 million equivalent of spot sales in the New
York market. After the Bonn meeting, the System once
again sold marks forward in New York and covered them
with a further $72.1 million equivalent of swap drawings.
These System obligations totaling $112.1 million equiv­
alent also were fully liquidated as the speculative fever
abated and funds flowed from Germany. In addition, Fed­
eral Reserve swap commitments in Swiss francs rose to
$320 million in late November, but the System was able
to reduce its obligation to $40 million equivalent by the
end of February. As of March 10, the Swiss franc draw­
ings were the only outstanding Federal Reserve commit­
ments under all swap arrangements.
Foreign central banks and the Bank for International
Settlements (BIS) continued to make heavy use of their
swap lines with borrowings of $1.7 billion outstanding
at the end of 1968 (see Table III). The Bank of England

reactivated its facility in July after having repaid all its
earlier outstanding swap debt; by the end of November
its drawings on the System totaled $1,150 million. Draw­
ings by the Bank of France reached a peak of $611 million
by late November, but these obligations were reduced to
$306 million by early March. By the end of October,
drawings by the National Bank of Belgium rose to $120.5
million, but nearly all these drawings had been repaid by
late February. When Euro-dollar rates rose in December,
the BIS placed a total of $80 million drawn from the
Federal Reserve to minimize any immediate pressures on
sterling. These drawings were repaid in January. In smaller
operations, the National Bank of Denmark drew $25 mil­
lion in January. On the other hand, the Netherlands Bank
liquidated an outstanding $29.8 million commitment to
the System in October, placing its $400 million facility
on a fully standby basis. Overall, credits extended under
the reciprocal currency arrangements since their inception
in March 1962 total $17.6 billion, of which $6.3 billion
has been drawn by the System and $11.3 billion by foreign
central banks and the BIS.
Since February 1964, the United States has drawn a
number of times on its gold tranche with the International
Monetary Fund (IMF), on some occasions in conjunction
with Fund repayments by other countries and on others to
settle United States foreign currency commitments. United
States repurchase obligations to the IMF reached a peak



of $964 million by December 1966. Subsequent drawings
of dollars by other countries reduced this obligation to
$284.3 million by late 1968. In November and Decem­
ber 1968, the Treasury voluntarily liquidated this obliga­
tion, using Netherlands guilders, Belgian francs, and
Italian lire, thereby fully reconstituting the United States
gold tranche of $1,290 million with the IMF.

Germany recorded large monthly trade surpluses
throughout 1968, but for most of the year the balance of
payments was roughly in equilibrium as there were offset­
ting capital outflows facilitated by the official policy of
monetary ease. In the exchange markets, however, atten­
tion tended to focus on the large trade surpluses which
were interpreted as evidence that the German economy
had developed a wide competitive advantage. Consequently,
there were frequent rumors of an imminent revaluation of
the mark, and on several occasions these set off vast shifts
of funds into Germany. German authorities repeatedly de­
nied that any revaluation was in the offing, and on the eve
of the Bonn conference took strong measures to reduce the
trade surplus and discourage the inflow of hot money. The
German Federal Bank met each inflow of funds with vigor­

ous exchange market operations and over the course of the
fall and early winter months succeeded in pushing out all
its huge dollar intake. Thus by February 1969 the spot
mark was once again well below par, as it had been last
summer before the speculation came to a head.
The first major wave of revaluation rumors occurred
toward the end of August 1968 and touched off heavy
speculative demand for marks. Within days the spot mark
had risen virtually to its ceiling (see Chart I ), and the
German Federal Bank had begun to take in huge amounts
of dollars. The bank’s market purchases amounted to $1.7
billion in the period August 27-September 6. Some of
the inflow represented conversions of sterling and French
francs, but a large part came from the Euro-dollar market.
From the outset, the Federal Bank moved to neutralize
the potentially disruptive effect of these inflows, as it had
in the past, by making available dollar-mark swaps at
rates that provided a sizable incentive to German banks
to channel the funds to the Euro-dollar market. The
United States authorities assisted these efforts by selling
some $33.8 million equivalent of marks in the forward
market in New York. After the monthly central bank
meeting in Basie on the weekend of September 7-8, the
demand for marks let up as speculative influences receded.
The German Federal Bank continued with its swap sales,

Table III
In millions of dollars
Drawings (+ ) or Repayments (—)
Banks committed
to Federal Reserve System


to System on
January 1,


National Bank of Belgium..............................................................



National Bank of Denmark............................................................
Bank of England..............................................................................









1 -1,645


Netherlands Bank............................................ ................................



Bank for International Settlements (against German marks)...

f + 66
1 — 412




f + 366
1 -4 1 2

f +1,030.7
{ -1,965.0

f + 600
1 — 200










| + 145
[ — 256



( +1,165.0

f +1,431.5

f + 390
} — 40





to System on
December 31,



Bank of France.................................................................................




+ 250

Bank of Canada................................................................................







Table IV
In millions of dollars equivalent
Issues or redemptions (—)
Issued to

outstanding on
January 1,


Austrian National Bank...................................



Bank of Italy......................................................
Netherlands Bank.............................................



f - 50.3
} 124.4



Bank for International Settlements'!*..............
















- 50.0*

German banks


Swiss National Bank........................................


— 60.4



outstanding on
arch 10,



German Federal Bank......................................



National Bank of Belgium...............................


January 1M
arch 10,







Note: Discrepancies in totals are due to valuation adjustments, refundings, and rounding.
• In addition, on January 16, 1969 the United States Treasury issued a medium-term security in place of a
certificate of indebtedness purchased by the German Federal Bank on December 27, 1968.
t Denominated in Swiss francs.

so that by the end of September the bank had returned to
the market virtually all it had taken in from the earlier
speculative inflow.
The market atmosphere remained quiet through most of
October, encouraging renewed capital outflows and con­
sequent substantial sales of dollars by the German Federal
Bank. As the spot rate declined, the Federal Reserve Bank
of New York made modest purchases of marks for Trea­
sury account, and the System and the Treasury paid off
maturing August-September forward sale commitments.
Market expectations of an eventual revaluation of the
mark persisted, however, and by the end of October
this undercurrent was reflected in a strengthening of the
spot rate. In early November, rumors of an imminent
revaluation once again swept the exchanges, triggering a
huge demand for marks, and the German Federal Bank
purchased nearly $2 billion by November 15. Although
the momentum behind the speculation was being gen­
erated mainly in Europe, the heavy demand reflected pur­
chases by United States firms as well. To meet some of the
demand in New York, the Federal Reserve Bank of New

York sold $47 million of marks on behalf of the Federal
Reserve. The System sales were covered through a $40
million drawing on the swap line with the German Fed­
eral Bank and from balances.
Once again the German Federal Bank acted to recycle
the funds by concluding market swap sales of dollars at at­
tractive rates. After swapping out some $1 billion of its
spot gains, however, the Federal Bank then took action
to curb the tendency of German banks to resell the spot
dollar proceeds of the swaps rather than hold the funds in
dollar investments, thereby in effect obtaining outright for­
ward cover as a result of the swaps. The authorities indi­
cated that they would conclude further swap sales of dollars
only if the banks invested the spot dollar proceeds in United
States Treasury bills. The German banks and their custom­
ers had become mainly interested in acquiring outright
forward cover in marks, and they chose not to engage in
swap transactions with the Federal Bank on these terms;
instead, they bid for spot marks and sought forward cover
through swaps in the market.
Speculative buying of marks continued with full fury



on Monday, November 18, when the regular monthly meet­
ing of central bankers at Basle ended without the of­
ficial statement that the market expected, and speculators
remained convinced that the next move would be an up­
ward revaluation of the mark. In two days through No­
vember 19 the Federal Bank purchased $850 million,
bringing gross purchases in November to more than $2.8
billion. On November 19, in an effort to calm the market,
the German authorities issued a formal communique stat­
ing that the mark would not be revalued and, to reduce the
German trade surplus, announced new tax measures that
would raise the price of exports while lowering import costs.
After a holiday on November 20, trading in Germany was
effectively suspended for the next two days before the week­
end as the finance ministers and central bank governors of
the Group of Ten nations met in emergency session in Bonn.
On November 22, the Group of Ten nations issued a com­
munique fully supporting the German government’s deci­
sion to stand firm at the existing mark parity, its new tax
measures, and the Federal Bank’s decision to impose 100
percent reserve requirements on new foreign-owned mark
deposits held in German banks. The monetary move, which
was designed to discourage further speculative inflows,
reinforced the ban on interest payments on foreign-owned
sight or time deposits denominated in marks already in ef­
fect. The German authorities also initiated legislation
authorizing the licensing of mark deposits by foreigners
with German banks.
When trading resumed in Frankfurt on November 25,
substantial amounts of funds began to flow from Germany
as market expectations of a revaluation receded and long
positions were liquidated. To encourage these and subse­
quent reflows, the Federal Bank offered outright forward
cover back into marks at a 3 percent per annum premium
for three-month maturities. The Federal Reserve backed
up the German Federal Bank’s operations, offering out­
right cover to the market at the same rates for the same
maturities. By the end of November the Federal Bank had
resold $880 million spot and sold $246 million of outright
forward marks. The System’s outright forward sales
reached $72.5 million equivalent, all covered by swap
drawings which raised Federal Reserve swap debt in marks
to $112.1 million equivalent.
On December 2 the Federal Bank and the Federal Re­
serve discontinued outright sales of forward marks, con­
cluding that they had served their purpose of encouraging
capital outflows and assuring the market that there would
be no parity change. The Federal Bank offered instead to
do swaps with its banks at improved rates and for a wider
range of maturities. Earlier the authorities had dropped
their requirement that the proceeds of the swaps be in­

vested in United States Treasury bills and requested only
that investments match the maturities of the official swap
contracts. German banks responded to the improved in­
centives, enabling the authorities to roll over into 1969
the very large December maturities of earlier swaps. More­
over, German banks also purchased very substantial
amounts of spot dollars, as foreigners withdrew funds
from Germany and commercial leads and lags began to
Heavy demand for dollars both spot and on a swap basis
continued into January 1969, reinforced by seasonal reflows
from the German money market. As the outflows continued,
the spot mark eased below par and the Federal Bank raised
the cost of its official swaps moderately in several steps.
Late in January, however, the very considerable outflows
finally brought about some tightening of German banks’
liquidity, and the Federal Bank’s swap sales began to taper
off. At the same time the Federal Bank raised its swap rates
again, to reduce the net incentive to move funds into the
Euro-dollar market.
During February the mark continued to move lower
in active trading. At first the German Federal Bank gained
reserves on balance, as receipts of dollars under maturing
forward contracts slightly exceeded current spot sales and
new swaps. By the month end, however, new outflows of
funds into dollar investments were again running ahead
of maturities. As of the end of February 1969, German
gold and foreign exchange reserves were $7.0 billion, com­
pared with $7.4 billion at the end of August 1968.
During the period of heavy outflows from Germany be­
ginning in late 1968, the Federal Reserve was able to ac­
cumulate substantial amounts of German marks. By late
January the System had purchased sufficient marks in
the market and from the German Federal Bank to repay
the entire $112.1 million of swap drawings from the Fed­
eral Bank. The System continued to acquire mark balances
during February and early March.
In early February the United States Treasury redeemed
at maturity a mark-denominated note equivalent to $50
million held by the German Federal Bank (see Table IV ).
The Treasury obtained the marks to meet the maturity di­
rectly from the German Federal Bank, which was losing
reserves at the time. During the period covered by this re­
port, in conjunction with the second agreement to neutral­
ize United States troop costs in Germany the Treasury had
issued new medium-term securities to the German Federal
Bank as part of the quarterly series of four issues to total
$500 million equivalent. By early January, three of these
securities had been purchased by the German Federal
Bank, bringing the total of such securities to $876 million



The political and economic crisis in France in May and
June 1968 gave rise to heavy selling of French francs in


the exchanges, and as the spot rate fell to its lower limit the
Bank of France suffered large dollar losses in support oper­
ations. The crisis atmosphere lifted in late June, after
the strikes were settled and returns from general elections
assured the continuation of a strong government. Further­
more, firm domestic and international measures were taken
to support the franc, including a $1.3 billion credit package
extended to France in early July by the United States, Ger­
many, Italy, the Netherlands, Belgium, and the BIS. United
States participation in the package took the form of a $600
million increase in the Federal Reserve swap arrangement
with the Bank of France, raising that facility to $700 mil­
Despite these stabilizing measures, the market remained
skeptical about the future of the franc, particularly in view
of the inflationary potential of the wage increases in June.
Pressure on the franc continued throughout the summer
and was aggravated by recurring rumors of a revaluation
of the German mark. Selling pressures eased only tempo­
rarily following the publication, in mid-September, of the
French government’s 1969 budgetary plans. At the same
time removal of exchange controls imposed in May also
had only a short-lived favorable impact.
Over the course of the summer the Bank of France drew
several times on the Federal Reserve swap line, using the
first $100 million by the end of June and drawing another
$390 million on the expanded facility through the end of
September. Net drawings on September 30 amounted to
only $450 million, however, since the Bank of France had
repaid $40 million of its drawings in the summer following
a sale of gold to the United States Treasury; France sold a
total of $240 million of gold to the United States in the
third quarter (after sales of $220 million in the second
quarter). The French authorities also made use of other
international credit facilities.
October was a generally quieter month, and the Bank of
France was able to repay $75 million of its swap debt to
the System and to reduce obligations under other interna­
tional credits. The respite was short-lived, however. The
outbreak of renewed speculation in marks in early Novem­
ber gave rise to a massive outpouring of funds from France,
with heavy losses to French official reserves. The French
authorities responded by tightening monetary policy— in­
cluding an increase in the discount rate to 6 percent and a
ceiling on short-term bank credit growth. On November
18, after the November 16-17 monthly central bankers’
meeting at Basle, Premier Couve de Murville went on na­
tionwide television to declare that France was assured of
“all the help she might need or will need in the future” and
promised large cuts in planned government spending to
bolster the franc. But the markets remained convinced that



the franc faced imminent devaluation, and heavy selling
continued. To meet the pressures the Bank of France drew
further on the Federal Reserve swap facility, raising its debt
under that line to $611 million, and also drew funds from
other participants in the July credit package. In view
of the continuing feverish speculation, the French author­
ities decided to close the Paris financial markets during the
period of the Bonn meeting (November 20-22). Although
the New York market remained open, there were only
scattered quotations for spot francs at deep discounts below
parity, and forward quotations were essentially unobtain­
able as the market believed that a devaluation of the franc
was certain to follow the meeting.
At the conclusion of the Bonn meeting a new central
bank credit facility for France in the amount of $2 billion
was announced. United States participation in the new
credits took the form of a $300 million increase in the
Federal Reserve swap line— raising the total to $1 billion
— and a $200 million facility extended to the Bank of
France by the United States Treasury. The next day Presi­
dent de Gaulle confounded market expectations by rejecting
devaluation of the franc, and on November 24 he set forth
a new program to defend the existing franc parity. The new
plan included a sharp cut in the government budget deficit,
further monetary curbs, price restraints, and tax adjust­
ments to improve the French competitive position, all
backed up by stringent exchange controls.
When trading resumed on Monday, November 25, there
was some immediate covering of short positions and the
Bank of France began to take in dollars. In subsequent
days the Bank of France continued to gain reserves, as the
newly imposed exchange controls stopped capital outflows
and French exporters complied with regulations requiring
them to repatriate export proceeds within a short period of
time. In early December, further restrictions required
French importers to abrogate a substantial portion of their
contracts to purchase forward cover in foreign exchange,
and French banks were obliged to sell to the Bank of
France the currencies held as cover against those con­
As a result of these moves the Bank of France continued
to gain reserves which it used in part to repay official bor­
rowings. By the year-end the bank had liquidated a total
of $181 million of its swap debt to the Federal Reserve,
lowering those commitments to $430 million. The bank
had also repaid substantial credits drawn from other EEC
countries and the BIS. At the same time the French au­
thorities made further gold sales, bringing those to the
United States to $600 million for the year.
The French franc remained generally firm during Janu­
ary and February 1969. French controls were tightened

further in January. The authorities requested that French
banks deposit with the Bank of France, over a period
of several months, an amount of foreign exchange rep­
resenting the net surplus of the banks’ foreign exchange
assets over liabilities in transactions with foreigners as of
the end of January. Those French banks with net borrow­
ings abroad were asked to maintain the existing level of
those foreign exchange liabilities. By this means the author­
ities mobilized substantial amounts of foreign exchange to
help cover the continuing French current-account deficit,
while the many corrective measures taken in recent months
worked their way through the French economy. In addi­
tion, the Bank of France used some of its reserve intake to
reduce its outstanding Federal Reserve swap debt to $306
million by early March.

Sterling recovered slowly from the shock of devalua­
tion, and it was not until the latter part of 1968 that a
material improvement began to be visible. During the first
half of last year, when many holders of sterling were
struggling to reassess their positions, the pound was caught
up first in the gold crisis and then in the backwash of the
French troubles in May and June. Thus it was not until the
summer that signs emerged of an improvement in the
fundamental position of sterling. Even then, however, for­
ward discounts remained relatively wide and sterling
continued to be vulnerable to any new external shocks.
Consequently, when speculation on a revaluation of the
German mark and a devaluation of the French franc
erupted again during the fall, sterling too came under
pressure. Once this crisis had been weathered, however,
and the exchange markets generally assumed a calmer
atmosphere, sterling was able to resume its recovery. Dur­
ing the first part of 1969, with increasing evidence that
the United Kingdom’s economic measures are taking hold,
sterling has been in a generally stronger position and the
United Kingdom authorities have been able to make some
progress in reducing Britain’s international indebtedness.
The second half of 1968 started rather auspiciously
for sterling. May and June had been very costly months
for United Kingdom reserves, as the uncertainties of the
deepening crisis in France compounded the adverse impact
on sterling of continuing large British trade deficits, threat­
ened labor disputes, and the pull of rising Euro-dollar
market rates. Despite these pressures, the United King­
dom authorities were able to make substantial repayments
of short-term assistance in June, mainly through use of
the full $1.4 billion available under a standby credit with
the IMF. Thus, at the end of June all outstanding debt


under the swap facility between the Federal Reserve and
the Bank of England was paid off, and the $2 billion
facility reverted to a standby basis (see Monthly Review,
September 1968).
Official confirmation on July 8 that twelve central banks
and the BIS were prepared to participate in a new multi­
lateral credit facility— amounting to $2 billion— to offset
reductions in the sterling balances of sterling area coun­
tries helped to turn market sentiment, which until that
period had been increasingly discouraged. More impor­
tant, June trade figures, showing reduced imports, seemed
to offer the first tangible evidence that devaluation was
working. Combined with a number of other encouraging
developments at home and abroad, these announcements
stimulated widespread buying of sterling, lifting the spot
rate above $2.3950 by the end of July. However, heavy
losses at the end of June and in the first week of July had
required the Bank of England to reinstitute drawings on
the Federal Reserve swap arrangement and, despite sizable
reserve gains in the last three weeks of July, outstanding
drawings amounted to $350 million at the month end.
Hopes for further improvement in the trade account
helped to sustain demand for pounds through early Au­
gust, and the Bank of England was able to reduce its swap
drawings by $50 million to $300 million. But these hopes
were dashed with the publication of July trade results
showing that the previous month’s gains had been re­
versed. Shortly afterward, Soviet intervention in Czecho­
slovakia brought new uncertainties, which were soon com­
pounded by mark revaluation rumors which in turn cast
new doubts on sterling. The pressures thus generated
carried through early September, by which time the spot
rate was back close to the floor and the Bank of England
had increased its drawings on the Federal Reserve to $400
As in earlier months, the market’s appraisal of sterling
turned heavily on the latest trade figures. Relatively favor­
able results for August and September were thus impor­
tant factors in sterling’s improved showing through the
end of October. The temporary subsiding of mark revalu­
ation rumors and the announcement in early September
that final agreement had been reached on the new sterling
balances arrangement were further elements in sterling’s
stronger market performance during this period.
A sharp run-up in sterling rates, following Pres­
ident Johnson’s announcement of a bombing halt in North
Vietnam, was abruptly halted by the new outbreak of
mark revaluation rumors in early November. The ster­
ling market remained roughly balanced at about $2.39
during the first two weeks of November despite uneasi­
ness over the implications for the domestic economy of


the government’s announcement of new instalment credit
restrictions. But news on November 13 of a doubling of
the United Kingdom trade deficit for October left sterling
fully exposed to the mounting pull of funds into Germany
in anticipation of an imminent mark revaluation. Before
the end of November the Bank of England had been forced
to extend heavy support to hold sterling at $2.3827 and
had increased its outstanding drawings on the Federal Re­
serve by $750 million, raising the total to $1,150 million.
During the Bonn meeting of November 20-22, foreign
exchange dealings were suspended in London as in several
other major European centers. Meanwhile, the United
Kingdom authorities acted to bolster their austerity pro­
gram through indirect tax increases, tightened credit curbs,
and a 50 percent deposit requirement against imports of
manufactured and semimanufactured goods.
Although speculation abated and markets were steadier
once the Bonn meeting was over, considerable uneasiness
remained. When trading resumed on November 25, demand
for pounds was limited to modest covering of short posi­
tions. Moreover, in the early part of December, sterling
was subjected to renewed selling pressure by the market’s
apprehensions over heightened tensions in the Middle East
and reports suggesting disagreement within the British
government regarding the austerity program. Higher United
States interest rates added to market pressures. In this
atmosphere, the Bank of England sustained substantial
losses in support of spot sterling and forward discounts
again widened sharply. By midmonth, however, the mar­
ket had become heavily oversold, and spurred by expec­
tations that the next set of trade figures would show
substantial improvement— as in fact was the case—traders
moved to cover short positions. The rebound enabled the
Bank of England to recover most of its losses earlier in
the month, but the market then turned cautious once
again. On balance, very little of the substantial reflux of
funds from Germany found its way back into sterling,
with the result that Bank of England commitments to the
Federal Reserve remained at $1,150 million at the yearend.
Increasing monetary restraint in the United States, sig­
naled by the V* percentage point increase in Federal Re­
serve discount rates effective December 18, was quickly
transmitted to the Euro-dollar market after the turn of the
year through the rapid rise in dollar placements with head
offices by the European branches of United States banks.
The contraseasonal upswing in Euro-dollar rates prob­
ably kept sterling from benefiting fully from the normal
seasonal reflows of funds from Continental centers, aug­
mented on this occasion by the sizable outflows from
Germany. About mid-January, as Euro-dollar pressures



eased temporarily and the market again expected favorable
trade figures, buying of sterling picked up, only to taper off
once more later in the month. Although the December trade
results failed to measure up to expectations, the release in
mid-February of sharply reduced deficit figures for January
again gave a boost to the market, which was also encour­
aged by prospects for much reduced British government
domestic borrowing during the coming year. Thus, despite
record levels for Euro-dollar rates in the latter part of Feb­
ruary, the Bank of England was able to announce an $18
million reserve gain for the month even after heavy debt
repayments, mainly to the IMF. On February 27, the Brit­
ish raised the bank rate by 1 percentage point to 8 percent,
in order to help achieve the desired reduction in bank credit
and to help insulate sterling from the pull of continuing
high Euro-dollar rates.

The Federal Reserve liquidated a large volume of Swiss
franc swap drawings during the first half of 1968, and
by mid-July the System’s Swiss franc swap lines were
entirely on a standby basis. Shortly afterward, however,
Swiss commercial banks began bringing home funds to meet
domestic liquidity needs, and the Federal Reserve re­
activated its swap line with the Swiss National Bank to
absorb dollars that were taken into Swiss reserves. By
August 1 the System had drawn $145 million equivalent
on the Swiss central bank. The inflow of funds to Switzer­
land brought about an easing of liquidity conditions in the
Swiss money market and subsequently a decline in the
spot franc rate which lasted well into August. Accordingly,
in August the System and the Treasury paid off the last
$36 million of forward franc commitments to the market
dating from late 1967 and early 1968.
After mid-August, the Soviet invasion of Czechoslovakia
and the uncertainties generated by a renewed flare-up of
speculation in German marks brought a sharp jump in
demand for Swiss francs. However, the franc rate did not
reach the Swiss National Bank’s upper intervention point,
and in early September the spot rate eased somewhat as
funds began to move out of Switzerland into Germany.
Later in that month, quarter-end liquidity demands re­
sulted in a firming of the franc, but Swiss banks sold only a
small amount of dollars to the National Bank, meeting
their liquidity needs primarily by rediscounting money mar­
ket paper with the Swiss National Bank rather than by
liquidating dollar assets in view of the relatively higher
Euro-dollar rates. In these circumstances, the Swiss Na­
tional Bank covered the dollar needs of the Swiss Confed­
eration and dollars required for exchange transactions with

other countries through purchases of dollars from the Fed­
eral Reserve, thereby providing the System with francs
needed to meet short-term obligations. Thus, by early
October the Federal Reserve had reduced its outstanding
swap debt to the Swiss National Bank by $105 million to
$40 million equivalent.
The Swiss money market remained tight in October,
and late in the month the Swiss National Bank had to take
in dollars. The Federal Reserve absorbed these gains by
drawing $80 million equivalent on the swap line with the
National Bank, raising the swap debt to $120 million equiv­
alent by early November. Subsequently the spot franc
dipped lower and traded quietly through mid-November,
despite the heavy speculation in the exchanges focused on
the German mark, French franc, and sterling. When inter­
national currency uncertainties intensified severely during
the three days of the Group of Ten meeting in Bonn, the
Swiss franc rose to the ceiling and the Swiss National Bank
took in some $215 million. The Federal Reserve absorbed
most of the Swiss National Bank’s intake of dollars by
drawing an additional $200 million equivalent on its swap
line with that bank. These drawings raised the System’s
indebtedness under the swap facility with the Swiss Na­
tional Bank to $320 million equivalent.
In December as in past years, the Swiss authorities
offered short-term swaps to Swiss commercial banks re­
patriating funds for year-end needs. The banks made
very heavy use of this facility, with total swaps rising to
$746 million. Following past procedure the Swiss authori­
ties rechanneled these dollars back to the Euro-dollar
market in order to prevent the disturbance of that market
that would otherwise have occurred.
After the year-end, the usual seasonal easing of liquid­
ity conditions in Switzerland, coupled with high and rising
Euro-dollar rates, resulted in substantial outflows of Swiss
funds and a sharp drop in the Swiss franc rate. The
dollars received by the banks under maturing swaps with
the Swiss National Bank were readily absorbed during
early January, and in the latter part of the month, as
additional demand for dollars pushed the spot franc
lower, the Swiss National Bank reentered the market as
a seller of dollars for the first time since April 1968. These
dollar sales provided the Federal Reserve with the op­
portunity to purchase francs from the Swiss National Bank.
By the end of February, the System had made $190 million
equivalent of such purchases. The System used the francs
to repay outstanding swap indebtedness to the Swiss
National Bank. Additional repayments were made with
$75 million equivalent of francs obtained through United
States Treasury issues of Swiss franc securities to the Swiss
National Bank and the BIS and with $15 million of francs


from balances. (At the same time the Swiss National Bank
purchased $25 million of gold from the Treasury.) Thus,
by the end of February, the System had reduced its Swiss
franc obligation by $280 million to $40 million equivalent.


million of its swap debt with the Federal Reserve, leaving
$7.5 million still outstanding at the end of 1968.
In the meantime, effective December 19, the Belgian
National Bank had raised its discount rate to AVz percent
from 3 3 percent, to help stem short-term capital outflows
and in response to evidence of money market strains in
Belgium associated with larger domestic borrowing re­
quirements. Subsequently the spot franc strengthened,
reaching par just before the year-end.
But selling of francs resumed in January 1969, largely
reflecting the weaker trend in the Belgian current account.
The Belgian National Bank again provided support for the
franc and eased the consequent reserve drains by making
use of its swap line with the Federal Reserve. In January
the bank drew a net of $33 million, raising its swap debt
to the System to $40.5 million. Trading in francs was
quieter in February and early March, and the Belgian
National Bank was able to make swap repayments totaling
$27.5 million, reducing the obligation to $13 million.
Effective March 6, that bank raised its discount rate by
V2 percentage point to 5 percent, in view of the rise in
interest rates abroad and to moderate domestic credit ex­

Economic recovery in Belgium and the maintenance of
relatively low levels of short-term interest rates resulted in
a steady decline in the Belgian franc rate during the sum­
mer of 1968. In July the spot franc dipped below par
($0.02000) and the Belgian National Bank provided sup­
port to slow the decline. As part of that operation the
bank utilized $20 million under its swap facility with the
Federal Reserve, the first such drawing since 1963. Selling
of francs continued intermittently through late summer,
especially during the period of heavy pressure on the
French franc. The selling was not severe, however, and in
the latter part of September the Belgian National Bank re­
paid the $20 million of credits drawn earlier under the
swap line with the Federal Reserve, thereby restoring the
entire $225 million arrangement to a standby basis.
Selling pressures resumed near the end of September
and carried into October. Part of the outflows from Bel­
gium reflected spot sales of francs by some United States
corporations which refinanced in Belgium dollar credits
employed earlier in direct investments in that country. Dur­
In June the Netherlands Bank had drawn $54.7 mil­
ing most of October the authorities held the spot franc lion under the Federal Reserve swap line after its dollar
moderately above its oflicial floor ($0.019851) and cov­ balances had been depleted by conversion of guilders
ered market losses with drawings on the Federal Reserve drawn from the IM F by France and the United Kingdom.
swap line. By the end of October, drawings by the Belgian Although the guilder drifted lower in July and August,
National Bank totaled $120.5 million.
the Netherlands Bank took in sufficient dollars to make a
November’s speculative upheaval in Europe gave rise $24.9 million swap repayment in early September.
to heavy selling of francs which cost the Belgian authori­
The downward drift of the spot rate continued into late
ties substantial support losses, although the pressures summer, as the Dutch current account weakened and as
lightened considerably in the quieter atmosphere after the Dutch funds moved into United States corporate securi­
Group of Ten meeting at Bonn. The Belgian central bank ties. A slight rise in Euro-dollar rates in early October
drew $65 million under its swap line with the Federal Re­ contributed to a further decline in the rate so that by midserve in November and another $5 million in December October it had reached $0.27441i , its lowest level since
to cover the cost of oflicial exchange market support. In the 1961 revaluation. During the course of the decline,
early November and late December the United States however, the Netherlands Bank provided only occasional
Treasury purchased a total of $216 million of Belgian and modest market support. In fact, in mid-October the
francs from the Belgian authorities; $60.4 million equiv­ bank was able to restore the full swap facility with the
alent of these francs was used to redeem in advance of Federal Reserve to a standby basis by repaying the $29.8
maturity a two-year note issued to the National Bank million outstanding balance of the June drawing.
in 1967 (leaving no further United States obligations
The downtrend ended when the money market in
in Belgian francs), and the balance was paid to the Amsterdam tightened in the last half of October. How­
IMF to help reconstitute the United States gold tranche ever, the spot rate held steady as an increasing demand
position with the Fund. For its part, the Belgian central for marks more or less outweighed the influence of the
bank used the dollar proceeds of the Treasury’s franc pur­ tight money market. At that time the Netherlands Bank
chases to replenish its reserves and repay a total of $183 increased its dollar balances by selling $25 million of



guilders to the United States Treasury, which used them
to make an advance repurchase of its obligation to the
IMF. After the Bonn meeting on November 20-22, the
demand for marks eased abruptly and the spot guilder
Year-end liquidity requirements in the Netherlands re­
sulted in a further firming of the guilder throughout De­
cember. Pressures were modest, however, and were relieved
through market purchases of dollars by the Netherlands
Bank, largely on a swap basis; the bank’s swap purchases
for December totaled $84 million. Just before Christmas
the Netherlands Bank raised its discount rate Vi percentage
point to 5 percent, explaining that the move was made in
response to the rise in rates abroad, a weaker trend in the
Dutch current account, and danger of renewed inflationary
tensions in the Dutch economy.
During the early months of 1969, the Dutch current
international payments position was roughly in balance
but, along with other European currencies, the spot
guilder responded to the pressures associated with active
demand for Euro-dollars. Thus the spot rate declined
moderately as Dutch interests switched some funds from
guilders to dollars, but the outflows were modest and cen­
tral bank activity was minimal.
Shortly before the end of 1968, the Dutch government
elected to prepay debts outstanding under postwar Mar­
shall Plan credits and purchased $65.7 million from the
United States Treasury for that purpose. The Treasury
used the entire guilder proceeds to redeem in advance of
maturity a one-year certificate of indebtedness issued to the
Netherlands Bank in January 1968. This was the only out­
standing United States obligation in guilders.

With the Italian economy showing signs of slower
growth through much of 1968, substantial amounts of
long-term capital moved abroad in response to more attrac­
tive investment opportunities, notably in the Euro-bond
market. Italian banks also placed large amounts of short­
term funds in the Euro-dollar market. As a consequence of
these capital outflows, Italian official reserve gains were
limited. These developments, and Italian official sales
of dollars in connection with conversion of lire drawn
from the IMF by France and the United Kingdom, pro­
vided the opportunity for the Federal Reserve to liquidate
completely its outstanding swap debt with the Bank of
Italy, thus placing the swap facility fully on a standby
basis by early July. Subsequently, in October the Federal
Reserve and the Bank of Italy agreed to increase their
reciprocal currency facility by $250 million, to $1 billion,

bringing it fully into line with the System’s reciprocal cur­
rency arrangements with other major countries.
As the Italian balance of payments moved into its
period of seasonal weakness, the lira began to ease in Sep­
tember and, during the November speculative upheaval
in European exchange markets, the lira came under fur­
ther selling pressure as Italians covered commitments in
marks. More normal trading patterns resumed after the
Bonn meeting and continued through the year-end. In
early 1969, however, the pull of interest rates in the
Euro-dollar market drew funds from Italy, and the Italian
authorities provided some support for the lira while per­
mitting the spot rate to fall sharply.
During the period under review the United States Trea­
sury added moderately to its technical forward lira com­
mitments, which have arisen in connection with dollar-lira
swaps extended by the Bank of Italy to its commercial
banks. (These commitments were described in the Septem­
ber 1968 issue of this Review, pages 188-89.) Shortly be­
fore the end of 1968, the Treasury issued to the Italian
Exchange Office a 4 Vi-year lira note, equivalent to $100
million, in connection with its understandings with Italy on
the neutralization of United States military expenditures.
The Treasury took advantage of the lira proceeds to make
an advance repurchase of its obligations to the IMF.

Once the speculative atmosphere of early 1968 cleared
away, Canada’s strong trading position and ready access
to long-term capital resources both in the United States and
Europe provided a buoyant market outlook for the Ca­
nadian dollar. During the summer months the Bank of
Canada repaid its earlier swap drawings on the Federal
Reserve, and other special international credit facilities
were terminated without the need for their use. Subse­
quently, through late summer the Canadian dollar remained
largely at its effective ceiling ($0.9324), as demand was
spurred in part by the conversion of Canadian borrowings
abroad. The Canadian authorities gained modest amounts
of reserves and the use of Canadian dollars in drawings on
the IMF by France and the United Kingdom substantially
reduced Canada’s repayment obligation to the Fund in­
curred earlier in 1968; by September Canada’s gold
tranche was reconstituted to the full $185 million.
The Canadian dollar continued to benefit from opti­
mistic market appraisals through the closing months of
1968. In mid-December, an exchange of letters took place
between United States and Canadian Treasury officials,
restating the United States exemption of Canada from all
United States balance-of-payments programs and the basic


principle that it would not be Canada’s intention to achieve
increases in its exchange reserves through borrowing in the
United States. Implementation of this principle does not
require that Canada’s reserves be limited to any particular
On December 18 the Bank of Canada raised its discount
rate by V2 percentage point to 6 V2 percent following an­
nounced increases in Federal Reserve discount rates. For
the month of December the Bank of Canada gained some
further reserves. Thus, despite a major crisis early in 1968,
Canada’s gold and foreign exchange reserves (including
the net creditor position with the IM F) were up by $332
million for the year as a whole.
The Canadian dollar edged off early in 1969, as the
further upswing in United States interest rates led to some
switching of Canadian funds into dollar investments. Never­
theless, the market undertone remained quite strong
through early March. Effective March 3, the Bank of
Canada raised its discount rate by another Vi percentage
point to 7 percent in view of strong demand for domestic
credit and the rise in short-term money rates following
higher rates abroad.


operations with German commercial banks. Moreover,
heavy drains on French reserves also tended to supply
funds to the market in early September. Consequently,
funds remained readily available in the market and interest
rates declined somewhat (see Chart II).
During the course of October, the Euro-dollar market
was generally much quieter, as were the exchange markets.
On the other hand, interest rates began to move up in
sympathy with somewhat firmer monetary conditions in
the United States.
The speculative upheaval in the exchange markets in
November caused only moderate strains in the Euro-dollar
market, as the German Federal Bank once again imme­
diately moved to rechannel a major portion of its dollar
intake out into the market through swaps. Moreover, the
Federal Bank’s outright sales of forward marks in the
first few days after the Bonn meeting encouraged addi­
tional reflows from Germany, and this operation was
backed up in New York where the Federal Reserve sold
forward marks.
Nevertheless, in early December Euro-dollar rates once


During the second half of 1968 and the first two months
of 1969, activity in the Euro-dollar market reached un­
precedented levels, but the massive flows of funds through
that market were accommodated in an orderly fashion
with the assistance of some defensive central bank op­
erations—primarily by the German Federal Bank and the
Swiss National Bank. Indeed, the Euro-dollar market
once again demonstrated its remarkable resiliency in the
face of extraordinary demands. In particular, it accom­
modated a further very substantial increase in the bor­
rowings by United States banks through their overseas
branches during a period in which there were massive
flows into and out of the market as a result of develop­
ments in the foreign exchange markets.
Early in July, with funds readily available after the
midyear adjustments by Continental banks, United States
banks increased their borrowings sharply, with total tak­
ings reaching $7.0 billion. During the rest of the month,
these borrowings were allowed to run off somewhat, to a
level of approximately $6.2 billion at the month end, only
to be followed by a further sharp rise in August. Late in
August, the outburst of speculation over a revaluation of
the German mark resulted in a heavy flow of funds,
some of which came out of Euro-dollars, into German
official reserves. The German authorities moved quickly
to push these funds out again through dollar-mark swap

Chart II



* Weekly averages of daily rates.
+ Between Euro-dollars and United Kingdom local authority deposits.





again began moving up sharply as United States domestic
interest rates advanced. Pressures were felt particularly
in the shorter maturities, reflecting not only generally
tighter monetary conditions in the United States but also
the usual seasonal pressures associated with year-end posi­
tioning by European banks. At the same time, exchange
market sentiment regarding sterling was softening once
again and, as discounts on forward sterling widened, a
substantial incentive developed in favor of Euro-dollars
over United Kingdom investments. To avoid any undue
additional strain on the pound in view of approaching
year-end repatriations of funds to the Continent, the BIS,
using dollars drawn on the swap line with the Federal Re­
serve, placed $80 million in the Euro-dollar market.
Although Euro-dollar rates rose further in the latter part
of December, the increase by and large reflected the higher
United States rates (following the V a percentage point in­
crease in Federal Reserve discount rates on December 18
and the further rise in United States banks’ prime loan rates
to 6% percent), and Euro-dollar market conditions re­
mained orderly. Reflows from Germany continued. At the
same time, Swiss commercial bank repatriations of funds
for domestic year-end needs were again accommodated
without undue strain on the market, thanks to the swap
operations of the Swiss National Bank. The Swiss commer­
cial banks undertook $746 million of swaps with the Na­
tional Bank, and the Swiss central bank in turn rechanneled
the dollars so obtained back into the Euro-dollar market,
both directly and through the BIS. In the latter part of
December, takings by United States banks’ branches
dropped sharply (to a total of about $6.0 billion), but
United States corporations took a substantial amount of
dollars out of Europe, partly in response to interest rate
considerations and partly to comply with provisions of
the Commerce Department’s program.

Seasonal pressures eased after the year-end, but never­
theless interest rates soon rose further as major United
States banks looked to the Euro-dollar market to relieve
liquidity drains imposed by large runoffs of certificates of
deposit. The advance in rates gained new momentum, fol­
lowing the Va percentage point rise in United States banks’
prime loan rates to 7 percent per annum on January 7.
United States banks bid aggressively for Euro-dollars
through their European branches, raising their takings to
a new peak of $8.6 billion by the end of January. Mean­
while market supplies were being augmented by further
flows of funds from Germany and reflows from Switzer­
land, and there was some reversal of the heavy United
States corporate repatriations just prior to the end of 1968.
With demand for funds heaviest in the short-term maturi­
ties, interest rates for one-month deposits advanced sharply,
to nearly 8 percent per annum in early January compared
with 7 percent per annum at the year-end.
In late January the heavy flow of funds to the Euro­
dollar market from Germany tapered off, and the German
Federal Bank began to take in dollars as German banks’
deliveries of dollars under maturing swap and forward sale
contracts exceeded German official spot dollar sales. De­
mand for Euro-dollars from United States banks’ branches
remained brisk in February, and repatriations by French
banks, which had to comply with newly tightened ex­
change controls, added to market pressures. As a result,
Euro-dollar rates moved up to new record levels— in
excess of 8 percent per annum for one- to six-month de­
posits— attracting funds from Italy and Switzerland in
particular and contributing to the generally weaker trend
in most Continental currencies through early March.
Nevertheless, throughout this period trading in Euro­
dollars remained quite orderly and market needs were met
without undue strain.



Coming Problems in the Control of Money and Credit*
By W i l l ia m F. T r e ib e r
First Vice President, Federal Reserve Bank of New York

In the fourth century B.C., writing about the Pelopon­
nesian War, Thucydides stressed the importance of “knowl­
edge of the past as an aid to the interpretation of the
future, which in the course of human things must re­
semble if it does not reflect it”. Taking Thucydides’ ad­
vice, I think a brief review of recent economic and
credit developments should facilitate an understanding of
coming problems in the control of money and credit.
Perhaps I shouldn’t even use the word “control” be­
cause it assumes a precision that does not exist. However,
the word was used in the title assigned to me by the pro­
gram planners, and there it is in the title of my remarks.
I would prefer to use the word “influence”. The Federal
Reserve System certainly can influence the amount, avail­
ability, and cost of money and credit.
Let us bear in mind that the control of money and
credit, or the influencing of money and credit, is not an
end in itself. It is a means of promoting our nation’s basic
economic goals of (1) maximum sustainable economic
growth, (2) maximum practicable employment, (3) rea­
sonable price stability, and (4) equilibrium in interna­
tional transactions.

The current unprecedented economic expansion began
eight years ago. At that time there were substantial un­
used resources of men and equipment. By the beginning
of 1965, this slack had been largely taken up. As unused
resources were brought into use, economic growth ex­
panded rapidly. Over the four-year period ended in

* An address before the financial conference of the National
Industrial Conference Board, New York City, February 20, 1969.

1964, we had an annual growth in gross national product
of about 5 V2 percent in real terms, a reduction in the
rate of unemployment from 7 percent to about 5 percent,
and relatively stable prices. Unfortunately, however, we
also had a large deficit in our international balance of
payments. With this exception, we did pretty well in pro­
moting our national economic goals. This achievement
was fostered by a mutually reinforcing combination of
fiscal policy and monetary policy.
But in 1965 inflation reared its ugly head. An escala­
tion of military expenditures on top of a fully employed
economy led to excessive aggregate demand. Unfortu­
nately, as a nation we delayed in taking adequate steps
to reduce the excessive stimulation that Federal Govern­
ment expenditures were having on the economy. Prices
rose at an accelerating rate. So did wages and unit costs
of production.
At long last, in June 1968, after much damage had
already occurred, the Congress enacted the Revenue and
Expenditure Control Act of 1968 which provided for the
surtax and certain spending restrictions. The legislation,
together with other factors, is converting a $25 billion
budgetary deficit in the fiscal year ended last June to an
approximate balance of receipts and expenditures this year.
Upon enactment of the legislation last June, much talk
was heard about the danger of economic “overkill” ; there
was fear that the restrictive effects of the tax and expend­
iture provisions would severely limit economic activity
and might bring about a recession.
But consumers kept up their spending in spite of the
tax increase; they reduced their rate of saving which pre­
viously had been much higher than normal. Residential
construction and business investment continued to be
vigorous. So was the demand for labor. There were many
labor bottlenecks, and unemployment was very low. In­
flationary pressures were stronger than they had been in



years, and there was a strong inflationary psychology.
Inflation stimulated imports and drastically reduced our
traditional substantial international trade surplus. In 1968,
the rise in consumer prices was 4.7 percent, the highest
it had been since 1951.1
On the financial side, the demand for credit was very
strong and interest rates reached their highest level in
decades. Commercial bank credit had risen in the first
half of 1968 at an annual rate of 6 percent, but in the
second half it rose at a 15 percent rate. The money sup­
ply, i.e., currency and demand deposits in the hands of
the public, rose at an annual rate of 6 percent in the
second half of the year, while the money supply plus
time deposits rose at a 12 percent rate.
In the first part of 1968, the main job of trying to
dampen the inflationary pressures fell on the Federal Re­
serve, which pursued a restrictive credit policy. Although
the Treasury normally retires debt in the first half of the
year, it had a large deficit in the first half of 1968. Thus,
it had to borrow substantially. Despite this development,
the 6 percent annual rate of bank credit expansion in that
period was about half as large as the rate of expansion in
the year 1967.
By midsummer, however, the Federal Reserve eased up
a bit in view of the new restrictive fiscal policy. In retro­
spect, one may question the wisdom of that action. By
the year’s end, however, the Federal Reserve was pursuing
a more restrictive policy and has continued to do so.
Before getting into a discussion of the problems now
confronting us in the control of money and credit, I would
comment briefly on our international balance of payments.
Our statistical record with respect to international capital
flows was much better in 1968. Foreigners increased their
investments in our stock market. Loans to foreigners and
investment outflows were curtailed under the temporary
Government programs administered by the Federal Reserve
and the Commerce Department. And our Treasury made
additional special arrangements with foreign monetary
authorities under which more of their reserves were placed
in less liquid form. Thus our recorded liquidity balance
showed a small surplus, and our official reserve trans­
actions balance showed a large surplus.
Let us not be misled, however, by these figures. There
are limitations on a continuing flow of equity investment
here by foreigners and on further special transactions with
foreign monetary authorities. And it would be a grave

mistake to make the foreign credit and investment re­
straint program permanent. Not only must we correct the
deterioration in our traditional trade surplus; we must
exert every effort to enlarge the surplus over the years.
Thus we still have an important balance-of-payments
problem that requires our best efforts to solve. I trust that
the improved balance-of-payments statistics for 1968 will
not obscure the need and create a euphoria which can
only worsen the long-run adjustment problem.

So much for background. In this setting, the basic prob­
lem before us is how best to promote our national eco­
nomic goals. More specifically, in the control of money
and credit, we must seek:
(1) to reduce gradually, but steadily, the rate of
price inflation,
(2) to do so without a substantial rise in unemploy­
ment or a recession,
(3) to bring to an end the current attitude of busi­
nessmen, investors, and consumers that infla­
tion will continue indefinitely,
(4) to promote economic balance in our relations
with the rest of the world, and
(5) thus establish a sound basis for healthy and
sustainable growth.,
In brief, these objectives will be promoted by checking
excessive overall demand in the economy. On the supply
side, we may reasonably expect the future to bring more
efficient productive facilities; these should come from large
investment, technological advances, and a larger effective
labor force as a result of general population growth and
better individual training. As these expectations are real­
ized, production should increase to meet the economy’s
demands, inflationary pressures should subside, and stabil­
ity should become a reality. Thus the main problem at
this time is the proper restraint of demand without
stifling it.
We should have no illusion that the transition from in­
flation to stability and sustainable growth will be easy.
Nor can it be accomplished overnight. But the transition
is essential for the long-run economic health of the United

1 In the period 1961-64, consumer prices rose only 1.2 percent
per year.

Fiscal policy and monetary policy should work to­
gether, seeking to restrain overall demand without stifling
it; they should support and complement each other. The


nub of a compensatory fiscal policy is a budgetary deficit
in a period in which a substantial portion of the nation’s
resources are idle, and a budgetary surplus in a period in
which excessive demand presses on available resources.
As we all know, in practice it has been easier to achieve
a deficit than a surplus. In the current situation of ex­
cessive demand, fiscal policy should continue to do its
part; it should avoid stimulating the economy. In my view,
in the absence of extraordinary developments— and I
don’t see any— the income surtax should not be allowed
to expire in June. I think it should be extended for another
year, and that there should continue to be a close scrutiny
of expenditures and a check on them. An effective fiscal
policy will contribute to a reduction of pressures in the
money and credit markets, and thus avoid placing an
excessive burden on monetary policy.
Monetary policy must also do its part. As you know, the
Federal Reserve discount rate was raised in mid-December
to bring it back to 5Vi percent, and since then there has
been increased pressure on the reserve position of member
The maximum rates of interest on certificates of de­
posit (CD’s) and other time deposits under Regulation Q
have been left unchanged despite a rise in interest rates
on marketable securities and a substantial runoff in the
amount of large CD’s outstanding as CD’s have become
less attractive to investors.
From early December through the first week of Feb­
ruary, large CD’s declined by more than $3Vi billion.
This decline, of course, has put some pressure on the
banks, but they have managed partly to offset these losses
by tapping the Euro-dollar market. In the first five weeks
of this year, Euro-dollar takings, i.e., the amount of ad­
vances by foreign branches of American banks to their
head offices, rose by $2Vi billion to $8Ms billion. The
rates paid for such funds have exceeded Regulation Q
ceilings by a good bit, but of course such borrowings are
exempt from interest rate ceilings and reserve require­
In 1966, after CD rates reached the Q ceilings in Au­
gust, the total borrowings of Euro-dollars by the large
banks rose by %\Vi billion, an amount roughly half as
large as the decline in CD’s. Since 1966 the money market
banks, which are the major source of business loans to
large corporate borrowers, have vastly developed their
capacity to tap the Euro-dollar market.
One of the problems in the control of money and credit
is the use of the Euro-dollar market by American banks
as a source of funds. There are indeed two aspects of the
problem: (1) the role of Euro-dollars in the process of
adjustment by the banks to pressures on their reserve


positions, and (2) the effect of the increased use of Euro­
dollars by our banks on interest rates in the foreign
markets in which the Euro-dollars are obtained.
Flows of personal savings into financial intermediaries
are also influenced by interest rate regulations. Although
the proportion of income saved by individuals was lower
after mid-1968, additions to savings accounts at com­
mercial banks and thrift accounts at mutual savings banks
and savings and loan associations were not greatly af­
fected. When in 1966 the overall net intake of funds into
the thrift institutions dwindled, residential construction
declined dramatically. A number of the institutions, in
fact, experienced sizable withdrawals. In this situation,
special arrangements were made by the Federal Reserve
to provide emergency credit assistance, but fortunately
there was no need to use them. I believe that the thrift
institutions have learned much from their experience in
1966. Then they had a good deal of “hot” money placed
with them by customers who were highly rate conscious.
Now they don’t have so much hot money, and they are in
a more liquid position. They are better equipped to handle
a slowdown in growth of thrift accounts or even a decline
in such accounts if such a slowdown or decline develops.
Nevertheless, I would expect the Federal Reserve to pro­
vide emergency credit assistance in the unlikely event of
a severe drain of funds that could not be accommodated
through customary adjustment procedures.
Another problem is a highly intangible one, incapable
of statistical measurement; it is the difficult problem of
inflationary expectations. Monetary restraint should be
sufficiently strong and clear to demonstrate to the public
that for the United States inflation is not going to be a
way of life. At the same time, Federal Reserve policy
should not be so tight as to cause recession. I hope we
can successfully steer this course between Scylla and
Over the last decade, as you know, a major considera­
tion in the formulation of monetary policy has been our
international balance of payments. We also have had to
take into account the possible effect on vulnerable foreign
currencies of changes in rates of interest in the United
States and of pressure on the reserve positions of our
banks. An important objective of monetary policy will be
to help improve our balance of payments.
The most important thing that can be done at this
time to improve our international position is to lick in­
flation at home. Reduction of excessive demand at home,
and curtailment of price increases which have recently
plagued us, should go far toward reducing the demand
for imports, which rose at an unprecedented rate in 1968.
At the same time, licking inflation should contribute to



keeping our products competitive in world markets and
should encourage greater effort to market our goods
abroad and thus expand our exports.
As we struggle to stabilize the purchasing power of
the dollar, we must be ever mindful, of course, that em­
ployment is an important economic goal. What is the best
way to promote employment? Are very rapid increases in
overall demand the only way? The experience of other
countries has shown that, although the stimulus of exces­
sive demand may temporarily reduce unemployment, the
resultant inflation over the longer run reduces employment
and creates severe hardships.
The National Industrial Conference Board help-wanted
ad index is at a record high. For over three years our rate
of unemployment has been at or below the 4 percent
interim unemployment target set by the Council of Eco­
nomic Advisers in 1961. The unemployment rate for
married men at 1.4 percent is the lowest since these
statistics were first collected in 1954. But the unemploy­
ment rate among white teen-agers (16 to 19 years, in­
clusive) is about 10 percent, and the rate among nonwhite
teen-agers is more than 20 percent. Maintaining an ex­
cessive overall demand will not solve the problem of those
unemployed persons who are inadequately trained or in­
adequately motivated. In this group different individuals
have different problems. Much has been done in the last
couple of years to provide training programs geared to
the needs of particular individuals and to likely work
opportunities. Much more must be done. This kind of
attention to the problems of individuals in the ghetto is
going to help them much more than keeping up an ex­
cessive demand for workers to fill jobs for which they
cannot now qualify.

Until it is clear that aggregate demand in the economy
is under adequate control, you can expect the Federal
Reserve to continue to seek to restrain the expansion of
credit which adds to demand.
In the present situation, with the economy operating at
practical capacity ceilings and with a pervasive inflationary
psychology, credit should not grow at the extraordinarily
rapid rate of last year. The shift of the Treasury from the
role of a massive net borrower to a neutral position will,
of course, reduce the demand for funds. But private de­
mands, as well as state and local government demands,
are large.

In the present economic setting the Federal Reserve
will not supply sufficient reserves to enable the banks to
acquire all the good investments offered them and to make
all the loans requested of them by borrowers of good
credit standing. This does not mean that the Federal Re­
serve wants to bring credit expansion to a halt; it wants
to moderate the pace of expansion so that overall eco­
nomic advance can be sustained but at a slower pace than
has recently prevailed.
There should be no need for banks to dump good assets
in an unreceptive market at unrealistic prices. Bankers
and others learned much in 1966, I think, about the
management of their assets and their liabilities. I think
they are better equipped now to take, and are more aware
of the need to take, appropriate steps to protect them­
selves from getting into a position where they must make
drastic changes in their policies and practices without
enough time for careful consideration and orderly de­
cision making. If a bank finds itself in need because of an
unusual loss of funds, or other special circumstances re­
quiring temporary assistance, it has, of course, access to
the Federal Reserve discount window. It is part of our
job to be of assistance while a bank is making necessary
Bankers and other lenders have already established
higher rates of interest— a traditional method of discourag­
ing borrowing. But rationing credit through rate alone is
not likely to be sufficient. Bankers in general will no doubt
conclude, as many have already, that they will have to
be more selective in meeting loan requests. They will have
to consider more criteria than merely the creditworthiness
of the borrower. They will have to apply some order of
priorities consistent with the time-honored necessity of
serving the public interest and of balancing the interests
of the banks’ customers, depositors, and stockholders.
Sometimes perhaps they will lend less than the borrower
requests. This type of selective action by individual
bankers, who have knowledge of all the relevant facts,
should gradually and with minimum disruption reduce the
temperature of our overheated economy.





As fiscal policy and monetary policy work together and
as private enterprise exercises self-restraint— as all of us
work together— it should be possible over time to lick the
inflation and restore stability and sustainable growth in
our economy.



The Business Situation
It appears increasingly clear that the tax surcharge en­
acted last June has restrained consumer spending in recent
months. Retail sales in January, though up from the de­
pressed December reading, were at a level no higher than
in mid-1968. Nonetheless, consumer behavior has been
highly unpredictable in the past few years and a re­
surgence of consumer demand cannot be ruled out,
especially in view of the currently high rate of personal
saving. At the same time, there are no indications that busi­
ness fixed investment, state and local government spending,
and residential construction— all of which were important
factors boosting the economy in the final months of last
year—have lost any of their momentum, and settlement
of the dock strike should push net exports up sharply over
the near term. Industrial production has continued to move
up, the labor markets remain extremely tight, and price in­
creases continue to be excessive.

operations now appear to have recovered to a more nor­
mal level, however, and are thus providing less thrust to
the expansion of total industrial production. Steel industry

C h art I

S e a s o n a lly a d ju ste d ; 1 9 5 7 -5 9 = 1 0 0


The Federal Reserve Board’s index of industrial pro­
duction recorded its fifth consecutive monthly gain in
January, when the index rose 0.5 percentage point to a
seasonally adjusted 169.4 percent of the 1957-59 average
(see Chart I). The January increase was, however, more
modest than the large advances recorded in each of the
final three months of 1968.
The January estimates indicate that production of
defense-oriented equipment was sharply below last sum­
mer’s peak, and this remains true after allowance for a
strike at a major aircraft producer during the month. On
the other hand, a sizable further gain in business equip­
ment output provided additional evidence that the surge in
capital investment which began last summer is continuing.
Materials output rose very little in January and much
less than in the preceding four months. The strength in
this sector through the past fall and early winter was
due in large measure to the rapid recovery of steel pro­
duction from the low point that followed the labor settle­
ment in that industry at the end of last July. Steel industry

Note: Indexes for defense equipment and nonautomotive consumer goods
were calculated at the Federal Reserve Bank of New York from data
published by the Board of G overnors of the Federal Reserve System.
Indexes are not plotted in rank order.
Source: Board of Governors of the Federal Reserve System.



output recorded a gain in January of about 2 percent, and
it appears that output increased in February by a com­
parable amount.
The output of consumer goods remained strong in Jan­
uary despite another decline in the production of auto­
motive products. Most household goods, with the excep­
tion of television sets, registered healthy gains. The weak­
ening in the automotive sector is reflected in figures on
new car assemblies. Auto production slipped to an annual
rate of 8.7 million units in January from the preceding
month’s 8.9 million unit pace, and fell further in Feb­
ruary to an annual rate of about 8 V2 million units.
Since dealers’ inventories are very high, the industry has
recently been curtailing production to realign output with
the somewhat reduced auto sales pace that developed last
Total inventories of manufacturing and trade firms reg­
istered a further sizable gain in December.1 Total business
sales declined in that month, moreover, and the overall
inventory-sales ratio increased to the highest level of the
year. The retail trade sector experienced a very large rise
in the ratio of inventories to sales. The ratio also in­
creased in manufacturing during December, but in January
a strong increase in manufacturers’ shipments, together
with a small further rise of inventories, brought the ratio
for manufacturing back down.
It is, of course, too early to assess the significance of the
recent move to higher levels of retail trade inventories
relative to sales. Part of the accumulation of stocks in the
final months of 1968 was undoubtedly involuntary— i.e.,
due to a failure of sales to come up to levels expected
when earlier inventory buying decisions were made. On the
other hand, some of the recent softness of sales may have
little longer run significance. This is especially true of the
December downturn, in view of the influenza epidemic
that swept the country that month. Indeed, according to
the advance report retail sales recovered in January, and
new auto sales showed renewed strength in February.
Total retail sales, however, remain below the peak reached
in August of last year.
Although new orders received by all manufacturing
firms edged down very slightly in January, they were

irThe Department of Commerce has revised upward the gross
national product (G N P ) estimate of fourth-quarter inventory ac­
cumulation to an annual rate of $10.6 billion from the preliminary
figure of $10.0 billion discussed in the February issue of this Review.
Consumption expenditures and state and local government spending
were also revised upward. However, these adjustments were more
than offset by a sharp downward revision in net exports, and the
estimate of fourth-quarter GNP was reduced by $0.4 billion.

well above the levels of most months of last year. New
orders received by manufacturers of durable goods actu­
ally rose slightly, but this was offset by a decline in orders
received by nondurables producers. Shipments of durables
increased rather strongly in January but remained a bit
below the level of new orders. Thus, the backlog of un­
filled orders on the books of durables manufacturers rose
further, continuing the uptrend that began last August.
Recent months have witnessed unusually wide swings
in housing starts. Although the rate of private housing
starts is highly volatile, gyrations of the magnitude of those
of recent months are atypical; the number of housing
units started rose solidly in November, dropped markedly
in December, and then increased steeply in January to a
1.8 million unit annual rate, the highest figure since early
1964. On the other hand, the number of new residential
building permits issued, which tends to change more
smoothly than starts, showed a fairly consistent, rising
trend from last May, but dropped sharply in January,
casting some doubt on the significance of that month’s
steep gain in starts.

A boost in the already strong demand for labor has been
apparent recently in the resumption of rapid growth in
employment and in the labor force as well. Employment
advanced by more than 450,000 persons in January,
bringing to 1.2 million the total increase since last Octo­
ber when employment growth began to accelerate. At the
same time, the civilian labor force has also been growing
at an unusually rapid pace. In January it stood at nearly
80 million persons, an increase of more than 1 million since
last October. In contrast, there had been a decline in the
civilian labor force of 100,000 persons in the June-October
period of last year. The recent strong rise in the labor force
has of course accommodated some of the accelerated em­
ployment gains, but the unemployment rate has never­
theless dropped rather markedly. From 3.6 percent in
October, the unemployment rate fell progressively to 3.3
percent in December and held at that fifteen-year low in
The strength of labor demand has also been apparent
in the number of workers on nonagricultural payrolls. Em­
ployment in nonagricultural establishments increased sub­
stantially in January for the fourth consecutive month.
The sizable January gain, amounting to a quarter of a
million persons, was concentrated in the trade and service
industries, reflecting both the rapid secular growth of
employment in those sectors and, especially in trade,


some recovery from the dampening effects of the flu
outbreak in December. The average workweek in manu­
facturing held steady at 40.7 hours but remained below
the high of 41.1 hours set in September.
Recently released figures on labor costs emphasize once
again the severity of the inflationary problem that con­
fronts the economy. Labor compensation per man-hour
in the private economy increased by 8 percent between
the final quarter of 1967 and the corresponding period in
1968, the sharpest over-the-year advance since 1956.
Comparing the full year 1968 with the preceding year, the
rise in compensation per man-hour was nearly as great,
amounting to IV 2 percent and the highest since early in
the Korean war. The impact on unit labor costs of the
swift advance in hourly compensation was softened to a
considerable extent, however, by a healthy gain in output
per man-hour. Productivity in the overall private economy
was up by 3.3 percent in 1968, and unit labor costs thus
averaged 4 percent above the preceding year. Although a
productivity gain of the size registered in 1968 is con­
sidered to be close to the long-run trend, it was due in
part to an acceleration of real growth in 1968 following
a significant slowing in 1967.
The Commerce Department has reported that personal
income rose by only $1.6 billion in January to a seasonally
adjusted annual rate of $715.1 billion. Although this
was the smallest gain in over a year, the size of the
increase was trimmed by nearly $1.8 billion because of the
January 1 boost in social security contributions. More­
over, major strikes— of longshoremen at Atlantic and Gulf
Coast ports and of some workers at petroleum refineries
— tended to slow the increase in aggregate wage and salary
disbursements. On the other hand, wages and salaries in
the trade sector made a strong recovery after having fallen
in December for the first time in over two years, a
decline apparently caused by the widespread outbreak of
the flu.
Although retail sales volume in January recovered most
of the December drop, according to advance data, total
sales at retail outlets remained below all other months since
June of last year (see Chart II). The weakness of sales in
the automotive group has been a dominant factor restrain­
ing overall retail volume, but even excluding this compo­
nent retail sales have shown little movement since last July,
when the 10 percent tax surcharge went into effect. Con­
sumer spending in the opening months of 1969 may also
be affected by the higher social security contributions that
went into effect January 1, and still further by the heavy
final payments of 1968 income taxes that are expected to
result from the retroactivity of the tax surcharge. The Fed­
eral minimum wage was increased for more than 2 million


C h art II

B illio n s of d o lla rs; s e a s o n a lly ad ju ste d

Note: Latest data plotted are based on advance reports.
Source: UnitedStates Department of Commerce, Bureau of the Census.

workers on February 1, but this is expected to supply
only a small boost to total disposable income.
In this connection, the Commerce Department’s quar­
terly survey of consumer buying expectations taken in
January suggests a continued downward drift in new car
sales, unchanged used car sales, and a little softening in
expenditures on houses. The only sizable advance indicated
by the survey is in purchases of household durables, a
finding that is consistent with the recent heavy demand
for new apartments and homes. The survey results imply a
rate of new car sales in the first half of 1969 close to the
pace of the comparable period in 1968, when sales of do­
mestic models averaged a seasonally adjusted annual rate of
SV4 million units. Actual sales volume appears to be mov­
ing a bit above this projection. Sales of domestic models
were at a seasonally adjusted annual rate of 8 V2 million
units in December and averaged about the same rate in
January and February combined. The sales pace reached
8% million units in February, but this may have involved
some purchases deferred from January when the sales rate
dropped to 8X million units. This recent performance rep­
resents a weakening when compared with the average sales
pace of about 9 million units sustained from July through




A steep increase in the prices of services lifted the
January consumer price index to a new high. While the
overall index rose at an annual rate of roughly 4 percent,
the services component jumped at a rate of nearly 8
percent. The sharp advance in the services area was the
largest in six months and was appreciably above the 5Vi
percent increase registered in all of 1968. Unusually large
gains were reported in the costs of auto ownership and
operation—insurance, registration, driver’s license fees—
and in home ownership costs. Food prices also continued

to climb swiftly, but prices of nonfood commodities edged
lower for the second consecutive month. Although the rate
of advance in the overall consumer price index has slowed
a little in the latest two months, the prospects for a continu­
ation of this slower uptrend are questionable in light of
soaring wholesale prices. The January advance for indus­
trial commodities was not only exceptionally large but
reflected price increases spread over a very broad range
of goods. It is too early to determine whether price rises
in February were as widespread, but preliminary data
indicate another very substantial advance in industrial
wholesale prices.

Fifty-Fourth Annual Report
The Federal Reserve Bank of New York has published its fifty-fourth Annual Report, review­
ing the major economic and financial developments of 1968.
The Report observes that the problem of inflation intensified in 1968, as the economy moved
through an unprecedented eighth consecutive year of expansion. Efforts through national stabiliza­
tion policies to restore reasonable price stability at high employment were frustrated by powerful
inflationary expectations. The formulation of monetary policy during the year was complicated by
uncertainty regarding the application of fiscal restraint and by a succession of crises in the inter­
national financial system.
Inflationary demand pressures in the economy resulted in an alarming deterioration in the
international trade balance. Nevertheless, because of favorable capital flows, the overall United
States payments position showed a small surplus in 1968, and the swing to surplus served to
strengthen the dollar in foreign exchange markets.
In his letter transmitting the Report to the member banks in the Second Federal Reserve
District, Alfred Hayes, President of the Bank, remarked: “In 1969, we must continue to seek a
reduction of inflationary pressures at home and an improvement of our trade position internationally.
Monetary policy, as well as fiscal policy, can make a major contribution to the achievement of
these goals.”
Copies of the Annual Report may be requested from the Public Information Department,
Federal Reserve Bank of New York, 33 Liberty Street, New York, N. Y. 10045.



The Money and Bond Markets in February
In February, participants in the money and bond markets
came increasingly to the view that fiscal and monetary
restraint would continue for an extended period, and in­
terest rates rose in the capital markets. The pervasive effects
of monetary restraint became more visible, and the new
Administration made clear the high priority it accorded
to combating inflation. In this context, market participants
expected that an extension would be sought in the income
tax surcharge currently scheduled to expire on June 30.
Also influencing the market were indications that the Trea­
sury would request the Congress to remove the W a percent
ceiling on the coupon rates of new Treasury bond offerings.
The banking system remained under considerable pres­
sure during the month as the runoff of large-denomination
certificates of deposits (CD’s) necessitated continuing ad­
justments. Bidding for Euro-dollars remained strong, and
with the availability of additional funds in this form more
limited than in January their rates rose. (The three-month
rate on Euro-dollar funds reached 8 percent bid at the
month end.) Banks drew further on their secondary re­
serves during the month and began selling intermediateand long-term Government securities as well.
The tone of the money market was quite firm during
most of the month. Federal funds transactions were pre­
dominantly in a 6 V4 to 7 percent range, but some trad­
ing occurred at rates exceeding 7 percent. Nationwide
reserve availability contracted and member bank borrow­
ings at the Reserve Banks averaged $836 million in Feb­
ruary, virtually unchanged from the relatively high January
average level.
In the market for Treasury notes and bonds, yields
moved higher on balance in February, with most of the up­
ward adjustment recorded in the second half of the month.
Elsewhere in the capital market, a somewhat improved tone
emerged in the corporate sector early in the month, partly
reflecting the favorable technical position of that market.
Renewed caution developed as the period progressed, how­
ever, and over the month as a whole yields on corporate
bonds rose. In the tax-exempt sector, attention continued
to focus upon fading commercial bank demand and yields
rose further in February.
Rates on Treasury bills moved lower through most of

the month. Strong demand for shorter term bills from in­
vestors fearful of the interest rate outlook was added to
reinvestment demand from holders of the $2 billion of
February 15 maturities redeemed during the Treasury’s
February refunding. Late in the month, however, bill
rates moved higher as talk of a possible rise in the com­
mercial bank prime rate increased. Over the month as a
whole, most bill rates were little changed on balance.

The tone of the money market was generally firm dur­
ing the February 5 statement week, and most Federal
funds transactions took place in a 6Va to 6% percent rate
range. Nationwide reserve distribution, which had been
unusually favorable to the large reserve city banks in the
latter part of January,1 continued to favor banks in the
central money market at the beginning of February. Con­
sequently, the large New York City banks as a group ac­
cumulated a sizable basic reserve surplus and made large
net sales of Federal funds. As the period progressed, how­
ever, reserve distribution gradually shifted in favor of
banks outside the leading money centers. As a result, the
basic reserve position of the major reserve city banks de­
teriorated sharply and they resumed their more character­
istic role of net purchasers of Federal funds.
During the February 12 statement period, the market
tone was affected by the weekend snowstorm, which par­
alyzed much of the Northeast and consequently impeded
flows of funds, as well as by the Lincoln’s Birthday bank
holiday which was observed in many money centers on
the final day of the period. Despite an expansion in Fed­
eral Reserve float following the snowstorm, average na­
tionwide reserve availability during the period contracted
by about $76 million from the preceding week (see Table
I), partly as a result of an increase in Treasury deposits
at the Federal Reserve Banks. Moreover, reserves con-

iF o r details see this Review (February 1969), pages 32 and 34.


Tabic I

Table II



In millions of dollars; (4 ) denotes increase,
(— decrease in excess reserves

In millions of dollars
Daily averages—week ended on
Factors affecting
basic reserve positions

Changes in daily averages—
week ended on





4 202



Total “ m arket” factors ......................




— 461
— 18

4- 194
— 204

- f 511
— 658
4- 98
4 161
— 578
— 342



— 263

— 458

4- 462


Reserve excess or deficiency(—)*.... — 20 17
Less borrowings from
Reserve Banks.....................................
Less net interbank Federal funds
purchases or sales(—) ..................... — 309
Gross purchases ............................. 1,172 1,633
1,482 1,119
Gross sales ....................................
Equals net basic reserve surplus
or deficit( —) .....................................
217 — 622 — 535 - 164
Net loans to Government
securities dealers ...............................
Net carry-over, excess or deficit(—)f..
2 —
35 -





Thirty-eight banks outside New York City

-1- 55



Repurchase agreements:
Government securities ..........................
Bankers' acceptances ............................


— 147



Direct Federal Reserve credit
Open market instrum ents
O utright holdings:
Government securities ..........................


Eight banks In New York City

Market” factors
Member bank required reserves ................
Operating transactions (subtotal) ..........
Federal Reserve float ......................
Treasury operations* ................................
Gold and foreign account ........................
Currency outside banks ............................
Other Federal Reservo accounts (n e t)t--







Averages of
four weeks
ended on
Feb. 26




4 - 15
4- 246



4- 16

4- 140








Member bank borrow ings..............................
Other loans, discounts, and advances-----

— 145

4- 29
+ 13
4- 50

Total ..........................................................

— 67

4- 237

4 631

— 635

4- 166

Excess reserves .............................................

4- 45

— 26

4- 173

— 173








— 134


Reserve excess or deficiency
55 1
32 4
Less borrowings from
Reserve B anks.....................................
Less net interbank Federal funds
1,325 1,580
purchases or sales( —) .....................
Gross purchases ............................. 2,870 3,067
Gross sales ....................................
1,545 1,487
Equals net basic reserve surplus
or deficit(—) ...................................... -1,409 —1,831 -1,34 4 -1,0 2 4
Net loans to Government
securities dealers ...............................
Net carry-over, excess or deficit(—)t „ 20

-1 ,4 0 2



Note: Because of rounding, figures do not necessarily add to totals.
* Reserves held after all adjustments applicable to the reporting period less
required reserves and carry-over reserve deficiencies,
t Not reflected in data above.

Table III
Daily average levels

In percent

Member bank:
Total reserves, including vault cash
Excess r
Borrowings ................................................
Free, or net borrowed (—), reserves..
Nonborrowed reserves ............................
Net carry-over, excess or deficit (—)§


— 545

— 621

— 694

— 582



— 610$

Weekly auction dates— Feb. 1969














Changes in Wednesday levels
Monthly auction dates—Dec. 1968 to Feb. 1969
System Account holdings of Government
securities maturing in:
— 263



— 442
- f 62

Total .........................................................

— 263


4- 265

— 380

Note: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
t Includes assets denominated in foreign currencies.
$ Average for four weeks ended on February 26, 1969.
§ Not reflected in data above.









Less than one year ........................................
More than one y e a r ........................................




+ 8,541

* Interest rates on bills are quoted in terms of a 360-day year, with the dis­
counts 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.


tinued to flow away from the major money market banks.
Against this background, the tone of the money market
was quite firm. As the basic reserve positions of the eight
large banks in New York City and the thirty-eight major
banks in other money centers deteriorated sharply, these
banks collectively made larger net purchases of Federal
funds and increased their borrowings from the Federal
Reserve Banks (see Table II).
In the February 19 statement period, nationwide re­
serve availability contracted further, largely as a result
of a substantial decline in vault cash and an expansion
in required reserves, and the tone of the money market
was quite taut. The large commercial banks, accord­
ingly, were strong bidders in the Federal funds market
where trading was predominantly in a 6% to IV* per­
cent range from February 13 through February 18. They
also increased their borrowings from the Federal Re­
serve Banks by $246 million on a daily average basis
during the statement period. On the final day of the state­
ment period, the major New York City banks which had
overprovided for their reserve needs, supplied a sizable
amount of reserves to the Federal funds market. As a
result, the effective rate in that market fell to 5 percent
and some trading took place at rates as low as 2 percent.
The money market was firm during the final statement
week of the month, but the tautness of the preceding
week did not persist. Federal funds traded predominantly
in a 6V2 to 6% percent range, the average level of borrow­
ings from the Federal Reserve Banks declined to $758 mil­
lion, and average net borrowed reserves eased to $582
million. In part, the moderation of pressures in the money
market reflected both the sizable amount of excess reserves
which member banks carried forward from the preceding
week (see Table I) and an improvement in the basic
reserve position of the banks in the major money centers
(see Table II).
Rates on several types of money market instruments
were adjusted higher in February. Rates quoted by dealers
in bankers’ acceptances on paper maturing in ninety
days generally rose by Va percent to 6 3 percent bid-6%
percent offered. Rates on dealer-placed prime four- to sixmonth commercial paper moved V* percent higher to 6 3
percent offered, and rates on various maturities of directly
placed commercial paper increased by Vs percent.
With new CD’s at a persisting rate disadvantage com­
pared with competing money market instruments (notably
Treasury bills), the outstanding volume of CD’s continued
to contract. At the weekly reporting banks in New York
City, the decline amounted to approximately $650 million
between January 29 and February 26, while CD’s outstand­
ing at all weekly reporting banks declined by $1.1 billion.


At the same time, liabilities of United States banks to
their foreign branches rose in February by $213 million,
far short of the much sharper rise recorded in January.

The subscription period for the Treasury’s refunding
operation occupied the first three business days of Feb­
ruary, and during that time activity was subdued in
the market for Treasury notes and bonds.2 Prices of
intermediate-term maturities fluctuated narrowly, as the
public accorded the Treasury’s offering a lukewarm recep­
tion. Prices of longer term issues at first declined rather
sharply, when there was some investor switching out of
long-term Treasury issues into corporate and Government
agency issues, but then quickly rebounded in response to
renewed investor demand.
On February 7, the Treasury announced the results of
the refunding. Approximately 36 percent of the maturing
securities held outside the Federal Reserve Banks and
Government accounts was not exchanged for the new
notes offered by the Treasury and thus was earmarked for
cash redemption. Total subscriptions (including those from
both public and official sources) amounted to about $12.5
billion or about 86 percent of the $14.5 billion of notes and
bonds maturing on February 15. Subscriptions totaled
$8.8 billion for the new 6 ¥a percent notes of 1970 and
$3.7 billion for the new 6lA percent notes of 1976, with
only $885 million of the latter taken by the public.
The attrition was considerably larger than had gen­
erally been expected by market participants. In particular,
the relatively small amount of public subscriptions for the
notes of 1976 implied that the issue would be in scarce
supply, and this sparked expanded demand for these obli­
gations (trading on a “when-issued” basis) and for out­
standing intermediate-term issues as well. Subsequently, a
steady investment demand developed for coupon issues of
various maturities. From February 6 through February
13, prices of long-term Treasury bonds generally rose,
reflecting both investment demand and the improved tone
of the corporate bond market, while prices of intermediateterm Government securities also edged higher. (Asso­
ciated yield declines are illustrated in the right-hand panel
of the chart.)
A more cautious atmosphere emerged in the coupon
sector around midmonth. Market participants grew more

2For details of the refunding offering, see this R eview (February
1969), page 31.



December 1968-February 1969



Jan u ary





Janu ary


N ote: D ata are shown for b usiness d a y s only.
M O N E Y M ARKET RA TES Q U O TED: D a ily ran ge of rates posted by m ajor N ew York C ity banks
on new c all loans (in Fed eral funds) secured b y United States G overnm ent securities (a point
ind ica te s the a b s e n c e o f any ran ge); o fferin g rates for d irectly p la ce d fin an ce com p an y paper.the effective rate on Fed eral fu n d s lthe rate most representative of the transactions executed);
clo sin g bid rates (quoted in terms of rate of discount) on newest outstanding three- and six-month
Treasury bills.

im m ediately after it has been rele ased from syndicate restrictions); d a ily a v e ra g e s of yie ld s on
seaso n ed A a a -ra te d co rp o rate b on d s; d a ily a v e ra g e s of yield s on lon g-term G overnm ent
securities (bonds due or c a lla b le in ten years or more) and on G overnm ent securities due in
three to five ye a rs , computed on the b asis o f clo sing bid prices,- Thu rsd ay a v e ra g e s of yields
on twenty seasoned twenty -ye ar tax-exem pt bonds (carrying M o ody’s ratin gs of A a o , A a ,
A , and Baa).

BO N D MARKET YIELDS Q U O TED: Y ie ld s on new A a a - and A a-ra te d pub lic utility bonds (arrows point Sources: Fed eral Reserve Bank of New York, Board o fG o ve rn o rs o f the F e d eral Reserve System,
M oody’s Investors Service, and The W eekly Bond Buyer.
from underwriting syn d icate reo fferin g yield on a given issue to market yield on the sam e issue

pessimistic about the interest rate outlook as they weighed
the possibility of further increases in the discount rate
and the prime rate, while also assessing comments from
members of the new Administration which suggested the
need for rather prolonged monetary and fiscal restraint.
Sentiment in the coupon sector was also affected by indi­
cations that the Administration would soon ask the Con­
gress to remove the 4 lA percent ceiling on the coupon rate
that the Treasury may offer on new bonds. Moreover, the
February 27 increase in the British bank rate from 7 per­
cent to 8 percent drew a cautious reaction in the market.
Against this background, prices of coupon issues generally
drifted steadily lower from February 14 through the end of
the month although the relatively strong technical position
of the market somewhat limited the extent of the decline.

Overall activity was generally light, but offerings were ab­
sorbed by a net investment demand. Prices of longer
term bonds suffered relatively large declines, reflecting both
some switching out of longer Treasury issues into corporate
bonds and outright sales by commercial banks.
Despite the pessimistic climate which generally per­
vaded most other sectors of the securities market, a rela­
tively strong tone was evident in the Treasury bill sector
during most of February as many investors preferred to
remain liquid in the face of major market uncertainties. In
the first few days of the month, a good investment demand
emerged for shorter term bills— which were in scarce sup­
ply— and their rates were generally steady to lower. At the
same time, however, professional offerings of longer term
bills expanded and rates on these obligations tended to edge


slightly higher. After the Treasury’s refunding results were
released on February 7, rates for all bill maturities moved
lower as the unexpectedly large attrition led participants to
look forward to sizable reinvestment demand for bills from
holders of the maturing coupon issues who had decided
not to exchange them for new notes. Bill rates continued
to decline through midmonth in response to broad invest­
ment demand from various sources, especially public funds
and other institutional investors. (See the left-hand panel of
the chart.) From midmonth through February 25, rates
moved irregularly, with declines outnumbering gains.
On February 19, the Treasury announced that it would
auction a $1 billion “strip” of bills on February 25 for
payment on March 3. The offering represented a $200
million addition to each of five outstanding bill issues
maturing from April through August, with subscribers re­
quired to take equal amounts of each of the reopened issues.
Commercial banks bid aggressively for the strip for which
they were permitted to make full payment in the form of
credits to Treasury Tax and Loan Accounts. The bill strip
was auctioned at an average issuing rate of 5.907 percent.
In the closing days of the month, some selling pressures
emerged in the bill market and rates edged higher, as
banks actively disposed of their awards of the bill strip.
At the regular monthly auction on February 20, aver­
age issuing rates on the new nine- and twelve-month bills
were set at 6.307 percent and 6.234 percent, respectively,
11 and 9 basis points higher than the average rates at the
comparable January auction (see Table III). At the final
regular weekly auction of the month, held on February 24,
average issuing rates for the new three- and six-month
bills were set at 6.080 percent and 6.258 percent, respec­
tively, 9 basis points lower and about unchanged from
the average rates established a month earlier.

In the markets for corporate and tax-exempt bonds,
yields on new and recent issues continued to move higher
in the opening days of the month amid persisting un­
certainty over the future course of interest rates. A new
Aaa-rated utility company issue of first mortgage bonds
carrying five years of call protection was offered to in­
vestors on February 4 at a price to yield 7.07 percent,
the highest offering yield ever recorded on a comparable
flotation. Nevertheless, investors did not respond enthu­
siastically to the offering. In both the corporate and
tax-exempt sectors, underwriters probed for yield levels
which would generate investor interest. Many syndicate


price terminations occurred in early February, and the
ensuing price reductions boosted yields 5 to 20 basis
points. A continuing concern over the dimensions of com­
mercial bank demand for obligations of state and local
governments added to the heavy atmosphere in the taxexempt market.
A more optimistic tone emerged in the corporate sector
during the statement period ended on February 12. Market
participants were heartened after investors (particularly
public pension funds) accorded an enthusiastic reception
to an Aaa-rated utility issue which was offered on Febru­
ary 6 to yield 7.06 percent. This excellent response stood
in contrast to the initial apathetic reception accorded a
somewhat similar flotation just two days earlier and
boosted sales of the earlier issue. The corporate bond
sector was also encouraged by the relatively moderate
February calendar of scheduled new offerings and by the
emergence of a steady investment demand. Against this
background, three corporate bond issues with small unsold
balances that were released from underwriter price restric­
tions promptly rose in price, in striking contrast to the price
cutting which had generally followed syndicate termina­
tions earlier in the month. In the tax-exempt market, how­
ever, attention continued to focus on the shallowness of
commercial bank demand and a restrained tone persisted
during the February 12 week. Despite minimal new issue
activity, dealers made little progress in reducing their in­
ventories of tax-exempt bonds during the period.
Subsequently, although the technical position of the
corporate bond sector remained strong, market partici­
pants reacted with considerable caution to new assess­
ments of the oudook for domestic economic policy and in­
terest rates. In this more bearish setting, corporate bond
yields generally adjusted higher in the second half of Feb­
ruary. At the same time, sentiment in the tax-exempt sec­
tor continued quite restrained and record yield levels pre­
dominated. A record 5.135 percent net interest cost was
set for a large issue of new Housing Authority bonds.
At the end of February, The Weekly Bond Buyer’s
yield index of twenty seasoned tax-exempt issues rose to
a modern high of 5.04 percent, 13 basis points higher
than a month earlier and well above the 4.95 to 4.96 per­
cent levels which had prevailed during the first three weeks
of the month. Moody’s index for seasoned Aaa-rated cor­
porate bonds closed the month at 6.69 percent, 10 basis
points higher than a month earlier. The Blue List of
advertised dealer inventories of tax-exempt securities
totaled $569 million at the end of the month as against
its January 31 level of $601 million.


Publications of the Federal Reserve Bank of New York
The following is a selected list of publications available from the Public Information Department,
Federal Reserve Bank of New York, 33 Liberty Street, New York, N. Y. 10045. Copies of charge pub­
lications are available at half price to educational institutions, unless otherwise noted.
1. c e n t r a l b a n k c o o p e r a t i o n : 1924-31 (1967) by Stephen V. O. Clarke. 234 pages. Dis­
cusses the efforts of American, British, French, and German central bankers to reestablish and maintain
international financial stability between 1924 and 1931. ($2 per copy)
2. e s s a y s i n m o n e y a n d c r e d i t (1964) 76 pages. Contains articles on select subjects in bank­
ing and the money market. (40 cents per copy)
3. k e e p i n g o u r m o n e y h e a l t h y (1966) 16 pages. An illustrated primer on how the Federal Re­
serve works to promote price stability, full employment, and economic growth. Designed mainly for sec­
ondary schools, but useful as an elementary introduction to the Federal Reserve. ($6 per 100 for copies in
excess of 100*)
4. m o n e y a n d e c o n o m i c b a l a n c e (1968) 27 pages. A teacher’s supplement to Keeping Our
Money Healthy. Written for secondary school teachers and students of economics and banking. ($8 per
100 for copies in excess of 100*)
5. m o n e y , b a n k i n g , a n d c r e d i t i n e a s t e r n e u r o p e (1966) by George Garvy. 167 pages.
Reviews recent changes in the monetary systems of the seven communist countries in Eastern Europe and
the steps taken toward greater reliance on financial incentives. ($1.25 per copy; 65 cents per copy to edu­
cational institutions)
6. m o n e y : m a s t e r o r s e r v a n t ? (1966) by Thomas O. Waage. 48 pages. Explains the role of
money and the Federal Reserve in the economy. Intended for students of economics and banking. ($13
per 100 for copies in excess of 100*)
7. p e r s p e c t i v e (January 1969) 9 pages. A layman’s guide to the economic and financial
highlights of the previous year. ($6 per 100 copies in excess of 100*)
8. t h e n e w y o r k f o r e i g n e x c h a n g e m a r k e t (1965) by Alan R. Holmes and Francis H.
Schott. 64 pages. Describes the organization and instruments of the foreign exchange market, the techniques
of exchange trading, and the relationship between spot and forward rates. (50 cents per copy)
9. t h e s t o r y o f c h e c k s (1966) 20 pages. An illustrated description of the origin and develop­
ment of checks and the growth and automation of check collection. Primarily for secondary schools but
useful as a primer on check collection. ($4 per 100 for copies in excess of 100*)
10. t h e b a l a n c e o f p a y m e n t s (1968) 6 pages. Discusses the dominant role of the dollar
in world trade and investments and the ABC’s of the United States balance of payments in nontechnical
language. ($3 per 100 copies in excess of 100*)
* Unlimited number of copies available to educational institutions without charge.

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