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50
MONTHLY REVIEW* MARCH 1970
Treasury and Federal Reserve Foreign Exchange Operations*
By C harles A. C oombs
The recurrent speculative storms that had swept across
the foreign exchanges during the first nine months of 1969
were succeeded during the fall and winter months by a
general clearing-away of market fears and tensions. Earlier
apprehension that the acute disequilibria in the French and
German payments positions might trigger a world financial
crisis was relieved by the successive devaluation of the
French franc in August and revaluation of the mark in
October. The vigorous recovery of sterling from earlier
deficits to a position of sustained surplus finally overcame
bearish market sentiment toward the pound and encouraged
the rebuilding of foreign balances normally held in Lon
don. More generally, the activation of the special drawing
rights (SDR) agreement, together with the abrupt decline
in the free market price of gold, contributed to a strong
revival of confidence in the continuing viability of the
international financial system.
In this relaxed atmosphere, hedging and speculative
positions taken earlier in the year were steadily unwound,
most strikingly evidenced in net outflows from Germany
of $5 billion during the final quarter of the year. While
the United States and the Euro-dollar markets were major
beneficiaries of these outflows from Germany, many other
currencies that had suffered from earlier hedging on the
mark also reacted buoyantly to the unwinding of specu
lative positions. The swing of the pendulum in the ex
change markets was accompanied by a similar swing of
creditor and debtor positions in the Federal Reserve swap
network and related credit facilities. (See Tables II and III.)
♦This report, covering the period September 1969 to March
1970, is the sixteenth in a series of reports by the Senior Vice
President in charge of the Foreign function of the Federal Reserve
Bank of New York and Special Manager, System Open Market
Account. The Bank acts as agent for both the Treasury and Fed
eral Reserve System in the conduct of foreign exchange operations.
Particularly noteworthy was the remarkable shift in the
Bank of England’s use of its $2 billion swap line with the
Federal Reserve. From a peak commitment of $1,415
million in May 1969, the Bank of England debt to the
Federal Reserve declined to $815 million as of the end
of July and, after rising to $1,145 million during August
and September, was progressively reduced to $650 mil
lion at the year-end and finally completely liquidated by
February 11, 1970. During this period the Bank of Eng
land also effected heavy repayments to other creditors.
As of the end of August 1969, the National Bank of
Belgium and the Netherlands Bank were indebted to
the System under the swap lines to the extent of $224
million and $109.7 million, respectively. In these two
instances the pendulum swung back well beyond center
as both the Belgian franc and the Dutch guilder became
regarded by the market as possible candidates for revalua
tion along with the German mark. The resultant influx of
funds into Brussels and Amsterdam not only enabled both
the Belgian and Dutch central banks to repay all outstand
ing debt due to the Federal Reserve, but shortly thereafter
necessitated System borrowing under the two swap lines to
absorb a heavy volume of surplus dollars acquired by each
central bank. In the case of the swap line with the National
Bank of Belgium, Federal Reserve drawings rose by Febru
ary 10 to a level of $85 million equivalent, all of which re
mained outstanding as of March 10, 1970. The flow of
funds to the Netherlands was considerably heavier, neces
sitating not only drawings totaling $300 million equivalent
by the Federal Reserve in October 1969 but also a concur
rent special swap of $200 million by the United States Trea
sury. As soon as the Dutch government formally rejected
any revaluation of the guilder, the flow of speculative funds
reversed itself, enabling the Treasury to liquidate its swap
within a week’s time. The Federal Reserve swap debt was
subsequently reduced by $170 million to $130 million
equivalent, which remained outstanding as of March 10.
FEDERAL RESERVE BANK OF NEW YORK
Although the Swiss franc had remained relatively un
affected by speculation on the mark during the summer
months of 1969, a general tightening of liquidity in Switzer
land toward the end of September brought an influx of
dollars, most of which were absorbed by a $200 million
drawing by the Federal Reserve on its swap line with the
Swiss National Bank. This debt was paid down by $25
million in November and a further $30 million in Decem
ber as Swiss francs became available through the market.
The remaining balance of $ 145 million equivalent was liqui
dated during February 1970 through two transactions
effected directly with the Swiss National Bank.
The French franc benefited considerably during the
fourth quarter of 1969 from the return flow of funds from
Germany and has remained strong since the turn of the
year, enabling the Bank of France to make further sizable
payments of short-term central bank credits. In connec
tion with these repayments the Bank of France activated
its swap line with the Federal Reserve on January 8,
drawing $100 million as interim financing of a debt re
payment due to Germany; the French drawing on the
System swap line was repaid on February 2, and the $1
billion facility reverted to a standby basis. As of March
Table I
FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS
March 10, 1970
In millions of dollars
Institution
Austrian National Bank.......
Amount of facility
200.0
National Bank of Belgium....
500.0
Bank of Canada....................
1,000.0
National Bank of Denmark..
200.0
Bank of England...................
2,000.0
Bank of France.....................
1,000.0
German Federal Bank..........
1,000.0
Bank of Italy.........................
1,000.0
Bank of Japan.......................
1,000.0
Bank of Mexico....................
130.0
Netherlands Bank.................
300.0
Bank of Norway....................
200.0
Bank of Sweden....................
250.0
Swiss National B ank............
600.0
Bank for International Settlements:
Swiss francs-dollars ..........................................
600.0
Other authorized European currencies-dollars..
1,000.0
Total .........................................................................
10,980.0
51
10, 1970 earlier credits of $200 million extended by the
United States Treasury to the Bank of France had been
paid down to $95 million.
The Italian lira became subject to pressure in Septem
ber 1969 with the approach of the German elections and,
to cover market losses, the Bank of Italy activated its $1
billion swap line with the Federal Reserve on September
23 by drawing $300 million. Following the mark re
valuation, the lira recovered as a return flow of funds
from Germany got under way, and by November 14 the
Bank of Italy was able to repay the $300 million drawn
from the Federal Reserve. Later in December the lira
once again came under pressure, reflecting the impact of
widespread strikes in November, domestic political uncer
tainties, and the pull of higher interest rates abroad. As
a result, the Bank of Italy reactivated its swap line with the
Federal Reserve on January 23, 1970, drawing $200
million on that day and making additional drawings in
February.
Drawings on the swap lines by the Federal Reserve and
its foreign central bank partners amounted to $3.1 billion
in 1969. The total of such drawings from the inception
of the swap network in March 1962 through the end of
1969 came to $20.5 billion. Over the same period, other
credits provided by foreign central banks and the United
States Treasury on an ad hoc basis totaled more than
$11.5 billion. Gold transactions between the United States
Treasury and the foreign central banks in the swap net
work came to $9.0 billion, while drawings on the Interna
tional Monetary Fund (IMF) by the governments of the
same countries amounted to $9.5 billion.
The Federal Reserve swap network was further en
larged in October 1969 by increases from $100 million
to $200 million each in the Federal Reserve swap facilities
with the Austrian National Bank, the National Bank of
Denmark, and the Bank of Norway. The System’s overall
swap network was thereby raised to $10,980 million (see
Table I).
Since the last report in this series, no new operations
in the forward markets have been undertaken by either
the Federal Reserve or the Treasury. Technical forward
commitments in lire assumed by the United States Trea
sury in earlier years were fully liquidated by the end of
November 1969.
From time to time beginning in May 1969 the Federal
Reserve bought foreign currencies on a three-month
swap basis from the Treasury’s Exchange Stabilization
Fund in order to free some of the Fund’s resources for
current operations, primarily gold purchases from foreign
countries. These swaps reached a peak of $1 billion early
in January, but were fully reversed later that month after
52
MONTHLY REVIEW, MARCH 1970
Table n
FEDERAL RESERVE SYSTEM DRAWINGS AND REPAYMENTS
UNDER ITS RECIPROCAL CREDIT ARRANGEMENTS
In millions of dollars equivalent
Drawings ( + ) or repayments ( — )
Transactions with
System swap
drawings
outstanding on
January 1,1969
1969
1
11
1970
111
+
National Bank of Belgium.............................
German Federal Bank.....................................
IV
112.1
Netherlands Bank ............................................
— 112.1
+
40.0
55.0
+
30.0
— 40.0
f +300.0
1 — 170.0
— 145.0
f + 30.0
1-145.0
Swiss National Bank........................................
320.0
— 280.0
JI —
+ 1450
4D.U
— 95.0
f +200.0
I - 55.0
Total
432.1
f + 40.0
1— 392.1
f + 100.0
1 - 85.0
— 95.0
f +555.0
1 — 225.0
.......... ........................................
January 1*
March 10
System swap
drawings
outstanding on
March 10,1970
85.0
130.0
215.0
the United States Treasury had monetized $1 billion of ally would force a mark revaluation. These fears culmi
gold previously held by the Exchange Stabilization Fund. nated in a huge rush of funds into Germany in November
During the period under review, the United States 1968, but speculation receded in the face of the determined
Treasury redeemed foreign currency securities valued at a refusal by the German government to revalue the mark.
total of $850.6 million equivalent. In October the Austrian Reversal of the massive influx of funds took some time,
National Bank encashed prior to maturity the remaining but by early 1969 German monetary reserves were back
$25.1 million equivalent note denominated in schillings to their pre-November 1968 level and the volume of
(see Table IV ). In November the German Federal Bank outstanding market swap commitments of the German
encashed prior to maturity four mark-denominated notes Federal Bank had been significantly reduced.
valued at $199.6 million equivalent and, in January, four
During the first quarter of 1969 the outflow of funds
notes valued at $500.5 million equivalent issued to it under from Germany continued unabated, as the authorities pur
the 1967 and 1968 agreements to neutralize the balance-of- sued a policy of monetary ease at a time when Euro-dollar
payments costs of United States military expenditures in rates were rising sharply. In addition to the substantial
Germany. In January 1970, the Treasury redeemed at flow into the short-term Euro-dollar market, long-term
maturity a lira-denominated note for $125.4 million equiv capital exports rose to record levels, as foreign borrowers
alent held by the Bank of Italy. As a result of these transac flooded the German capital market with loan demands and
tions, and taking into account certain valuation changes securities issues in response to the relatively low borrow
following the German mark’s revaluation, total United ing costs in Germany.
By early April, however, congestion in the capital mar
States Treasury foreign currency-denominated securities
outstanding declined from $2.2 billion to $1.4 billion ket was becoming severe and the West German Capital
Market Committee acted to space out issuance of securities
equivalent during the period.
by foreign borrowers. With capital outflows dropping sharp
ly, the steady decline in German reserves came to an end.
GERM AN M ARK
Moreover, the gradual shift in official policy toward re
During 1968 there were recurrent rumors of immi straint aroused concern that reliance on monetary means
nent revaluation of the mark as Germany continued to to curb inflationary pressures might result in reflows of
show a very large surplus in its balance of payments on funds to Germany and consequent renewed buying pressure
current account. Although the current-account surplus was on the mark. The 1 percentage point jump to 4 percent in
offset by an even larger outflow of long-term capital, the the Federal Bank’s discount rate on April 18 pointed up
markets remained apprehensive that the outflow could not this potential dilemma inherent in official efforts to avert
be sustained and that German competitive strength eventu domestic inflation while avoiding internationally disruptive
S3
FEDERAL RESERVE BANK OF NEW YORK
shifts of funds into Germany. Late in April, demand for German government announced late on May 9 that it
marks rose sharply with the approach of the referendum would not revalue the mark and that supporting measures
on which General de Gaulle had staked his presidency. would be announced in a few days. By then the exchange
(See Chart I.) The German Federal Bank immedi markets had witnessed the heaviest flow in international
ately resumed mark swap operations, however, and thereby financial history. The speculative onslaught between the
succeeded in rechanneling to the international money end of April and May 9 increased German monetary
markets most of the $500 million taken in during this reserves by some $4.1 billion—including $2.5 billion
on May 8 and 9 alone—to a record level of $12.4 billion.
period.
The exchange markets began returning to normal fol
The market atmosphere changed dramatically over
night, however, following reports that German official lowing the German government’s decision, which was
circles might be willing to consider a mark revaluation as backed up by an official communique from Basle declar
part of a multilateral realignment of parities. Demand for ing that agreement had been reached among the central
marks soared as firms with commitments in marks rushed banks on steps to recycle the speculative flows. There
to hedge them, commercial payments leads and lags be after, there was a large outflow of funds from Germany
gan to swing heavily in favor of the mark, and outright which continued through early June, as Euro-dollar rates
speculation began again. Between April 30 and Friday, moved higher and as the Federal Bank resumed swap op
erations. A tightening of liquidity conditions in Germany
May 2, the Federal Bank purchased over $850 million.
Speculative pressures built up on an even more massive around the mid-June tax date temporarily checked the out
scale during the following week. Frenzied speculation in flow, which resumed toward the month end and continued
duced huge shifts of funds to Germany, exerting strong into early July. By then nearly $3 billion had returned to
pressure on the Euro-dollar market and dangerously the international markets.
The devaluation of the French franc on August 8
straining the international reserves of some of Germany’s
trading partners. The speculation did not halt until the introduced new uncertainties and triggered a fresh rush of
Table III
DRAWINGS AND REPAYMENTS BY FOREIGN CENTRAL BANKS
AND THE BANK FOR INTERNATIONAL SETTLEMENTS
UNDER RECIPROCAL CURRENCY ARRANGEMENTS
In millions of dollars
Drawings ( + ) or repayments ( — )
Banks drawing on
Federal Reserve System
Drawings on
Federal Reserve
System outstanding
on January 1,1969
Drawings on
Federal Reserve
System outstanding
on December 31,1969
1969
111
Austrian National Bank........................................................
National Bank of Belgium.....................................................
7.5
f + 74.0
1 — 58.5
X +25.0
1 - 25.0
National Bank of Denmark...................................................
Bank of England......................................................................
1,150.0
Bank of France........................................................................
430.0
— 50.0
+
50.0
—
50.0
f+
1—
195.0
104.0
f±
244.0
154.0
—
204.0
—
450.0
300.0
|+
100.0
100.0
f+
I—
465.0
540.0
f+
1—
330.0
255.0
-
461.0
f+
{ -
65.0
65.0
+
300.0
—
— 109.7
Bank of Italy............................................................................
Netherlands Bank ..................................................................
Bank for International Settlements (against German marks).
Total
80.0
51.0
— 131.0
1,667.5
f +375.0
1-458.5
IV
+
82.2
f+
1—
109.7
82.2
1+
1-
25.0
25.0
f+
I—
4.0
4.0
f + 917.2
{ — 1,230.0
| + 1,052.7
610.2
f+
1 -
650.0
62.0
62.0
f+
62.0
1— 1,125.7
650.0
54
MONTHLY REVIEW, MARCH 1970
Table IV
OUTSTANDING UNITED STATES TREASURY SECURITIES
FOREIGN CURRENCY SERIES
In millions of dollars equivalent
Issues ( + ) or redemptions (—)
Issued to
Amount
outstanding on
January 1,1969
Austrian National Bank.................................
50.3
German Federal Bank....................................
1,176.3
1969
1
II
—50.0*
C+ 124.3
] — 49.9
German banks ................................................
125.1
225.6
Swiss National Bank......................................
444.7
+25.4
Bank for International Settlements§..............
207.7
+49.7
2,229.7
+25.2
......... .........................................
Ml
— 25.2
Bank of Italy...................................................
Total
1970
IV
-
January 1March 10
—0—
25.1
—199.6
Amount
outstanding on
March 10,1970
—500.5
519.61
125.1
—100.2$
+ 39.5
+ 113.8
—125.4
—0—
+ 30.0
540.6
-
204.4
53.2
—148.6
—224.7
—625.9
l,389.7t
Note: Discrepancies in totals are due to valuation adjustments and to 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 Including certain revaluation adjustments.
X Security issued in favor of Ufficio Italiano dei Cambi.
§ Denominated in Swiss francs.
demand for marks. The Federal Bank once again pur
chased dollars, but the buying pressures were not sustained
and the authorities were able to swap back to the market
a substantial part of the inflow.
The market then remained quiet for a few weeks but,
as the date of the German elections approached, there
was sizable covering of foreign currency positions by Ger
mans as well as mark hedging by foreigners, and the
German Federal Bank purchased increasing amounts of
dollars during the course of September. The Federal Bank
was simultaneously selling dollars on a swap basis but on
September 18, after such sales had reached $0.7 billion
over a ten-day period, the Federal Bank raised its swap
rate, thus bringing to a virtual halt the covered movements
of German funds into the Euro-dollar market. Although
anxious to encourage a reflow of funds, the authorities felt
that the market swaps were again beginning to be used to
finance speculative purchases of marks. The spot inflow
continued unabated, however, and by September 24, the
Wednesday before the election weekend, the Federal Bank
had purchased $1.5 billion in an increasingly active market.
After the close of the Frankfurt market on that day,
the German authorities, at the suggestion of the Federal
Bank, announced their decision to suspend official foreign
exchange dealings until after the elections, thereby fore
stalling an influx of funds into Germany that might well
have approached the massive proportions of the two pre
ceding crises—in November 1968 and May 1969. The
mark continued to be traded that afternoon in New York
and on Thursday and Friday in all international exchanges,
but activity was limited. With ^ official intervention and
with conflicting rumors swaying the market, the rate moved
above its ceiling of $0.2518% to as high as $0.2570 on
Thursday, September 25 (see Chart II).
The election returns, which came in Sunday night,
showed that no party had won a parliamentary majority.
Negotiations were promptly undertaken, however, by the
Social Democratic and Free Democratic parties to form a
coalition government, which would presumably favor re
valuation. Against this political background, the Federal
Bank reentered the market on Monday morning, Septem
ber 29, and was immediately flooded with $245 million
in the first hour and a half of trading. At that point the
German government accepted a recommendation by the
Federal Bank that the mark be permitted to “floaty tem
porarily—by suspension of intervention at the ceiling.
The mark rate immediately rose above the ceiling
and within a week—by early October—had reached a pre
mium of about 63A percent; it advanced more slowly
thereafter to a premium of some 7V4 percent by midmonth
and then fluctuated narrowly around that level. Despite
continuing nervousness, the market adapted to the changed
FEDERAL RESERVE BANK OF NEW YORK
circumstances satisfactorily as two factors combined to
ensure orderly conditions during the transition period.
First, by October 2 it had become reasonably clear that
a Social Democratic-Free Democratic coalition govern
ment would take office when the Bundestag reconvened
on October 21 and would revalue the mark shortly there
after. Thus, the main question in the market became the
size, rather than the possibility, of a parity change. And
even on this score there was little diversity of views in the
market, with traders widely expecting the new parity to
be set at $0.27027 (DM 3.70).
Second, the German Federal Bank exerted a strongly
stabilizing influence by standing ready each day to buy
marks at rates slightly below those prevailing in the market,
thereby in effect placing a floor just below each successive
advance of the rate. Since the mark was technically weak at
the time because of the withdrawal of foreign funds which
was already under way, there could have been wide fluctu
ations in the spot rate and repeated departures from the
longer term equilibrium rate had the Federal Bank not
stood ready to prevent disorderly fluctuations. The Fed
eral Bank’s dollar sales in these operations varied widely
from day to day, but amounted to $1 billion by the time
the new parity was fixed.
On Friday, October,24, the German government re
valued the mark by 9.3 percent to $0.2732*4. As had
been expected, it also eliminated the special border-tax
adjustments that had been introduced in November 1968
to make exports more expensive and imports cheaper and
that had been temporarily suspended on October 11,1969.
The revaluation was larger than had generally been antici
pated, thus decisively removing the mark from the realm
of speculation while setting into action economic forces that
should tend to foster both internal and external equilib
rium. The move was well received by the market, which
quickly became convinced that a period of much greater
calm would ensue.
The German mark traded at its new floor of $0.2710
when the market opened on Monday, October 27, and,
apart from a short-lived rally in early December, remained
there through the end of the year while the substantial
positions built up in September and during earlier periods
were being unwound. Moreover, with interest rates lower in
Germany than abroad, foreign firms made large drawings
on credit lines established with German banks earlier in
the year. Consequently, there were extremely heavy dollar
sales by the Federal Bank. By the year-end, such sales
totaled more than %6Vi billion (including the $1 billion
sold during the period when the mark was permitted to
float) but were partly offset by about %\V2 billion in
maturing forward contracts. The net outflow of $5 billion
55
Chart I
EXC H A N G E RATES
J A N U A R Y 1 9 6 9 T O M A R C H 19 70
Cents p e r unit of foreign c u rre n c y *
2 7 .8 3 5 8
/
Netherlands ^
2 7 .6 2 4 3
\
i
1
27.4160
!
!
i
i
i
i
i
l
l
2.0151
i^vy Wivv
J
B elgium
2.0 000
1.9851
_
i
---------i
i
i
i
9 2 .5 0 0
91.575
Note: Upper and lower boundaries of charts represent official buying and
selling rates of dollars against the various currencies. However, the Bank of
C anada has informed the market that its intervention points in transactions
with banks are $0.9324 (upper limit) and $0.9174 (lower limit).
* W eekly averages of New York noon offered rates.
-------------------Par value of currency.
t A s of August 10,1969.
^ A s of October 26,1969.
56
MONTHLY REVIEW, MARCH 1970
created both internal and external problems. Domestically,
the authorities were not averse to having some additional
pressure exerted on liquidity, since this reinforced their
policy of monetary restraint, but they were anxious to avoid
the development of too severe or abrupt a squeeze. From an
international point of view, a considerable reflow of capital
was desirable, since it. would help rebuild the reserves of
other countries, but the actual size of the reflow was of
such a magnitude as to reduce sharply the Federal Bank’s
holdings of liquid dollars.
To provide some relief to German commercial banks
from the liquidity-tightening effects of the outflow, effec
tive November 1 the Federal Bank reduced minimum
reserve requirements by 10 percent for resident deposits and
30 percent for nonresident deposits. The bank also elimi
nated the special 100 percent marginal reserve requirement
that had been imposed earlier on foreign deposits; reserve
requirements against nonresident liabilities were thus again
brought into line with those applying to domestic liabilities.
Credit conditions continued to tighten, however, as the
outflow persisted, and commercial banks were forced to
borrow heavily from the Federal Bank. When year-end
stringencies began to add to the pressure, the Federal
Bank announced on December 4 that reserve requirements
would be lowered by another 10 percent, but for the
month of December only. At the same time, to discourage
both domestic credit expansion and capital outflows, the
Federal Bank raised its “Lombard” rate on secured ad
vances by IV2 percentage points to 9 percent, thus widen
ing the spread between that rate and the discount rate
(which had been raised to 6 percent on September 11)
to 3 percentage points, an unusually large amount. Fur
thermore, in mid-December, the authorities eliminated the
prohibition against payment of interest by German banks
on foreign-owned deposits, which had been designed to
discourage inflows of short-term funds.
On the external side, in financing the huge outflow of
funds, the Federal Bank had used up most of its liquid
dollar holdings by mid-November, although total official
reserves remained very large. As a consequence, the Ger
man authorities encashed in advance of maturity four
mark-denominated United States Treasury notes totaling
DM 800 million. The Treasury purchased the necessary
marks directly from the German Federal Bank against dol
lars. In addition to the dollars acquired in this transaction,
Germany had recourse to its creditor position within the
IMF— drawing $540 million on November 26, and mobiliz
ing an additional $550 million on December 9 representing
its claims under the General Arrangements to Borrow.
There were further heavy outflows during the second half
of December, and Germany sold $500 million of gold to
the United States Treasury on December 29. In the first half
of January, furthermore, the Federal Bank encashed in
advance of maturity four 4Vi-year mark-denominated
United States Treasury securities totaling DM 2 billion that
had been issued to it under the 1967 and 1968 agreements
to neutralize the balance-of-payments costs to the United
States of maintaining military forces in Germany. The
Treasury again acquired the marks through direct pur
chases from the Federal Bank, which used the dollars to
build up its liquid balances.
Germany’s reserve losses were very heavy in December,
as United States and European corporations, which had
transferred funds to Germany earlier in 1969 for invest
ment in instruments maturing prior to the end of the year,
repatriated those funds in order to meet balance-ofpayments targets or year-end needs. Moreover, there were
exceptionally large takedowns of long-term credits from
German banks. After such year-end positioning had
been completed and with the sharp decline in Euro-
FEDERAL RESERVE BANK OF NEW YORK
dollar rates, the outflows from Germany came to an abrupt
halt. The mark then firmed and generally traded above its
floor in January, although it eased slightly in February,
moving close to the floor by the month end. During this
period the Federal Reserve built up its mark balances. In
early March, the mark strengthened in anticipation of a
further tightening of German monetary policy. The spot
rate then jumped sharply on March 6, when the Federal
Bank announced a lVi percentage point rise in its dis
count rate to IV2 percent and a Vi percentage point rise
in its “Lombard” rate to 9 Vi percent.
S T E R L IN G
In 1969, the United Kingdom’s balance of payments on
current and long-term capital accounts at last turned from
deficit to surplus. It was not until late autumn that this
improvement was reflected in market sentiment, however,
since the underlying demand for sterling that set in early
in the year was repeatedly swamped by bouts of heavy
selling during the periods of speculative activity in the
German mark and French franc.
Although the United Kingdom’s basic balance of pay
ments remained in small deficit during the first quarter,
seasonal strength in the exports of the overseas sterling
area enabled the Bank of England to make substantial
market gains. The British authorities used the dollar in
flow to meet repayment obligations to the IMF and to
begin repaying outstanding shorter term indebtedness. By
early April, the Bank of England had reduced its draw
ings from the Federal Reserve from $1,150 million to $950
million. Later in April, sterling weakened as the French
constitutional referendum approached, but there was no
large-scale selling and official support costs were modest.
Just as the market was beginning to regain its equi
librium, a new wave of speculation on possible parity re
alignments was unleashed by reports of German official
willingness to consider revaluing the mark as part of a
broader readjustment of parities. As funds flowed from
virtually every major center into Germany at the be
ginning of May, sterling was particularly hard hit, with
the familiar buildup of selling pressure in advance of the
weekends. Over ten days of hectic speculation, Bank of
England support costs in the spot market were very large,
while forward sterling discounts widened sharply.
This episode, of course, interrupted the progress the
United Kingdom authorities had been making in reducing
their external indebtedness, and the Bank of England had
to draw on the swap line with the Federal Reserve to
help cover market losses. At their peak, swap drawings
reached $1,415 million, but sterling had been very heavily
57
oversold and rebounded sharply following the German
government’s rejection of a revaluation of the mark on
May 9. During the remainder of May and through July
the Bank of England was able to make sizable reserve
gains despite the upsurge of interest rates in the Euro
dollar market.
The reserve gains once again were used to make repay
ments of debt under various international credit lines.
By the end of July the Bank of England had succeeded
in reducing its outstanding drawings from the Federal
Reserve to $815 million. In addition, during May and
June the United Kingdom made a large scheduled repay
ment to the IMF and liquidated the bulk of the credit
still outstanding under the 1968 sterling balances arrange
ment. On the other hand, the Bank of England obtained
new credit from the German Federal Bank under a re
cycling arrangement designed to neutralize part of the
speculative flow from the United Kingdom into Germany,
and drew $500 million from the IMF under a new standby
facility.
The market remained nervous, however, and there were
a few selling flurries during the summer months. In these
circumstances, the devaluation of the French franc on
August 8 brought renewed speculation that abruptly
halted the Bank of England’s gains. Both spot and forward
sterling rates fell sharply, and pressures became substan
tial on August 13, with the release of figures showing an
enlarged British trade deficit. Heavy support of the spot
rate was required for a few days, and the Bank of Eng
land drew $160 million on its swap line with the Federal
Reserve. But more sterling had been sold than the market
could deliver, and once again the Bank of England quickly
recouped a significant part of its losses. Nevertheless, the
underlying tone of the market remained pessimistic and,
once the cash squeeze had ended, sterling again drifted
down close to its floor and required modest support. At the
end of August, drawings on the swap line stood at $975
million.
This atmosphere persisted into early September and, on
September 2 and 3, the Bank of England again drew on
its swap line with the System. Thereafter, however, ster
ling recovered strongly, particularly following the release
of data indicating that the United Kingdom’s underlying
balance of payments had been in substantial surplus dur
ing the second quarter. The approach of the German elec
tions brought sterling under modest pressure, but the Bank
of England had to make only a small additional drawing
on its Federal Reserve swap line, bringing the total out
standing to $1,145 million. When the German mark was
allowed to appreciate, sterling moved up smartly and the
Bank of England resumed its dollar purchases. The bank
58
MONTHLY REVIEW* MARCH 1970
then made repayments on the swap line, reducing drawings lion in January and of $350 million in February, thereby
outstanding to $1,100 million at the end of September.
restoring the $2 billion swap line to a fully available
The recovery continued throughout October, sustained standby basis for the first time since July 1968. Certain
by oil company purchases of sterling for tax and royalty other short-term credits extended to the Bank of England
payments, by the announcement of the second consecutive by the United States Treasury still remain outstanding.
monthly trade surplus, for September, and by the rise in During this period the Federal Reserve and the Treasury
the market value of the German mark (which made fur received scheduled repayments totaling $156 million of
ther speculation in marks unattractive and induced some British borrowings associated with the first sterlingprofit taking). The sterling spot rate reached the $2.39 balances arrangement of June 1966. Very substantial debt
level by mid-October, for the first time since early Au repayments were also made to other creditors. In view of
gust; it rose further in the second half of the month and the exceptionally strong performance of sterling during re
fluctuated just below parity during most of the remaining cent months, the Bank of England on March 5 cut its
two months of the year. At the same time forward ster discount rate by Vi percentage point to IV2 percent.
ling discounts narrowed sharply, the three-month rate
moving down to under 1 percent per annum from a range
FRENC H FR A N C
of 6 to 9 percent in August-September. The much im
The 11.1 percent devaluation of the French franc on
proved tone of the market reflected a new confidence in
the basic soundness of Britain’s balance-of-payments posi last August 8 was greeted with relief in the foreign ex
tion, a belief that was bolstered by continued monthly change markets, which had been repeatedly rocked by
trade surpluses and reserve gains as well as by the an speculation against the franc since the events of May
nouncement that, in the third quarter, the United Kingdom 1968. During the earlier months of 1969 the franc had
had achieved a second consecutive quarterly surplus in its been under heavy pressure, as lack of confidence in the
basic balance. The renewed confidence led to a strong re franc and excess demand in the economy led to a rapidly
versal of the unfavorable shift in commercial leads and rising trade deficit as well as to a smaller but continuing
lags that had occurred in late summer, and enabled ster outflow of capital. The situation was aggravated, more
ling to remain firm even toward the year-end, when the over, by political uncertainties and labor unrest. A much
very high levels to which Euro-dollar interest rates had calmer atmosphere had set in early in the summer, as the
political crisis was resolved and the labor difliculties were
advanced were exerting a considerable pull.
Euro-dollar rates dropped sharply in the last two days held in abeyance over the vacation period; but the market
of December, and sterling moved above par for the first remained pessimistic about France’s underlying payments
time since April 1968. The spot rate dipped slightly in position, and the franc stayed close to its floor.
The devaluation, which was to be backed up by a fur
early January, when the market became worried by a
wave of very large wage demands, but rose above par ther tightening of economic policy, was therefore wel
again as short positions were being covered and funds be comed as attacking the payments problem at its root.
gan to move into the London money market. During the More generally, the size of the devaluation was judged—
second half of January and throughout February and early by the market as well as by the authorities of other coun
March, a period of seasonal strength, sterling advanced tries— to be within the limits that could be accommodated
further in widespread and sustained demand, reaching a by the existing framework of exchange rates. Moreover,
high of $2.4086 on March 4.
at the end of August the French government announced
With this strong undertone in the market, the Bank of that it had $1.6 billion of international credits available
England was able to purchase dollars throughout the and was applying to the IMF for a facility of $985 mil
fourth quarter of 1969 and in the first two months of this lion. In early September the authorities strengthened their
year. Although the United Kingdom’s reserves were al austerity program with further curbs on consumer credit,
lowed to increase moderately, the bulk of the reserve gain measures to encourage savings, and substantial cuts in
was used to repay debts. Thus, during the fourth quarter public spending. Finance Minister Giscard d’Estaing de
the Bank of England reduced its swap drawings on the clared that the new measures were designed to bring the
Federal Reserve by $200 million each in October and No French trade balance into equilibrium by July 1, 1970.
vember and by an additional $50 million in December,
These measures at first met with a rather lukewarm re
bringing outstanding drawings down to $650 million ception in the exchange market, since even more severe
at the end of 1969. These drawings were fully liqui action had been expected, and the French franc tended
dated in early 1970 through repayments of $300 mil to weaken early in September in both spot and forward
FEDERAL RESERVE BANK OF NEW YORK
markets. It came under increasing pressure later that
month as several major strikes and renewed labor mili
tancy added to the uncertainties generated by the ap
proaching German elections, and by mid-September the
spot rate had declined below par. The franc remained
under pressure through mid-October—even though the
German mark had been allowed to appreciate consider
ably above its old ceiling—because the market remained
disturbed by France’s large current-account deficit and
by the labor situation. As a consequence, the Bank of
France had to provide substantial support to the spot mar
ket throughout this period. On September 25 the Bank of
France reactivated its swap line with the Federal Re
serve, drawing $65 million to help cover recent market
losses. This credit was repaid the following day with part
of the initial $500 million takedown on France’s standby
agreement with the IMF.
A clear improvement got under way after mid-October.
By the end of the month the spot franc was firmer and—
although forward discounts remained relatively wide— the
Bank of France was purchasing dollars almost every day.
While reflows of funds from Germany provided the initial
strength, it is now clear that the firming of the spot franc
reflected the improved underlying situation as well as both
tight domestic credit conditions and a change in market
sentiment. Several measures underscored the French au
thorities’ resolve to slow the growth of domestic demand.
The Bank of France on October 8 raised its discount rates
by 1 percentage point to exceptionally high levels— 8 per
cent for the basic rate and IOV2 percent for the penalty rate
—thus signaling even firmer monetary restraint. Also early
in October, the government approved a very tight budget
for 1970, providing for virtually no increase in expendi
tures in real terms and for a shift from a sizable deficit
in 1969 to a small surplus in 1970. On November 5 the
National Credit Council extended the ceiling on bank
credit to the end of June 1970 and placed ceilings on
medium-term and mortgage credits.
This significant stiffening of French economic policy
was well received by the market and the atmosphere was
also improved by Finance Minister Giscard d’Estaing’s
reaffirmation of his confidence that France’s trade deficit
would be eliminated by mid-1970. The release of trade
figures that showed considerable progress in October,
November, and December reinforced that forecast.
Benefiting from the shift in sentiment, as well as from
the very taut credit conditions in France, the spot franc
remained firm in November and the first half of Decem
ber while forward rates strengthened markedly. The
franc rose sharply toward the close of the year, bolstered
by corporate purchases for year-end needs. In November
59
and December the Bank of France more than recouped
its losses of the previous two months and used the major
portion of these gains to repay short-term international
debts and maturing foreign exchange deposits of French
commercial banks.
The upswing in the spot rate continued into the new
year, as the pull of the Euro-dollar market lessened,
domestic credit conditions were kept tight, and commer
cial demand continued strong. Even though the franc had
exhibited sustained strength for some time, the authorities
maintained their policy of domestic restraint. The franc
reached parity in January, and traded above that level
through the end of the period under review.
The Bank of France continued to purchase dollars in
January and February, and again used the bulk of these
market gains to reduce foreign official indebtedness and
foreign exchange deposits of French commercial banks.
In connection with these repayments, the Bank of France
activated its swap line with the Federal Reserve on Jan
uary 8, drawing $100 million as interim financing of a
debt repayment due to Germany. Additional repayments
of foreign official assistance were made with the proceeds
of the final drawing of $485 million on February 2 under
France’s standby arrangement with the IMF. The French
drawing on the System line was repaid, and the $1 billion
facility reverted to a standby basis. Included also was a
repayment of $70 million to the United States Treasury,
reducing the commitment to $130 million. In early March,
a further $35 million repayment brought the debt down to
$95 million. Thus, partly on the basis of the IMF draw
ings but also because of the improved performance of the
franc in recent months, France has been able to liquidate
a substantial volume of short-term debt in foreign ex
change. Moreover, the Bank of France added to its official
reserves, bringing them to $3,957 million at the end of
February, some $365 million above the low point last July
prior to the devaluation.
IT A L IA N L IR A
After five years of surplus, the Italian balance of pay
ments moved into deficit in 1969. The deficit stemmed
from a sharp rise in capital outflows rather than from a
deterioration of Italy’s competitive position in world mar
kets. Net capital outflows reached $2.8 billion in 1969,
fully two thirds of which moved abroad through the export
of Italian bank notes. Political uncertainties and labor un
rest, especially in the second half of the year, spurred with
drawals of foreign and domestic funds; the upward surge of
interest rates in the Euro-dollar and Euro-bond markets
resulted in heavy outflows of funds from Italy; and, as in
60
MONTHLY REVIEW, MARCH 1970
earlier years, Italian savings were attracted by the broad
range of financial instruments available in foreign money
and capital markets, as well as by the anonymity which
foreign placements provide. In addition, the Italian lira—
like many other currencies— was subjected to heavy selling
during each bout of speculation on the German mark.
To curtail the outflow of funds and protect official reserves, the Italian authorities took a number of steps
during the first half of the year. Italian banks were asked
to repatriate funds by midyear, long-term investment
abroad was restricted, and the authorities moved to re
duce excess domestic liquidity and to align Italian interest
rates more closely with those abroad.
The cumulative impact of these measures brought the
lira rate above par by late April, and the Bank of Italy
purchased some dollars. The recovery ended, however,
with the new eruption of mark revaluation fears. Italian
residents joined the speculative rush for marks and also
sold lire in order to cover the commitments in German
marks, and to some extent in Swiss francs, that they had
undertaken because of relatively low interest rates in
Germany and Switzerland. As the spot rate dropped, the
Bank of Italy provided substantial support through May 9.
Once the speculation in marks subsided the lira mar
ket improved, and during late spring and early summer
there was some reflow from German marks. This reflow,
combined with repatriations of funds by Italian banks act
ing under the official request, more than offset the further
outflow of Italian capital via export of Italian currency.
Effective July 1, the Bank of Italy reinforced its defensive
measures by imposing a penalty rate of 1Vi points above its
discount rate of 3 Vi percent for banks making excessive
use of central bank borrowing.
New uncertainties unsettled the lira market with the
fall of the Italian government in early July. Despite the
subsequent formation of a new government, a strong un
dercurrent of apprehension persisted. When the French
franc was devalued, the spot rate dropped to its floor,
and during the next few days of exchange market uncer
tainties lire were offered in heavy volume, with the Bank
of Italy extending sizable support. On August 14 the
Bank of Italy raised its discount rate to 4 percent, and as
the speculative pressures subsided the lira firmed. It held
well above the floor through the end of August.
At the beginning of September, however, the lira came
under renewed pressure as sporadic strikes presaged dif
ficult wage negotiations and possibly inflationary settle
ments late in the year, when large labor contracts were due
to expire. Moreover, with the German elections approach
ing, Italian residents who had commitments outstanding
in German marks and Swiss francs moved quickly to
cover themselves by buying these currencies. The lira
dropped back to its floor, and the Italian authorities had
to provide substantial support. To cover market losses,
the Bank of Italy activated its $1 billion swap line with
the Federal Reserve on September 23, drawing $300 mil
lion. Under these circumstances, the United States and
Italian authorities agreed that it was appropriate to ter
minate the United States Treasury’s remaining technical
forward lira commitments which had arisen in connection
with dollar-lira swaps extended by the Italian Exchange
Office to its commercial banks. Consequently, these com
mitments were reduced progressively during the autumn,
and by the end of November they had been fully liquidated.
Although the lira remained at the floor in early Octo
ber, pressures eased considerably as soon as the German
mark was permitted to appreciate. By midmonth a much
firmer tone had set in as the unwinding of mark positions
got under way. With repatriations from Germany continu
ing and the exchange markets more relaxed, the lira moved
up close to its parity by the middle of November. During
this period the Bank of Italy was able to absorb dollars
from the market and, on November 14, it repaid its out
standing $300 million swap commitment to the Federal
Reserve.
The lira held just below par in the first half of Decem
ber but, as the impact of November’s strikes began to be
felt in reduced exports and higher imports, it began to
weaken and by early January had reached its floor again.
This deterioration in the current account—which is season
ally weak in the winter months in any case— was accom
panied by further pressures on the capital side and, there
fore, the lira remained under persistent selling pressure
through January and February. The outflow of funds
through bank-note exports continued heavy. The Italian
commercial banks, moreover, were highly liquid and, be
cause interest rates-were higher abroad, were placing their
excess funds in very short-term Euro-dollar investments.
In addition, they were lending to Italian corporations which
wanted to repay foreign loans and to foreigners who began
to borrow in Italy. As a result, the Bank of Italy had to
extend sizable support and to cover market losses reacti
vated its swap line with the Federal Reserve on January 23,
drawing $200 million on that day and making additional
drawings in February.
In mid-February the Bank of Italy took steps designed
to curtail the capital outflow. First, it reminded the Italian
commercial banks that, under the exchange regulations,
lending to nonresidents required official approval. Second,
it modified the regulations pertaining to the handling of
Italian bank notes purchased by foreign banks and pre
sented for conversion. Previously, Italian banks had paid
FEDERAL RESERVE BANK OF NEW YORK
61
through October. The Netherlands Bank at first held the
spot rate just below the ceiling, but later allowed the rate
to move up to that level. By October 24, the inflow into
Dutch reserves during the period of the “floating” mark
had reached $785 million. Part of these gains had been
used to liquidate by October 8 the Netherlands Bank’s
outstanding drawings of $109.7 million under the Federal
Reserve swap line. In order to provide cover for some of
the Netherlands Bank’s additional dollar intake, the Sys
tem in turn subsequently reactivated the swap arrange
ment, drawing the full $300 million equivalent of guilders
available under that line, and sold guilder balances to
absorb a further $5 million. In addition, on October 29,
the United States Treasury covered $200 million through
a special one-week swap with the Netherlands Bank.
On the same weekend that the mark was formally
revalued, the Dutch government made known its decision
not to revalue the guilder. The spot rate then quickly
backed away from the ceiling as speculative positions were
unwound. By November 5 the Netherlands Bank had sold
slightly more than one third of the dollars it had pur
D U T C H G U IL D E R
chased in October. Consequently, the United States
The guilder had been under selling pressure early in Treasury had no difficulty in repaying its swap and the
1969, with the high and rising interest rates available Federal Reserve repaid $70 million equivalent of its in
abroad attracting funds out of the Netherlands at a time debtedness on November 6, thereby reducing its out
when the current account was seasonally weak. In the standing swap commitments in guilders to $230 million.
spring and early summer, monetary policy was tightened
More normal trading activity prevailed throughout
substantially as the authorities moved against the strong November, with the spot rate remaining fairly strong as
inflationary pressures set off by the continuing vigorous the Dutch money market tightened and local interest
economic expansion. To help finance these sizable out rates tended to rise. With trading in guilders generally
flows, the Federal Reserve’s outstanding swap drawing of balanced, the Federal Reserve was able to repay a further
$40 million equivalent on the Netherlands Bank was re $30 million equivalent on its swap debt, as the Nether
paid, and later the Dutch central bank in turn drew on the lands Bank reduced its dollar position by converting into
swap line, for a total of $192 million by the end of July. dollars the guilders which Germany had obtained as part
Further tightening measures in July and August— and the of an IMF drawing at the end of the month.
onset of seasonal balance-of-payments strength— gave rise
In December, Dutch funds moved to the Euro-dollar
to a demand for guilders, and the spot rate soon moved market where interest rates were rising rapidly. As a re
above par. The Netherlands Bank began adding to its sult, the spot guilder began to weaken and the Nether
reserves and, late in August, repaid $82.2 million of its lands Bank provided support to ease the decline of the rate.
swap indebtedness to the System.
The dollar losses by the Netherlands Bank enabled the
In the latter part of September, the widespread ner System to repay a further $70 million equivalent of its
vousness in the exchange markets over the outcome swap debt, reducing its outstanding commitments in guilders
of the German elections and its implications for the to $130 million by the year-end.
Demand for guilders softened further in January and
mark parity became a major influence in the guilder
market. The market viewed the guilder as a leading candi early February, reflecting the seasonal weakness of the
date to follow a possible mark revaluation, and hedging Netherlands’ current account in the early months of the
and speculative inflows into the Netherlands brought heavy year and some easing of domestic credit conditions.
demand for guilders. After the German Federal Bank Despite the decline in the spot rate, however, the Dutch
suspended its intervention at the mark ceiling and the authorities did not have to intervene, and as of March 10
mark rate rose sharply, buying of guilders intensified and the Federal Reserve swap drawings in Dutch guilders re
inflows into the Netherlands became increasingly heavy mained at $130 million equivalent.
the foreign banks on the basis of a telephoned notification
that Italian bank notes were being shipped for conversion.
Under the new regulations the Bank of Italy makes the
payment directly or transfers the lire to the external account
of the foreign bank with an Italian correspondent, and only
after it has physically received and counted the notes at the
head office in Rome. The new procedure, by lengthening
the period during which foreign banks have to bear— or
otherwise find cover for—an exchange risk on the notes
they buy, naturally brought about a drop in the prices
offered for Italian bank notes abroad and reduced the
outflow. Finally, the authorities moved to reduce the pos
sibility of large shifts in commercial leads and lags: pre
payments of imports were limited to no more than 30 days
in advance of delivery and repatriations of export earnings
were required within 120 days of shipment, compared with
one year in each case under the earlier regulations. Further
more, on March 6 the Bank of Italy announced that it was
increasing its discount rate from 4 percent to 5Vi percent.
62
MONTHLY REVIEW, MARCH 1970
SW IS S FRAN C
As the movement of funds from Switzerland to the
Euro-dollar market lessened after midyear, the Swiss franc
firmed, reflecting the continuing large current-account
surplus. Throughout 1969, Swiss exports had pursued
their strong expansion, accelerating the pace of domestic
economic activity and leading to a buildup of inflationary
forces. Imports soared as a consequence, but the currentaccount surplus, also bolstered by rising earnings on for
eign investments, remained very substantial. Although
there was a considerable churning of funds into and out
of Switzerland, the Swiss franc remained relatively free
of the speculative fluctuations besetting the other major
European currencies.
In view of the increasing pressures on the labor supply,
industrial capacity, and prices, the Swiss authorities began
to tighten domestic policy late in August. Moreover, in
mid-September, in response to rising interest rates at home
and abroad, the Swiss National Bank raised its discount
rate by 3A percentage point to 3% percent and its
“Lombard” rate on secured advances by a full percentage
point to 43A percent. The Swiss National Bank also ad
vised the commercial banks that it would undertake no
September quarter-end swaps and that discount facilities
would be limited. Accordingly, it requested the banks to
repatriate funds from abroad to meet their liquidity needs.
With domestic credit conditions thus beginning to
tighten, the Swiss banks met their quarterly requirements
at the end of September in large part through the repatri
ation of funds. This demand helped push the franc rate to
its ceiling and the Swiss National Bank took in a substantial
amount of dollars. The Federal Reserve consequently re
activated its $600 million swap facility with the Swiss
National Bank on October 10, drawing $200 million
equivalent in order to absorb some of that bank’s dollar
gains. After the quarter end, however, the pull of high
Euro-dollar interest rates began to draw funds out of
Switzerland and the franc soon began to weaken, reaching
an eighteen-month low on November 6. During this period
the Federal Reserve acquired small amounts of Swiss
francs in the New York market and from a correspondent,
and on November 10 repaid $25 million equivalent of
its swap debt to the Swiss National Bank.
Although there had been considerable press and market
discussion of the possibility of a Swiss franc revaluation
linked to a large revaluation of the German mark, there
was no speculative rush into francs when the mark parity
was changed. In mid-November a flurry did occur,
however, and the spot rate advanced sharply, but the
rumors were quickly dispelled by a reaffirmation of the
Swiss government’s decision not to revalue the franc.
The franc began to firm again in the second half of
November, largely reflecting the usual year-end demand.
As in previous years, to help the commercial banks cover
their year-end liquidity requirements the Swiss National
Bank offered market swaps of Swiss francs against dollars.
These swaps, the first of which were contracted in early
December, totaled $793 million by the end of the month
— a record amount— and helped keep the spot rate for the
franc below its ceiling. As in the past, the Swiss National
Bank returned the dollars thus acquired to the Euro-dollar
market in order to neutralize the effects of the year-end
withdrawals on that market.
On December 30 the Federal Reserve reduced its swap
indebtedness to the Swiss National Bank by $30 million
equivalent to $145 million, mainly using francs purchased
in the market in the latter part of November and early in
December. The Swiss franc began to ease toward the end
of December, as year-end positioning proceeded smoothly
with the National Bank’s help, and declined further in
early January when, with year-end demand out of the way,
Swiss banks were temporarily in a very liquid position in
francs. The decline, however, was smaller and shorter
than in previous years, and the spot franc soon firmed, as
repayments of swaps with the National Bank tightened
the commercial banks’ Swiss franc liquidity positions.
In the meantime, the Swiss authorities were moving
further to combat the inflationary pressures generated by
the export-led boom. Late in December the government
announced it had decided to complete by April 1 the tariff
cuts it had agreed to undertake in 1971 and 1972 under
the Kennedy-round negotiations. In January the Na
tional Bank and the Swiss commercial banks reached an
understanding whereby the banks would more closely
limit their credit expansion during the first half of 1970.
Early in February the Federal Reserve repaid $20 mil
lion of its swap indebtedness to the Swiss National Bank,
purchasing the francs from that bank. Later in the month,
the Federal Reserve and the Swiss National Bank decided
that, with relative calm in the markets, the time had come
to clear up the System’s remaining swap debt, which
had been outstanding since last October. Consequently, the
National Bank sold $120.7 million equivalent of francs to
the System. The Federal Reserve used these francs and
some from balances to repay the swap drawing, thereby
restoring the swap arrangement to a fully available stand
by basis.
B E L G IA N F R A N C
The Belgian franc strengthened during July, follow
ing official measures to tighten domestic credit con
FEDERAL RESERVE BANK OF NEW YORK
ditions and to insulate the Belgian money market from
credit pressures abroad. In early August, however, this
firming was brought to an abrupt halt by the devalua
tion of the French franc, which was followed by wide
spread market rumors that the Belgian franc also would
be devalued. The spot rate quickly dropped to its floor
under heavy selling pressure, and in the first week follow
ing the French move the National Bank of Belgium suf
fered substantial reserve losses. To cover the drain, the
National Bank reactivated its swap line with the Federal
Reserve, drawing a total of $244 million out of the $300
million then available. A calmer atmosphere soon emerged,
however, as the market came to appreciate the strength of
Belgium’s underlying balance-of-payments position. The
franc strengthened and the authorities began to recoup
some of their reserve loss. In late August the National
Bank repaid $20 million of the outstanding drawings, re
ducing the total to $224 million. Meanwhile, negotiations
had been completed for an increase in the reciprocal credit
facility with the Federal Reserve by $200 million to $500
million and this was put into effect on September 2. The
National Bank of Belgium simultaneously obtained a new
$100 million equivalent credit facility from the German
Federal Bank.
The Belgian franc began rising sharply in September,
despite growing speculation in German marks. The im
proved tone of the franc was especially pronounced after
midmonth when the Belgian authorities announced a
number of anti-inflationary measures: the introduction of
the value-added tax, scheduled for January 1, 1970, was
postponed for another year in order to avoid further in
creases in domestic prices, while the National Bank raised
its discount rate another Vi percentage point to IVi per
cent, effective September 18, and tightened quantitative
credit restrictions. Supported by these domestic measures
and the increased availability of foreign official credit, the
franc firmed toward the end of September. As the rate
strengthened, the National Bank purchased dollars in the
market, enabling it to repay $20 million of outstanding
drawings on its swap line with the Federal Reserve by the
end of the month.
As soon as the German mark was allowed to rise above
its ceiling, the exchange markets again demonstrated their
capacity for abrupt changes; the Belgian franc suddenly
was seen as a candidate for revaluation along with the
mark only two months after it had been subjected to heavy
speculative selling. The spot rate moved to parity early in
October and rose to its ceiling later that month, while the
National Bank made increasingly large market gains. The
speculation reached its climax on Monday, October 27, the
first business day after the German revaluation. The next
63
day the Belgian government stated firmly that the franc
would not be revalued, and the speculation died down. By
that time the National Bank had acquired an amount of
dollars more than sufficient to repay in full during the
course of October its remaining $204 million swap in
debtedness to the Federal Reserve.
Even after the speculative outburst had ended, however,
the demand for francs remained very strong. Commercial
leads and lags, which had moved sharply against Belgium
in August and September, were being reversed in subse
quent months. Credit conditions, moreover, remained
very tight, causing short-term funds to flow in. With the
spot rate not far from its ceiling, the National Bank took
in dollars from time to time throughout the rest of 1969
and into early 1970. In order to provide cover for some
of these dollars, the Federal Reserve reactivated its swap
line with the National Bank, drawing a total of $55 mil
lion equivalent in November and December. Additional
drawings of $30 million in February raised the System’s
commitment to $85 million.
C A N A D IA N D O L L A R
During the first half of 1969 the Canadian dollar
felt the effects of rapidly rising interest rates abroad.
While monetary conditions were also becoming pro
gressively tighter in Canada—partly in response to the
authorities’ anti-inflationary policies—the attraction of
substantially higher returns on United States dollar in
struments not subject to Regulation Q ceilings led to a
large short-term capital outflow, primarily through the
channel of “swapped” deposits. (In these transactions,
Canadian dollar funds are converted into United States
dollars on a covered basis and the United States dollars
placed on deposit with Canadian banks; the latter in
turn invest such funds in United States dollar instru
ments.) The persistent outflow of short-term funds at a
time of seasonal weakness in Canada’s current-account
balance led to a steady softening of the spot rate despite
continued heavy long-term capital inflows.
To curtail the outflow of short-term funds, the Bank
of Canada raised its discount rate in two V2 percentage
point steps in mid-June and mid-July, to 8 percent, and
it asked the Canadian banks to regard their July 15 level
of swapped deposits as a temporary ceiling. As the Ca
nadian banks complied with this request, and with the
domestic money market tightening in response to heavy
credit demands and the discount rate increases, the outflow
was substantially reduced and the spot rate immediately
moved above par. Seasonal strength in the current account
and an increased volume of long-term capital inflows fur
64
MONTHLY REVIEW, MARCH 1970
ther added to the demand for Canadian dollars, and the
spot rate firmed through the end of August.
The rolling-over of a large amount of maturing swapped
deposits temporarily depressed the spot rate in Septem
ber and early October. However, the rate was soon
pushed up sharply again by strong commercial demand.
Furthermore, because the Canadian chartered banks had
previously built up positions in United States dollars,
they were able to accommodate the usual year-end de
mand for United States dollars without having much
recourse to the spot market. This, along with tight mone
tary conditions in Canada, helped push the Canadian
dollar to its effective ceiling ($0.9324) by the year-end,
and it traded at or just below that rate throughout Janu
ary. Toward the end of that month the Bank of Canada
also moved to halt the practice of splitting swapped de
posit transactions— a practice whereby swaps were done
with one bank and the United States dollars placed on
deposit with another. This move tended further to
strengthen the spot rate, and the Bank of Canada made
some moderate reserve gains. The demand for Canadian
dollar balances began to ease early in February, however,
and the spot rate moved slightly away from its effective
ceiling.
Continuing tight money in Canada, coupled with large
month-end corporate demands, resulted in a strengthening
of the Canadian dollar late in February and, in the closing
days of the month, the Bank of Canada made fairly siz
able purchases of dollars when the rate reached the inter
vention level.
Chart HI
SELECTED INTEREST RATES IN THE UNITSD STATES
THE UNITED K IN G D O M , WEST G ERM ANY
A N D THE EURO-DOLLAR MARKET
TH R EE -M O N T H M A T U R IT IE S
Percent________________W e ek ly a v e ra g e s of doiiy rotes_________
___Percent
interb an k lo a n s
2I....L , 1 J__ 1..1 1 1 1 !
11
1 1 1 b
Chart IV
UNITED STATES BANKS’ LIABILITIES TO FOREIGN BRANCHES
Billions of d ollars
W e d n e sd a y data
1969
Billions of d ollars
1970
E U R O -D O L L A R M A R K E T
During late summer the Euro-dollar borrowings of United
States banks through their foreign branches had tended to
stabilize at around $14Vi billion—a level $7 billion higher
than the 1968 peak— and interest rates had started to recede
from their mid-June record highs (see Charts III and IV).
This tendency was reinforced by several measures taken by
the Board of Governors of the Federal Reserve System in
order to prevent a resurgence of the flow of Euro-dollars to
United States banks. First, the Board amended Regulation
D (which governs reserves of member banks) in order to
eliminate a technical loophole which had led banks to in
crease their use of overnight borrowing of Euro-dollars.
Subsequently, it amended Regulation M (which governs the
foreign activities of member banks) by placing a reserve re
quirement of 10 percent on member bank liabilities to
foreign branches in excess of the levels outstanding in a
base period and on United States assets acquired by for
eign branches from their home offices. Also, Regulation D
was further amended to place reserve requirements against
borrowings from nonaffiliated foreign banks
These measures reduced the incentive for United States
banks to seek Euro-dollar funds and encouraged them to
look for other sources of funds. One alternative that many
banks found attractive was the commercial paper market
and, as Euro-dollar liabilities stabilized, commercial paper
borrowings rose sharply during the summer months. In
September, United States banks’ liabilities to their own
foreign branches declined slightly, thus helping to bring
about some easing of Euro-dollar rates for the shorter
maturities: the three-month rate declined to less than
11 percent per annum by September 17. After a sharp but
brief recovery around the time of the German elections, the
rates resumed their decline and, under the pressure of
the heavy reflux of funds from Germany in October, they
FEDERAL RESERVE BANK OF NEW YORK
dropped below 9 percent.
As the use of the commercial paper market by banks
through the intermediary of bank-affiliated holding com
panies or subsidiaries grew, the Board of Governors became
concerned that such borrowing might reduce the impact of
monetary restraint. Consequently, the Board announced on
October 29 that it was considering an amendment to Regula
tion Q which would subject all such bank-related commer
cial paper to the interest rate ceilings that apply to large
CD’s. Moreover, in a separate but related action, the Board
ruled that commercial paper issued by subsidiaries of mem
ber banks already is covered by existing provisions of Regu
lations Q and D.
The prospect of closer regulation of member banks’ use
of the commercial paper market was swiftly reflected in
the Euro-dollar market and, combined with the expecta
tion of continuing tight credit conditions in the United
States, contributed to a surge in interest rates from late
October to mid-November. In December the short-term
rates moved even higher, as banks attempted to main
tain their Euro-dollar borrowings in the face of year-end
repatriations of funds by United States corporations and for
eign banks. By December 18, call money was at 11 per
cent, the rate for one-month deposits had reached 12%
percent, and that for three-month funds 11
percent.
After allowance for the 10 percent marginal reserve re
quirement, the effective cost of one-month Euro-dollars
for United States banks which were above the ceiling of
their base period reached at times 14 percent, exceeding
the record levels attained in June. However, during the
last two weeks of December, as repatriations of funds
by United States corporations preparing to meet their
balance-of-payments guidelines reached yet a new yearend high, United States banks’ takings of Euro-dollar funds
fell by some $1.6 billion, bringing the level of their liabili
ties to their foreign branches to $13.0 billion.
As soon as the pressures of year-end demand disap
peared, Euro-dollar rates dropped. They continued to recede
in January, but the movement stopped toward the month
end. The increase of Regulation Q ceilings on January 21
had no immediate effect on rates, since permissible CD rates
were still well below Euro-dollar quotations, but it probably
contributed to market expectations that rates were likely
to decline somewhat in coming months.
Euro-dollar rates fluctuated within very narrow mar
gins in February. Tightening monetary conditions in a
number of continental European countries, as well as the
flows into the United Kingdom, tended to draw short
term funds from the Euro-dollar market; on the other
hand, United States banks’ takings from their own foreign
branches, which had risen by $1.3 billion after the yearend, began to decline in mid-January, reaching $12.8
billion by March 4, while outflows from Italy increased
the supply of Euro-dollars. By early March, Euro-dollar
rates for most maturities were between 9 and 93A percent
per annum.
Per Jacobsson Foundation Lecture
The Per Jacobsson Foundation in Washington, D.C., has made available to the Federal Re
serve Bank of New York a limited number of copies of the 1969 lecture on international mone
tary affairs. In sponsoring and publishing annual lectures on this topic by recognized authorities,
the Foundation continues to honor the late Managing Director of the International Monetary Fund.
The sixth lecture in this series was held on September 28, 1969 in Washington, D.C. Professor
Alexandre Lamfalussy of the University of Louvain, Belgium (also Managing Director of the Bank
of Brussels) spoke on “The Role of Monetary Gold over the Next Ten Years”. Discussion on the
subject was by Mr. Wilfrid Baumgartner, President of Rhone Poulenc, S.A., Paris, France (for
merly Governor of the Bank of France and former Minister of Finance), Governor Guido Carli
of the Bank of Italy, and Governor L. K. Jha of the Reserve Bank of India.
This Bank will make copies of the lecture available without charge to readers of this Review
who have an interest in international monetary affairs.
Requests should be addressed to the Public Information Department, Federal Reserve Bank
of New York, 33 Liberty Street, New York, N.Y. 10045. French and Spanish versions are also
available.
65
MONTHLY REVIEW, MARCH 1970
66
The Business Situation
The pace of economic activity continued to moderate Board’s index of industrial production fell 1.2 percentage
as the new year began. In January, industrial production points to 169.9 percent of the 1957-59 average (see Chart
declined for the sixth month in a row, and the volume of I). This latest drop brought the index to a level 2.7 per
new orders for durable goods fell for the fourth consecu cent below the peak reached last July. The strike at
tive month. Activity in the construction sector—where General Electric, which began late in October and conoutput fell steadily throughout 1969— continued depressed,
as housing starts and permits fell further. Conditions in the
labor markets eased, with the unemployment rate rising to
4.2 percent in February. Reflecting the recent lack of
Chort 1
growth in nonagricultural employment, personal incomes
INDUSTRIAL PRODUCTION
rose in January by the smallest amount in almost two
Se ason ally adjusted; 1 9 5 7 -5 9 = 1 0 0
years. Although signs of a slackening from the earlier
hectic pace of business activity are widespread, the rate
of price increases remains clearly excessive. At the con
sumer level, prices rose sharply in both December and
January on a seasonally adjusted basis. At the wholesale
level, the uptrend through January in prices of industrial
commodities has been steep. The February rise in indus
trial wholesale prices was relatively small, but one month’s
reading of this series does not provide a basis for drawing
significant conclusions.
The continued decline of several monthly indicators in
January, following the small drop in real gross national
product (GNP) in the fourth quarter of 1969, has raised
some discussion of the possibility that we may be in a pe
riod of “recession”. The decline currently indicated for the
fourth quarter of last year, however, was very small and
would probably not have occurred in the absence of strikes.
Moreover, given the small size of the reported decrease, its
reality will remain a question until the Commerce Depart
ment’s annual revision of the GNP data later on this year.
The danger is that the current period of slowdown, what
ever language is ultimately used to describe it, may prove
too brief to make a serious dent in the inflation problem.
It would be most unfortunate if a renewal of excessive
demand were to add further to inflationary pressures.
P R O D U C T IO N
The volume of industrial output declined again in
January, with the continuing slump in automobile produc
tion an important factor in the drop. The Federal Reserve
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 Governors of the Federal Reserve System.
Indexes are not plotted in rank order. Data for latest four months ere
subject to revision.
Source: Board of Governors of the Federal Reserve System.
FEDERAL RESERVE BANK OF NEW YORK
C hart II
DOMESTIC A U T O PRODUCTION A N D SALES
S e a s o n a lly adju sted a n n u a l rates
M illio n s o f ears
M illio n s o f cars
67
to revised data. Indeed, the decline of the motor vehicles
and parts component by itself has accounted for about a
quarter of the total July-January decrease in the industrial
production index, and has also created layoffs in that and
other related industries.
While the index for automotive products was cut back
substantially in January, output of most other consumer
goods was about unchanged. There has been some weak
ening in production of consumer goods exclusive of
automotive products since the July peak, but the decrease
has not been large. Partly reflecting reduced demands
from auto makers, iron and steel production fell 4.6 per
cent in January. Steel ingot production, which accounts
for about half of the overall iron and steel component of
the industrial production index, edged down further in
February.
O R D E R S , S H I P M E N T S , A N D IN V E N T O R I E S
Source: W o rd ’s Automotive Reports, seasonally adjusted at the Federal Reserve
Bank of New York.
tinued through early February, contributed to the slump.
Excluding the effects of this strike, the overall decline has
been about 2 percent. Last month’s settlement of the GE
strike will tend to shore up the February production
index, particularly equipment output. The equipment
index dropped rather sharply after the strike began, and
December and January saw further small declines.
A good part of the recent slowdown in the industrial
sector has resulted from developments in automobile sales
and production. The final quarter of 1969 was marked by
a substantial weakening in sales of domestically produced
automobiles (see Chart II), although sales for the calendar
year as a whole totaled 8.5 million units. The beginning
of the new year saw a somewhat mixed pattern: in January,
sales fell by over 10 percent to a seasonally adjusted an
nual rate of 6% million units; in February sales jumped to
an 8 million unit rate, although a considerable part of this
rise may reflect an unusually large number of sales contests
as well as General Motors’ introduction of new models.
The drop in sales has led to a substantial increase in
dealers’ stocks. As in the past, auto producers reacted
quickly to the change in demand and reduced production
schedules. After averaging yearly production rates of 8%
million units (seasonally adjusted) in the August-October
period, production fell to an average of IV2 million units
in the final two months of last year and then dropped to a
634 million unit rate in January and February, according
The recent behavior of new orders for durable goods
increases the prospects for a continuation of the current
weakness in industrial production. The volume of durables
orders fell by 5.2 percent in January, the fourth consecu
tive month of decline. This latest drop pushed the volume
down to $28.7 billion, 11 percent below the record
reached last September. The January fall was broadly
based, as orders for automobiles, aircraft, fabricated
metals, construction materials, and machinery all dropped.
The January data on manufacturers’ inventories and
shipments suggest further involuntary inventory accumula
tion among durables manufacturers. For durables indus
tries, the inventory-sales ratio has increased steadily since
last October, while the nondurables ratio has fallen to
record lows. By December, it had become apparent that
some imbalance between inventories and sales was de
veloping in the trade sector as well as in manufacturing
(see Chart III). In that month, total business sales
dropped by $1 billion and total business stocks increased
by that amount.1 Thus the inventory-sales ratio for all
business rose sharply, reaching the highest level since early
irThe Department of Commerce has revised downward its gross
national product estimate of business inventory accumulation
to an annual rate of $7.7 billion from the preliminary figure
of $7.8 billion discussed in the February issue of this Review.
Consumption spending was revised upward, while the estimates for
business fixed investment and government spending were reduced.
The estimate of total fourth-quarter GNP was revised downward
by $0.9 billion to a seasonally adjusted annual rate of $952.2
billion, and real GNP was revised down by $0.7 billion to $729.8
billion, $0.8 billion below the third-quarter rate.
68
MONTHLY REVIEW, MARCH 1970
Chart HI
INVENTORY-SALES RATIOS
Se a so n a lly adjusted
M o n th s of scies
19 53 5 4 5 5
M o n th s of sales
56
57 5 8
59
60
61
62 63
64
65 66
67
68 69
1969 the number of new private housing starts declined,
although for the year as a whole starts totaled 1,463,000
units— slightly above the levels averaged in the last eight
years. In January the downward movement continued, as
the volume of starts fell by almost 100,000 to a seasonally
adjusted annual rate of 1,166,000 units, the lowest since
early 1967. Recent behavior of the series on building per
mits also points to continued weakness in residential con
struction. The volume of permits issued by local authorities
headed down for most of last year, and in January of this
year permits dropped by a precipitous 25 percent to a level
20 percent below the 1957-59 average and about 40 per
cent below the 1969 rate.
Data on housing starts and permits relate to housing
units built on site— that is, these data measure output in
the residential construction sector and do not include
mobile home production. If mobile home output is added
to the public and private starts figure, the volume of new
housing units produced in 1969 actually surpassed 1968
output. While mobile homes are not necessarily close sub
stitutes for conventional housing, an increasing number
of persons apparently regard them as an attractive alterna
tive, particularly in light of current housing market condi
tions. Last year, mobile home sales reached 400,000 units,
almost half of all new single-family housing units pur
chased. Moreover, these sales accounted for 90 percent
of those new units which sold for under $15,000.
Note: Shaded areas represent recession periods, according to the National
Bureau of Economic Research chronology.
Source: United States Department of Commerce.
P L A N T A N D E Q U IP M E N T S P E N D IN G
In sharp contrast to the slowing in most sectors of the
economy, the demand for capital investment was firm
through the end of 1969, and it is possible that this strength
1967. In contrast to the experience in 1967, when much will continue this year. The results of private surveys, taken
of the rise in the inventory-sales ratios resulted from an in February, of business spending plans for plant and equip
actual step-up in the pace of inventory accumulation, the ment were in line with the trend seen in both Government
recent rise in the ratios stems chiefly from a decline in and private surveys taken in the latter half of last year.
sales. The major inventory-sales problem appeared to be As 1969 drew to a close, successive surveys tended to re
in the retail sector, where the ratio was the highest since port increasingly higher advances in capital investment
1954. While an increase in retail auto inventories was a plans for 1970. The size of the planned rise reported in
factor in this rise, a steep run-up in the inventory-sales ratio these surveys varied between 5 percent and 9 Vi percent,
also occurred among other durables stores and at nondur with the latter increase reported by the special survey taken
ables outlets. These increases occurred at a time when high by the Department of Commerce and the Securities and
interest rates presumably would have encouraged low Exchange Commission in December. These late-1969 sur
inventory levels.
veys were taken before the slackening in economic activity
became very marked, and it has been widely thought that
subsequent surveys would indicate a downward revision in
R E S I D E N T I A L C O N S T R U C T IO N
business spending plans. The private February surveys
The downtrend in residential construction activity has did point to a cutback by automotive companies, but total
been much steeper than the decline in the industrial sector, outlays by manufacturers are scheduled to rise by more
and the near-term outlook remains weak. Throughout than had been anticipated last fall. The fourth-quarter
FEDERAL RESERVE RANK OF NEW YORK
1969 decline in manufacturers’ net new capital appropria
tions suggests that the increase in manufacturing outlays
may be confined to the first half of 1970. The private
surveys taken in February forecast a 10 to 14 percent rise
in total plant and equipment expenditures in 1970. While
the results of these surveys are consistent with the trend
shown in those taken last year, their findings must be
viewed with caution. Tight credit conditions, the profit
squeeze, the low level of corporate liquidity, and the
weaker sales outlook are all major factors dampening the
prospects for capital spending this year.
69
months of last year. The employment survey conducted
among households also points to an easing of labor market
pressures. The unemployment rate, which had averaged
3.4 percent in the first eight months of last year, rose in
the September-December period to an average of 3.7 per
cent. The rate jumped to 3.9 percent in January, as a large
increase in the labor force outweighed a gain in employ
ment. In February, nonagricultural employment fell back
to the December level and the number of unemployed
rose, pushing the unemployment rate to 4.2 percent.
R E C E N T P R IC E D E V E L O P M E N T S
CO NSUM ER D EM A N D , EM PLO YM ENT, A N D
P E R S O N A L IN C O M E
Despite the clearly evident slowing of the economy in
the last few months, the excessive rate of price increases
Much of the current slowing in economic activity has thus far continued unabated. In January the season
has stemmed from the continued sluggishness of retail ally adjusted consumer price index rose at a 7.2 percent
sales. For most of 1969 the sales pace was lackluster: annual rate for the third month in a row.2 Leading the
total sales for the year were up only 3 Vi percent from January advance was a jump in the transportation index,
1968, compared with an 8V4 percent advance the year which reflected increases in automobile insurance and re
before. The increase in sales was substantially less than pairs as well as the 50 percent hike in the New York City
the 5Vi percent rate averaged by the consumer price transit fare. Higher food prices—particularly for meat
index. In the last several months, retail sales have declined and eggs—were a major factor in the latest rise. On a
steadily and the weakness has been broad based, though December-to-December basis, food prices last year climbed
the slump in auto sales has been a major factor. In by 7.2 percent, while the total index rose by 6.1 percent.
January, according to the preliminary estimate, sales fell
At wholesale, prices of both industrial goods and farm
a further 1 percent to $29.1 billion— a level $0.5 billion and food products rose sharply in January, pushing the
below the October peak.
total wholesale price index up by 0.8 percent. Increases
Part of the recent weakness in retail sales can be attrib in the cost of both ferrous and nonferrous metals were
uted to the slowdown in personal income growth. In Jan major factors in the advance in industrial prices. The
uary, the increase in incomes was the smallest in almost preliminary estimate for February indicates only a small
two years. Wage and salary disbursements rose by only rise in prices for both industrial and agricultural commodi
$1.2 billion to a seasonally adjusted annual rate of $529.0 ties, following January’s surge.
billion. Since October the monthly gains in wage and salary
disbursements have averaged $2.3 billion, compared with
an average of $3.6 billion in the first ten months of last year.
The lower rate of advance in personal income has largely
reflected the recent easing in labor market conditions.
2The Bureau of Labor Statistics is now incorporating a seasonal
Payroll employment surveys indicate that between October adjustment factor into its series on consumer prices. While some
of the components of the index—such as food—have substantial
and February nonfarm employment rose by only 100,000, seasonal
variations, for most months these changes are about off
compared with an advance of 1% million in the first ten setting. Thus, the seasonal pattern for the total index is small.
Subscriptions to the m o n t h l y r e v i e w are available to the public without charge. Additional
copies of any issue may be obtained from the Public Information Department, Federal Reserve Bank
of New York, 33 Liberty Street, New York, N.Y. 10045.
70
MONTHLY REVIEW, MARCH 1970
The Money and Bond Markets in February
Strong price advances in the money and bond markets
during February carried most short- and long-term inter
est rates to the lowest levels since last fall. Investor
belief that a turning point in interest rates might be at hand
was fed by increasing conviction that economic activity
was slowing and by anticipation, fostered by statements
from prominent officials, that a relaxation of monetary
policy was a near-term possibility.
In the market for United States Government securities,
very sharp yield declines were registered in all maturity
sectors. Treasury bill rates dropped precipitously as strong
investment demand pressed on low dealer inventories.
Rates leveled off toward the end of the month, when the
supply of bills was augmented by the auction of $1,750
million of April tax anticipation bills (TAB’s) and in
creases of $100 million and $200 million, respectively, in
regular auctions of six- and twelve-month bills. Early in
the month the three issues of new notes offered in ex
change for issues maturing in mid-February and midMarch attracted very strong demand, and attrition was
well below that expected earlier. The new notes maturing
in 1971, 1973, and 1977 were quoted at rising price
premiums over the month, as dealers and investors be
came increasingly confident that rates would continue to
fall. Over the month as a whole, bid rates on almost all
maturities of Treasury bills dropped around a full per
centage point, three- to seven-year notes yielded from 65
to almost 100 basis points lower, and long-term bond
yields declined 40 to 60 basis points.
New issues of corporate debt were aided considerably
by the shift in investor sentiment, and offering yields fell
steadily over most of the month. A Bell System financing
in mid-February carried an 8.50 percent yield to investors,
30 basis points below that of a similar offering a few
weeks earlier. Individual investors were major buyers of
the new issues, but during the month large institutional
investors also began to commit funds. In the buoyant
atmosphere, additions to the forward calendar of flotations
checked, but did not reverse, the price trend. The recovery
in the tax-exempt sector was less vigorous initially but
tended to pick up steam as the month progressed. Never
theless, the large backlog of financings and the continued
reserve stringency impinging on commercial banks exerted
some cautionary influence.
BANK R ESER V E S A N D THE M ONEY M ARKET
Borrowings from Federal Reserve Banks averaged above
$1.1 billion in February, and net borrowed reserves were
slightly below the $1 billion mark (see Table I). The ef
fective rates on Federal funds were around 9 Va percent
most of the month, but drifted as low as 7Vi to 8 Vi per
cent in the last week (see Chart I). Other money market
rates edged down during February. Three-month Euro
dollars were about Va point lower over the month, but the
9 to 9 Vi percent range of quotations was as much as 2
percentage points below rates in December. One factor in
the drop of Euro-dollar interest rates since the year-end
has been the slackening in demand for these funds by United
States banks, which in January raised about $1.2 billion in
the commercial paper market. Rates on directly placed
ninety-day finance company paper eased in two steps by a
total of % percentage point and closed the month at 1 3/ a
percent.
System open market operations provided $288 million
of reserves over the month. Operating transactions, which
did not fluctuate so widely from week to week as they
did the month before, absorbed $1,025 million, while re
quired reserves dropped $995 million. In the aggregate,
major money market banks experienced fairly typical
intramonthly shifts in their basic reserve position (see
Chart II). During the week of February 4, however, New
York City banks enjoyed an unusual deposit inflow and
were net sellers of $460 million in Federal funds (see
Table II)— the largest weekly volume of net sales by these
banks since the series began in 1959. Indeed, some banks
tended to overestimate the size of the temporary reserve
windfall, and late on the final day of the settlement period
a scramble for reserves briefly pushed the Federal funds
rate to 12 percent, a new record high. Succeeding weeks
during February witnessed more normal deposit flows
between money center banks and others, and demands
71
FEDERAL RESERVE BANK OF NEW YORK
C h a rt I
SELECTED INTEREST RATES
D e ce m b e r 1 9 6 9 -F e b r u a r y 1 9 7 0
M O N E Y M ARKET RATES
B O N D M A R K E T Y IE L D S
Decem ber
Jan ua ry
Fe b rua ry
Note: Data are shown for business d ays only.
M O N E Y MARKET RATES Q UOTED: Bid rates for three-month Euro-dollars in London; offering
rates for directly placed finance company ppper; the effective rate on Federal funds (the
rate most representative of the transactions executed); closing bid rates (quoted in terms
of rate of discount) on newest outstanding three-month and one-vear Treasury bills.
B O N D MARKET YIELDS QUOTED: Yields on new A a a - and Aa-rated public utility bonds
(arrows point from underwriting syndicate reoffering yield on a given issue to market
yield on the same issue immediately after it has been released from syndicate restrictions);
for reserves were fairly steady throughout each of the
periods, with the result that rates stayed around 9 percent
or above until the last week of the month. In the state
ment week ended on February 25, more comfortable con
ditions emerged before the long weekend (many banks
were closed February 23 in observance of the Washington’s
Birthday holiday), and on the final two days of the period
the availability of a large volume of excess reserves pushed
the effective rate on Federal funds down to IV2 to 8 per
cent. A comfortable tone persisted as the month closed.
The money supply declined at a seasonally adjusted
annual rate of 10 percent in February, according to pre
liminary data, after a 9 Vi percent advance in January.
This month-to-month reversal was unusually large and
affected the behavior of growth rates over a longer time
daily averages of yields on seasoned Aaa-rated corporate bonds; daily averages of
yields on lon g-term Government securities (bonds due or callable in ten years or more)
and on Government securities due in three to five years, computed on the basis of closing
bid prices; Thursday averages of yields on twenty seasoned twenty-year tox-exempt bonds
(carrying M o o d y 's ratings of A a a , Aa, A, and Baa).
Sources: Federal Reserve Bank of New York, Board of Governors of the Federal Reserve System,
M o od y’s Investors Service, and The W e ekly Bond Buyer.
horizon. Increases for three-month periods ranged from
about zero to IVz percent in each of the last six months of
1969, then jumped to over 4 percent in January 1970
before falling back almost to zero in February (see Chart
III). The adjusted bank credit proxy (member bank de
posits subject to reserve requirements plus certain non
deposit liabilities)1 also dropped in February, bringing the
rate of decline for the latest three months to nearly 3 per
cent as compared with a 3 percent gain in the period ended
in January. While total time deposits edged down about 1
1 The composition of these nondeposit liabilities is detailed in a
footnote to Chart III.
72
MONTHLY REVIEW, MARCH 1970
Chart li
BASIC RESERVE POSITION OF
M A JO R M O N E Y MARKET BANKS
Billions of d ollars
B illion s of d ollars
DEFICIT
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Fe b ruary
Note: Calculation of the basic reserve position is illustrated in Table II.
percent in February and were 3 percent lower over the
latest three months, most of the recent decline took place
in January, when banks lost a sizable volume of individuals’
time and savings deposits after the December interestcrediting period. By contrast, the sharp drop in time de
posits during 1969 was attributable mainly to runoffs of
large certificates of deposit.
T H E G O V E R N M E N T S E C U R IT IE S M A R K E T
Prices of United States Government securities rallied
strongly throughout February amid increasingly pervasive
sentiment that the long-awaited turn in interest rates had
finally materialized. Investor conviction that economic ac
tivity was slowing and public statements by Administration
officials and others about the appropriate stance of mone
tary policy in the coming months contributed to expectations
of lower interest rates. In this atmosphere, both short- and
long-term Treasury issues enjoyed price advances which
in many cases pushed yields to their lowest levels since last
October.
The Treasury February refunding, which had dominated
market attention in the latter part of January, coincided
with the dramatic shift in market sentiment, and the rate
of attrition on the maturing issues turned out to be well
below that expected in late January.2 To a considerable
extent, strong dealer interest in the new issues accounted
for the very favorable exchange results, and dealer efforts
to maintain their positions subsequently contributed to
the upward pressure on prices. Over the month, yields
on the new notes fell between 79 and 97 basis points to
close at levels between 7.15 percent and 7.30 percent.
In the market for Treasury bills, strong investor demand
—in part from foreign sources and from reinvestment of
proceeds from the maturing February 15 notes— encoun
tered relatively thin dealer positions. As a result, rates
dropped very sharply throughout most of the month.
Bidding at the regular weekly auctions was generally ag
gressive and, while the average proportion of noncom
petitive tenders to awards dropped below 25 percent from
around 33 percent in January, participation by small in
vestors nonetheless influenced the slide of yields.
On February 13 the Treasury announced plans to raise
cash by the sale on February 25 of $1,750 million of
April TAB’s and by increases of $100 million in the reg
ular weekly six-month bill auction, beginning with the
February 20 auction, and $200 million in the regular
monthly one-year bill auction, beginning February 24.
While the new cash operations of the Treasury did not
produce a rollback in the price gains in the bill market,
the concentration of three bill auctions during the last few
business days of February did foster a note of caution in
bidding as dealers probed investor demand at the lower
rate levels. After week-to-week drops of from 30 to 60
basis points in new-issue rates, yields on the new threeand six-month bills tended to level off in the last weekly
auction of the month— held February 20 because of the
Washington’s Birthday holiday on February 23 (see
Table III). The auction of nine- and twelve-month bills
on February 24 received good interest, and average rates
were set at 6.994 percent and 6.933 percent, respectively,
73 and 60 basis points below those a month earlier. The
next day, bidding was somewhat cautious in the April
TAB auction— dominated by banks which could credit
2 Of the approximately $5.6 billion of maturing issues in the
hands of the public, about $4.9 billion was exchanged into the
three new issues: the 8!4 percent notes due in August 1971, the
8V6 percent notes due in August 1973, and the 8 percent notes
due in February 1977. The 12.8 percent attrition rate on this ex
change was about one half the rate of the previous refunding in
October.
FEDERAL RESERVE BANK OF NEW YORK
proceeds to Treasury Tax and Loan Accounts. The issue
rate averaged 6.552 percent, and investor demand for
the bilk proved to be moderately strong.
In the market for Federal agency issues, four large
offerings during February were very well received by in
vestors at yields below those on new issues in the previous
month. The largest financing for new funds came late in
February, when the Federal National Mortgage Associa
tion (FNMA) raised $800 million by offering $500 million
of 8Ys percent 1%-year debentures and $300 million of
8.10 percent 3 Vi-year debentures. These rates were
around s/s percentage point below those paid by FNMA
in a flotation in late January.
73
Chart ill
CHANGES IN M ON ETAR Y A N D RESERVE AGGREGATES
FROM THREE M O N TH S EARLIER
* Se a so n a lly adjusted a n n u a l growth rates
Percent
..... ......... 1r
20
MONEY SUPPLYi
Percent
20
............
. 15
- 15
- 10
10 5
5
-
0
-5 -1 0
- -5
I l l .Ll.ll.llil. j l l L l l 1.l i .Ll l n l i i l i i l i r
i i 11111l I.i i . II
-1 0
O T H E R S E C U R IT IE S M A R K E T S
New issues of corporate and tax-exempt securities ben
efited from many of the same influences that pushed
Government securities prices sharply higher. Not all
offerings during the month were immediately sold out,
however. The high volume of financings, aggressive pricing
by underwriters, and somewhat reluctant institutional par
ticipation until after midmonth all combined to produce
a succession of tests of the markets’ absorptive capacity.
Throughout the period, of course, the record $1.57 billion
debenture offering by American Telephone and Telegraph
Company, scheduled for April, continued to cast a very
sizable shadow.
After disposing of the remnants of some late-January
market congestion, the corporate market quickly reflected
the shift in investor expectations. In many cases, new flo
tations were marketed at yields well below levels antici
pated only days before. For example, $80 million of 25year Aaa-rated bonds offered by Philadelphia Electric Com
pany on February 3 sold out quickly at a yield to investors
of about 8.78 percent, compared with earlier estimates of
from 8.80 percent to 8.90 percent. The receptions of other
new offerings during the first half of February were mixed,
however, but a brief easing in the volume of new financings
during this period gave underwriters an opportunity to
work inventories down.
The highlight of the month’s new issue activity was
provided at midmonth by a $150 million offering of
forty-year debentures by Michigan Bell Telephone Com
pany. The 8.50 percent yield to investors set on these
debentures was 30 basis points lower than that on a Bell
System financing in late January. Initially, smaller in
vestors responded well to the offering, and large insti
tutional buying later entered the market and absorbed the
balance. Although financing activity slackened briefly
toward the month end, on balance new issue yields held
Note: Rates for the latest month are based on preliminary data.
* Total member bank deposits subject to reserve requirements plus liabilities
to foreign branches and, beginning in September 1969, other nondeposit
liabilities including Euro-dollars borrowed directly from foreign banks or
through brokers and dealers, bank liabilities to own branches in United States
territories and possessions, commercial paper issued by bank holding
companies or other bank affiliates, and loans or participation in pools of
loans sold under repurchase agreement to other than banks and other than
banks* own affiliates or subsidiaries.
* At all commercial banks.
74
MONTHLY REVIEW, MARCH 1970
Table I
Table II
FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, FEBRUARY 1970
RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS
FEBRUARY 1970
In millions of dollars; (+) denotes increase
(—) decrease in excess reserves
In millions of dollars
1
Changes in daily averages—
week ended on
Factors
l
Feb. | Feb.
4
! 11
j
Feb.
IS
Daily averages— week ended on
Net
changes
+
*
— 135
+ 415
+ 78
+ 137
— 25
+ 44
— 27
+ 995
—1,025
— 514
+ 180
+
41
— 647
— 92
— 26
+
86
— 51
—
83
— 443
+ 187
— 267
+ 493
—
30
+ 414
— 130
+ 575
— 571
+
288
-f
—
+
+
+
—
— 56
+
2
—
—
15
2
Total “ market" factors .......................
Gold and foreign a cc o u n t.......................
+ 395
— 208
+ 17
— 70
9
4
10
1
22
1
Other Federal Reserve assetsf ...................
— 104
__ 7
— 30
— 187
+ 98
+ 454
+ 45
+ 55
+ 40
— 274
— 454
— 43
— 20
— 47
+ 48
+ 226
+
23
+
56
+
36
— 256
Total ......................................................
+ 516
— 219
+ 341
— 570
+
68
+
— 32
+
+
38
73
Feb.
25
74 ! — 77
i
2
Reserve excess or deficiency (—) * ........
24
13
22 —
—
Less borrowings from Reserve Banks..
75
130
218
Less net interbank Federal funds
purchases or sales (—) .......................... — 460
707
565
177
Gross purchases ....................................
1,537
2 ,0 1 1
1,934
1,807
1,303
1,997
1,369
1,630
Equals net basic reserve surplus
or deficit (—) ........................................... + 409 — 824 — 761 — 179
Net loans to Government
securities dealers ......................................
608
366
594
359
Net carry-over, excess or deficit (—) t . .
12
54
15
14
166
247
1,822
1,575
— 339
482
90
Reserve excess or deficiency (—) * ........
Less borrowings from Reserve Banks..
Less net interbank Federal funds
purchases or sales (—) ..........................
Gross purchases ....................................
36
388
350
57
258
36
275
35
318
3,178
4,093
1,815
3,536
5,508
1,972
3,158
5,379
S,066
4,832
1,765
3,235
5,178
1*943
8,305
—3,518
41
24
14
11
2 ,2 2 1
Equals net basic reserve surplus
+ 330
+ 28
+ 51
+ 230
— 128
Bankers* acceptances............................
Federal agency obligations .................
Feb.
18
Thirty-eight banks outside New York City
Direct Federal Reserve credit
transactions
Open market operations (subtotal)
Outright holdings:
Government securities..........................
Bankers* acceptances............................
Repurchase agreements:
Feb.
11
Eight banks in New York City
— 3
— 264
— 107
+ 130
+ 10
— 383
Other Federal Reserve liabilities
and capital ...............................................
Operating transactions (subtotal) ............
Feb.
4
Averages of
four weeks
ended on
Feb. 25
Feb.
25
“Market” factors
+ 188
— 631
— 501
-{-145
— 20
— 102
Factors affecting
basic reserve positions
—3,530 —3,876 —3,359
—
Net loans to Government
12
6
Net carry-over, excess or deficit (—) t . •
39 —
28 _
45
4
12
Note: Because of rounding, figures do not necessarily add to totals.
♦Reserves held after all adjustments applicable to the reporting period less required
reserves,
t Not reflected in data above.
i
Daily average levels
Table HI
Member bank:
Total reserves, including vault c a s h ..........
28,391
28,211
180
1,258
Free, or net borrowed (—), reserves........ —1,078
Nonborrowed reserves .................................. 27,133
64
Net carry-over, excess or deficit (—) § ....
27,964
27,816
148
1,071
— 923
26,893
117
28,042
27,819
223
1 ,1 1 1
— 888
26,931
81
27,525
27,404
146
1,064
— 918
26,461
153
27,981$
27,8131
1741
1,126$
952$
26,855$
104$
AVERAGE ISSUING RATES*
AT REGULAR TREASURY BILL AUCTIONS
In percent
i
|
Maturities
Weekly auction dates— February 1970
,------------------------------------------------------Feb.
Feb.
Feb.
Feb.
2
9
16
20
i
j
7.754
7.718
7.312
7.387
6.777
6.917
6.812
6.975
Monthly auction dates— December-February 1970
|
|
Dec.
23
Jan.
27
i
!
i
I
Feb.
24
i
............. !
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 25.
§ Not reflected in data above.
7.801
7.725
7.533
6.994
6.933
* Interest rates on bills are quoted in terms of a 360-day year, with the discounts from
par as the return on the face amount of the bills payable at maturity. Bond yield
equivalents, related to the amount actually invested, would be slightly higher.
FEDERAL RESERVE BANK OF NEW YORK
steady. The announcements of several large industrial
offerings scheduled for early March added to an already
sizable calendar and contributed to investor caution.
In the tax-exempt sector, interest rates generally moved
lower as dealers were able to maintain workable inven
tories in spite of a heavy volume of financings. Offerings
with short maturities appeared to be relatively more at
tractive to investors, and the largest rate declines were
on those issues. On February 10 local urban renewal
agencies under the auspices of the Department of Hous
ing and Urban Development (HUD) sold $263 million
of eight-month project notes at an average cost of 4.89
percent, 66 basis points below the January level and also
the lowest rate since the spring of last year. A week later
local housing authorities sold (also under HUD auspices)
eight-month project notes totaling $440 million at a net
interest cost of 4.83 percent, 85 basis points below the
rate in a January financing.
Issuers of longer term obligations benefited a bit less
from the renewed optimism over the course of interest
rates— in part because banks continue to be under severe
liquidity pressures. Early in February an offering rated
Aaa moved slowly at yields to investors from 4.90 per
cent in 1971 to 6.15 percent in 1990, around 10 basis
points below rates on comparable maturities in a similarly
rated financing in mid-January. Two weeks later, however,
demand had strengthened and a flotation of Aa-rated
bonds with equivalent yields and maturities sold out
quickly. During the last week of February another Aarated offering sold at yields of from 4.60 percent for short
maturities to 5.90 percent for maturities around 1990. The
Blue List of dealer-advertised holdings drifted down to
$346 million at the month end, $94 million below the endof-January level. The Weekly Bond Buyer’s index of yields
on twenty municipal bonds closed February at 6.16 per
cent, 62 basis points lower over the month.
Fifty-fifth Annual Report
The Federal Reserve Bank of New York has published its fifty-fifth Annual Report, review
ing the major economic and financial developments of 1969.
The Report notes that all the traditional monetary instruments were used in the firmly restric
tive stance of monetary policy during 1969. It also observes that the experience of the late 1960’s
makes clear “the danger of relaxing policies of restraint before there are clear signs that inflationary
expectations are being overcome”. Although continued restraint involves an increasing risk of re
cession as the growth of the economy slows, the Report states that “policy makers are as aware
of the danger of pushing restraint too far as of relaxing too soon”.
One facet of the inflation that has plagued the American economy in the second half of the six
ties is the balance of payments, which “remains a major unresolved problem for the United States
and potentially a very disturbing element in the international system”, according to the Report. In
1969, however, monetary restraint helped keep the dollar strong in foreign markets and there
were a number of developments “that augured well” for the international financial system.
In his letter presenting the Report, President Hayes declares that “in 1970 we must get
on with the task of checking inflation and improving the country’s competitive position in world
markets. The achievement of these goals will be neither easy nor painless. Fiscal policy, as well
as monetary policy, must play a part in convincing the general public that inflation cannot and
will not be permitted to continue. Leaders in business and labor must become more acutely aware
that they too have responsibilities to this end”.
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.
75
@FedFRASER