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FEDERAL RESERVE BANK OF NEW YORK

43

Treasury and Federal Reserve Foreign Exchange Operations*
By

C h ar les

The dominant feature of the foreign exchange markets
during the past six months has been the heavy flow of
short-term funds across the exchanges in response to in­
terest rate differentials. The swing in the official settle­
ments balance of the United States from a surplus in 1969
of $2.7 billion to a deficit in 1970 of $10.7 billion did
not reflect any deterioration in our underlying balance-ofpayments position. But, as United States money rates and
credit conditions progressively eased in 1970 and early
1971 while European rates lagged well behind, short­
term money naturally flowed in heavy volume from the
United States to the Euro-dollar market and on from
there to the national money markets and central bank
reserves of Europe. The great bulk of this flood of short­
term money represented repayments by United States
banks of earlier borrowings of foreign-owned funds from
the Euro-dollar market. Thus, the Euro-dollar debt of
United States banks to their overseas branches plummeted
from a peak of $15 billion outstanding in October 1969
to less than $8 billion at the close of 1970 and has de­
clined still further so far in 1971.
The resultant overflow of dollars from the Euro-dollar
market into the European money markets was naturally
attracted to the highest bidders. Throughout most of the
period, German short-term rates exerted the strongest
pull, with the result that German banks and industrial
firms in seeking an escape from stringent credit conditions

*This report, covering the period September 1970 to March
1971, is the eighteenth 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.




A.

Coombs

in Germany borrowed well over $6 billion abroad in 1970,
thereby more than accounting for the $6.3 billion in­
crease in the reserves of the German Federal Bank. The
second leading recipient of short-term money flows was
the United Kingdom, where consistently high money rates
in relation to the Euro-dollar market attracted a large
volume of short-term money and thereby facilitated the
remarkable progress of the United Kingdom in paying off
$3 billion of official debt. Other major recipients of the
overflow from the Euro-dollar market were France, where
flows into official reserves totaled some $1.8 billion in
1970, Italy, Belgium, the Netherlands, and Switzerland.
As these flows of short-term dollar funds moved across
the European exchange markets, all the major European
currency rates were pushed up toward their official ceilings.
At these levels, the European central banks were required
to absorb dollars from the market and, in the process,
were in some instances forced to dilute their own credit
restraint policies by injecting new liquidity into their
commercial banking systems. It is not surprising, there­
fore, that several European governments and central
banks have taken action to restrain the access of their
nationals to the short-term credit facilities of the Euro­
dollar market. In the absence of similar restraining action
by the German government, the Federal Bank felt it had
no alternative but to mop up inflows of new liquidity by
increasing bank reserve requirements and thus setting the
stage for renewed inflows. On the United States side, the
Federal Reserve sought to temper the rundown of E uro­
dollar debt by United States banks by raising, on Novem­
ber 30, 1970, the marginal reserve requirements of
United States banks on liabilities to their branches, and
in early 1971 the Export-Import Bank offered the
branches issues of three-month securities totaling $1.5
billion. By amendment of Federal Reserve regulations

44

MONTHLY REVIEW, MARCH 1971

these securities can be counted against the marginal
reserve-base level. In effect, the operation absorbed dollars
that otherwise might have flowed back to the Euro-dollar
market.
Financing by the United States of the unusually high
official settlements deficit in 1970 was facilitated by the
fact that a substantial part of dollar reserve gains abroad
favored those countries which were in the process of re­
building depleted dollar reserves or were fully content to
accumulate dollars in anticipation of scheduled debt re­
payments to United States official agencies or to the
International Monetary Fund (IM F ). Special financing
arrangements previously negotiated by the United States
Treasury with the governments of Canada and Germany
took care of another important segment of the financing
problem. On the other hand, Switzerland, Belgium, and the
Netherlands had to purchase dollars in amounts exceed­
ing their normal central bank holdings and, during 1970
and into early 1971, these central banks repeatedly re­
quested the Federal Reserve to draw on the respective
swap lines (see Table I) so as to absorb such surplus dol-

Table I
FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS
March 10, 1971
In m illio n s o f d o lla rs

Amount of facility

Institution

A u s tria n N a tio n a l B an k

...........................................................

200

N a tio n a l B a n k of B elgium ......................................................

500

........................................................................

1,000

B ank of C an ad a

....................................................

200

.......................................................................

2,000

...........................................................................

1,000

N a tio n a l B a n k o f D e n m a rk
B an k

o f E n g la n d

B an k o f F ra n c e

............................................................

1,000

...............................................................................

1,250

........................................................................

1,000

G e rm a n F e d e ra l B a n k
B a n k o f Ita ly
B ank of Ja p a n
B a n k o f M ex ico
N e th e rla n d s B a n k

..................................................................
.................................
.........................

200

.................

..................................

250

................................................................

600

B a n k of N o rw a y
B a n k of S w eden
Sw iss N a tio n a l B a n k

130
300

..........

B a n k fo r I n te rn a tio n a l S e ttle m e n ts:
.............................................................

600

O th e r a u th o riz e d E u ro p e a n c u rre n c ie s-d o lla rs ........

1,000

Swiss

T otal

fra n c s-d o lla rs

..................................................




11,230

lars. In contrast to earlier experience, virtually none of
these Federal Reserve drawings on the swap lines, totaling
$1,680 million since January 1, 1970, have proved re­
versible through market transactions.
In October 1970 and in early M arch 1971, the Federal
Reserve drew a total of $450 million equivalent on its
swap line with the Swiss National Bank (see Table II ).
These drawings were paid off in their entirety in early
March through a combination of a United States Treasury
sale of $75 million of gold, the issuance of a $250 million
Swiss franc security to the Swiss National Bank, and a
direct purchase by the Federal Reserve from the Swiss
National Bank of $125 million equivalent of Swiss francs
against dollars.
In the case of the Netherlands, the Federal Reserve in
several transactions beginning in July 1970 drew the full
$300 million available under its swap line with the
Netherlands Bank which also conducted market swaps in
Amsterdam to deal directly with additional excess dollar
inflows. This $300 million of Federal Reserve debt— plus
another $25 million of surplus dollars on the books of
the Netherlands Bank— was fully liquidated in a series of
special transactions involving (1 ) a Federal Reserve sale
of $75 million equivalent of German m ark balances to the
Netherlands Bank, (2 ) a United States Treasury sale of
$25 million of gold and $100 million of special drawing
rights (SDR’s) to the Dutch authorities, and (3 ) a United
States drawing of $125 million equivalent of guilders from
the IMF.
The most intensive use of the swap facilities by the
Federal Reserve occurred, however, in the case of Belgium
where drawings of $655 million of Belgian francs have
been made since late June. Some progress was made in
reducing these swap drawings by two special operations.
On December 23, the United States Treasury sold $110
million of SDR’s to the National Bank of Belgium, and in
January 1971 drew $125 million of Belgian francs from
the IMF. As of March 10, the Federal Reserve debt out­
standing under the Belgian franc swap line amounted to
$420 million.
During the period under review, only one swap drawing
was made by a foreign central bank on the Federal Re­
serve. This was a drawing of $400 million by the Bank
of England in September 1970 (see Table III). The
primary cause of this drawing was speculation against the
pound engendered by rumors of major moves toward
greater exchange rate flexibility at the approaching IM F
meeting in Copenhagen. With tight credit conditions in
the United Kingdom, an acute shortage of sterling quickly
developed, however, and helped choke off such specula­
tion. The subsequent proceedings of the Copenhagen

45

FEDERAL RESERVE BANK OF NEW YORK
Table II
FEDERAL RESERVE SYSTEM DRAWINGS AND REPAYMENTS
UNDER RECIPROCAL CURRENCY ARRANGEMENTS
In m illio n s o f d o lla rs e q u iv a le n t

Drawings ( + ) or repayments ( — )

Transactions with

System swap
drawings
outstanding on
January 1, 1970

+

50.0

II

III

IV

January 1March 10

( + 45.0
1 — 130.0

+ 135.0

f + 165.0
1 — 110.0

{±S

+270.0

+

30.0

— 300.0

-0-

420.0

..................................................

55.0

.........................................................

130.0

...............................................

145.0

— 145.0

+ 200.0

— 200.0

+ 300.0

f+150.0
1— 450.0

-0-

................. ....................................

330.0

f + 50.0
1 — 145.0

f +245.0
1 — 260.0

f +405.0
1 — 200.0

r +495.0
1 — 110.0

f+485.0
1— 875.0

420.0

N a tio n a l B a n k o f B elg iu m

Sw iss N a tio n a l B a n k

Total

System swap
drawings
outstanding on
March 10,1971

— 130.0

1

N e th e rla n d s B a n k

1971

1970

meeting then relieved market fears by ruling out the more
extreme approaches to exchange rate flexibility. The Bank
of England liquidated this $400 million drawing in its
entirety in October and November 1970. As of March
10, 1971 no foreign central bank drawing on the swap
network was outstanding.
During the period covered by this report there were
no swap operations with the central banks of Austria,
Canada, Denmark, France, Germany, Italy, Japan, Mex­
ico, Norway, or Sweden. The United States Treasury issued
to the Swiss National Bank a Swiss franc-denominated
security equivalent to $250 million in March, while other
foreign-currency-denominated securities were rolled over
at maturity. The total of such securities now outstanding
is $1.6 billion (see Table IV ).
EUR O -D O LLAR M A R K E T

Euro-dollar rates declined fairly steadily through the
second half of 1970 and the first two months of 1971,
with only modest interruptions during September and
December (see Chart I) . From close to 9 percent at the
end of June 1970 the three-month deposit rate fell to 5
percent by early March 1971, and through most of the
period covered by this report was significantly below com­
parable rates in many European centers. Thus, in the space
of only a few months, the pattern of interest rates in the
major international markets had shifted profoundly. Where
the Euro-dollar market previously had been exerting a sub­
stantial upward pull on European domestic interest rates,




it now was providing borrowers on the Continent with
relatively cheap funds in heavy volume.
As in any market situation, this change in the direction
of flows through the Euro-dollar market reflected a variety
of factors on both the supply and demand sides, but clearly
the most important single change was in United States
domestic interest rates and credit demands. Throughout
1969 United States banks had borrowed extremely heav­
ily in the Euro-dollar market, both through their own
European branches and to some extent directly, in an
effort to offset the effects of monetary stringency in this
country. With credit demand in the Euro-dollar market
already strong because of boom conditions prevailing in
many European countries, the consequence was a sharp
escalation of rates. Once excess demand was curbed in this
country, some of the pressure on the Euro-dollar market
was relieved, but it was not until the partial suspension of
Regulation Q ceilings and the easing of liquidity condi­
tions here following the Penn Central bankruptcy in June
that a marked shift occurred in the behavior of United
States banks in the Euro-dollar market. As banks found
that they could once again write domestic certificates of
deposit (C D ’s) at competitive rates, they began to reduce
their dependence on the Euro-dollar market and to repay
borrowings through their branches. From late June to the
end of September 1970, the liabilities of United States
banks to their own foreign branches declined by $2.4 bil­
lion to below $10 billion (see Chart II).
Interest rates in the Euro-dollar market naturally eased
in the face of these repayments by United States banks,

MONTHLY REVIEW, MARCH 1971

46

but there was no precipitous decline, as demands for
Euro-dollar loans on the Continent remained substantial.
Most European countries still were pursuing policies of
monetary restraint, either to combat continuing infla­
tion and excess demand or to rebuild depleted monetary
reserves. Consequently, any decline in Euro-dollar loan
rates to levels below those prevailing in European do­
mestic markets led to surges of borrowing from those m ar­
kets and concomitant strains on the exchange markets as
the loans were converted into local currencies. German
business firms, in particular, were heavy borrowers— and
remained so throughout the fall and winter months— but
there were sizable flows to other countries as well.
Credit demands from Europe, while large, were not suf­
ficient to stabilize the situation in the Euro-currency
markets. The progressive easing of monetary policy in the
United States, coupled with the continued slack in the
United States economy, made it possible for United States
banks to turn to relatively cheaper domestic sources for
most of the funds they needed. A number of banks, there­
fore, continued to reduce their Euro-dollar positions
through October and November, even though this meant
eroding their reserve-free Euro-dollar bases established
under amendments to Regulation M of the Board of
Governors of the Federal Reserve System.
Several foreign central banks reduced their discount
and lending rates during this period (see Chart III),

but the continuing decline in Euro-dollar rates, reflecting
the outflow of funds from the United States, complicated
the task of monetary management in a number of Euro­
pean countries. Consequently, the Federal Reserve Board
moved at the end of November 1970 to moderate the pace
of repayment by United States banks by raising from 10
percent to 20 percent the reserves required to be held
against Euro-dollar borrowings in excess of the reservefree base level and, at the same time, amended the regula­
tions regarding the computation of the bases. The changes
did not require any banks to put up reserves immediately,
but they served to signal the Board’s concern over the
rapidity of repayments and encouraged banks to take a
second look at the possible cost of borrowing should they
need to have recourse to the Euro-dollar market in the
future. The announcement of these changes came just
when year-end demands were beginning to exert their
usual tightening effect on the market, and there was a brief
sharp upward move in rates, especially at the short end
of the maturity spectrum. The year-end squeeze, never­
theless, was very much less marked than in 1969, and after
peaking in mid-December, rates resumed their downward
trend in the second half of the month and into the new
year.
The further decline of rates in the Euro-dollar market
in January reflected the continued slide of interest rates in
the United States, as credit demand remained slack in

Table III
DRAWINGS AND REPAYMENTS BY FOREIGN CENTRAL BANKS
AND THE BANK FOR INTERNATIONAL SETTLEMENTS
UNDER RECIPROCAL CURRENCY ARRANGEMENTS
I n m illio n s o f d o lla rs

Drawings (-}-) or repayments ( — )
Drawings on
Federal Reserve
System outstanding
on January 1, 1970

Banks drawing on
Federal Reserve System

i

1970
!
1..-_

B an k o f E n g la n d ..........................................................................................................

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




.....

650.0

)—

5+
1—

B an k fo r In te rn a tio n a l S e ttle m e n ts (a g a in s t G e rm a n m a r k s ) ................

800.0
136.0
136.0

)-

' H
| 1
i

Drawings on
Federal Reserve
System outstanding
on December 31,1970

IV

io o .o
100.0

+

.................................................................................................................

III

650.0

5 41—

B an k o f F r a n c e ................................................. ..........................................................
B an k o f Ita ly

II

1

____

—

650.0

|

1.036.0
886.0

4- 400.0

f

-f

J -lj -

—

400.0

5-f
—

44.0
44.0

i

44.0
444.0

200.0
600.0

—

400.0

77.0
77.0

)—

f+

77.0
77.0

)

1

477.0
477.0

}

277.0
677.0

S
}

\

-0-

47

FEDERAL RESERVE BANK OF NEW YORK
Table IV
UNITED STATES TREASURY SECURITIES
FOREIGN CURRENCY SERIES
In m illio n s o f d o lla rs e q u iv a le n t

Issues (-}-) or redemptions ( — )
Issued to

Amount
outstanding on
January 1,1970

1970
1

....................................... .................

1,081.6*

..................................................................

banks

III

IV

B an k o f Ita ly ....................................................................... ........

125.4

Sw iss N a tio n a l B a n k

.............................................................

539.6

-5 4 2 .0

135,5
— 125.4

540.6

B an k fo r I n te rn a tio n a l S e ttle m e n ts-! .............................
*

204.4

Total

...............................................................................

2,087.6

Amount
outstanding on
March 10,1971

January 1March 10

135.5*

G e rm a n F e d e r a l B a n k
G e rm a n

II

1971

-0249.7
— 54.7

-6 6 7 .4

- 5 4 .7

790.5
150.0

-0-

-0-

249.7

1,615.6

N o te : D isc re p a n c ie s in to ta ls re su lt fro m m in o r v a lu a tio n a d ju stm e n ts a n d fro m ro u n d in g .
♦ In clu d es v a lu a tio n a d ju stm e n ts s u b se q u e n t to th e re v a lu a tio n o f th e G e rm a n m a rk ,
t D e n o m in a te d in Sw iss fra n c s.

January. By midmonth, the liabilities of United States
banks to their foreign branches stood at $7.9 billion, some
$6.1 billion below the year-earlier figure, the three-month
Euro-dollar rate had receded to 6 percent, and funds were
continuing to move into European centers at a rapid
pace. The United States authorities decided, therefore, that
further action was necessary to moderate the impact of
these flows of funds. On January 15 the Export-Import
Bank announced that it would offer $1 billion of threemonth securities at 6 percent to the foreign branches of
United States banks, and at the same time the Federal
Reserve Board amended Regulation M to permit United
States banks to count holdings of these securities toward
maintenance of their reserve-free Euro-dollar bases. The
issue was oversubscribed and was allotted to the branches
on the basis of their outstanding lendings to their head
offices. Thus, some $1 billion that might otherwise have
accrued to foreign central banks as a result of bank re­
payments was immobilized.
The decline in United States and Euro-dollar rates con­
tinued into February, however, and there were further
reflows from the United States and into European centers
where restrictive monetary policies were still being pur­
sued. Consequently, on February 23 the Export-Import
Bank announced an additional three-month borrowing of
$500 million at the then-prevailing market rate of 5Vs
percent. In early March the three-month rate eased to
5 percent.




STE R LIN G

Sterling was in strong demand in the early months of
1970, partly because of favorable seasonal factors but
largely as a result of a major improvement in the British
balance of payments on current account. Evidence of the
underlying improvement helped to restore market confi­
dence, and there were substantial flows of funds into the
United Kingdom. With the spot sterling rate rising, the
Bank of England was able to purchase large amounts of
dollars and to repay a considerable portion of its inter­
national short-term indebtedness. In the spring, however,
the market turned easier. By then, seasonal factors were
no longer so favorable, while the trade account deteriorated
in late spring, and deficits persisted in subsequent months.
In addition, with the rise in prices in Britain already ac­
celerating, the market showed concern over the implica­
tions of increasingly costly wage settlements. Spot sterling
began to decline in May and moved generally downward
during the summer months (see Chart IV ). By the end of
August the rate had fallen close to its lower limit.
Late in August and in the early days of September,
when demand for sterling tends to be seasonally slack,
market sentiment deteriorated sharply and the Bank of
England had to provide considerable support to maintain
the spot rate above the floor. This burst of selling reflected
not only concern over the continued wage-price spiral in
the United Kingdom, but also market fears over the out­

MONTHLY REVIEW, MARCH 1971

48

come of the IM F study on exchange rate flexibility to be
discussed at the Fund’s annual meeting later in the month.
The underlying position of the pound was still firm, how­
ever, as the balance of payments on current account re­
mained in surplus. Consequently, a shortage of sterling
developed in the market soon after the wave of short
selling, and beginning on September 8 the squeeze on
sterling balances lifted the spot rate well above the floor.
Nevertheless, the Bank of England was unable to recoup
much of its earlier losses and reactivated its swap line
with the Federal Reserve by drawing $400 million at the
month end.
Trading was quieter in early October. Demand then
picked up when, on October 14, a small trade surplus
was announced for September, contrary to the m arket’s

C h a rt I

SELECTED INTEREST RATES IN THE UNITED STATES
THE UNITED K IN G D O M , WEST GERM ANY
A N D THE EURO-DOLLAR MARKET
T H R E E -M O N T H

P erce nt

M A T U R IT IE S E X C E PT W H E R E O T H E R W IS E N O T E D

W e e k ly a v e ra g e s o f d a ily ra te s

121

P ercent

112

J i l l ___I . I . I___I__I___I__I__I___ I I___l2
C h a rt II

UNITED STATES B A N K S ’ LIABILITIES TO FOREIGN BRANCHES
B illio n s o f d o lla r s




W e d n e s d a y d a ta

197 0

B illio n s o f d o lla r s

1971

expectation of a large deficit. Moreover, Euro-dollar rates
had been dropping while United Kingdom rates had been
held firm, with the result that international interest rate
comparisons had turned in favor of sterling. Toward the end
of the month, the United Kingdom government announced
an interim budget which mainly served to shift priorities
somewhat among various revenue and expenditure items
but was largely neutral in its immediate effects on ag­
gregate demand. These fiscal measures were accompanied,
however, by strong statements on the need to curb infla­
tionary wage settlements and an indication that some
tightening of monetary policy was forthcoming. Then on
October 29 the Bank of England announced a substantial
increase, effective November 11, in the amount of special
deposits the London clearing and Scottish banks are re­
quired to hold with the central bank. Sterling immediately
surged to $2.39, and moved well above that level in early
November, when a $72 million increase in official reserves
was announced for October.

FEDERAL RESERVE BANK OF NEW YORK

Confidence in sterling improved further in November
following the release of another set of good trade figures.
Moreover, a further significant decline in Euro-dollar rates
widened arbitrage differentials in favor of the pound. The
Bank of England again gained reserves during November,
and by the end of that month had repaid in full the $400
million drawing under the Federal Reserve swap arrange­
ment made in September. Also in November the Bank of
England prepaid the year-end instalment due under the
June 1966 Basle credit arrangement; of this payment the
Federal Reserve and Treasury share was $39 million.
Although developments in December were blurred by
year-end factors, British reserves showed an increase of
$24 million for the month, after repayments of $264 mil­
lion to the United States and Canada on long-term debt
outstanding from World War II and the early postwar
period. This increase in reserves was well received by the
market and, in heavy trading, the sterling rate moved up
close to par in the early days of January.
Demand for sterling began to build up even further in
January. Seasonal factors normally favor sterling early
in the year. Moreover, United Kingdom interest rates
were held firm in the face of further sharp declines in the
Euro-dollar market, and interest arbitrage incentives wid­
ened in favor of sterling. Against this background the
authorities became concerned over the danger of excessive
inflows of “hot money” and, effective January 12, the ex­
change control regulations were modified so as to restrain
new foreign currency borrowings by British corporations
for domestic use. The market took this as a sign of offi­
cial confidence, and the spot rate moved above par on
that day. On January 14 a substantial trade surplus was
announced for December, much larger than expected, and
in heavy bidding the spot rate rose as high as $2.41.
Over the rest of January and into February, interest
rate relationships played a dominant role in the market.
The continuing decline in Euro-dollar rates in the second
half of January occurred at a time when a squeeze was
developing in the London money market, widening even
further the uncovered arbitrage incentives favoring ster­
ling. Moreover, rumors abounded that the Bank of Eng­
land’s discount rate, held at 7 percent since last April,
would be lowered, and this led to large-scale purchases
of United Kingdom Treasury securities in the gilt-edged
market, including the absorption of several tap issues;
this flow into new gilt-edged securities tied up funds so
that the money-creating effects of the inflow of foreign
exchange was neutralized. Although a postal strike started
on January 20, it did not seriously disrupt business cor­
respondence, and seasonal tax payments to the United
Kingdom Treasury by the British corporations were made




49

Chart IV

EXCHANGE RATES
CENTS PER UNIT OF FOREIGN CURRENCY*
January 1970 to March 1971

S w itz e r la n d
2 2 .8 6 8 5

___ |____ |___ L
22.47191___ |___ 1

J ____ I___ 1
___ L

.1612
Ita ly

*

.1600

.1589 —

“—

_L_

_ L..

1.

t" ' I

1“

1 I

2 7 .6 2 4 3
N e th e r la n d s

- - 11 1 1_ 1_L
1.-- . _ _
B e lg iu

J__ I _1_ I _1_L
_ _ _ _
Cents
100.000

C anada

91 .5 7 5 . J .

.1

1

I

I

...

J

l

l

I

I

J

1970
Note:

I

...1 .

J

L_

F

.

9 3 .4 2 5
9 2 .5 0 0
9 1 .5 7 5

M

1971

Upper ond low er bou n d a rie s of charts represent o ffic ia l buying and selling

rates of d o lla rs a g a in st the various currencies. Until the end of M ay 1970,
however, the Bank of C anada had in fo rm e d the m arket that its inte rve n tio n
points in transactions with banks were $0.9324 (upper lim it) and $0.9174
(low er lim it). On M ay 31, 1970, the C anadian a uthorities announced they w ould
no lo n g e r keep the m arket rate from exceeding the o ffic ia l buying rote of
$0.93425, and the boun d a rie s o f the C anadian d o lla r chart from th a t p o in t on
are draw n fo r g ra p h ica l convenience o nly and on a much reduced scale.
* W e e kly averages of New York noon o ffered rates.
-------

-------- ------- Par value of currency.

MONTHLY REVIEW, MARCH 1971

50

in heavy volume. Sterling rose steadily through January
and by the month end was near its ceiling of $2.42. For
the month of January, British reserves rose by $175 mil­
lion, after repayment in full of the remaining $226 mil­
lion of international credits under the 1966 Basle ar­
rangements (of this payment, $76 million was equally
shared by the United States Treasury and the Federal
R eserve); the January reserve gain, however, included the
$299 million allocation of SDR’s to the United Kingdom.
Spot sterling continued strong in February, quickly
overriding a brief weakening following the announcement
on February 4 that Rolls-Royce would go into receiver­
ship. The wide interest differentials between Euro-dollars
and sterling continued to generate additional flows into
sterling, while there evidently were very sizable repatria­
tions of funds by United Kingdom corporations from their
overseas subsidiaries. Activity in the market remained at
high levels throughout February, and the rate held near
the ceiling of $2.42 through most of the second half of the
month. British reserves rose by a further $192 million in
February after Bank of England repurchases from the
Federal Reserve and the United States Treasury of some
$99 million equivalent of sterling held on a covered or
guaranteed basis. This transaction liquidated the final
portion of such Federal Reserve and Treasury sterling
holdings.
GERM AN MARK

In the spring of 1970, German monetary policy moved
forcefully toward restraint in an effort to counteract the
inflationary forces unleashed by the excessive pace of
economic expansion. With domestic credit conditions
tightening sharply, the German mark rate rose rapidly
from the floor, where it had held most of the time since
the October 1969 revaluation, and in early April the
Federal Bank again began absorbing dollars from the
market. By mid-May, as the borrowings abroad of Ger­
man industry reached major proportions, the spot rate rose
to its ceiling and the Federal Bank had to absorb a large
amount of dollars. The floating of the Canadian dollar on
June 1 added a new speculative element to the continuing
inflow of short-term funds stemming from interest rate
considerations, and the Federal Bank made substantial
reserve gains that month. In all, during the second quarter
of 1970 the reserves of the German Federal Bank rose by
$1,450 million, with the largest part of the inflow occur­
ring in June.
The heavy movements of funds clearly illustrated the
difficulties of fighting inflation with monetary policy alone
in an environment of declining interest rates abroad. Early




in July, therefore, the German cabinet moved to tighten
fiscal policy, thereby allowing some easing of monetary
restraint, and effective July 16 the Federal Bank reduced
its discount and “Lom bard” rates by V2 percentage point,
to the still very high levels of 7 percent and 9 percent,
respectively. German money market rates nevertheless
remained firm, ranging above 9 percent, so that with the
gradual easing of Euro-dollar quotations a considerable
interest-arbitrage incentive in favor of Germany persisted.
As a consequence, demand for marks dipped but briefly,
and the central bank again made large dollar gains in the
latter part of July.
By late July the German money market began to
respond to the influx of liquidity from abroad; domestic
interest rates eased and the demand for marks lessened,
so that in August the central bank’s dollar purchases
tapered off. The expansion of domestic liquidity by
then had become excessive, however, and threatened to
thwart the German authorities’ anti-inflationary efforts.
The Federal Bank Council therefore announced in midAugust that, effective September 1, increases in bank
liabilities above the second-quarter average would be sub­
jected to heavy new reserve requirements.
The tighter domestic credit conditions brought about by
this measure strengthened the demand for marks, and
the Federal Bank again had to absorb dollars from the
market, especially at the time of the mid-September tax
payments in Germany. For the third quarter as a whole,
the Federal Bank’s reserve gain amounted to $2,485 mil­
lion. This influx of liquidity eased domestic monetary
conditions, and the spot rate declined in the latter part of
September.
The somewhat softer tone continued through October,
although the mark was bid up quite sharply at times.
There were recurrent m arket expectations that the Fed­
eral Bank’s lending rates would be cut, so as to reduce the
widening gap between domestic money market rates and
declining Euro-dollar rates, and each time these anticipa­
tions were proved wrong there was a brief surge of de­
mand for marks. This was notably the case when on
October 21-22 the Federal Bank Council, rather than
lowering its rates, took the alternative route of attempting
to curb inflows by modifying minimum reserve require­
ment rules. This was done mainly by placing such require­
ments against certain interest-arbitrage transactions and
the guarantees extended by banks on the rapidly growing
borrowings abroad by German firms. Indeed, the volume
of foreign credit taken up by German institutions between
July and October was not far below the net growth in
lending by the German banking system. Fears that these
new reserve measures presaged further and more drastic

FEDERAL RESERVE BANK OF NEW YORK

limitations led to a brief, but strong burst of demand for
marks.
With German money market rates commanding in­
creasingly wide premiums over rates in most other major
countries and in the Euro-dollar market, rumors of a cut
in the Federal Bank’s lending rates naturally flourished.
The spot mark moved up close to the ceiling at the end
of October, and during the first half of November the
German authorities again began to take in dollars. Then,
on November 17, the Federal Bank Council cut the dis­
count rate from 7 percent to 6 V2 percent, and the Lom­
bard rate on secured advances from 9 percent to 8 per­
cent. The Council also announced a restructuring of re­
serve requirements: the additional reserve requirement on
increases in domestic liabilities was abolished on December
1, but the funds thus released were fully tied up (for the
banking system as a whole) by raising the minimum
reserves required against the banks’ total liabilities by
15 percent. The special marginal reserve requirement on
external liabilities was reduced slightly to 30 percent, and
the base for calculating the growth of the external liabili­
ties was updated.
The commercial banks apparently feared that this re­
structuring of reserve requirements would prove restric­
tive, especially toward the year-end when liquidity needs
are heavy in Germany, and they began to repatriate funds
from abroad, while German corporations stepped up their
Euro-dollar borrowings. This set off a ground swell of
demand for marks, which was further intensified as some
traders, who had gone short of marks in the expectation
that the news of a bank rate cut would weaken the spot
rate, scrambled to cover their positions. As a result, in
just over one week, the Federal Bank had to absorb
more than $1 billion from the market.
This large influx of liquidity eased domestic credit
conditions and, with the late-November rise in Euro-dollar
rates, the interest-arbitrage incentives in favor of Germany
narrowed, bringing the Federal Bank’s dollar purchases to
a temporary halt. The spot rate drifted down to
$0.27513 by December 1, when the discount rate cuts
/4
in the United States bolstered expectations of similar
action in Germany. The Federal Bank Council did, in fact,
announce the following day that the discount and Lombard
rates would again be reduced, by V2 percentage point to
6 percent and IV 2 percent, respectively. Although pri­
marily motivated by balance-of-payments considerations,
these relatively small cuts were also consistent with devel­
opments in the domestic economy. Demand pressures had
begun to relax, while strains on productive capacity and
the labor force, albeit still strong, were becoming less
acute. Cost pressures, notably wage increases, continued




51

to be great, however, and the monetary authorities felt
that a more general easing of their policy was as yet un­
warranted.
On December 3, the day when the cuts in the central
bank’s lending rates became effective, the spot mark rate
broke sharply. The drop reflected the considerable over­
estimation by German banks and business firms of their
December needs in the context of the restructured reserve
requirements; having previously brought in more funds
than they could use domestically, they now began ex­
porting some of their excess liquidity. With domestic in­
terest rates easing further, the differentials over E uro­
dollar yields narrowed sharply— disappearing or even
turning against the mark at the very short end of the
maturity range— and this induced the banks to shift some
funds on a covered basis to the Euro-dollar market; as a
result, the premium on the one-month mark surged by %
percentage point that day to 1.21 percent per annum.
Finally, some traders who had established long positions
in marks began to unwind them. This snowballing effect
gained momentum the following morning in Frankfurt,
and in very heavy and somewhat erratic trading the rate
fell all the way to par ($ 0 .2 7 3 2 % ). Trading remained
very active for about a week and, with considerable un­
certainty as to the outlook for interest rates in Germany
and in the Euro-dollar market, the spot rate continued to
fluctuate widely. By mid-December a much calmer tone
had emerged in the market, although the spot rate re­
mained soft. When Euro-dollar yields fell off in the latter
part of December, however, German banks withdrew
funds from that market and the m ark began to firm.
Over the fourth quarter, the reserve gains of the
Federal Bank amounted to $2,309 million; for 1970 as
a whole, reserves rose by $6,481 million (including an
allocation of $202 million of SDR’s) to $13.6 billion.
There had been a substantial deterioration on current ac­
count during the year, essentially on service items, but
this was more than offset by the various forms of capital
inflows. The German authorities have estimated, on the
basis of both recorded and unrecorded flows, that Ger­
man banks and business firms borrowed some $6.6 bil­
lion abroad during the year.
German money market rates came down further in
January, but an even sharper decline in Euro-dollar rates
further increased the incentive to borrow abroad. The spot
rate for the mark rose steadily during the month, while the
forward rate moved to a discount. By late January, the spot
rate had risen to its ceiling and the Federal Bank again
began to absorb substantial amounts of dollars from the
market. Euro-dollar rates continued to ease through Feb­
ruary, while German money market rates remained firm,

52

MONTHLY REVIEW, MARCH 1971

with the inevitable consequence of additional large flows
of funds into the official reserves. Through the end of Feb­
ruary, Germany’s gold and foreign exchange reserves had
risen by a further $1 billion. In early M arch the Federal
Bank continued to take in dollars. The spot rate generally
remained at or near the ceiling, while the forward discount
widened from about 1.1 percent per annum on threemonth marks to close to 2.0 percent.
BE LG IA N F R A N C

During last summer Belgium’s balance of payments on
current account was in substantial and growing surplus, as
the pace of the domestic expansion had moderated while
price inflation was substantially less than in most other
industrial countries. The inflation was nevertheless cause
for concern to the Belgian authorities, and as interest rates
in other centers moved down, particularly in the Euro­
dollar market, Belgium’s interest rates were kept relatively
steady. This resulted in a narrowing of the earlier large
uncovered arbitrage differentials against Belgium, thereby
lessening the scope for capital outflows that could offset
the marked strengthening of the current-account surplus
in the third quarter. Throughout the summer, therefore,
the Belgian franc rate held close to its upper limit and the
National Bank of Belgium purchased substantial amounts
of dollars. To provide cover for the bulk of these reserve
gains, the Federal Reserve reactivated its swap line in
June and had drawn a total of $95 million equivalent of
francs by the end of August. In September, when some
nervousness developed prior to the IM F meeting, there
was a further flow of funds to Belgium and the Federal
Reserve drew an additional $60 million, bringing its
Belgian franc swap drawings to $155 million.
As Euro-dollar rates resumed their decline in October
and Belgian money market rates continued high, interestarbitrage incentives in favor of Belgian franc placements
emerged. This situation persisted even after the National
Bank had lowered its discount rate from IV 2 percent to
7 percent effective October 22. The spot rate remained
at or close to its ceiling, and the National Bank continued
to take in dollars on a substantial scale until the end of
November. To provide cover for the National Bank’s
dollar intake over the autumn months, the Federal Reserve
drew repeatedly on the swap facility: $70 million equiva­
lent was drawn in October, $65 million in November, and
$30 million in early December, thereby bringing Belgian
franc commitments to a total of $320 million.
In early December the firming of Euro-dollar rates led
to some softening of the demand for francs. The spot
franc rate eased further after the central bank cut its dis­




count rate by another V2 percentage point on December
10. There was no reflux of funds from Belgium, how­
ever, and on December 23 the United States Treasury sold
$110 million of SDR’s to the National Bank of Belgium
in order to enable the Federal Reserve to buy from that
bank the francs necessary to liquidate an equivalent
amount of swap drawings that had been outstanding since
the summer.
The Belgian franc began to strengthen again early in
January. With the passing of year-end demands and a
further drop in interest rates in the United States, E uro­
dollar rates declined rapidly, once again opening an
interest-arbitrage incentive in favor of Belgium. Moreover,
in January, the Belgian Treasury made two large domestic
borrowings which absorbed liquidity from the Brussels
money market and attracted funds from abroad. At the
same time, Belgium’s current account remained strong.
By midmonth the spot rate had returned to the ceiling
and, with the interest differential widening further, the
National Bank absorbed large amounts of dollars, for
which the Federal Reserve provided cover by drawing
a total of $145 million equivalent on the swap line. Thus,
by January 27, $355 million equivalent of the $500 mil­
lion facility was in use. On January 29 the United States
Treasury obtained $125 million of Belgian francs under
a multicurrency drawing on the IM F and sold these francs
to the Federal Reserve, thereby enabling the System to
reduce its Belgian franc swap commitments to $230
million. The National Bank continued to absorb large
amounts of dollars from the market, however, and the
System drew $155 million in February and an additional
$35 million in early March, bringing swap commitments
to the National Bank up to $420 million equivalent as of
March 10, 1971.
D U T C H G U IL D E R

The Dutch guilder began a period of sustained strength
last summer, despite continuing strong domestic inflation­
ary pressures and a deteriorating current account. In early
summer the financing of a major industrial take-over
in the Netherlands through the repatriation of funds from
abroad pushed the guilder rate up and brought the
Netherlands Bank into the market to slow the rise in
the rate. But interest rates were the dominant factor
in sustaining the firmness of the guilder during the second
half of 1970 and into this year. M onetary policy in
the Netherlands remained tight in the face of continued
excess demand, while interest rates in the Euro-dollar
market declined, thus reducing the incentive for Dutch
banks to hold their liquid funds abroad. At the same

FEDERAL RESERVE BANK OF NEW YORK

time, considerable foreign interest developed in guilderdenominated bond issues being floated in the Dutch and
international capital markets.
By mid-July, the guilder had moved up well above par
and the Netherlands Bank was purchasing considerable
amounts of dollars from the market. The Federal Reserve
was soon called upon to reactivate its swap line with the
Netherlands Bank. The System drew a total of $75
million equivalent of guilders in July and an additional
$145 million in August, when the capital inflow intensi­
fied. In late August, credit conditions eased in the Nether­
lands and the guilder market turned quieter. A renewed
demand for guilders emerged in the second half of Sep­
tember, primarily as a result of domestic money market
developments. To provide cover for the Netherlands
Bank’s latest acquisition of dollars, the Federal Reserve
drew another $50 million on the swap line. Consequently,
by September 28, $270 million out of the $300 million
facility was in use.
The Netherlands Bank was faced with the prospect of
a further large intake of dollars during the fourth quarter.
The Dutch current account, to be sure, was progressively
moving into deeper deficit as the growth of domestic
demand pressed against productive capacity, but this
seemed likely to be more than offset by continuing large
capital inflows. The strong foreign demand for guilderdenominated bond issues showed no signs of abating and,
furthermore, domestic monetary conditions were likely to
be kept very taut by large tax payments made in
September and October. To avoid increasing its uncovered
dollar reserves during this period, while giving some tem­
porary relief to the money market, the Netherlands Bank
decided to offer, starting on October 1, to buy dollars spot
against sale for delivery in three months’ time at rates
favorable to the Dutch banks. Consequently, the spot
guilder rate softened in the early part of October. Around
midmonth, however, the combination of tight money m ar­
ket conditions in the Netherlands and still lower Euro­
dollar rates shifted the short-term interest-arbitrage incen­
tives in favor of the guilder, while the large demand from
abroad for guilder-denominated bond issues continued. The
spot rate rose to the then-current intervention level of the
Netherlands Bank, a few points away from the $0.2783Vi
ceiling. After purchasing a sizable amount of dollars, the
Netherlands Bank decided in early November to let the
rate move to the ceiling, and demand soon eased. To ab­
sorb the latest dollar gains by the Netherlands Bank, the
Federal Reserve drew the remaining $30 million equivalent
available under the swap facility, while the Treasury sold
to the Netherlands Bank $30 million of gold and $30
million of SDR's. After softening a bit around mid-




53

November, the guilder fell fairly sharply in early De­
cember; trading was not heavy, however, and the spot
rate soon firmed.
Toward the end of 1970 the Dutch authorities took
several anti-inflationary measures, to become effective at
the start of the new year: taxes were temporarily increased,
quantitative restrictions for credit expansion were ex­
tended through January and February, and ceilings were
placed on wage increases in the first half of 1971.
In January, new tap issues by the Dutch Treasury were
heavily subscribed while the commercial banks sought
guilders to liquidate the swaps entered into with the
Netherlands Bank in October. As a result, liquidity con­
ditions remained tight in January, contrary to their usual
sharp seasonal easing. With demand for guilders there­
fore very strong and the spot rate close to the ceiling, the
Netherlands Bank undertook a new series of three-month
swaps with the commercial banks and also purchased some
dollars outright. These market swap transactions were con­
tinued through February, with the result that the guilder
remained below its ceiling through the month and into
March.
By January, a considerable portion of the Federal
Reserve’s swap drawings on the Netherlands Bank had
been outstanding for some six months, and the sustained
strength of the guilder had left no opportunity for the
System to acquire guilders through the market. In keep­
ing with the principle that use of central bank credit
should not be unduly prolonged, United States reserve
assets were employed to reduce the swap commitments.
On January 22 the Treasury sold to the Netherlands
Bank $100 million of SDR’s, and on January 29 the
Treasury drew $125 million of guilders from the IM F
and sold $25 million of gold to the Netherlands Bank.
Through these transactions, $25 million of excess dollars
was absorbed directly from the Netherlands Bank and the
Federal Reserve was able to purchase sufficient guilders to
liquidate a total $225 million of swaps, thereby reducing
System guilder commitments to $75 million equivalent.
Then on March 5 the Federal Reserve sold to the Nether­
lands Bank from balances $75 million equivalent of Ger­
man marks for guilders and paid off the remainder of the
swap drawings, thereby restoring the line to a fully stand­
by basis.
SW ISS FRANC

During the second half of 1970, movements in the Swiss
franc exchange rate again mainly reflected changing liquid­
ity conditions in Switzerland. In July the Swiss banks
were generally short of franc liquidity; at the end of the

54

MONTHLY REVIEW, MARCH 1971

month the spot franc rate was bid up to the ceiling, and
the National Bank had to absorb $120 million from the
market. Demand for Swiss francs subsequently lessened,
and a somewhat easier tone prevailed until midSeptember. (As noted in the previous report, in August the
Federal Reserve completed the repayment of a $200 mil­
lion equivalent swap drawing of last May on the Swiss
National Bank.) By September, however, much of the
earlier liquidity had been gradually absorbed, and there
was the possibility of a considerable tightening at the
quarter’s end. To help the Swiss banks meet their end-ofSeptember liquidity needs, the central bank rediscounted
a substantial amount of domestic paper, entered into $425
million of swaps (buying dollars spot against sale for
delivery in early O ctober), and purchased outright $180
million from the banks. Following this injection of liquid­
ity in late September, the spot franc rate declined sharply.
To provide cover for the Swiss National Bank’s outright
dollar purchases during the third quarter, the Federal R e­
serve reactivated its swap facility with that bank, drawing
$300 million equivalent on October 1.
With domestic liquidity conditions now much easier,
in early October the Swiss banks once again began to
place funds abroad in considerable volume. Their offerings
of francs progressively depressed the spot rate, which
dipped to a twelve-month low of $0.2306 at the end of
October. Strong credit demand in Switzerland soon began
to pick up the slack, and the banks started to bring funds
home again in November and early December, bidding up
the spot franc rate in the process. Year-end repatriations
were expected to be sizable, and the National Bank again
offered assistance to the banks through swaps, providing
Swiss francs against dollars for up to a month’s maturity.
The National Bank did a total of $1,116 million of swaps,
a new record. As before when the dollars were taken in
on a swap basis, the National Bank simultaneously placed
them in the Euro-dollar market to avoid serious disturb­
ance of that market by the year-end Hows to Switzerland.
The spot franc continued to rise in December but did not
reach the ceiling, and the National Bank did not have to
take in dollars on an outright basis.
Liquidity conditions in Switzerland in January were
heavily influenced by the efforts of the Swiss banks to
repay the swaps, as continued strong domestic credit de­
mand had further absorbed their franc availabilities. M ore­
over, with the continued decline in Euro-dollar rates there
was less incentive to make placements abroad. As a result,
the Swiss franc rate continued to rise in January and Feb­
ruary, and on February 24 it reached the National Bank’s
intervention level. At that point, the National Bank pur­
chased $150 million, and the rate dropped away once




again. To provide cover for this latest intake, the Federal
Reserve drew an equivalent amount on March 1, bring­
ing its Swiss franc swap commitments to the National
Bank to $450 million. In early March, the United States
Treasury sold $75 million of gold to the Swiss National
Bank and issued to it a $250 million equivalent francdenominated security. The Federal Reserve in turn pur­
chased $200 million equivalent of francs directly from the
National Bank and acquired from the Treasury the pro­
ceeds of the security issue. The System then paid off the
entire $450 million equivalent of swap drawings out­
standing.
FRENCH FRANC

The French balance of payments moved into substantial
surplus in early 1970, and by midyear the French author­
ities had liquidated the remaining short-term debt to for­
eign central banks and had begun to relax somewhat their
severe domestic restraints. Over the course of sub­
sequent months a somewhat easier policy was adopted,
and on August 27 the Bank of France cut its rates on
discounts and secured advances, by Vi percentage point
to IV i percent and 9 percent, respectively. The spot franc
was exceptionally strong in the next few days, largely be­
cause of the conversion of export receipts accumulated
during the August vacation period, and the rate reached
$0.1814 in early September, only slightly below the ceil­
ing. Subsequently, with Euro-dollar rates firming in Sep­
tember, the spot franc rate backed down. Nevertheless,
French reserves posted a modest increase over the month
and, on the basis of the reserve gains over the past year,
France was required in September to make a $246 million
repayment of debt to the IMF.
The market for francs was relatively quiet in October.
Euro-dollar rates were falling sharply, however, once again
widening interest-arbitrage spreads in favor of the franc
and raising the possibility of additional inflows of liquid
funds. Moreover, the French authorities decided that
there was scope on the domestic side for a further modest
easing of monetary policy. On October 20, the Bank of
France’s rates on discounts and advances were lowered
by a further Vi percentage point. A few days later, all
quantitative restrictions on bank credit expansion were
eliminated. The French move on interest rates closed
the gap vis-a-vis Euro-dollar rates once again, but only
temporarily. Euro-dollar rates continued to head down­
ward, and with French interest rates holding steady the
franc was strongly bid once again in November. No
further change was made in the central bank’s rates on
discounts and advances, but the Bank of France did re­

FEDERAL RESERVE BANK OF NEW YORK

duce its domestic intervention rate to bring domestic money
market rates more in line with those in the Euro-dollar
market. Then in early December Euro-dollar rates firmed
on year-end demand and the franc eased, but as Euro­
dollar rates resumed their decline later that month the
franc began to strengthen once again. Over the fourth
quarter, French reserves rose by $217 million; for the
year as a whole the total reserve increase was $962 mil­
lion, excluding a $165 million SDR allocation.
Strong demand for francs continued into January with
the sharp drop in Euro-dollar rates, and was not slowed
by a further Vi percentage point cut in the Bank of
France’s rates on discounts and advances to 6 V2 percent
and 8 percent, respectively, on January 8. Indeed, demand
for French francs was very heavy in the second half of
the month and abated only after the French monetary
authorities, by repeatedly reducing their domestic inter­
vention rate on government paper, again narrowed the
interest-arbitrage spread over Euro-dollar placements.
Once a closer rate relationship had been reestablished, the
exchange market moved into better balance through the
end of February. Thus, whereas reserves rose by $224
million in January (excluding a SDR allocation of $161
m illion), the increase in February was only $59 million,
to $5,078 million.
IT A L IA N LIRA

Beginning in the fall of 1969 the Italian lira had come
under recurrent heavy selling pressure, owing to a grow­
ing impasse on social and economic issues in that country.
The stalemate was reflected in a wave of strikes which
severely impeded production and in the dissolution of two
cabinets by July 1970. A number of measures were taken
in late 1969 and early 1970 to stem the outflow of funds:
Italian interest rates were raised into better alignment with
those abroad; the export of Italian bank notes was dis­
couraged through tighter procedures regarding the con­
version of such notes; the potential for large shifts in
commercial leads and lags was curtailed by shortening
the periods in which export proceeds had to be re­
patriated or for which imports could be prepaid; and
official entities were encouraged to meet their capital
needs by borrowing abroad. By the summer these mea­
sures were beginning to show results. At the same time
the strike situation improved and Italian production be­
gan to show signs of picking up once again. Moreover,
early August saw the installation of a new government,
headed by former Finance Minister Colombo. As the new
government’s programs began to be formulated in midAugust, market confidence began to recover from the ex­




55

tremely pessimistic state it had reached, in which immi­
nent devaluation of the lira was widely expected, and
there was some covering of short positions as well as
some unwinding of leads and lags. Late in the month the
government announced its new fiscal program— including
a hike in gasoline prices, higher excise taxes, and several
measures designed to shift resources from the private to
the public sector and to encourage investment. The spot
rate then rose above par, for the first time in a year and a
half, and the Italian authorities began to accumulate dol­
lars from the market. The rally faltered temporarily in the
first half of September, but the recovery regained mo­
mentum by midmonth and, with market sentiment becom­
ing very buoyant, the lira moved well over par again.
Demand for lire strengthened further in October and
early November. The unwinding of leads and lags was in
full swing. Italian banks, for their part, had to follow
the rule imposed by the central bank to balance their
foreign positions, so that there was a substantial inflow
of funds deriving from the elimination of previous sur­
pluses, while at the same time investment possibilities
at home were becoming increasingly attractive. Further­
more, Italian corporations and official entities resumed
making substantial longer term borrowings abroad. In
mid-November, however, a softer tone developed in the
market as the government’s efforts to enact tax measures
and to resolve other political issues, such as the divorce
question, reached a crucial stage in Parliament. The par­
liamentary deadlock was broken at the end of November
and this again improved market atmosphere, but rising
Euro-dollar rates depressed the lira a bit further until
mid-December. When Euro-dollar rates resumed their
decline in late December, however, the demand for the
lira picked up again and the rate ended the year on a
strong note. From the end of July through December,
Italian reserve gains amounted to $1.1 billion, after a
net loss of $0.9 billion in the earlier months of the year.
The winter months are a seasonally slack period for the
Italian balance of payments, but as 1971 began interest
rates in Italy remained relatively high and Italian firms
continued to be heavy borrowers in the Euro-dollar m ar­
ket. The resultant strength of the lira enabled the author­
ities on January 7 to restore the time in which export
earnings must be repatriated to 360 days from the date of
shipment. Shortly thereafter the Bank of Italy, con­
tinuing with the easier policy inaugurated in October
through changes in regulations concerning the composition
of compulsory reserves, took another small step in the
same direction of easing monetary restraint by reducing
its rate on secured advances by V2 percentage point to
5 percent effective January 11. The discount rate was kept

56

MONTHLY REVIEW, MARCH 1971

unchanged at 5 Vi percent, as were the additional penalties
of up to 1 Vi percentage points on borrowings by banks
making large and frequent use of central bank credit. Late
in January, when there was some slight firming of Euro­
dollar rates, the lira rate eased, but in February, with the
renewed decline of Euro-dollar rates, demand for lire
strengthened once again. The Italian authorities continued
to accumulate dollars from the market in January and
February and into March.

C h a rt V

C A N A D IA N DOLLAR
UNITED STATES CENTS PER C A N A D IA N D O L L A R *
M a y 1 9 7 0 to M a rc h 1971

I.

K
C A N A D IA N D O LLAR

Over the early months of 1970, the Canadian dollar
had been in heavy demand, reflecting a strong trade per­
formance, substantial long-term capital inflows, and
mounting short-term inflows that eventually included an
element of speculation over the possibility of a revaluation.
Canadian official foreign exchange reserves had risen
strongly— some $1.2 billion over the first five months—
and further large reserve increases seemed likely. Domes­
tically, this situation had threatened not only to create
massive excess liquidity in the Canadian economy, but
also to become a budgetary problem since the Canadian
dollars supplied to the market by the Bank of Canada
would eventually have to be financed out of general mar­
ket borrowings by the Canadian government. Against this
background, the Canadian government had announced on
May 31 that it would no longer defend the established
parity limits for the Canadian dollar, effectively setting
the rate free for the time being to seek its own level. As
related in the previous report, trading had been very ac­
tive in the first days of June, quieter later that month and
into July, with the rate settling above $ 0 .9 6 ^ , but then
more active through August as a wave of dem and pushed
the rate to around $ 0 .9 8 ^ (see Chart V ). The advance
mainly reflected the continuing strength of the trade bal­
ance and an inflow of short-term funds resulting from a
sharp squeeze for balances in Canada. Day-to-day rate
movements were fairly wide and the Bank of Canada in­
tervened on both sides of the market to avoid even wider
swings. On balance, however, the Canadian authorities
took in United States dollars as the rate tended to move
up.
On August 31 the Bank of Canada announced that, in
view of both external and domestic economic develop­
ments, it was cutting its discount rate by Vi percentage
point to 6 V2 percent. The spot rate dipped only slightly
for a few days, and it soon turned back upward once
again. Demand quickly snowballed, as traders who had
gone short of Canadian dollars in anticipation of some
eventual easing of the rate sought to cover their positions




H9

V **, v

,ll

r

I

H ig h

-I- A v e r a g e n o o n ra te s
'

92 l l

I

M ay

Low

•

A t e ffe c tiv e c e ilin g th ro u g h o u t th e w e e k

I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I 19 2
Jun

Jul

Aug
1970

Sep

O ct

Nov

D ec

Jan

Feb

M ar

1971

* New York o ffe re d rate$.

or, in some instances, to establish long positions; the spot
rate surged to $0.9969 by the morning of September 17.
The buying wave then broke, however, and the market
turned around. Sensing that the rate might have peaked,
many traders hastened to cover themselves against a fur­
ther drop in the rate, thereby sharpening its fall. By the
morning of the next day, the spot rate had tumbled a full
cent to $0.9869. Shortly thereafter, on September 22,
Finance Minister Benson said in his speech at the IM F
meeting in Copenhagen that the current quite exceptional
strength in Canada’s payments position did not provide
a good basis for the choice of a rate that would be viable
for an appreciable period. The spot rate then dropped
further, dipping below $0.98 before leveling off.
From late September to mid-December the Canadian
dollar market, although fairly active, was well balanced
and, except for occasional flurries, day-to-day rate move­
ments were more moderate; the spot rate held within a
fairly broad range around $0.98. With international and
domestic interest rates declining, the Bank of Canada cut

FEDERAL RESERVE BANK OF NEW YORK

its discount rate by V2 percent to 6 percent on November
12, but the market took this move in stride. Normally, De­
cember is a weak month for the Canadian dollar, with
heavy dividend and interest payments to foreigners, and
many professional traders had established short positions
on the expectation of a fall in the rate. Nevertheless, in
mid-December, good commercial demand appeared in the
market and figures were released indicating continued
strength in Canada’s trade balance and in the overall
payments position. With heavy bidding leading to an acute
squeeze for Canadian dollar balances, the spot rate broke
out of its previous pattern and was on an upswing at the
year-end. On January 6, the rate hit $0.9912. Once again,
the market turned quite suddenly when the squeeze for
balances ended, and the spot rate dropped precipitously,
reaching $0.9844 by the morning of January 8. The rate
then firmed until midmonth but held below $0.99.
With interest rates falling sharply in the United States

through most of January and February, there was a wid­
ening of arbitrage incentives for funds to flow into Can­
ada; at the same time, the decline in Euro-dollar rates
may have led to some repatriation of previous outflows to
that market from Canada. These factors, in addition to
continued strong commercial demand for Canadian dol­
lars, helped lift the spot rate above $0.99 once again on
January 26. It held quietly just above that level until midFebruary. Despite a % percent cut in the Bank of Can­
ada’s discount rate, effective February 15, a new surge
of demand developed and pushed the price even higher,
to a peak of $0.9979 on February 22. A t that point the
Bank of Canada lowered its discount rate by V2 percent­
age point to 5 % percent, and major Canadian commercial
banks reduced their prime rates. This easing of interest
rates was immediately followed by a drop in the Canadian
dollar spot rate to just above $0.99% , but in early M arch
it moved up once again.

Fifty-sixth Annual Report
The Federal Reserve Bank of New York has published its fifty-sixth Annual Report, review­
ing the major economic and financial developments of 1970.
The Report observed that “the attempt to bring inflation under some measure of control
rem ained a major objective of monetary policy in 1970, although rising unemployment and in­
creasing economic slack emerged early in the year as an additional major problem facing policy
makers”. Moderate growth in the monetary and credit aggregates was an underlying aim of mon­
etary policy throughout 1970, the Report states, but it notes that this goal “took second place
in the spring and early summer to concern over tensions in the financial markets, reflecting the
basic responsibility of a central bank to ensure the orderly functioning of these markets and to
serve as lender of last resort”.
In his letter presenting the Report, Alfred Hayes, President of the Bank, said that “the
easing of credit conditions at home imposed a heavy new burden on our international payments
position”, and he expressed the view that “our international payments problems will require close
official attention in 1971” . He further declared that “we must not abandon the battle against
inflation, but neither can we ignore the problem of unemployment. Ways must be found to break
the circular process of wage and price escalation, while at the same time encouraging a resump­
tion of sound economic growth.”
The Annual Report may be requested from the Public Information Department, Federal R e­
serve Bank of New York, 33 Liberty Street, New York, N.Y. 10045. A copy is being mailed to
Monthly Review subscribers.




57

58

MONTHLY REVIEW, MARCH 1971

The Business Situation
In the opening months of 1971 many business indica­
tors have moved upward, as stepped-up activity in the
automobile industry was reflected in higher levels of pro­
duction, income, orders, and sales. However, since much
— but not all— of these gains in economic activity are
strike related, there has as yet been little evidence of a
significant underlying strengthening in the economy. In
fact, in January, industrial production and manufacturing
payroll employment were below the levels that had pre­
vailed at the outset of the General Motors strike. In part,
this is a reflection of the relatively slow pace at which
automobile production has been resumed after the work
stoppage. While interpretation of recent inventory data is
complicated by the strike and its aftermath, the most re­
cent information suggests that stocks in some sectors are
a bit on the high side in relation to sales quite apart from
any strike-induced distortions. The likelihood of substan­
tial stockpiling of steel mill products in anticipation of a
midsummer steel strike will probably push inventories
higher in the coming months.
The behavior of wages continues to be inflationary.
During the fourth quarter of 1970 and for the year as a
whole, compensation per man-hour in the private economy
rose at a rate only a trifle below the rapid expansion ex­
perienced in the preceding year. The value of newly nego­
tiated wage settlements continues to surge ahead at an
essentially unabated rate, providing wage increases far in
excess of any conceivable long-run gains in productivity.
Moreover, the magnitude of the wage gains embodied in
these contracts may be understated, since the contracts
frequently provide cost-of-living adjustments which are
not fully reflected in the reported data. Recent price de­
velopments have been somewhat mixed, in part because of
volatile movements in the agricultural and food components
of both the consumer and wholesale price indexes. How­
ever, in January the rate of increase in nonfood commodity
prices moderated at the consumer level, and preliminary
data for February suggest a slowing of wholesale indus­
trial prices. While both of these developments are encour­
aging, one- or two-month slowdowns in these price indexes
have materialized in the past only to be quickly reversed.




PR O D U C T IO N , S H IP M E N T S , A N D IN V E N T O R IE S

The Federal Reserve Board’s index of industrial pro­
duction increased in January for the second consecutive
month. The index rose by 0.7 percent on a seasonally
adjusted basis, with higher output of automobiles and steel
accounting for all of the gain. A t a level of 165.1 percent
of the 1957-59 base, the index in January was about 2
percent below its position last August— the month prior to
the GM strike— and was about 5.4 percent below the peak
attained in July 1969 (see Chart I) . The failure of the
index to regain its pre-strike level in January suggests that
the fourth-quarter slump in business activity extended
beyond the depressing influence of the automotive strike.
In part, this development is also attributable to the rela­
tively slow pace at which automobile output has been
resumed following the termination of the strike. For
example, January automobile production ran at a season­
ally adjusted annual rate of 8.3 million units, about 0.2
million units below the production rates recorded in July
and August of 1970, thus suggesting little or no catch-up
production as of that point. Production data for February,
however, indicate that automobile output reached about 9
million units, the largest volume since m id-1969.
Aside from the upward movement in production stem­
ming from higher automobile output— and the partially re­
lated gain in steel production— industrial activity showed
little change in January (see Chart I ) . In fact, the total pro­
duction index excluding the steel and automotive com­
ponents posted a small decline on a seasonally adjusted
basis. Once again, a factor in this turn of events was a
further drop in the production of equipment.
In January, manufacturers’ sales posted a relatively
large gain of $1.1 billion following an impressive rise in
December that has been revised upward to $1.8 billion.
Much, but not all, of this recent strength reflects higher
levels of activity in the motor vehicles and parts industry
group which, of course, is a result of strike-recovery ac­
tivity. However, the January data in particular suggest
that the rise in sales was not confined to the automobile
and related industries. For example, shipments at manu-

FEDERAL RESERVE BANK OF NEW YORK

59

the durables industries excluding autos and steel were
about 1 V2 percent above the fourth-quarter average, with
the gain spread out among several industry groupings. On
balance, the orders situation in January appears to have
improved somewhat from recent experience.
R E S ID E N T IA L C O N S T R U C T IO N A C T IV IT Y

facturers’ durables exclusive of motor vehicles and parts
rose by $0.4 billion, and sales by nondurables firms rose
by $0.3 billion. Despite these gains, however, January
sales at durables manufacturers excluding the auto group
were still below the volume which prevailed in the AugustSeptember period of last year.
Concurrent with the fairly large gain of $1.1 billion in
total manufacturers’ sales, inventories fell by $0.4 billion
in January. Thus, the inventory-sales ratio for all manu­
facturers dropped to 1.74, about the level which prevailed
prior to the auto strike. Much of the decline in inventories
reflected a $0.3 billion runoff in stocks at durables manu­
facturers exclusive of automobile and parts. Accordingly,
the inventory-sales ratio for these firms declined from its
very high fourth-quarter level. Nevertheless, at 2.30, this
ratio is still on the high side by comparison with the ex­
perience of the last year and a half.
In January, new orders for durable goods rose by about
$1.2 billion, a gain of about 4 percent from the December
level. Much of this increase in orders reflected higher
bookings for automobiles and steel mill products. Exclud­
ing autos and steel, durables orders rose by $0.5 billion
or by about 2 percent. At their January levels, orders in




In January the number of new private housing starts
fell by about 16 percent from the December seasonally
adjusted rate of 2.0 million units annually. However, at
1.7 million units, January starts were still 17 percent
above the average level recorded in 1970. There are rea­
sons to believe that the December figure and thus the
January decline were exaggerated by special factors. For
example, on a nonseasonally adjusted basis, 54 percent
of the December starts were financed by the Federal Hous­
ing Administration, up from 28 percent a year earlier.
Thus, it may be that the early-December reduction in the
FHA mortgage rate caused a one-shot surge in starts. The
fact that the fraction of FHA-financed starts dropped back
to a more normal 30 percent in January lends credence
to this view. There is also the possibility that the recent
volatility in housing starts has been exaggerated by sea­
sonal adjustment problems since the seasonal factors for
construction activity are always tenuous in the winter
months. Along with the fall in housing starts, building
permits also declined from their December high. How­
ever, here too, the January level of permits was a full 20
percent above the average number of permits issued in
1970 as a whole. In short, indications remain strong that
the residential construction sector will be a source of con­
siderable economic strength in 1971.
PERSONAL

IN C O M E A N D C O N S U M E R D E M A N D

Personal income posted a relatively large gain of $7.9
billion at a seasonally adjusted annual rate in January.
While part of this increase can be traced to special factors,
the rise in income exclusive of these nonrecurring elements
was about $2 billion more than the average monthly in­
crement in total personal income recorded in 1970. The
major factor accounting for the January strength was a
$6.8 billion increase in wage and salary disbursements,
part of which was attributable to higher payroll employ­
ment in January. About a $2.2 billion salary boost for
Federal Government employees also contributed to the
rise in wage and salary payments. Partly offsetting these
gains was a $1.8 billion increase in employee social se­
curity tax payments, which are treated as a reduction in
personal income. With the exception of dividend payments,

MONTHLY REVIEW, MARCH 1971

60

which posted a large $1.8 billion rise, the other compo­
nents of personal income showed little change. The January
gain in dividends was simply a reflection of the fact that
the December level of these payments was unusually low
because of the failure of a number of companies to pay
customary year-end extra dividends.
On the basis of advance information, retail sales posted
a 1.1 percent gain in January. This increase followed a
rise of almost 1 percent in retail volume in December. In
both months, higher sales of durable goods accounted for
virtually all of the increment in total retail activity. In turn,
stepped-up automobile sales have been a major factor in
the recent strengthening of durables purchases. Never­
theless, at their January level, retail durables sales were
still below the volume that prevailed in September, the
last month in which these data were reasonably free of
strike-induced distortions. This would suggest that con­
sumer spending decisions are still being tempered by higher
prices, high unemployment, and general economic un­
certainties.
L A B O R C O S T S , P R O D U C T IV IT Y , A N D P R IC E S

The fourth-quarter data on compensation per manhour, productivity, and unit labor costs were severely dis­
torted by the effects of the GM strike. However, even al­
lowing for this factor, the evidence remains strong that
rising wage costs have shown little reaction to the marked
increase in unemployment which emerged during 1970.
During the final three months of last year, compensation
per man-hour in the private economy rose at a seasonally
adjusted annual rate of about 6.4 percent, down from the
7.5 percent increase registered in the previous quarter.
However, indications are that most— if not all— of this
slowing reflected a shift in the composition of employ­
ment away from the high-wage industries, which were most
affected by the automobile strike, and the concurrent fall
in overtime hours worked. For 1970 as a whole, the rise
in compensation per man-hour equaled 6.6 percent, only
slightly below the 1969 gain of about 7 percent. Consider­
ing the reduction in expensive overtime hours in 1970
and— even more importantly— the rise in unemployment,
this rather slight moderation in the increase in compensa­
tion per man-hour is certainly a disappointing develop­
ment. By way of contrast, in the other post-Korean war
periods of declining economic activity the rate of gain in
compensation per man-hour moved decisively lower as the
economy slowed.
In the fourth quarter, the rise in compensation exceeded
by a wide margin the gain in output per man-hour, so that
unit labor costs rose at an annual rate of about 5.7




percent. The acceleration in unit labor costs in the
October-December period reflected the sluggish growth of
productivity in the period. This development was mainly
attributable to a pronounced decline in output per manhour occurring in the manufacturing sector, which in turn
was largely the result of the automotive strike. In con­
trast, during each of the two preceding quarters produc­
tivity in the private economy had posted relatively large
increases which had yielded some moderation in the rise
in unit labor costs. A resumption of a more normal
growth of output per man-hour should tend to dampen
the impact of rising compensation per man-hour relative
to the experience of the fourth quarter. However, even
allowing for this eventuality, rapidly rising wage rates are
continuing to place severe pressures on the price level.
One factor contributing to the strong upward thrust in
wages in 1970 has been the breakneck pace of newly
negotiated wage contract settlements (see Chart II).
During the four quarters ended in December 1970, the
mean increase in wages and fringe benefits in newly nego­
tiated contracts covering 5,000 or more workers was 9.1
percent over the life of the contracts, most of which ex­
tend for three years. This contrasts with gains of 8.2 per­
cent and 6.5 percent in 1969 and 1968, respectively.
During 1970, the first-year adjustments in these contracts

C h a rt II

M A JO R LABOR CONTRACT SETTLEMENTS
M e a n p e rc e n t
per annum

W A G E S * N D BENEFITS

M ean p . „
p er a n n u m

14

12

10

8

6

4

2

0
Source:

U nited States D epartm ent of Labor, Bureau of Lab or Statistics.

FEDERAL RESERVE BANK OF NEW YORK

amounted to an astounding 13.2 percent. While huge
contract settlements have been negotiated in virtually all
sectors of the economy, the problem was most severe in
the construction industry. For the year ended in December
1970, new contract settlements in the construction sector
have resulted in a mean first-year increase in wages ex­
cluding fringe benefits of 18.3 percent, while over the life
of the contract the rise has amounted to 14.7 percent.
While major contract settlements directly affect the wages
of only a relatively small share of the work force, the pub­
licity surrounding them is such that their implications far
transcend the number of workers involved. Certainly, one
necessary step toward significant and permanent progress
in the battle against inflation is a scaling-down of the pace
of new collective bargaining settlements.
On the price front, the most recent data provide some
very tentative signs of an improvement in the underlying
inflationary situation. According to preliminary figures—
which are sometimes subject to large revisions— the index
of industrial wholesale prices increased at a seasonally
adjusted annual rate of 1.6 percent in February, about half
the rate of gain registered in the past eight months (see
Chart 111). While industrial prices were moderating, a
sharp rise in the index for farm products, processed foods,
and feeds resulted in a very rapid 7.6 percent rate of in­
crease in the overall wholesale price index. The accelera­
tion of wholesale agricultural prices was in part attributable
to bad weather in the Midwest, which curtailed shipments
of livestock.
At the consumer level, January price developments
were also somewhat encouraging. The overall consumer
price index advanced at a seasonally adjusted rate of 3.4




61

C h a rt III

WHOLESALE PRICE CHANGES
S easo n a lly a d ju s te d a n n u a l rates

H H 1967

|

• I 1968

H H 1969

( I ^ j | D e c 6 9 .J u n 7 0 H

Jun 7 0 -F e b 71 *

* February 1971 data prelim inary.
Source: United States D epartm ent o f Labor, Bureau of Labor Statistics.

percent, significantly below the 4.9 percent gain experi­
enced over the second half of 1970. Unchanged food prices
accounted for part of this improvement. Indeed, during
the past year, moderating food prices have held down the
overall increase in consumer prices. In January, however,
nonfood commodity prices moderated considerably from
recent experience, rising at a seasonally adjusted annual
rate of only 2.1 percent. While this development is cer­
tainly welcome, it should be emphasized that, over the past
two years, one- or two-month slowdowns in this price
measure have been quickly reversed.

62

MONTHLY REVIEW, MARCH 1971

The Money and Bond Markets in February
Short-term and long-term interest rates moved in oppo­
site directions during February. Short-term rates continued
to fall sharply, in some cases to the lowest levels seen since
1964. In response to declines in other short-term rates,
the Federal Reserve discount rate was also reduced by Va
percentage point to 4% percent. This marked the fifth
such reduction in the discount rate since the beginning
of November.
In contrast to short-term rates, yields rose in the capital
markets during February. The deterioration in the market
atmosphere was especially pronounced in the corporate
bond sector, where the calendar of prospective offerings
mounted steeply. Yields on new Aa-rated utilities in­
creased by about 70 basis points over the month. The rise
in municipal bond yields was somewhat less pronounced.
The Weekly Bond Buyer's twenty-bond index rose to 5.34
percent at the end of February, up 18 basis points from
four weeks earlier but 29 basis points above the two-year
low reached early in February. Yields on most long-term
Treasury bonds increased by 15 to 22 basis points over
the month.
The monetary and credit aggregates rose sharply in
February (see Chart I). For example, the narrowly defined
money supply— demand deposits and currency held by the
public— grew at a rapid seasonally adjusted annual rate
of about 12 percent. Over the three months ended in
February, the annual growth rate of the money supply
averaged about 6 V2 percent. In comparison, during all of
1970 the money supply increased by 5.4 percent. The
adjusted bank credit proxy1 rose at a seasonally adjusted
annual rate of about 13 percent in February and 13 Vi
percent over the three months ended in February. During
all of 1970, the adjusted bank credit proxy expanded by
8.3 percent.

THE M ONEY M ARKET

Money market conditions continued to ease in February,
as System open market operations provided a sizable vol­
ume of reserves. The average effective rate on Federal
funds fell to 3.72 percent in February, down 42 basis
points from January’s average and the lowest monthly
average since November 1964. Yields on all other money
market instruments also fell substantially (see Chart II ).
The offering rate on dealer-placed four- to six-month prime

CREDIT A N D MONETARY AGGREGATES
S e a s o n a lly a d ju s te d w e e k ly a v e ra g e s
O c to b e r 1 9 7 0 - F e b ru a r y 1971
llio n s o f d o lla rs
_ R a tio scale
_

220

!
M o n e y s u p p ly
-

I , i 1 ! i i

j

^
] 1 1 ! 1 1 LI

i
M i l

_

320

-_

n "
r

244

R a tio scale

Ti me d e p o s its *

_

:

<TTj
7

14 21 28

O c to b e r

i
4

i
i
11 18 25

N ovem ber

2

9

16 23 3 0

D ecem ber

!
6

1 1 1
13 2 0 27

J a n u a ry

i

i

3

10

i
17 24

F e b ru a ry

Note: D ata for F e b ru ary are prelim inary.
* Tot al m e m b e r b a n k d e p o s i t s s u b j e c t to r e s e rv e r e q u i r e m e n t s p l u s n o n d e p o s i t
l i a b i l i t i e s , i n c l u d i n g Eu ro d o l l a r b o r r o w i n g s a n d c o m m e r c i a l p a p e r i s s u e d by

1 A measure of bank liabilities, which includes deposits subject
to reserve requirements and nondeposit items such as Euro-dollar
liabilities and bank-related commercial paper.




ba n k ho ld in g c om p an ie s or other affiliates.
t A t al l c o m m e r c i a l b a n k s .

63

FEDERAL RESERVE BANK OF NEW YORK

C h a rt II

SELECTED INTEREST RATES
M O N E Y M ARKET RATES

D ecem ber

J a n u a ry

D e c e m b e r 1 9 7 0 - F e b r u a r y 1971

F e b ru a ry

D ecem ber

B O N D M A R K E T YIELDS

J a n u a ry

P e rc e n t

F e b ru a ry

N ote.- D a ta a r e s h o w n fo r b u s in e s s d a y s o n ly .
M O N E Y M A R K E T RATES Q U O T E D : B id r a te s fo r th re e - m o n th E u r o - d o lla r s in L o n d o n ; o f fe r in g

d a ily a v e r a g e s o f y ie ld s o n s e a s o n e d A a a - r a t e d c o r p o r a t e b o n d s ; d a ily a v e r a g e s o f

ra te s fo r d i r e c tly p la c e d fin a n c e c o m p a n y pap_er; th e e f fe c t iv e r a te o n Fe d e r a l fu n d s (the

y ie ld s o n lo n g - te r m G o v e r n m e n t s e c u ritie s ( b o n d s d u e o r c a l la b le in te n y e a r s o r m ore)

r a te m o s t r e p r e s e n ta t iv e o f th e tr a n s a c t io n s e x e c u t e d ) ; c lo s in g b id r a te s ( q u o te d in te rm s

a n d o n G o v e r n m e n t s e c u r itie s d u e in th re e to fiv e y e a r s , c o m p u te d o n th e b a s is o f c lo s in g

o f r a te o f d is c o u n t) o n n e w e s t o u ts ta n d in g t h r e e - m o n th a n d o n e - y e a r T r e a s u r y b i lls .

b id p r ic e s ; T h u rs d a y a v e r a g e s o f y ie ld s o n tw e n ty s e a s o n e d t w e n ty - y e a r ta x - e x e m p t b o n d s

B O N D M A R K E T YIELDS Q U O T E D : Y ie ld s o n n e w A a a - a n d A a - r a t e d p u b lic u t ilit y b o n d s
(a r ro w s p o in t fr o m u n d e r w r it i n g s y n d ic a te r e o ffe r in g y ie ld o n a g iv e n

is s u e to m a r k e t

y ie ld on th e s a m e is s u e im m e d ia te ly a f t e r it h a s b e e n r e le a s e d fr o m s y n d ic a te r e s tr ic tio n s ) ;

commercial paper fell to 4 V\ percent, down 3 percentage
/s
point from the end of January. Likewise, interest rates on
directly placed commercial paper and bankers’ acceptances
moved appreciably lower during the month, and some ma­
jor banks trimmed as much as Vi percentage point off the
rates they were willing to pay on negotiable certificates of
deposit (CD’s). As short-term market interest rates con­
tinued to post steep declines, the twelve Federal Reserve
Banks reduced the discount rate from 5 percent to 4%
percent. This was the fifth Va point reduction in the dis­
count rate in three months.
Reflecting the general ease of conditions in the money
market, the prime rate was cut by % percentage point in
February to 53 percent. This was the latest in a series of
A
nine reductions that began in March 1970, when the prime




( c a r r y in g M o o d y 's r a tin g s o f A a a , A a , A , a n d B a a ).
S o u rc e s : F e d e r a l R e s e rv e B a n k o f N e w Y o rk , B o a r d o f G o v e r n o r s o f th e F e d e r a l R e s e rv e S y s te m ,
M o o d y ’ s In v e s to r s S e rv ic e , a n d T he W e e k ly B o n d B u y e r .

rate stood at 8 V2 percent. Despite these reductions, com­
mercial bank business loans had been quite weak during
the last quarter of 1970. Modest growth resulted in Janu­
ary, however, and picked up further in February.
Member bank borrowings from the Federal Reserve
Banks averaged $336 million during the four weeks ended
February 24 (see Table I) , $34 million below the Janu­
ary average. The decline would have been greater but for
a bulge in member bank borrowings that occurred in the
third statement week. Banks in some states— including
those in New York— were closed for four consecutive days
during this week, which was the longest bank holiday since
the compulsory closing of banks in 1933. The extended
holiday weekend complicated commercial banks’ estima­
tion of their reserves and compounded the difficulties of

MONTHLY REVIEW, MARCH 1971

61

Table 1
FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, FEBRUARY 1971
In m illio n s o f d o lla rs ; ( + ) d e n o te s in c re a se
( — ) d e c re a se in excess re se rv e s

Changes in daily averages—
week ended

Net
changes

Factors
Feb.

Feb.

10

3

Feb.

17

Feb.

24

“ M arket” factors
Member bank required reserves-----Operating transactions (subtotal) .
Federal Reserve float ..................
Treasury operations* ....................
Gold and foreign account ..........
Currency outside banks ..............
Other Federal Reserve liabilities
and capital ....................................

+ 3

-f
+
+
—
—
—

— 135

— 37 4-

+ 168
— 229
— 402
- f 289
+

16

Total “market” factors ..........

167
17
543
256
4
229

4- 184

— 358 4- 340
— 976 4-1,004
— 554 4- 839
— 50 4- 418
—
10 42
— 108

4- 317
— 184
4- 426
4- 401

4

+
— 911

215 — 146

— 103

-1,334 4-1,344

4- 133

Direct Federal Reserve credit
transactions
Open market operations (subtotal)
Outright holdings:
Government securities ..............
Bankers’ acceptances ..............
Repurchase agreements:
Government securities ..............
Bankers’ acceptances ..............
Federal agency obligations
Member bank borrowings ..............
Other Federal Reserve assets!
Total

........

Excess reserves

+
—

4- 471

4-1,209

79
26

—

61 + 439 —
1— 5 +

—

2

—

+

87

—
—

1

110

+ H

9

12

+ 643 — 509
+
47
16 4- 85
3 4- 317 — 315
6
20 — 118 — 369

+ 6

—

+ 8

4-

+

— 216 4-1,408

—

71

16

— 45

—

+

4- 343
— 7

+ 111
4- 17

+ 7
— 105
— 459
— 93

4-

43

4- 40

Monthly
averages

Daily average levels

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

29,959
29,722
237
283
— 46
29,676
120

2!),760 30,192
2!i,r>r>5 29,913
205
279
247
564
— 42 — 285
29,513 29,02S
101
142

29,895
29,573
322
249
73
29,646
129

29,952
29,091
261
336
— 75
29,616
123

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.
t Average for four weeks ended February 24.
§ Not reflected in data above.

System reserve management. As a result, when the holiday
ended on Tuesday, February 16, commercial banks found
themselves extremely short of reserves with only two days
to cover their reserve deficiencies. Although the System




injected massive amounts of funds to alleviate this short­
age, operating factors during the statement week— includ­
ing a drop of $554 million in Federal Reserve float and
an increase of $577 million in currency outside banks—
absorbed a large volume of reserves. Consequently, the
Federal funds rate rose sharply and banks borrowed heav­
ily from the System on Tuesday and Wednesday, bringing
the average level of member bank borrowings to $564
million for the week.
Turning to the monetary aggregates, the narrowly de­
fined money supply expanded in February at a rapid
seasonally adjusted annual rate of about 12 percent,
according to preliminary data. This rise follows gains of
6.2 percent in December and only 1.1 percent (revised)
in January. As was the case over this most recent threemonth interval, this aggregate often displays wide short­
term fluctuations. However, since the short-term fluctua­
tions generally arise from technical distortions of one type
or another, it is usually more useful and relevant to look
at growth rates extending over at least several months.
In this vein, over the three months ended in February,
the narrow money supply expanded at a seasonally ad­
justed annual rate of about 6 V2 percent, compared with
the 5.4 percent growth recorded over 1970 as a whole.
The adjusted bank credit proxy rose at an annual rate of
about 13 percent in February and 13 Vi percent over the
three months ended in February. Most of the growth of
the credit proxy in February was in time and savings
deposits other than large negotiable CD’s. The latter rose
by only $281 million (not seasonally adjusted) in Febru­
ary, following increases averaging $2.0 billion over the
seven previous months. Bank-related commercial paper
continued to trickle off, falling by $129 million to a level
of $1.9 billion by the end of February, and liabilities to
foreign branches were reduced by $875 million to $5.8
billion. (These data are not seasonally adjusted.)
TH E G O V E R N M E N T SE C U R IT IE S M A R K E T

Yield trends were mixed in the market for Government
securities during February. Yields on Treasury bills and
intermediate-term coupon issues continued their steep
decline which began in early 1970. However, investor en­
thusiasm in the long-term Treasury bond market dam­
pened, and yields on most securities rose by 15 to 22 basis
points over the month.
The upward drift in long-term Treasury bond yields
during February reflected principally the weak climate
in the corporate bond market, which diminished expecta­
tions of further declines in long-term interest rates. A
longer run factor was the February 18 approval by the

FEDERAL RESERVE BANK OF NEW YORK

House Ways and Means Committee of a proposal to per­
mit the Treasury to sell a total of $10 billion of long-term
bonds at rates above the statutory 4 V4 percent ceiling rate
established in 1918. Because long-term market rates have
been higher than the ceiling, the Treasury has been unable
to sell securities with maturities longer than seven years
since 1965. (The statutory ceiling rate does not apply to
Treasury notes, which range up to a maturity of seven
years.) Consequently, only $17.7 billion of privately held2
Federal debt outstanding represents bonds of longer than
seven years’ maturity, compared with $44.9 billion in mid1965. Prospects that the Congress might approve of the
Committee’s action generated mild market concern. On
the other hand, many market participants expected that
passage of the legislation would facilitate judicious exten­
sion of the Treasury’s debt and contribute to improved
investor interest in long-term Government securities.
Although the rally of recent months faltered in the long­
term market, a firm tone prevailed in February in the
market for bills and intermediate-term Treasury issues.
Yields on intermediate-term notes declined 36 to 60 basis
points below their January lows for most issues, and
bill rates generally declined by a net of 65 to 80 basis
points. Market participants were encouraged early in the
month by reports of Federal Reserve System repurchase
agreements at a rate Vi percentage point below the dis­
count rate. This served to increase expectations of a reduc­
tion in both the Federal Reserve discount rate and the
commercial bank prime rate.
Some market disappointment was felt when the X
A
percentage point cut in these two rates was less than some
observers had anticipated. However, large Federal Reserve
System purchases, including coupon-bearing securities,
and the Federal Home Loan Banks’ decision not to refi­
nance $600 million of its maturing issues more than
offset any adverse effect on prices. Some brief market
hesitation occurred in the bill market during the second
week of the month, when the Treasury announced the of­
fering of a $ 1.2 billion strip of bills consisting of six $200
million additions to outstanding weekly issues due from
May 27 to July 1. When auctioned on February 18, the
new strip of bills was aggressively bid for by commercial
banks, which could pay for the bills through credit to
Treasury Tax and Loan Accounts. Thereafter, the down­
ward trend in yields continued and sizable buying interest

65
Table II

AVERAGE ISSUING RATES*
AT REGULAR TREASURY BILL AUCTIONS
I n p e rc e n t

Weekly auction dates— February 1971
Maturities
Feb.
1

Feb.
11

Feb.
22

4.110
4.114

Three-month
Six-month ..

Feb.
8
3.845
3.839

3.640
3.679

3.497
3.590

Monthly auctions— December 1970-February 1971
Dec.
23
Nine-month ..........................................

Jan.
26

Feb.
23

4.949
4.886

4.268
4.248

3.691
3.675

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.

developed in the weekly bill auctions. The average issuing
rate on the one-year bill plummeted to 3.675 percent in
the monthly auction on February 23 (see Table II). This
was over 57 basis points below the rate set in the auc­
tion of four weeks earlier and the lowest such yield since
July 1964.
O TH ER SE C U R IT IE S M A R K E T S

The record-setting seven-month rally in the corporate
and municipal bond markets halted in February, as inves­
tors grew increasingly apprehensive over the mounting
volume of new and planned corporate offerings. The final
week’s total of $863 million was the largest weekly amount
of corporate bonds issued in over two months. The
projected $3.2 billion schedule of public offerings for
March is a record monthly volume and is substantially
above the monthly average of $2.1 billion in 1970. In­
cluded in the schedule for M arch is a large volume of
securities of commercial banks and bank affiliates. This is
the first time since 1965 that banks have borrowed so
heavily in the capital market. It weighed heavily on m ar­
ket attitudes, since some investors took it to mean that
many bankers did not expect further declines in long­
term interest rates in the near future.
The pressure of this increasing supply pushed the yield
on newly issued prime corporate bonds up 70 basis points
over the month, nearly retracing the full percentage point
2 Other than those of the Federal Reserve Banks and United
decline recorded for February. The rise on newly issued
States Government investment accounts.




MONTHLY REVIEW, MARCH 1971

66

municipals was more moderate, and The Weekly Bond
Buyer's twenty-bond index of municipal bond yields closed
the month at 5.34 percent, 18 basis points above its level
at the end of January.
Investor enthusiasm in the corporate bond market
showed signs of receding late in January when a $200
million Southwestern Bell issue, priced to yield 6.80 per­
cent, remained largely unsold at the close of the month.
During the first week of February, new offerings of bonds
continued to sell slowly as investors waited to see what
terms would be set on the giant $500 million American
Telephone and Telegraph Company issue. On February 9,
the thirty-year AT&T bond issue reached the market,
priced to yield 7.06 percent. The entire issue was very
well received and quickly sold, sparking new sales of
previously slow-moving issues still in syndicate hands. On
the same day, a $36 million Aa-rated thirty-year firstmortgage bond issue of the Central Power and Light
Company was offered to the public at a yield of 6.95
percent. This was the lowest yield offered on new highgrade electric utility bonds since January 1969 and 2.45
percentage points less than the record 9.40 return on sim­
ilarly rated bonds in June 1970. However, the Central
Power and Light Company bond issue was priced too
aggressively to suit most investors. A pessimistic atmo­
sphere began to pervade the bond market, and this bond

issue was finally permitted to trade at an unrestricted
price on February 16, lifting its yield to 7.26 percent.
Several other corporate issues— including the $200 million
of Southwestern Bell debentures first offered on January
26— were also freed from syndicate price restrictions in
the middle of February, resulting in upward yield adjust­
ments by as much as 33 basis points. Toward the close of
the month the rise in yields on new issues accelerated, as
underwriters probed for yield levels that would stimulate
investor interest. Such a level seemed to be found near the
end of the month, when two Aa-rated utility issues were
marketed successfully at a yield of 7.87 percent.
A somewhat similar pattern characterized the munici­
pal bond market. The downturn in prices of municipal
bonds began late in January and continued through the
first week of February. Syndicates were able to move large
unsold balances of municipal offerings only by raising
yields by as much as 50 basis points, while new issues
attracted selective attention. Although the successful m ar­
keting of AT&T debentures sparked a brief recovery in the
second week of February, investor enthusiasm again
weakened and syndicate inventories began to accumulate.
The Blue List of advertised dealer inventories climbed to
$950 million on February 19, up from $700 million on
February 10, prompting dealers to make further cuts on
their asking prices during the remainder of the month.

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