Full text of Economic Policy Review (Federal Reserve Bank of New York) : March 1974, Vol. 56, No. 3

View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

MONTHLY REVIEW, MARCH 1974

Tre a su ry and Federal Reserve Foreign Exchange Operations*
By C h a r l e s A . C o o m b s

Over the six-month period, August 1973-January 1974,
covered by this report, the dollar recovered strongly from
the speculative attack that, during the first week of July,
had driven down the dollar against the major European
currencies to as much as 20 percent below official central
rates. This sharp depreciation of dollar rates was unwar
ranted by the improving United States external position
and threatened to magnify the impact of worldwide infla
tion on price levels here in this country. The speculative
wave was abruptly broken on July 9 as reports circulated
of an imminent resumption of exchange operations by the
Federal Reserve, backed up by a major enlargement of the
System’s reciprocal lines of credit with foreign central
banks. Subsequent Federal Reserve intervention in support
of the dollar during the rest of July totaled $273.4 million,
entirely financed by drawings on the swap lines with for
eign central banks.
These swap credits taken down by the Federal Reserve
during July were completely repaid by mid-August as
dollar rates moved up. From late August through October,
the exchange markets gradually settled down to more or
derly trading conditions, with much narrower fluctuations
in rates from day to day as well as during trading sessions.
In this improved atmosphere, the m arket also showed
greater resilience in absorbing the shocks of adverse poli
tical and economic news here and abroad. During this pe
riod, the Federal Reserve stood ready to intervene on nu

* This report, covering the period August 1973 through January
1974, is the twenty-fourth in a series of reports by the Senior Vice
President in charge of the Foreign Function of the Federal Reserve
Bank o f New York and Special Manager, System Open Market
Account. The Bank acts as agent for both the Treasury and Federal
Reserve System in the conduct o f foreign exchange operations.

merous occasions, but operations were required only
in five instances. These System operations, as detailed in
the interim report appearing in the December issue of this
Review, totaled $243.3 million, of which $238.9 million
was drawn under the swap lines and repaid by the end of
October 1973.
From November through late January, the dollar’s re
covery gained increasing momentum as evidence accu
mulated that the United States balance of payments was
moving decisively into surplus. As United States exports
soared, the trade account showed a dramatic turnaround,
registering a sequence of monthly surpluses. Heavy foreign
purchases of United States securities, foreign direct invest
ments in the United States, and repatriations by United
States companies of buoyant overseas earnings reinforced
the demand for dollars. Set against the weakening pay
ments positions of several major foreign countries, the
general improvement in the United States position gave
a strong boost to confidence in the dollar. As the oil crisis
suddenly erupted, cutbacks in oil supplies and the succes
sive steep price increases by the producing nations clearly
threatened to have far-reaching effects on industrial out
put and employment, price inflation, and the balance of
payments in the major industrialized countries. On each
of these counts, the market took the view that the United
States, far less dependent on imported oil than Europe and
Japan, could better cope with the damaging consequences
of supply restrictions and more readily absorb the pay
ments burden of costlier oil. A t the same time, it was
widely anticipated that a major share of the oil producers’
higher revenues would be attracted to dollar investments.
This favorable market assessment of United States pros
pects triggered a strong movement of short-term funds out
of the major European currencies and the Japanese yen
into dollars. Rising dollar rates were accelerated by a largescale unwinding of long-standing speculative positions in

FEDERAL RESERVE BANK OF NEW YORK

foreign currencies, and various foreign central banks sold
dollars from their reserves to moderate the declines of their
currencies. Nevertheless, by mid-January, the German
mark and Swiss franc had fallen by roughly 23 percent
against the dollar from their peak levels of early July
1973, while other major European currencies had also de
clined sharply. In late January, following the widespread
dismantling of capital restrictions here and abroad, dollar
rates topped off and a declining trend developed during
February.
With the dollar rising steadily on its own from Novem
ber through January, there was naturally no need for even
temporary support operations by the System. As foreign
currencies came on offer, however, both the Federal R e
serve and the United States Treasury were able to make
further progress in repaying foreign debt left outstanding
at the time of closure of the gold window in August 1971.
Beginning in August 1973, the Federal Reserve resumed
modest daily purchases of Belgian francs in the market to
repay swap drawings on the National Bank of Belgium
incurred prior to August 15, 1971. By the end of January
1974, $128.2 million of those drawings had been repaid,
leaving $261.8 million equivalent remaining (see Table II ).
In January 1974, the System also repaid through market
purchases $193.8 million of Swiss franc debt incurred
prior to August 15, 1971, thereby reducing the System’s
total Swiss franc debt to $971.2 million. As of January 31,

Chart I

SELECTED EX CHANGE RATES*

1973
1974
Percentage deviations of weekly averages of New York noon offered
rates from New York noon offered rates on January 2, 1973.

55
Table I

FEDERAL RESERVE RECIPROCAL CURRENCY ARRANG EM EN TS
In millions of dollars
Institution

Amount of facility
February 1, 1974

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

250

National Bank of B elg iu m ..........................................

1,000

Bank of C an ad a..............................................................

2,000

National Bank of D en m a rk ........................................

250

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

2,000

Bank of F ra n ce................................................................

2,000

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

2,000

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

3.000

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

2.000

Bank of M exico ..............................................................

180

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

500

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

250

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

300

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

1,400

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

600
1,250
18,980

therefore, System swap debt had been cut down to
$1,232.9 million, compared with the peak of $3,045 mil
lion outstanding on August 15, 1971.
The Treasury also took advantage of the strengthening
of the dollar to make net purchases during December 1973
and January 1974 of $186.5 million of German marks,
French francs, Belgian francs, and Japanese yen, of which
$132.9 million equivalent was subsequently used to pay
down United States Treasury debt to the International
Monetary Fund (IM F ) to an end-of-January total of $1.3
billion. In addition, in October 1973 the Treasury had re
paid at maturity the last of its German-mark-denominated
securities with marks purchased from the Bundesbank. As
a result, by end-January, the remaining Treasury mediumterm foreign currency debt, all denominated in Swiss
francs, totaled $1,587.9 million equivalent (see Table IV ).
Effective February 1, the swap line between the Bank
of Italy and the Federal Reserve was increased from $2
billion to $3 billion. In this connection, Chairman Bums
noted that increases in other lines might be considered as
needed.

MONTHLY REVIEW, MARCH 1974

GERMAN MARK

Chart II

GE RMA NY

In the massive speculation against the dollar, which
erupted last spring and carried into early summer, the
German mark spearheaded the rise of European Com
munity (E C ) currencies. By early July 1973, the mark
rate had been pushed to as high as $0.4525, some
31 percent above its February central rate. The Federal
Reserve had then resumed intervention in the exchanges,
beginning on July 10. Such intervention initially encoun
tered considerable market resistance, as a severe liquidity
squeeze in Frankfurt touched off renewed heavy bidding
for marks. By the end of July, the Federal Reserve had
sold a total of $220.5 million equivalent of marks financed
by drawings under the swap arrangement with the Bundes
bank. The Bundesbank also had intervened in Frankfurt.
Late in the month the Bundesbank succeeded in reliev
ing the immediate domestic liquidity squeeze and, with in
terest rates rising in the United States at the same time that
this country’s trade outlook was improving, the dollar began
to stage a generalized recovery in the exchanges. Conse
quently, in early August, the mark came heavily on offer.
As the mark rate declined, the Federal Reserve took the
opportunity to acquire marks in the market. Some $4.2
million equivalent of these balances was sold in the m ar
ket on August 7 when there was a brief run-up of the
mark rate, but the decline in the rate quickly resumed.
By mid-August, the Federal Reserve had repaid through
market purchases the $220.5 million equivalent of swap
drawings on the Bundesbank. Meanwhile, the Bundesbank
had sold some of the dollars it had purchased during the
coordinated intervention of July.
Over subsequent weeks, even as favorable trade and
balance-of-payments figures were released for the United
States, new uncertainties about price trends and political
developments in this country surfaced from time to time.
With the dollar still vulnerable, the Federal Reserve re
entered the market to resist excessive movements of m ar
ket rates. Thus, on August 20-21, when there was a
resurgence of demand for marks ahead of the release
of German trade figures, the Federal Reserve offered marks
on those two days and again briefly later in the month.
In the two episodes the System sold a total of $54.5
million equivalent of marks drawn under the swap line
with the Bundesbank, while the German central bank
made modest purchases of dollars in Frankfurt. Then, in
early September, just ahead of the official announcement
of United States wholesale prices for August, the dollar
again came under some pressure against the mark, and
the Federal Reserve sold $8.2 million equivalent of marks,
of which $3.9 million was drawn under the swap line

MOVEMENTS IN EXCHANGE RATE *
Percent

Percent

40 -

25 20

J
'

/
//

25
20

- i 15

—

if—

—
Smith
sonian
central
rate

\
\

15
10

t ___ J

—' 5

l
1

40
35

0
-5

-5

-1 0
J

1
F

1
M

I
J

J
1973

I I
A

j
O

1
J

-1 0

F
1974

* In this and the following currency charts, movements in exchange rates are
measured as percentage deviations of weekly averages of New York noon
offered rates from the middle or central rates established under the
Smithsonian agreement of December 18, 1971.
"|" Upper and lower intervention limits established in December 1971.
Upper and lower intervention limits around new central rate established on
February 13, 1973 following devaluation of United States dollar. Limits
suspended on March 1, 1973.

and the remainder came from balances on hand. In
all of these instances, however, the dollar recovered
quickly, and the Federal Reserve was able to liquidate
its swap drawings within a matter of days with m arks
purchased in the market. A part from these occasions,
exchange market conditions tended to improve and day-today fluctuations in the mark rate narrowed significantly
as the dollar consolidated its earlier gains.
The relative calm in the exchanges was suddenly
shaken by the unexpected revaluation of the Netherlands
guilder on September 15, which immediately raised ex
pectations of further central rate changes in the EC cur
rency arrangement. Renewed speculative demand for
marks appeared, pushing up the m ark rate and pulling the
other currencies in the EC band up in its wake. The Fed
eral Reserve stepped in, in coordination with the Bundes
bank, to moderate the rise in the mark. Between Septem
ber 17 and 26 the Federal Reserve sold $156.7 million
equivalent of German marks drawn under the swap line,
while the Bundesbank intervened in Frankfurt by buying
nearly $140 million. This forceful intervention, together
with complementary action in other EC countries, effec

FEDERAL RESERVE BANK OF NEW YORK

tively stemmed the speculative outburst.
By late September, the mark rate had steadied once
again and, with underlying trade and investment
flows tending to strengthen the dollar, the Federal
Reserve was subsequently able to purchase sufficient
marks to repay $86.1 million equivalent of the outstanding
swap debt to the Bundesbank. In mid-October, the im
provement in the dollar was again temporarily interrupted
by a sharp fall in United States interest rates, the outbreak
of war in the Mideast, and the resignation of Vice President
Agnew. When news of the resignation hit the markets,
dem and for marks suddenly intensified. To guard against
disorderly trading conditions, the Federal Reserve made
unusually large offers of marks in the New York market,
of which $21 million equivalent was sold.
Late in October, the market atmosphere was dram at
ically transformed when United States trade figures,
showing an unexpectedly large $873 million surplus for
September, confirmed to the market that the long-awaited
turnaround in the United States trade position was clearly
under way. The mark, in particular, came under heavy
selling pressure, and the Federal Reserve purchased suffi
cient marks to repay the remaining $91.5 million equiva
lent of swap debt then owed to the Bundesbank. By early
November, when the unfolding oil crisis was becoming the

focus of attention in the exchange markets, the cutback
of Arab oil deliveries was seen as threatening severe dis
locations for the German economy. The m ark’s decline
was accelerated by the unwinding of earlier favorable leads
and lags and the cutting-out of entrenched long positions
in marks. In occasionally very heavy dealing, the mark
plunged by 7 percent against the dollar in November and
a further IV\ percent by mid-December. The mark
dropped also to the lower range of the EC “snake” and
required support during nearly all of November.
While the cutbacks of oil to Europe were eased over the
December 22 weekend, the simultaneous doubling of oil
prices in the Persian Gulf, followed by even higher prices
on the part of Libya, sent new shock waves through the
market. The general view was that these prices would
jeopardize the balance-of-payments positions of all indus
trialized countries but that the United States would be
in a better position than European countries to withstand
the added cost. The mark, therefore, came heavily on offer
along with other European currencies in late December
and the Bundesbank intervened in the exchanges, fairly
substantially on some days. Beginning in late December,
this Bank also began to purchase marks in New York. An
initial $23.7 million purchased for Treasury account and
$24.3 million purchased for System account in early Janu-

Table II
FED ER AL RESERVE SYSTEM D R A W IN G S A N D REPAYM ENTS
U N D E R RECIPROCAL C URRENCY A R R ANG EM ENTS
In millions of dollars equivalent
Drawings ( + ) or repayments (—)

Transactions with

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

System swap
commitments on
December 31,1972

415.0

1974

1973

25.0

III

f + 6.0
1 - 52.0

— 82.2

|+ 1 0 4 .6
104.6

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

f+435.6
1—278.9

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

570.0

Bank for International Settlements (Swiss francs)....

600.0

Note: Discrepancies in totals are due to rounding.

January

261.8

f + 47.0
i - 47.0

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

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

System swap
commitments on
January 31, 1974

1,585.0

f + 21.0
(—177.7

—

0—

f+
1-

—

0—

2.9
2.9
-193.8

5.0

371.2
600.0

f+104.6
{-1 3 4 .6

J+488.6
{—377.8

f + 23.8
I — 262.8

-1 9 3 .8

1,232.9

MONTHLY REVIEW, MARCH 1974
Table i n
D R A W IN G S A N D R EPAYM ENTS B Y FO REIG N CENTRAL BA NK S
A N D THE B A N K FOR IN T ER N A TIO N A L SETTLEMENTS
U N D E R RECIPROCAL C URRENCY ARR A NG EM EN TS
In millions of dollars
Drawings ( + ) or repayments (—)
1973

{+23.0
1—23.0

(+36.0
I - 36.0

f+23.0
(—23.0

j+ 3 6 .0
1 -3 6 .0

0—

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

—

0—

{ + 11.0
1 -1 1 .0

o©

—

ary were largely resold to the Bundesbank against dollars.
Further purchases were then made to build up m ark bal
ances of the United States Treasury.
The downward momentum of the spot m ark neverthe
less continued, and by mid-January the rate had declined
to $0.3462, a further 8 percent from mid-December levels
and its lowest level in nearly a year. At that point, it stood
just Vi percent above its February 1973 central rate and
fully 2 3 ^ percent below its peak of July 1973.
The decision of the French authorities on January 19
to float the French franc independently from the other
currencies within the EC snake caught dealers by surprise.
The German mark, which had recovered from its lowest
point, suddenly came on offer along with other currencies
remaining in the snake as dealers awaited the outcome of
negotiations over the future of the EC monetary arrange
ment. As this pressure persisted, even after announcement
by EC officials that the band arrangement would be
continued on a more limited scale, this Bank again pur
chased marks in the New York market for United States
Treasury account in an effort to avoid an even further de
cline in the spot rate. These purchases raised the Treasury’s
net acquisitions of marks to $112.5 million, and $105.2
million of the Treasury’s accumulated balances was used
in a repayment to the IM F on January 28.
Once the initial shock effects of the floating of the
French franc had passed, the market began to reappraise
the outlook for the dollar. By that time, there were reports
that the oil embargo would be lifted or that oil prices
would be rolled back, leading some dealers to believe that
the previous rush into dollars had perhaps been overdone.
Moreover, interest rates in the United States had begun

Drawings on
Federal Reserve
System outstanding
January 31, 1974

January

III

\6 \q

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

1974

I t

Banks drawing on
Federal Reserve System

Drawings on
Federal Reserve
System outstanding
December 31,1972

{+ 2 .0
1 -2 .0

— 0—

{+46.0
1 -4 6 .0

{+ 2.0
1 -2 .0

—

to decline relative to rates abroad. Then, on January 29,
the United States Government announced the termination
of its controls on capital outflows. The dollar quickly came
on offer and, since Germany’s strong trade balance and
very substantial international reserves were seen as help
ing that country meet the added payments burden of the
higher oil prices, the German m ark in particular began
to rise sharply. Subsequently, the German authorities also
relaxed many of their controls against inflows, lifting re
strictions against nonresident purchases of long-term Ger
man securities and direct investments, allowing residents
to borrow abroad without prior official approval and re
ducing the “bardepot” deposit requirement from 50 per
cent to 20 percent. These developments stimulated further
bidding for marks, and by the end of January the spot rate
had advanced by 4V4 percent from the lows reached ear
lier in the month.
STERLING

Despite an abrupt slackening in the rate of growth last
summer, the British economy remained gripped by severe
inflation. The government responded by providing stimulus
through fiscal policy, while seeking to decelerate the wageprice spiral by moving to a longer term “Stage III” con
trol mechanism. Meanwhile, however, the willingness of
the trade unions to accept continuing restraint on wages
was being undermined by the persistent run-up of prices.
Inflationary pressures were exacerbated by external fac
tors. The worldwide rise in commodity prices and the sub
stantial depreciation of sterling since June 1972— to which
the trade accounts had not yet responded— had seriously

FEDERAL RESERVE BANK OF NEW YORK

inflated Britain’s import bill and ratcheted domestic prices
even higher. To help curb these pressures and to bolster
sterling, the Bank of England had tightened monetary
policy considerably. By early August, interest rates had
moved up to historic highs and the bank’s minimum lend
ing rate had advanced to IIV 2 percent. Partly as a means
of reinforcing Britain’s reserves, the authorities had also
encouraged public-sector borrowings in the Euro-currency
markets, and over $ 1 billion of these borrowings had been
announced. Protected by London’s relatively high interest
rates, sterling declined less rapidly than other currencies in
August, falling back from $2.50 to around $2.46 as the
dollar generally strengthened.
Early in September, however, the pound suffered a sud
den sell-off on growing concern over the prospects for the
British economy and on rumors that the United Kingdom
would allow the sterling-balance guarantees with former
sterling-area countries to lapse when they expired on
September 24. Speculation quickly fed on itself and in just
three days the pound plunged more than 7 cents, to a low
of $2.38 in London on September 6. At that point the
Bank of England stepped in with strong support, and the
government announced its decision to extend the sterling
guarantees for another six months at $2.4213, prompting
a rebound in sterling to around that level. In subsequent
weeks, trading remained nervous as the market awaited
signs of progress in the final negotiations among govern
ment, labor, and employers over the ultimate shape of the
Stage III controls. Spot sterling, therefore, did not partici
pate in the rise in Continental currencies following the re
valuation of the Netherlands guilder. Instead, the rate
held fairly steady through early October and showed little
response to the British government’s announcement of
Stage III guidelines, as the market deferred judgment on
the effectiveness of the new controls until the trade unions’
response could be weighed.
The October 6 war in the Mideast then became the
dominant factor in the exchanges. Funds were initially
shifted out of dollars into sterling, attracted by the rela
tively high interest rates available in London. As a result,
sterling rose as high as $2.46 at one point in midOctober, even as the Bank of England purchased dollars
to moderate the rise. Later that month, however, an
nouncement of the huge United States trade surplus for
September and of cutbacks in Arab oil production exerted
a drag on sterling. But as the immediate impact of differen
tial supply cutbacks was viewed as less damaging to the
United Kingdom than to many of the industrialized coun
tries, sterling fell off less sharply than other currencies.
Nevertheless, the longer run implications for sterling
of the unexpectedly steep rise in oil prices in October

were worrisome, as they portended an escalation of the
inflationary pressures and a worsening of the trade balance
— already at a record deficit of <£364 million in Octo
ber. Moreover, a confrontation between labor and
government was shaping up as the coal miners, in partic
ular, dramatized their objections to the new wage guide
lines in mid-November by banning overtime and weekend
work. With this action threatening cutbacks in electricity
production and posing serious implications for the econ
omy as a whole, market sentiment toward sterling turned
bearish.
The Bank of England then moved to keep the money
market firm by hiking its minimum lending rate to 13 per
cent and by calling for additional special deposits. The
tighter money market conditions held sterling in line
with other European currencies, but against the dollar it
dropped sharply after midmonth, with renewed specula
tive overtones, to as low as $2.30Vi by December 11.
The Bank of England provided increasing support for
the pound in the exchange market, while allowing a money
market squeeze to increase the interest cost of maintaining
short positions in sterling.
As the conflict of the miners’ union and the govern
ment hardened and coal supplies dwindled, the govern
ment announced on December 13 a draconian electricitysaving plan, including a three-day workweek. This was
followed by a new restrictive budget, designed to reduce
aggregate demand in line with production cutbacks and
to improve the balance of payments. A t the same time,

MONTHLY REVIEW, MARCH 1974

the Bank of England took further steps to curb excessive
credit expansion, introducing new reserve requirements
to supplement existing credit control arrangements.
Dealers saw these measures as marking an end to the
government’s long-standing commitment to rapid growth,
while at the same time limiting Britain’s capacity to
export. Even so, the attraction of continuing high interest
rates in London kept the pound near $2.31 through the
end of the year.
With sterling already in a vulnerable position, the
doubling of oil prices in late December, potentially raising
Britain’s import bill by several billion dollars, triggered a
sharp fall for the pound against the dollar. A t first, the
movement was roughly in line with the decline of other
major European currencies. But, as talk spread of an early
general election to resolve the continuing confrontation
between labor militants and the government, sterling came
even more heavily on offer. In extremely tense and nervous
trading especially in the aftermath of the French decision
to float the franc, the spot rate plunged by January 21 to
a record low of $2.15 Vi in London. This represented a
drop of some 7 percent below the end-of-December level
and 17% percent below the Smithsonian central rate.
Thereafter, sterling began to rally, as tax payments and
the massive overhang of short positions combined to pro
duce an unprecedented liquidity squeeze in the London
money market. This upturn was reinforced when the an
nouncement of the termination of United States capital
controls raised expectations of sizable inflows into highyielding sterling investments. By the end of January, the
spot rate had been bid back up to $2.27, for a rise of 5Vi
percent from the January 21 low.
FRENCH FRANC

In the various exchange market upheavals over the
first seven months of 1973, the French franc had been
bolstered by the solid surplus in France’s trade account
as well as by occasional speculative inflows. The franc
rate had been pushed as high as $0.2626 in early July,
some 21 percent above its February central rate. In the
subsequent resumption of exchange market intervention
by the United States during July, the Federal Reserve
had sold some $47 million equivalent of francs in the
market, financed by drawings under the swap line with
the Bank of France. As the dollar improved across the
board in early August, the Federal Reserve readily
acquired in the market sufficient francs to repay those
swap drawings.
As elsewhere, inflationary pressures had mounted in
France, and to protect the franc’s position the authorities

Chart IV

FRANCE
MOVEMENTS IN EXCHANGE R A T E *
Percent

Percent
30

25
20

- 20

tr-r-wV
1/

10 —

- 15
\

— 10

t j I1

5—
Smithsonian
par
value
-5

~T~5
0

-5

-1 0
J

I I I !
F

III

II
S

1973

-10

J
F
1974

* See footnote on Chart II.
■j" Upper and lower intervention limits established in December 1971.

^ Upper and intervention limits as of February 14, 1973. Limits suspended on
March 2, 1973.

had gradually stiffened monetary policy. Thus, to keep
pace with the escalation of interest rates in other major
centers, in early August the Bank of France raised its
discount rate by 1 percentage point to 9 Vi percent. Even
so, money market rates in Paris failed to match the even
higher levels reached in other financial centers, and a
subsequent liberalization of exchange controls led to some
outflows of funds. The franc thus remained near the
bottom of the EC band and required occasional central
bank support during August and early September.
The market generally considered the French trade
surplus modest, compared with the massive trade sur
pluses of some of France’s trading partners in the EC
snake, and the unexpected revaluation of the Dutch
guilder led to an outbreak of speculation over further ad
justments, including a possible devaluation of the franc.
Offerings of French francs against German marks and
Belgian francs— the currencies at the top of the EC band
— soon swelled to massive proportions, and the Bank of
France and other EC central banks intervened heavily in
support of the franc. In addition, the French authorities
hiked the discount rate to 11 percent, the highest in one
hundred years, raised bank reserve requirements, and
tightened credit ceilings, while also asking the banks to re
frain temporarily from lending French francs to nonresi
dents.
By September 24, these actions had blunted expecta
tions of an imminent devaluation. At the same time, the
heavy intervention of the previous week had created an

FEDERAL RESERVE BANK OF NEW YORK

unprecedented squeeze for franc balances, raising the
cost of financing speculative short positions in francs, and
some dealers moved to cover their positions. As a result,
the franc edged off the bottom of the snake. The
authorities soon lifted the restraint on lending to non
residents but also announced a far-reaching dismantling
of those banking regulations adopted in M arch 1973 to
deter capital inflows. The commercial banks quickly
began to offer positive yields to nonresidents once again.
These measures provided a firmer tone to the market
through late October, although there was occasional
moderate intervention to support the franc at the lower
limit of the EC band. Then, as the dollar came into wide
spread demand after announcement of the United States
huge September trade surplus, other European currencies
were depressed even more than the franc, with the result
that no further intervention was required.
In early November, the market’s focus suddenly shifted
to the potentially serious effects on European countries of
cutbacks of crude oil supplies from the Mideast. This
led to a generalized demand for dollars, but at the same
time the market took the view that France would suffer
relatively less than other European countries from the
differential cutbacks of oil deliveries. Additional antiinflationary measures by the French authorities, including
selective price controls and some tightening of both
monetary and fiscal policies, also buoyed the franc. Thus,
while dropping progressively lower against the dollar

throughout November and early December, the franc de
clined less steeply than the other EC currencies. Indeed,
by December, the franc was at the top of the EC band
and there were moderate official sales of francs at the
upper limit.
By mid-December, however, the market was shifting
to the view that the oil crisis might also have a disruptive
effect on the French economy. Then, the subsequent hike
of Mideast oil prices came as a severe blow and, by adding
substantially to the prospective import bill, threatened to
turn France’s trade position into sizable deficit. The franc
declined precipitously against the dollar in occasionally
heavy selling and once again dropped to the bottom
of the EC band. The Bank of France intervened at first
in other EC currencies and then also in dollars to keep
the franc within the limits of that band. In conjunction
with these operations, this Bank began in early January
to purchase francs in New York for the United States
Treasury, accumulating a total of $33.1 million equivalent.
The pressures on the franc nevertheless remained inter
mittently heavy through midmonth, and by January 18
the spot rate had fallen over 8 percent from its midDecernber level against the dollar.
On January 19, the French authorities announced that
France would withdraw from the EC currency arrange
ment and allow the franc to float independently for six
months, explaining that prospects of a massive oil-induced
deterioration in their balance of payments made immediate

Table IV
U N IT E D STATES TREA SU R Y SECURITIES
FO REIG N CURRENCY SERIES
In millions of dollars equivalent
Issues ( + ) or redemptions (—)
Issued to

Amount
outstanding
December 31,1972

1973
1

1974
III

Amount
outstanding
January 31, 1974

January

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

306.0

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

1,232.9

+ 63.6

+127.3

1,587.9

Bank for International Settlements* ...................

170.9

-6 2 .2

-1 2 7 .3

— 0—

T otal ................................................................................

1,709.8

J-bl27.3
1-127.3

1,587.9

-1 5 3 .0

—172.4

— 0—

f+63.6
1 -6 2 .2

-1 7 2 .4

—0—

Note: Valuation changes account for numerical discrepancies, as well as for different dollar values in the third quarter 1973 which involved
refinancing by the Swiss N ational Bank o f a Swiss-franc-denominated security held by the Bank for International Settlements.
• Denominated in Swiss francs.

MONTHLY REVIEW, MARCH 1974

action necessary to protect French reserves and employ
ment. The French authorities simultaneously moved to
protect the currency by banning franc loans to nonresi
dents once again and by adjusting other banking regula
tions. The decision to float independently came as a shock
to the market. Consequently, when trading resumed on
Monday, January 21, the franc came under selling pres
sure, and the Bank of France stepped in to support the
rate through dollar sales. The pressure nevertheless was
such that the franc dropped by about 6 percent to $0.1894
in Paris. Over subsequent days, trading remained excep
tionally nervous, and the Bank of France continued to in
tervene to moderate rate movements, not only in Paris
but also in New York through the agency of the Federal
Reserve Bank of New York.
Late in January, the franc was bolstered by reports of
an imminent $1.5 billion Euro-dollar borrowing by the
French government, along with other borrowings being
arranged abroad by official French institutions, since these
borrowings were seen as reinforcing reserves for future
support of the exchange rate. The franc then joined in the
general advance of European exchange rates against the
dollar following the termination of United States capital
controls, and the Bank of France bought modest amounts
of dollars, again partly through this Bank, to moderate
the rise. By the end of January the spot franc had ad
vanced 4 Vi percent from its low of the previous week.
SWISS FRANC

In midsummer of last year the Swiss banking system
was relatively liquid despite the restrictive monetary policy
introduced in 1972. As a result, when the dollar strength
ened across the board in early August, the Swiss franc
declined more rapidly than many other currencies. Once
the dollar’s advance was established, entrenched long
positions in francs began to be unwound, adding to the
immediate demand for dollars. By August 23, the spot
franc had dropped 13 Vi percent against the dollar from
its July peak level of $0.3774 while also depreciating 3
percent against the currency of its principal trading part
ner, Germany.
Exchange trading then turned quieter, and the Swiss
franc joined in the general firming of European exchange
rates against the dollar later in August and in early
September. Concern also arose early in September over
possible liquidity pressures at the quarter end, but the Swiss
National Bank announced that it again stood ready to
provide assistance through short-dated swaps (of which
it ultimately did $900 million). As a result, dealers felt
reassured that the authorities were intent on maintaining

Chart V

S W IT Z E R L A N D
MOVEMENTS IN EXCHANGE RATE

*
Percent
40

Percent
40

- 35

35 -

30 -

y s /

20 -

/
/

15 10 -

J-

10
5

5
Smith
sonian
central
rate
-5

i/ f
o
* '" * !
J

I I !
M

I l l

J
1973

I I
S

I I

1
J

-5

F
1974

•)* See footnote on Chart II.
"(" Upper and lower intervention limits established in December 1971.
F Intervention limits suspended on January 23, 1973.

balanced conditions in the Swiss money m arket at least
for the time being. Against this background, the Swiss
franc traded narrowly, with only modest fluctuations
at the time of the guilder revaluation in September and
again at the outbreak of the Mideast war. The author
ities took advantage of these improved market conditions
to reduce to zero the 2 percent per quarter negative inter
est charge on excess nonresident Swiss franc balances and
to lift the restriction that the banks maintain balanced
foreign exchange positions on a daily basis. But even such
a substantial relaxation of controls had only a transitory
impact on the market.
During this period of relatively quiet trading from
late August through mid-October, the Swiss franc, while
holding steady against the dollar, was losing some further
ground against the German mark. The cumulative, adverse
shift in Switzerland’s terms of trade threatened to boost
the already disturbing rate of domestic inflation. M ore
over, the authorities were becoming concerned about the
quickening pace of credit expansion since the summer.
Thus, when in late October the release of strong United
States trade figures for September touched off a vigorous
advance of dollar rates throughout Europe, the Swiss
authorities took advantage of their room to maneuver to
tighten monetary policy. Accordingly, the National Bank
raised minimum reserve requirements on foreign funds by
25 percent, while imposing a 10 percent marginal reserve
requirement on domestic Swiss franc and foreign cur

FEDERAL RESERVE BANK OF NEW YORK

rency time deposits above M arch 1972 levels. In addition,
the requirement that a fraction of foreign capital issues in
Switzerland be converted at the central bank was reim
posed with a conversion ratio of 10 percent. These mea
sures, together with the m arket’s assessment that the Swiss
economy was less vulnerable than most of Europe to the
immediate effects of oil-production cutbacks, contributed
to the strengthening of the Swiss franc against the other
European currencies. Consequently, even as the franc fell
by some 6 percent against the dollar in the five weeks to
November 23, it advanced more than 3 percent against the
German mark as some dealers switched funds out of marks
and into Swiss francs.
The franc moved more nearly in line with other Euro
pean currencies until early December, when liquidity con
ditions in Switzerland tightened as banks began to seek
funds for normal end-of-year requirements. Since the
National Bank, in an attempt to keep a tight rein on do
mestic monetary expansion, provided only part of the
banks’ needs through dollar swaps and a temporary re
lease of minimum reserves, the Swiss banks turned to the
exchange market. At first they sold dollars forward in or
der to leave their spot positions intact at a time when the
dollar was strengthening sharply against all other cur
rencies. But, as the year-end approached, the scramble for
funds became unexpectedly heavy and spilled over into the
spot market. Thus, while other European currencies began
to decline sharply against the dollar in late December, the
Swiss franc held relatively firm.
Once trading for the year-end was completed, however,
the Swiss franc also came under heavy selling pressure,
falling more than 7 percent against the dollar by early
January, and the Swiss National Bank occasionally sold
dollars to m oderate the decline. Moreover, as the Swiss
franc declined, the Federal Reserve began a program of
regular purchases of Swiss francs in the market, using the
francs to repay remaining indebtedness to the National
Bank incurred prior to August 15, 1971. Over the next
three weeks, the System thereby repaid a total of $193.8
million equivalent of swap commitments, reducing its
overall Swiss franc indebtedness to $971.2 million equiva
lent. Meanwhile, the Swiss authorities sought to avoid an
imminent liquidity squeeze by canceling the recall of
minimum reserves that had been delayed at the end of
the year and by reducing required reserves another 20
percent. The Swiss banks nevertheless remained ex
tremely cautious as the month end approached and
began to bid for francs, with the result that interest rates
in Switzerland and on Euro-Swiss francs started to ad
vance. The franc was thus on a firming trend when the
termination of United States capital controls was an

nounced on January 29, prompting a further sharp rise in
the Swiss franc, along with other European currencies.
For their part, the Swiss authorities also eased controls
further, lifting the prohibition on foreign purchases of
Swiss securities. At the end of January, the Swiss franc
traded at $0.3060, up 5 percent from its early-January low
and IIV 2 percent above its Smithsonian central rate.
BELGIAN FRANC

The continuing demand for Belgian exports, while main
taining Belgium’s already strong trade position, exerted
increasing pressure on productive capacity, thereby con
tributing to the buildup of inflationary pressures in the
Belgian economy. To contain these pressures, the National
Bank of Belgium, in early August, began to tighten its
monetary policy by raising its discount rate and limit
ing access to central bank credit. Initially, these actions
brought Belgian interest rates more in line with other EC
interest rates, and the Belgian franc thus held in the
middle of the EC snake as the joint float moved down
against the dollar. Taking advantage of the improvement
in the dollar rate, the Federal Reserve acquired sufficient
francs to repay in full the $6 million of swap debt in Bel
gian francs incurred during the July support operations.
When, in late August and early September, Belgian inter
est rates again fell behind rising rates elsewhere and capi
tal outflows from Belgium resumed, the commercial rate

Chart VI

BELGIUM
MOVEMENTS IN EXCHANGE RATE *
Percent
30

Percent

10
5
Smith
sonian
central
rate

“ f
-,

-5

1. 1..1.....1 1 1

-1 0

1... 1

I.....

1973
*

1
1974

See footnote on Chart II.

"f Upper and lower intervention limits established in December 1971.
^ Upper and lower intervention limits around new central rate established
on February 14, 1973. Limits suspended on March 1, 1973.

MONTHLY REVIEW, MARCH 1974

settled to the bottom of the IV2 percent Benelux band,
where it was supported against the Netherlands guilder,
and to the lower range of the EC arrangement. Mean
while, the Federal Reserve began to purchase small
amounts of Belgian francs on a daily basis to cover re
maining pre-August 15, 1971 swap commitments to the N a
tional Bank of Belgium. By mid-September, the System
had repaid $43 million of this debt, reducing remaining
commitments to $347 million equivalent.
Following the September 15 revaluation of the Dutch
guilder, the Belgian franc became a target of speculation,
as the market focused on the close link between the two
currencies and noted that Belgium, like the Netherlands,
had a sizable current-account surplus. The commercial
rate was quickly pushed to the top of the EC and Benelux
bands, and substantial official sales of Belgian francs
against both French francs and Dutch guilders were
needed to hold the rate within its upper intervention limits.
It also rose against the dollar, reaching $0.027800, some
12 percent above the February 1973 central rate.
The Belgian authorities announced that they would not
revalue the franc and acted to curb speculative inflows by
reimposing the X
A percent per week charge on excess
nonresident franc holdings, imposed in March but removed
in early September, and by requesting the banks to cut
their foreign liability positions by 25 percent. These firm
measures broke the speculative wave, and by mid-October,
as relative interest incentives had again turned against
Belgium, the Belgian franc had begun to ease against the
dollar while settling back to trade near the bottom of the
Benelux band and in the middle of the EC joint float.
The Federal Reserve, therefore, resumed its purchases of
Belgian francs and by early November repaid a further
$85.2 million equivalent of swap indebtedness, reducing
outstanding debt to $261.8 million equivalent.
When the dollar strengthened against the European
currencies in late October following announcement of the
large United States September trade surplus, the Belgian
franc declined more gradually than other EC currencies.
The relative strength of the franc reflected a sudden tight
ening of liquidity in Brussels which was later reinforced
by successive increases in the National Bank of Belgium’s
discount rate to 7% percent. Thus, as the entire EC bloc
of currencies dropped sharply against the dollar in N o
vember with the unfolding of the oil crisis, the commercial
franc held briefly near the top of both the EC and the
Benelux bands, requiring moderate official sales of Belgian
francs against marks and Dutch guilders to maintain the
prescribed limits. Thereafter, the commercial franc re
mained near the middle of the EC band when, with con
cern over the differential oil supply cutbacks weighing on

the market, the Dutch guilder weakened. As a result, some
intervention was required to maintain the Benelux ar
rangement. By mid-December the commercial rate had
fallen lOVi percent against the dollar from its October
highs, and it subsequently eased below its February 1973
central rate.
Toward the turn of the year, when the oil price hikes
shifted the focus of market attention from supply to price,
the effect on the Belgian payments position was judged to
be relatively severe. The franc therefore came on offer,
weakening against the dollar as well as against some other
EC currencies during the last week of December. Effec
tive January 1, the Belgian authorities removed again the
V4 percent per week charge on excess nonresident franc
holdings. The Belgian franc then moved up within the EC
band until the floating of the French franc led to a new
dip in the Belgian franc, both against the dollar and with
in the snake. During the month this Bank purchased
francs in the market on behalf of the United States Trea
sury. A total of $36.2 million equivalent of francs was
acquired, of which $23 million was used in a repayment
to the IMF.
Late in January, in the wake of the termination of
United States capital controls, the Belgian authorities lifted
the prohibition of interest payments to nonresidents and
abolished the 100 percent marginal reserve requirement
on nonresident accounts. These actions were expected to
induce inflows into Belgium, and the Belgian franc firmed
to $0.023800 by the month end, some 43A percent above
its January low and 4 percent below its February 1973
centra] rate.
N ETH ER LA N D S GUILDER

As with most other industrial countries the Nether
lands had suffered an upsurge of inflation, but real eco
nomic growth remained sluggish during much of the year.
Lagging domestic demand had contributed to a widening
of the already sizable current-account surplus in the
Dutch payments balance but, at the same time, had
constrained the authorities from using monetary policy in
an all-out fight against inflation. Consequently, interest
rates remained lower in the Netherlands than in most of its
major trading partners, and outflows of interest-sensitive
funds exerted a strong drag on the guilder in the exchanges.
The spot rate moved in line with other EC currencies
against the dollar but held at or near the bottom of the
2Va percent EC band in the late spring and early summer.
The guilder had also peaked against the dollar in early
July, at $0.4000, some 163/4 percent above its February
1973 central rate.

FEDERAL RESERVE BANK OF NEW YORK

Chart VII

N ETH ERLAN DS
MOVEMENTS IN EXCHANGE RATE *
_______________________________ __________________

Percent
35
30 25

I\f\

Tf / \
/ —

—

20 -

Percent

—

J—

^ .

'
--------------------------------*

—
—

Smithsonian
central
rate

«—^

i
i

t" T
J

I I I
F

1
M

1
J
1973

I I
A

I I
O

1
J

F
1974

♦ See footnote on Chart II.
"t" Upper and lower intervention limits established in December 1971.
t Upper and lower intervention limits around new central rate established
on February 14, 1973. Limits suspended on March 1, 1973.

By late summer, however, the employment picture had
brightened somewhat, and the improved domestic situation
allowed the Dutch authorities to employ some monetary
restraint in an effort to curb inflation. The Netherlands
Bank accordingly introduced liquidity ratios for the com
mercial banks in mid-July and progressively raised its
discount rate, with the result that by early August Dutch
interest rates had moved up into line with rates in other
major centers. As the outflow of interest-sensitive funds
slowed, the guilder became more buoyant in the exchanges.
Although the guilder followed the general decline of Euro
pean currencies against the dollar in early August, it now
moved to the top of both the EC and the Benelux bands,
requiring occasional moderate intervention at the upper
limits of those bands by early September.
On September 15 the Dutch authorities announced
that the guilder wTould be revalued by 5 percent vis-a-vis
special drawing rights (SDRs) as part of a package of
measures aimed at curbing domestic inflation and stimulat
ing employment. This action caught the market by sur
prise and was followed by substantial speculative flows
into German marks and Belgian francs and out of French
francs— and out of dollars as well— to hedge against the
risk of further exchange rate adjustments within the EC
snake. Concerted central bank action soon helped quell
these fears and, after trading erratically for several days
when the guilder required support in the Benelux band, it
settled at around $0.3930, 9 lA percent above its new

central rate and near the middle of the EC band.
By late September the Amsterdam money m arket was
tightening substantially, partly on seasonal factors, and
interest rates were rising sharply. As the liquidity squeeze
intensified, the Netherlands Bank moved to relieve some
of the pressure by selling guilders spot in the exchange
market while simultaneously repurchasing them forward.
Despite substantial swap assistance, however, the Dutch
banks remained short of liquidity and, early in October,
the guilder was driven once again to the top of the EC
band, where moderate daily intervention was required.
On October 15 the Netherlands Bank announced a further
increase in its discount rate to 7 percent, and pressure on
the guilder at the top of the EC band intensified. Then,
as rumors began to circulate that the guilder would again
be revalued, intervention under the EC arrangement
grew even more substantial. Against the dollar, the spot
rate rose to as high as $0.4081, over 13 percent above
its September central rate. On October 23, along with
heavy intervention in EC currencies, the Netherlands
Bank also began to purchase substantial amounts of
spot dollars to curb the rise of the guilder. This inter
vention had a useful effect, and the Federal Reserve,
after consultation with the Netherlands Bank, followed
up by offering guilders in New York, selling $2.9 million
equivalent drawn under the swap line with the Dutch
central bank. Over subsequent days, the guilder joined
other currencies in dropping sharply against the dollar
in response to news of the huge United States September
trade surplus. As the spot guilder fell, the Federal Reserve
acquired in the market sufficient guilders to repay its swap
commitment.
By early November the m arket’s attention shifted to
the vast new uncertainties associated with the oil crisis.
Although the Netherlands was the only EC country faced
with a total Mideast oil embargo, there was little overt
exchange market reaction until early November. Then,
the ban on Sunday driving in the Netherlands high
lighted the potentially grave consequences of the embargo
to the Dutch economy. The guilder came on offer,
dropping sharply against the dollar and falling to the
bottom of both the EC and the Benelux bands. This pres
sure continued through succeeding weeks, and by early
December the spot rate had plunged some 13 percent
from its October highs against the dollar to trade below
its new central rate. A t the same time, the Netherlands
Bank and other EC central banks were obliged to intervene
forcefully in support of the guilder at the lower limits of
the snake. This sizable intervention, which contributed to
a further tightening of the Amsterdam money market,
helped check the speculative pressures, and the spot rate

MONTHLY REVIEW, MARCH 1974

began to recover in mid-December. The guilder then came
off the bottom of the EC band, leaving room for the Neth
erlands Bank to provide money market relief by further
dollar swaps and by easing commercial bank access to
central bank credit.
Following the doubling of Arab oil prices late in Decem
ber, the guilder joined in the general decline of European
currencies against the dollar, falling to $0.3367, 6%
percent below its central rate, before leveling off. By midJanuary, the immediate concern over the energy situation
in the Netherlands had eased and the guilder declined
more gradually than other EC currencies. In the aftermath
of the floating of the French franc, the Dutch authorities
agreed with the remaining EC participants to maintain the
snake arrangement. At first the guilder dipped against the
dollar, but it soon began to recover. In reaction to the lift
ing of United States controls on capital outflows later in
the month, the recovery gathered pace. At that time, the
Dutch authorities took the opportunity to eliminate the
separate exchange market for purchases of Dutch secu
rities, the so-called obligation guilder. By the end of Janu
ary the guilder had advanced to $0.3470, just 3 V2 per
cent below its central rate.
ITA LIA N

LIRA

By midsummer 1973, a sharp recovery of Italian
business activity, rising domestic inflation, and speculation
in the commodity markets had swollen Italy’s imports and
seriously weakened the trade position. To bolster the lira
in the face of heavy demand for foreign currencies, the
authorities had reaffirmed their intention to provide sup
port for the floating commercial rate, and had reinforced
their reserves with new foreign borrowings by public
enterprises, while also negotiating increased short-term
credit facilities. In addition, the new coalition government
had announced strong measures to come to grips with
inflation, including a ninety-day price freeze, selective
credit ceilings on the banks, and new exchange controls.
The market responded favorably to these official initiatives,
and in August, when other European currencies were
weakening against the dollar, the lira was on an upswing,
reaching as high as $0.001773 or some 3 percent above its
Smithsonian central rate.
In September the lira’s improvement faltered as a
result of a further widening of Italy’s trade deficit and
concern over the outlook for the domestic economy after
the temporary price freeze would expire. The Bank of Italy
again intervened in support of the lira while repaying most
of the remaining dollar swaps it had with the commercial
banks. In addition, it tightened monetary policy by raising

basic lending rates to a uniform 6 V2 percent and by unify
ing the system of penalty rates on repeated commercial
bank borrowing at the central bank. Trading then quieted,
and the lira held steady through mid-October.
The war in the Mideast and the subsequently an
nounced cutbacks of oil supplies provoked a new burst
of import demand, largely reflecting a precautionary
buildup of inventories of petroleum products and other
raw materials. Consequently, the lira once again came
under selling pressure and the rate began to ease. The drop
in the lira gained momentum with announcement of the
huge United States trade surplus for September. Growing
awareness of the seriousness of the oil situation with regard
first to quantity and then to prices soon triggered an acrossthe-board decline for the lira as well as other European
currencies. By mid-November, the lira’s decline began to
outpace those for other European currencies as the build
up of consumer-goods imports and the impact of higher
oil prices caused a further deterioration in Italy’s trade
position. By early December, in progressively heavier
trading, the commercial rate had plummeted roughly 8
percent from late-October levels to a little more than 5
percent below the Smithsonian level. The Bank of Italy
intervened heavily to resist the erosion of the rate. By
mid-December, selling pressures eased off somewhat al
though the m arket remained nervous and uncertain.

FEDERAL RESERVE BANK OF NEW YORK

In view of Italy’s already substantial trade deficit, the
doubling of Persian Gulf oil prices in late December was
seen as a further severe blow to Italy’s payments position,
and the lira came heavily on offer again in late December
and early January. Against this unsettled background, the
French decision to pull out of the EC snake arrangement,
as the Italian authorities had done eleven months before,
was a further shock to the market. Along with the newly
floating French franc, the lira immediately began to drop
precipitously. By January 23, the commercial lira had
plunged to as low as $0.001480, a decline of nearly 10
percent since the beginning of the year and fully 14 per
cent below the Smithsonian central rate. The Bank of
Italy continued to intervene in support of the lira, and
late in January additional Euro-dollar borrowings by
Italian public enterprises were announced, raising the total
of such borrowings since m id-1972 to over $6 billion.
Following the termination of United States capital con
trols, the lira joined in the general advance of European
currencies against the dollar, recovering by almost 3 per
cent to a level IIV 2 percent below its Smithsonian central
rate. At the end of January, the Bank of Italy and the
Federal Reserve agreed on an increase in their reciprocal
swap arrangement from $2 billion to $3 billion, effective
February 1.
JAPANESE YEN

When the Japanese yen was floated in February 1973,
it quickly jumped up to some 20 percent above its
Smithsonian level. Starting in March, however, and
continuing through the spring and summer, the yen came
on offer in the exchanges as importers and exporters un
wound earlier leads and lags of payments in favor of the
yen. Various measures to encourage capital outflows taken
in the previous year led to a strong growth of direct and
portfolio investments abroad and of Japanese banks’ for
eign lending. At the same time, Japan’s massive trade sur
plus was shrinking. The rapid expansion of the Japanese
economy stimulated strong import demand for raw m ate
rials and industrial commodities, while the worldwide es
calation of commodity prices further magnified the coun
try’s total import bill. The result was a persistent demand
for dollars, which was met by regular intervention by the
Bank of Japan around the ¥ 265 level. Consequently,
Japan’s reserves fell by $4 billion from early March to the
end of July and declined a further $375 million through
September. The Bank of Japan then began to permit some
easing in the spot rate. But, as the market became increas
ingly aware of the underlying weakening in the Japanese
payments position, adverse leads and lags developed and

Chart IX

JA P A N
MOVEMENTS IN EXCHANGE R A T E *
Percent
25

Percent
25

20 -

15 -

15
10

10 5
t ___ ^
Smith
-t
sonian
central
rate
-5 1
1f
J
F

J-

5
o

I I
M

I I I
M

J
1973

I I
A

-5

F
1974

* See footnote on Chart II.
f

Upper and lower intervention limits established in December 1971.

Intervention limits suspended on February 14, 1973,

the pressure on official reserves continued into October.
Later that month, the cutbacks of oil supplies and the
sharp increases in posted oil prices announced by Mideast
ern countries intensified selling pressure on the yen. With
over 70 percent of its total energy requirements met by
imported oil, the Japanese economy was seen as particu
larly vulnerable to the energy crisis. As selling pressure on
the yen built up, the Bank of Japan allowed the rate to de
cline in several steps to about ¥ 280 by mid-November.
The Japanese authorities also began to shift the pattern of
capital controls, banning Japanese purchases of short-dated
foreign assets and relaxing certain capital inflow controls,
and cut back their program of lending dollars for import
financing. Speculation over a possible further fall in the
yen continued to build up, however. The Bank of Japan
provided firm support to maintain the ¥ 280 level through
the rest of November and December, with the result that
official reserves declined by a further $2.5 billion over the
fourth quarter. In addition, in December, the authorities
further tightened restraints on capital outflows and, to con
tain domestic inflation, increased the Bank of Japan’s dis
count rate by a full 2 percentage points to 9 percent while
cutting budgeted increases in government expenditures.
The late-December announcement of a doubling in the
price of Persian Gulf crude oil set off an even greater
wave of selling pressure against the yen. After a deter
mined effort to hold the spot rate, on January 7 the Bank
of Japan suspended its support of the ¥ 280 level and the
yen dropped to ¥ 300, a 7 percent fallback almost to pre
float levels. To encourage inflows and discourage outflows
of funds, the Ministry of Finance announced liberalized
rules for prepayments of Japanese exports, a relaxation of

MONTHLY REVIEW, MARCH 1974

regulations on foreign borrowings by domestic companies,
new restrictions on foreign-currency bank loans to resi
dents, used mainly for financing outward direct invest
ments, and new constraints on Japanese purchases of for
eign securities. The selling of yen moderated in response
to these measures, but the Bank of Japan still had to in
tervene regularly to keep the rate from going beyond the
¥ 300 level.
In the wake of the French decision to float the franc,
the Japanese authorities closed the Tokyo market for two
days, during which the yen fell as much as 2 5/s percent in
New York. They nevertheless decided to hold firm at
¥ 300, and when trading resumed in Tokyo, on January
23, the Bank of Japan sold a massive amount of dollars
at that level. After the close in Tokyo that day the
yen again declined in foreign markets. Following consulta
tions between United States and Japanese authorities, this
Bank began to bid for yen in the New York market to
bring the yen rate back to near the Bank of Japan’s inter
vention level. These purchases, on behalf of the United
States Treasury, totaled $4.3 million equivalent and were
subsequently used for a United States repayment to the
IMF. By the end of January the market was in better bal
ance, with the yen having moved away from the interven
tion rate. But Japanese reserves had declined by a further
$680 million in January, or by a total of $7Vi billion since
the floating of the yen in February 1973.
CANADIAN DOLLAR

With Canada’s underlying balance of payments remain
ing in small surplus during the late summer of 1973,
movements in the Canadian dollar rate were mainly
influenced by interest-sensitive flows of funds. The Ca
nadian authorities, while careful not to brake the expansion
of the domestic economy, had moved interest rates higher,
with the Bank of Canada’s discount rate reaching IV 4
percent in September. The gradual rise in Canadian market
interest rates nevertheless had lagged behind earlier sharp
rate increases in the United States and elsewhere, and the
resulting outflows of funds tended to depress the spot
Canadian dollar. Strikes on the Canadian railways and in
some export industries also raised concern in the market,
and the spot rate eased from about $1.00 in early August
to just below $0.99 by mid-September, with the Bank of
Canada providing support.
Later that month, a sharp decline in interest rates in
the United States, with rates in Canada holding steady,
led to a squeezing-out of the adverse interest differentials
and stimulated some reflows into Canada. Moreover, there
were sizable new foreign borrowings by Canadian provin

cial authorities. In late October, as Canadian banks sought
funds for their end-of-fiscal-year needs, the influx of funds
accelerated. Consequently, the spot rate moved up to as
high as $1.003/4, while the forward rate was simulta
neously driven to a discount for the first time since August
1972. Once the banks met their needs, the money market
turned more liquid and the Canadian dollar rate edged
down to the $1.00 level by early November.
Through most of December the Canadian dollar held
steady against the United States dollar. Consequently, it
appreciated sharply against major European currencies, on
the m arket’s view that Canada’s relative self-sufficiency in
oil would protect the Canadian balance of payments from
both supply shortages and higher costs.
By the turn of the year the market had taken an even
more bullish view of the Canadian dollar’s near-term
prospects. Again, this partly reflected the expectation that
Canada would weather the oil price increases better than
other major countries. Moreover, the continued worldwide
rush into raw materials and other commodities was ex
pected to improve C anada’s terms of trade and overall
trade position even further. In addition, a bunching of
long-term foreign issues by Canadian borrowers strength
ened current and potential demand for Canadian dollars,
while the downturn of United States interest rates after
mid-January, with Canadian interest rates steady, stimu
lated short-term inflows to Canada as well. Consequently,
the Canadian dollar appreciated sharply against all major
foreign currencies and advanced to $1.01 Va by the month
end, with the Bank of Canada intervening to moderate the
rise. Canadian official reserves increased by $85 million in
January after little net change in the closing months of
1973.

FEDERAL RESERVE BANK OF NEW YORK

EURO-DOLLAR

The substantial improvement in the United States
balance of payments and the marked erosion in the pay
ments position of major foreign countries began to gener
ate a significant shift in the flow of funds through inter
national capital markets late last summer and early fall.
As the dollar strengthened in the exchanges, earlier bor
rowings to finance speculative sales of dollars were repaid
and dollars purchased against foreign currencies were
placed in short-term Euro-dollar deposits. Meanwhile, as
primary goods prices again shot up sharply, a large por
tion of the increased dollar receipts of commodity pro
ducers was invested in the Euro-dollar market. On the de
mand side of the market, in addition to the normal corpo
rate borrowers, public entities of both industrialized and
developing nations appeared increasingly as borrowers,

Chart XI

INTEREST RATES IN THE UNITED STATES, C A N A D A ,
A N D THE E U R O -D O LL A R M A R K E T
ent

THREE-MONTH MATURITIES*

Chart XII

SELECTED INTEREST RATES
THREE-MONTH MATURITIES*

1973
* Weakly averagos of daily rates.

Perc

encouraged by their governments to seek external credit.
As investors remained reluctant to acquire fixed-interest
securities in view of escalating world inflation and con
tinued wide fluctuations in short-term interest rates, only
a small fraction of all borrowers’ needs was met through
public offerings in the Euro-bond market. Instead, a larger
and growing portion was financed through privately placed
medium-term Euro-dollar loans, on which interest rates
would be adjusted periodically to reflect changes in the
lending banks’ cost of funds.
Late in the year, the steep increases in world oil prices
prompted a far-reaching reassessment of how the radically
altered balance-of-payments prospects for the producing
and consuming nations would affect the Euro-dollar m ar
ket. On the one hand, it was widely expected that the
producing nations would channel a significant portion of
their higher revenues into the market. On the other hand,
governments of oil-consuming countries indicated their
intention increasingly to tap the market for funds to
cushion their reserves. Although the market remained
generally receptive to the expanding needs of public as
well as private borrowers, some new loans met investor
resistance.
Meanwhile, in response to the dollar’s strong improve
ment in the exchanges, the governments of Germany and
most other Continental countries had begun to relax their
restraints on capital inflows. Effective January 1, the United
States joined in this progressive easing of controls by re
ducing the interest equalization tax from Vi percent to
V4 percent, liberalizing the foreign direct investment pro
gram and raising bank lending ceilings under the Federal
Reserve’s voluntary foreign credit restraint program. Then,
effective January 29, these control programs were termi
nated altogether, and other governments quickly responded
by speeding up their own relaxation of controls.
During the period under review, Euro-dollar rates on
three-month maturities moved more closely in line with
United States domestic interest rates than with rates in
the major European markets. At the same time, interest
differentials between comparable Euro-dollar and United
States deposit instruments narrowed significantly, except
at the year-end when normal seasonal positioning in the
Euro-dollar market provided a temporary buoyancy for
Euro-dollar rates. Thus, by the end of January, threemonth Euro-dollars and United States certificates of de
posit were both quoted just slightly above 8 Vi percent;
late last summer, by comparison, the rates were at about
H V i percent and IOV2 percent, respectively.

MONTHLY REVIEW, MARCH 1974

Th e Business Situation
Economic activity apparently declined early in 1974.
Much of this weakness can be attributed to the effects
of the Arab oil embargo which, while weighing very
heavily on particular sectors, has had widespread ramifi
cations. Industrial production fell in January for the
second consecutive month, with reductions in energy
and auto output accounting for about half of the total
January contraction and all of the December decline.
Sales of new domestic-type passenger cars slumped
somewhat further in February to the slowest pace in
three and one-half years. Personal income also dropped
significantly in January, partly as a result of reduced
employment in several key sectors and a widespread
shortening of the workweek. A substantial portion of the
rise in unemployment during recent months can be traced to
the direct and indirect consequences of the energy shortage.
There are, however, some tentatively encouraging signs.
Residential construction activity perked up somewhat in
January, as housing starts rose from the 3 Vi-year low of
the month before and newly issued building permits also
increased. In addition, retail sales registered a sizable
increase in January. New orders for durable goods rose
nearly 5 percent in January, after dropping more than
6 percent during the previous month, and the backlog
of unfilled orders continued to climb. Recent evidence sug
gests that business capital spending plans for 1974 may
have strengthened in the face of the energy shortage.
A special survey conducted by McGraw-Hill projects a large
18 percent increase in capital outlays. Inventory accumu
lation has been rapid and, while extraordinary price in
creases have greatly inflated book values, a substantial
amount of real inventory accumulation has been taking
place. The accelerated pace of physical accumulation
apparently represents investment that is intended by
business, with the exception of the automotive sector
where a substantial buildup of unsold large cars occurred
late last year. Even here, though, inventories seemed to be
moving toward a somewhat more balanced condition in
February since new domestic auto sales once again out
paced assemblies.

Meanwhile, inflation has intensified. Based on re
vised data, the gross national product (G N P) deflator
climbed at an 8.8 percent annual rate in the fourth quarter
of 1973, up from the original estimate of 7.9 percent.1 Led
by soaring food and energy costs, prices at both the whole
sale and retail levels advanced along a broad front in
January.
INDUSTRIAL PRODUCTION, ORDERS,
AND INVENTORIES

The Federal Reserve Board’s index of industrial produc
tion declined at a 9 Vi percent seasonally adjusted annual
rate in January after falling at a 7 !/2 percent pace in the
previous month. By way of perspective, industrial output
had climbed rapidly into early 1973, rising more than 12
percent over the year ended February 1973 (see Chart I).
As the year wore on, a noticeable slowing in production
growth emerged; output rose at a 4.4 percent annual rate
during the February-November interval, when a wide
variety of capacity limitations and shortages held the rate
of increase in check. The declines of December and Janu
ary bear the unmistakable imprint of the Arab oil embargo.
Cutbacks in automotive production and energy output
accounted for all of the reduction in December and half of
the January dip.
Passenger car assemblies fell 16 percent in January to
a seasonally adjusted annual rate of 6.9 million units, the
slowest pace since late 1970 when auto output was de
pressed by the strike at General Motors. Current produc

1 The estimate of fourth-quarter current-dollar GNP growth has
been revised upward from $29.5 billion to $33 billion. Investment
in business inventories was raised from a $15.9 billion to an
$18 billion rate. Net exports were also raised significantly. On
the other hand, consumption spending turned out to be even
weaker than first indicated, with outlays up by only $9.2 billion.
In real terms, GNP is now estimated to have grown at a 1.6 percent
annual rate in the fourth quarter, compared with the initial esti
mate of 1.3 percent.

FEDERAL RESERVE BANK OF NEW YORK

tion is symptomatic of the continuing low overall level of
auto sales and the exceptionally high stocks of unsold large
cars held by retail dealers. Moreover, production has
been somewhat constrained because the industry is cur
rently undergoing a major retooling process in an effort to
increase production of the very popular smaller cars.
Preliminary data suggest that passenger car output de
creased modestly further in February.
The energy component of industrial production, which
includes refined petroleum products, electric power, and
gas utilities, dropped at a seasonally adjusted annual rate
of 9Vi percent in January after falling at a 42 percent
annual rate in December. In January, energy production
was off nearly 3 percent from its year-earlier level. It is
interesting to note that the nation’s output of energy
peaked last July and began to decline somewhat before
the start of the Arab oil embargo. The most recent
drop continues to reflect a shortage of petroleum which is
related to the embargo, as well as conservation measures
taken by residential and industrial users, and the abnor
mally mild weather which covered much of the nation
during the last half of January. On the other hand, the
extraction of coal— the most abundant energy source in
the United States— jumped very sharply in January.
Since the imposition of the Arab oil embargo, the attrac
tiveness of coal as an alternate source of energy has
increased substantially. Several utilities along the Eastern
Seaboard have been granted permission to burn coal
instead of residual oil, which is in short supply. However,
the index of coal output tends to be quite volatile on a
month-to-month basis, and the rise early this year only
served to return coal output to the approximate level
reached in several months of 1973.
New orders placed with manufacturers of durable goods
jumped nearly 5 percent in January, on a seasonally
adjusted basis, after a drop of more than 6 percent during
the previous month. Any assessment of the underlying sit
uation is complicated by the fact that the flow of bookings
has been particularly volatile during the recent past. For
example, new orders declined during each month of the
third quarter, but rose substantially over the next two
months. On balance, the overall flow of new orders has
remained sizable, with orders in January about 1.3
percent above the June-July 1973 average. During January,
a large rise of $1 billion in the very volatile defense
orders series was partially offset by a $0.6 billion drop in
primary metal bookings. After declining in December,
orders for nondefense capital goods rose $0.4 billion in
January to a level 5.1 percent above the mid-1973 pace.
Meanwhile, the backlog of unfilled orders continued to
swell in January, and the very large backlog should serve

to bolster production in the near future.
There is recent evidence that capital spending plans
for 1974 have strengthened even further. A special sur
vey conducted by McGraw-Hill during late January
and early February indicated that businesses are planning
to raise their plant and equipment outlays by 18 percent
in 1974. This is substantially above the increases of 12
percent to 14 percent previously projected for this year on
the basis of surveys conducted in late 1973 by McGrawHill, Lionel D. Edie, and the Commerce Department.
Moreover, the most recent information suggests that the
net effect of the energy situation on capital spending may
be positive, even though some sectors have substantially
pared their spending plans.
Business inventory spending continued its rapid rise
on a book value basis in December, increasing at a sea
sonally adjusted annual rate of $32 billion after the record
shattering $39 billion November rise. As a result, the
expansion in total business inventories during the final
quarter of 1973 amounted to $32 billion at an annual rate,
easily the largest quarterly gain in business inventories
since the end of World W ar II.
Some of the recent climb in inventories represents the
undesired buildup of unsold large cars. During both Octo

MONTHLY REVIEW, MARCH 1974

ber and November, the dollar value of inventories at retail
automotive outlets jumped an average of $6 billion (sea
sonally adjusted annual ra te ), but this slowed significantly
to a $ m billion rate of accumulation in December.
By the end of January the number of new cars in
the hands of dealers had, on a seasonally adjusted basis,
been reduced somewhat from the levels reached during the
final months of last year. Relative to sales, however, they
still remained very high. Preliminary data for February
indicate that the seasonally adjusted pace of domestic-type
passenger car assemblies was again below that of new
car sales, suggesting that a further decline in auto inven
tories may have taken place. Also it is true that much
of the rapid climb in the book value of inventories reflects
the extraordinary rates of inflation experienced recently
rather than the growth of physical stocks. Nonetheless,
a substantial buildup of physical stocks also took
place outside the automotive sector toward the end
of 1973. As shown in the GNP accounts, the fourthquarter change in real business inventories— excluding
the very large rise in automotive dealers’ stocks— was
three times as large as the average increase over the
first three quarters of the year. Much of this steppedup spending appears to have been deliberate. For example,
approximately half of the unusually steep December climb
in the book value of durables manufacturers’ inventories
consisted of increased holdings of materials and supplies.
This was very likely an intentional response to the wide
spread shortages of materials that plagued firms during
much of the recent past.
The ratio of inventories to sales for all businesses rose
from 1.41 in November to 1.45 in December, largely as a
result of the drop in auto sales together with the buildup
in auto inventories. Although the December ratio was the
highest in 1973, it was still lower than at any time during
the 1968-72 period. Moreover, when the automobile
sector is excluded, the inventory-sales ratio was lower in
December than in some earlier months of the year, sug
gesting that most inventories remain lean relative to sales
volume.
PERSONAL INCOME, CONSUMER DEMAND,
AND R ES ID EN TIA L CONSTUCTION

Personal income declined $4.1 billion in January to a
seasonally adjusted annual rate of $1,084.9 billion. This
was the first decline in nineteen months and the largest
drop since July 1971, when income plunged by $10.1
billion. However, both of these earlier declines reflected
mainly once-and-for-all developments. In June 1972,
personal income fell mostly because of the aftereffects

Chart II

RETAIL SALES
S e a so n a lly a d ju ste d
Billions of d ollars

Source:

Billions of dollars

U n i t e d S t at e s D e p a r t m e n t o f C o m m e r c e , B u r e a u o f t h e C en s us .

of tropical storm Agnes, while the earlier drop followed a
big lump sum social security payment. Some of the
weakness evident in January can be traced to higher social
insurance contributions which are deducted from personal
income. Much of the recent decline, though, is indicative
of the weakening in economic activity. This is seen most
clearly in the behavior of wage and salary disbursements.
Wage and salary payments dropped $2.7 billion in January
after having added an average of $5.7 billion to personal
income during each of the preceding twelve months. The
January decline was concentrated in manufacturing and
construction, where falling employment and shortened
workweeks reduced wage and salary payments by $3.5
billion and $1.1 billion, respectively. Farm income also
declined by a substantial $2.8 billion as a result of lower
subsidy payments under the Agriculture and Consumer
Protection Act of 1973.
According to the preliminary estimate, retail sales in
January climbed a sizable 2.5 percent above the depressed
December level (see Chart II ). The January rise in
current-dollar sales was the largest in seven months and
seemed to be fairly broad based. If this advance estimate

FEDERAL RESERVE BANK OF NEW YORK

holds up under subsequent revisions, the nominal value
of retail sales will have climbed slightly above the peak
reached last November. However, in real terms, retail sales
remain well below the peak level measured last March.
Sales of new domestic-type passenger automobiles
slipped a bit further in February to a seasonally adjusted
annual rate of 7.4 million units from January’s depressed
7.7 million unit pace. During the past several months,
sales of domestic autos have receded to the lowest level
since the last quarter of 1970, when a strike at General
Motors drastically reduced the available supply of do
mestic passenger cars. It may be too early to tell whether
the decline in auto sales, which began with the intro
duction of the 1974 models and continued with the
start of the oil embargo, has just about run its course.
However, sales should rise as production shifts yield
increased supplies of the popular small vehicles.
Residential construction activity picked up somewhat
in January, as housing starts rose 6.1 percent to a season
ally adjusted annual rate of 1.49 million units in compari
son with 1.40 million units started in December. While
the January pace was still 40 percent below the 2.47
million units started one year earlier, the increase may
mark the end of the pronounced downtrend that began in
the middle of last year. The recent behavior of building
permits also provides some encouragement: newly issued
permits jumped 9Vi percent in January to the highest rate
in several months. The availability of mortgage money
has been enhanced by the flow of funds to mutual savings
banks and savings and loan associations. Deposit growth
at these institutions, which are the major sources of mort
gage lending, has strengthened considerably after taper
ing off dramatically during the summer months. According
to preliminary data, seasonally adjusted net deposit inflows
were at an annual rate of about 12 percent in January,
the fastest pace since the same month a year ago. There is
also some indication that inflows remained strong during
February.
During December, shipments of mobile homes, which
in recent years have represented a substantial portion of
the supply of new housing, were at a seasonally adjusted
annual rate of 466,000 units, about equal to the average
number of shipments over the last several months. None
theless, current shipments are sharply below the record
level of 737,000 units sold in M arch 1973. Sales of
new single-family homes also fell sharply in December
to the slowest pace in three and one-half years, while
inventories of unsold homes have shown little change.
Consequently, the ratio of unsold homes to sales rose to a
record 12.8 months of sales, almost twice the level re
corded in the year-earlier period.

PRICES

Inflation continued to intensify during January, as sea
sonally adjusted wholesale prices rose at a sizzling 38
percent annual rate. Although the rise was only about one
half the size of the enormous post-freeze surge registered
last August, it was still the second largest monthly
increase in wholesale prices in more than a quarter century,
underscoring the severity of the current inflation.
Perhaps the most distressing feature of the January
advance in wholesale prices was its pervasiveness. Prices
of farm products, processed foods, and feeds jumped at a
61 percent annual rate after declining in three of the four
previous months. Over the year ended in January, these
prices rose by almost 30 percent. The resurgence of food
price pressures is mainly attributable to rising prices of
wheat and beef. The realization that stocks of wheat are
at low levels has helped push wheat prices up. Beef prices
have increased in response to forces set in motion last
summer. At that time, farmers reduced the volume of
cattle placed on feed for winter marketing in reaction to
the price ceilings placed on beef. Ceilings were lifted
September 10, but this was too late to affect measurably
the supplies currently coming to market.
Meanwhile, fuel and power prices leaped 82 percent at
an annual rate in January, mainly because of a huge

Chart III

C H A N G E S IN C O N S U M E R PRICES
S easonally a djusted a n n u a l rates

P eriod ended Ja n u a ry 1974
1 m onth

13 months

|m |l2

months

Source: United States Department of Labor, Bureau of Labor Statistic

MONTHLY REVIEW, MARCH 1974

increase in the price of crude petroleum (over 260 per
cent at an annual rate). Since the start of the Arab oil em
bargo last October, wholesale fuel and power prices
have risen at an annual rate of 172 percent, compared with
the rise of 25 percent in the year preceding the boycott.
While energy price increases dominated the overall indus
trial commodities index, other industrial prices also climbed
very rapidly. Excluding the fuel and power component,
wholesale prices of industrial commodities rose at a 22
percent annual rate in January, the largest one-month rise
on record. Over the twelve months ended in January, such
prices increased 11 percent.
Consumer prices surged ahead at a 12 Vi percent sea
sonally adjusted annual rate in January (see Chart III)
after rising at a 6 Vi percent pace in December. Except for
the burst last August associated with the lifting of the
second price freeze on most foods, this was the largest
month-to-month increase in consumer prices since the

early days of the Korean war. Advances in the prices of
food and energy contributed substantially to the overall
increase in consumer prices in January and in the last
several months. When these two components were ex
cluded from the index, the consumer price index rose at
an annual rate of 4.5 percent in January and at the same
rate during the last three months. Over the preceding
year the index rose at a 5.1 percent annual rate.
Consumer power and fuel prices continued to soar,
rising at an annual rate of 66 percent in January. This
component, which includes gasoline, home heating oil, and
gas and electricity, has increased more than 50 percent
(annual rate) since the start of the oil embargo last Octo
ber. At the same time, food prices rose at an annual rate of
19 percent in January. This brought the rise over the past
year to 20 percent. Based on recent estimates made by the
United States Department of Agriculture, food prices are
expected to advance substantially in the near future.

Fifty-ninth Annual Report
The Federal Reserve Bank of New York has published its fifty-ninth Annual Report, re
viewing major economic and financial developments and the Bank’s operations in 1973.
The Report observed that “inflation reemerged as the param ount economic problem in
the United States in 1973, exploding with a force not seen since the early days of the Korean
war” . With regard to monetary policy, the Report said that “the Federal Reserve pursued a
policy of active restraint in 1973”, while at the same time the monetary authorities “sought to
avoid extreme pressures on financial markets which could seriously disrupt credit flows and ulti
mately risk generating a substantial contraction in economic activity”. Although the interna
tional financial system experienced considerable stress during the first half of 1973, the R e
port noted that “the fact that the central banks were prepared to intervene to prevent the reemer
gence of disorderly conditions contributed to a much calmer atmosphere in the m arkets” during
the remainder of the year.
In his letter presenting the Report to the member banks, Alfred Hayes, President of the
Bank, stated that “we must seek to reduce inflationary pressures and to reverse the escalation
of cost and price increases. Both the reconstruction of the international monetary system and
the restoration of confidence in the dollar depend heavily on the resumption of a reasonable de
gree of price stability in the United States” . Mr. Hayes added that “we must, at the same time,
seek to encourage sustainable economic growth . . . . Progress toward these objectives calls for
the determined, coordinated efforts of monetary and fiscal polices.”
The Annual Report may be requested from the Public Information Department, Federal
Reserve Bank of New York, 33 Liberty Street, New York, N.Y. 10045. A copy is being mailed
to Monthly Review subscribers.

FEDERAL RESERVE BANK OF NEW YORK

Th e M oney and Bond Markets in February
Interest rates fell considerably in early February, but
sharp yield increases toward the end of the month erased
much of the earlier declines. In the money market, down
ward pressure on rates emerged as market participants
observed a greater availability of reserves in the banking
system early in the month and projected a further easing
of monetary policy. Although revisions of these projections
caused some rates to rise toward the close of the month,
the rate on four- to six-month commercial paper dropped
50 basis points over the course of the month, while the
average effective rate on Federal funds fell 68 basis points
below its January average. These declines were accom
panied by three V* percentage point reductions in the
commercial bank prime lending rate on loans to large
business borrowers. As a result, the prime rate closed
the month at 83A percent, its lowest level since July 30,
1973.
Early in the month the easing of money market condi
tions provided a firm undertone for the Government
securities market, and the rally which began late in Jan
uary gathered strength. Treasury bill rates and yields
on intermediate-term coupon issues dropped sharply in
the first statement week of the month, and the Treasury’s
refunding operation was highly successful. The down
ward movement of long-term rates was more restrained,
however, as investors remained concerned about the
future course of inflation and the longer run outlook
for interest rates. The rally subsequently faded in the wake
of Chairman Burns’s Congressional testimony which was
interpreted as indicating that the apparent easing of mone
tary policy would not be pushed further. Near the end of the
month, market participants began to press their accumu
lated positions on the m arket and yields rose. Long-term
corporate and municipal bond yields also rose. Over the
month, the Federal Reserve Board’s index of yields on
newly issued Aaa-rated utility bonds increased 4 basis
points to 8.30 percent and The Bond Buyer index of
municipal bond yields rose 6 basis points to 5.26 percent.
Available data suggest that the seasonally adjusted
narrow money supply (M a) — private demand deposits

adjusted plus currency outside commercial banks— grew
substantially in the first three statement weeks of Febru
ary following the decline experienced in January. Time
and savings deposits at commercial banks, other than large
negotiable certificates of deposit (C D s), apparently grew
at a fairly rapid rate over the first three weeks of February
as well. Consequently, the broad money supply (M 2) —
plus consumer-type time and savings accounts at commer
cial banks— rose sharply. However, the adjusted bank
credit proxy, which includes all deposits of member banks
plus certain nondeposit liabilities, appears to have experi
enced a slight decline in the three-statement-week interval
ended February 20, as increases in private deposits were
offset by a fairly large decline in Government balances at
commercial banks.
TH E M ONEY M ARKET, BANK RESERVES,
AND TH E M O N ETA R Y AGGREGATES

Rates on most money m arket instruments continued to
fall sharply early in February but then rose somewhat over
the remainder of the month (see Chart I ) . For the month as
a whole, the effective rate on Federal funds averaged 8.97
percent, 68 basis points below January’s average and its
lowest level since June 1973. The bid rate on bankers’ accep
tances closed the month at 8 Vs percent, down from a level
of 8% percent at the end of January. In the commercial
paper market, rate declines on directly placed and dealerplaced paper ranged from 25 to 75 basis points. In line
with the drop in other money m arket rates, most major
commercial banks reduced their prime lending rates to
large business borrowers in three X
A percentage point steps
to 83A percent. M ember bank borrowings from the Federal
Reserve System, however, edged upward in February (see
Table I ) , after declining over the five preceding months.
According to available data, both M 1 and M 2 rose
rapidly in the first three statement weeks of February,
but the bank credit proxy declined slightly. Since short-run
changes in these monetary aggregates are often influenced
by random unpredictable movements that belie underlying

MONTHLY REVIEW, MARCH 1974

Chart I

SELECTED INTEREST RATES
December 1973 - February 1974

percent

MONEY MARKET RATES

1973
Note:

1974

BOND MARKET YIELDS

1973

Percent

1974

Data are shown fo r business days only.

MONEY MARKET RATES QUOTED:

Bid rates for three-m onth Euro-dollors in London; offering

standard A aa-rated bond o f at least twenty years’ maturity; d a ily averages of

rates (quoted in terms of rate o f discount) on 90- to 119-day prim e commercial poper

yields on seasoned A aa-rated corporate bonds; d a ily averages o f yields on lo ng;

quoted by three o f the five dealers that report their rates, or the midpoint of the range

term Government securities (bonds due or callable in ten years or more) and

quoted if no consensus is available; the effective rate on Federal funds (the rate most
representative o f the transactions executed); closing bid rates (quoted in terms o f rate of

on Government securities due in three to five years, computed on the basis of
closing bid prices; Thursday averages o f yields on twenty seasoned twenty-year
tax-exempt bonds (carrying M oody's ratings of Aaa, Aa, A , and Baa).

discount) on newest outstanding three-month Treasury bills.
BOND MARKET YIELDS QUOTED: Yields on new A ao-rated public u tility bonds are based
on prices asked by und erw ritin g syndicates, adjusted to make them equivalent to a

trends, it is useful to consider the behavior of the monetary
aggregates within a longer run perspective. Over the last
year the growth of M 1? for example, has slowed appreciably.
Seasonally adjusted daily average M x from the four-week
interval ended m id-February 1973 to the four-week inter
val ended February 20, 1974 rose 5.4 percent (see
Chart II ). This represents a 3 percentage point decelera
tion in Mi growth from that experienced over the pre
ceding year. During the same period, the rate of change
of M 2 fell 1.6 percent from its rate of growth in the
preceding year to 8.7 percent.
With short-term interest rates declining, banks re
duced offering rates on large negotiable CDs and still
attracted a substantial volume of funds through this

Sources: Federal Reserve Bank of New York, Board o f G overnors o f the Federal
Reserve System, M o o dy’ s Investors Service, Inc., and The Bond Buyer.

instrument. The offering rate on three-month CDs in
the secondary market declined 80 basis points to 8.07
percent by the end of February despite some increase
in the rate toward the close of the month. On a sea
sonally adjusted annual basis, CDs grew at the rapid
rate of 40.1 percent in the four statement weeks ended
February 20, compared with the preceding four-statementweek period. From December 12, when the marginal
reserve requirement on CDs was lowered to 8 percent,
through February 20, CDs grew at a seasonally adjusted
annual rate of about 29 percent, compared with the sea
sonally adjusted decline of CDs outstanding at virtually
the same rate while the 11 percent marginal reserve
requirement was in effect from September 19 through

FEDERAL RESERVE BANK OF NEW YORK

December 12. Despite this resurgence of CD growth, the
increase of the adjusted bank credit proxy has remained
moderate, with its recent growth inhibited by the rundown
of Government deposits at commercial banks. Relative to
its four-week average level in the period ended thirteen
weeks earlier, the proxy grew at a seasonally adjusted
annual rate of 6.5 percent over the four-week interval
ended February 20. This is an acceleration from the rate of
increase experienced by the proxy in the preceding
thirteen-week interval, but it is well below the growth
rates of the proxy experienced in early 1973.
TH E GOVERNM ENT SECURITIES M ARK ET

As February began, a major rally was in progress in the
m arket for United States Treasury obligations. The rally
had been sparked in late January by signs that some easing
of monetary policy was in progress. These indications were
reinforced by further injections of reserves by the Federal
Reserve System in early February. In addition, market
sentiment was bolstered by the removal of restrictions on
foreign capital flows, including the interest equalization
tax, and the terms of the Treasury’s February refunding.
The latter development was viewed positively since the
Treasury announced plans to pay down about $0.5 billion
of debt.
In this environment, rates on Treasury bills dropped
sharply during the initial statement week of the month.
Bidding was very aggressive at the first regular weekly
auction in February, and the average issuing rates on the
new three- and six-month bills fell to 6.95 percent and
6.75 percent, respectively (see Table II ) , their lowest
levels since May 1973. Together with the yield declines
registered at the preceding week’s auction, these decreases
brought the three- and six-month auction rates down more
than 100 basis points from their levels of m id-January
and more than 200 basis points below their peaks of
August 1973. Some profit taking emerged shortly after the
auction, but the market firmed prior to the monthly sale
of 52-week bills. This issue was auctioned at an average
rate of 6.34 percent, down 61 basis points from the Janu
ary issuing rate. Subsequently, the market softened in the
wake of Chairman Burns’s testimony before Congress which
was interpreted as indicating that monetary policy would not
ease significantly further. The auction on February 26 of
$1.5 billion of tax anticipation bills due April 19, 1974
drew only routine bidding and the average issuing rate was
set at 7.45 percent. With the rise of rates toward the end
of February, the market yield on the three-month bill
closed the month only 2 basis points below its end-ofJanuary level and the yields on the six-month and 52-week

77
Table I

FACTORS T E N D IN G TO INCREASE OR DECREASE
MEM BER B A N K RESERVES, FE B R U A R Y 1974
In millions of dollars; (+ ) denotes increase
and (—) decrease in excess reserves

Changes in daily averages—
week ended

Net
changes

Factors
Feb.
6

Feb.
13

Feb.
20

Feb.
27

“ M arket” factors
Member bank required reserves ..................

+ 529

+ 303

— 221

4- 625

4-1,236

Operating transactions (subtotal) ..............

- f 212

— 633

— 492 4- 655

— 258

Federal Reserve f lo a t..................................

+ 100

4- 131

4- 285

Treasury operations* ..................................

— 325

+ 599 - f 189

- f 493

— 71 +

Gold and foreign account ........................

+ 188

-f

Currency outside b a n k s ..............................

— Ill

— 626

-f

234

— 875 4- 346

—1,266

—

Other Federal Reserve liabilities
and capital ..................................................

-f

- f 166

— 162 —

Total “ market” factors ............................

- f 741

— 330

— 713 4-1,280

4- 978

— 685

+ 270

+ 887 —1,000

— 528

— 482

- f 260

+ 382

Direct Federal Reserve credit
transactions
Open market operations (subtotal) ............
Outright holdings:
Treasury se c u ritie s ......................................
Rankers' accep tan ces..................................

Federal agency obligations ......................

— 18

_i_
i

3
— 22

— 373
+

+ 120

Repurchase agreements:
Treasury s e c u ritie s ......................................

— 131

+ 290 — 498

— 323

Bankers' accep tan ces..................................

—

4- 29 —

—

Federal agency obligations ......................

— 50

4- 65 —

—

Member bank borrowings ..............................

— 223

+ 155

—

4- 224

Seasonal borrowings! ................................

Other Federal Reserve a s s e t s t ......................

- f 100

— 593
4- 518 —1,163

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

— 87G

+ 525

Excess reserves^ ................................................

— 135

+ 195

5 —

195

— 501

4- 117

— 996
—

Monthly
averages!

Daily average levels

Member bank:
Total reserves, including vault c a s h ! ..........

35,475

35,367

35,393

34,885

35,280

Required reserves ............................................

35,351

35,048

35,269

34,644

35,078

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

124

319

124

Total borrow ings......................................

998

l, loo

1,377

241

1,ZOO

202
1,196

Seasonal borrowings! ................................

Nonborrowed reserves ....................................

34,477

34,214

34,016

gq flon
00,001)

34,084

Net carry-over, excess or deficit (—) | | ___

167

128

108

Note: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
t Included in total member bank borrowings.
t Includes assets denominated in foreign currencies.
§ Average for four weeks ended February 27, 1974.
II Not reflected in d ata above.

MONTHLY REVIEW, MARCH 1974

bills closed 13 and 5 basis points, respectively, above their
end-of-January levels.
Indications of an easing in money market conditions, the
favorable terms of the refunding, and the drop in bill rates
prom pted substantial declines in rates on intermediateterm Government securities during the early part of
February. Yields on issues of more than ten years’ maturity
moved only modestly lower, however. On Tuesday, Feb
ruary 5, the Treasury auctioned $1.5 billion of seven-year
7 percent notes. Interest in this issue, part of the February
refunding package, was enthusiastic, and the average issu
ing rate was set at 6.95 percent. Interest in the 3 ^ -year
6% percent note offering the following day was somewhat
subdued. Nonetheless, the average issue price was above
par, providing a yield of 6.70 percent. Following the auc
tion the tone of the market deteriorated somewhat in re
sponse to Chairman Burns’s testimony, but the auction of
$300 million of bonds due in August 1993, the final part of
the refinancing, attracted strong interest. The Treasury
employed the technique of awarding all of the bonds at
the price of the lowest accepted bid, and the yield to m a
turity was set at 7.45 percent. Yields on Treasury coupon
issues generally rose during the second half of the month.
Yields on intermediate-term issues closed the month up
about 4 to 9 basis points, while yields on issues due in ten
years or more ranged from 6 to 20 basis points higher.
The market for Federally sponsored credit agency se
curities benefited initially from the good tone of the Gov
ernment securities m arket which prevailed early in the
month. About $2.3 billion in new agency securities was
marketed in February. The early issues were well received
at yields considerably below those on recent previous of
ferings. At the beginning of the month, one of the farm
credit agencies, the Federal Land Banks, marketed $389
million of 5Vi-year 7.15 percent bonds. Shortly thereafter,
the Federal Home Loan Banks sold $300 million of
eighteen-month 6.80 percent bonds and $300 million of sixyear 7.05 percent bonds. This offering represented a net
paydown of about $650 million of debt, and investor inter
est in these issues was strong. The paydown reflected the re
duced dependence of savings and loan associations upon
Federal Home Loan Bank advances as a source of funds
now that rapid growth of savings deposits has resumed and
mortgage demand has slackened. Later in the month, the
Export-Im port Bank sold $400 million of five-year 7 per
cent debentures priced to yield 6.95 percent. This issue did
not encounter a good reception, and the underwriters cut
prices sharply in order to distribute the large unsold por
tion of the issue. A Federal National Mortgage Associa
tion $1.2 billion issue met a mixed reception as optimism
faded in the final week of the month.

OTH ER SECURITIES M ARKETS

Yields on short-dated municipals declined in February.
However, offerings of newly issued municipal and corpo
rate long-term debt met stiff investor resistance when un
derwriters sought to attain lower rate levels, and long-term
rates changed little. Investors generally felt it prudent to
avoid lower yields at present, in anticipation of better
buys in the future. As a result, a number of aggressively
priced issues failed to attract investor attention and a sub
stantial buildup in dealer inventories developed. This
backlog of issues in inventory gradually came to weigh
heavily on the market and, as the month progressed, syn
dicate price restrictions on a num ber of slow-moving is
sues were removed, resulting in considerable upward
adjustments in yields.
The corporate bond m arket absorbed large volumes of
intermediate-term issues in February, as manifested by the
rapid sellout of three A aa-rated bank holding company

Chart II

C H A N G E S IN M O N E T A R Y A N D CREDIT A G G R E G A T E S
Seasonally adju sted a n n u a l rates
Percent

Percent
1 ...... !5
From 13
weeks e a rlie r _

Ml
v

/ " \

\ ' --------* /
f
From 52
weeks e a rlie r

1 1 1 1 1 1 1 1 1 I 1

1 1 1 1 1 1 1 1 1 1 1

1 .1..

15 M2

------

;
5 j|

ol
20

1 1 1 1 1 1 1 1

\y \

From 52
weeks e a rlie r

1 I

_
/

- 5

From 13
Iw eeks e a rlie r 1 . .
1 1 1 i i i i i 1 1 1

ADJUSTED BANK CREDIT PROXY

1 1

0
20

From 13 |
Y * w e e k s e a rlie r

From 52
weeks e a rlie r

1 1 1 1 1 1 1 1 1 1
1972

1 i

1 i
1973

1 i i

---- -

_ 10

1 1
1974

Note: Growth rates are computed on the basis of four-week averages of daily
figures for periods ended in the statement week plotted, 13 weeks earlier
and 52 weeks earlier. The latest statement week plotted is February 20, 1974.
Ml = Currency plus adjusted demand deposits held by the public.
M2 = Ml plus commercial bank savings and time deposits held by the public,
less negotiable certificates of deposit issued in denominations of $100,000
or more.
Adjusted bank credit proxy = Total member bank deposits subject to reserve
requirements plus nondeposit sources of funds, such as Euro dollar
borrowings and the proceeds of commercial paper issued by bank holding
companies or other affiliates.
Source: Board of Governors of the Federal Reserve System.

FEDERAL RESERVE BANK OF NEW YORK

note offerings. These bank note offerings represent part
of an extraordinarily large volume of bank issues sched
uled to be marketed in 1974. The difficulty of marketing
long-term debt at lower yields became apparent early in
the month when $50 million of Aa-rated twenty-year util
ity bonds met a poor reception when priced to yield 7.97
percent. This was about the same rate as that on an Aaarated utility issue sold at the end of January. Investors were
somewhat more enthusiastic about an offering of $70 million
of thirty-year utility bonds priced to yield 8.22 percent. Al
though this issue was rated Aa by one rating agency and
only A by another, investors considered it comparable to
the A a-rated utility marketed earlier and bid more aggres
sively for it. Nonetheless, yields on both issues rose when
underwriters removed syndicate restrictions later in the
month. Subsequent to these issues, market attention fo
cused upon a $300 million offering— the largest of the
year to date— of forty-year 8 percent debentures of a
m ajor Bell System subsidiary. As it turned out, the Aaarated issue attracted only moderate interest when priced
to yield 8.06 percent, 1 basis point above the yield on an
Aaa-rated Bell issue sold the month before. Further evi
dence of the lack of interest in long-term issues material
ized later in the month, as $100 million of Aaa-rated
thirty-year bank holding company debentures met a poor
reception when priced to yield 8.19 percent, despite the
fine reception accorded the company’s note offering.
In the tax-exempt market, the major long-term issues
of the month also experienced relatively modest retail
demand. Early in the month, $168 million of A 1-rated
bonds sold slowly when offered to yield from 4.20 per
cent in 1974 to 5.90 percent in 2015. Later in the month,

79
Table II

A V E R A G E IS S U IN G R A TES
A T R E G U L A R T R E A S U R Y B ILL A U C T IO N S*
In percent
Weekly auction dates— February 1974
Maturity

Three-month ........................................

Feb.
4

Feb.
11

Feb.
15

6.951

7.081

7.018

7.188

6.747

6.882

6.787

7.081

Feb.
25

Monthly auction dates— December 1973-February 1974

Fifty-two weeks ..................................

Dec.
12

Jan.
9

Feb.
6

6.881

6.948

6.342

* 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 m aturity. Bond yield
equivalents, related to the amount actually invested, would be slightly higher.

two Aaa-rated municipal offerings attracted only fair re
ceptions. In the first, $59.6 million of bonds was priced
to yield from 3.75 percent in 1975 to 5.25 percent in
1994. Subsequently, a $100 million issue, priced to return
from 3.75 percent in 1975 to 5.00 percent in 1994, was
marketed. Syndicate restrictions had to be removed from
both issues for the offerings to sell out. Although shortdated issues sold well, the Blue List of dealers’ advertised
inventories rose $108 million to $1,142 million by the
end of the month.

Full text of Economic Policy Review (Federal Reserve Bank of New York) : March 1974, Vol. 56, No. 3

FRASER