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Treasury and Federal Reserve Foreign Exchange
Operations, by Charles A . Coombs and
Scott E. Pardee ....................................................... 39
The Business Situation ................................................ 57
The Money and Bond Markets in Feb ruary............. 61

V olum e 57

No. 3



Treasury and Federal Reserve Foreign Exchange Operations
August 1974—January 1975

C harles


C oom bs

Through the late summer of 1974 the dollar showed
considerable buoyancy in the exchange markets but, from
October on, became subject to continuing selling pressure.
By late January, the dollar had fallen from its highs by
some 27 percent against the Swiss franc and 17 percent
against the German mark and other currencies in the
European monetary bloc. Dollar quotations had also de­
clined by some 3 to 4 percent against sterling, the Italian
lira, and the Japanese yen.
The dollar’s strength in August and September re­
flected primarily the pull of unusually high interest rates
in New York and the Euro-dollar market, reinforced by
expectations that surplus oil revenues would flow into the
United States financial markets after saturating investment
outlets elsewhere. With the dollar in demand, the Federal
Reserve was able to buy sufficient marks in the market not
only to repay the remaining $64.6 million equivalent of
drawings on the Bundesbank outstanding from earlier in
the year, but also to build up balances to finance inter­
vention should selling pressure suddenly erupt. On one
such occasion, on August 8 and 9, the Federal Reserve sold
$20.8 million of marks from balances, $5.3 million of
Dutch guilders drawn on the swap line with the Nether­
lands Bank, and $2.5 million of Belgian francs of which
$0.8 million was from balances and $1.7 million drawn

*On February 19, 1975, Mr. Coombs resigned as Special Man­
ager of the System Open Market Account and Mr. Pardee was
appointed Deputy Manager for Foreign Operations. Alan R.
Holmes, Manager of the Open Market Account, has assumed
Mr. Coombs’s responsibilities for supervision of foreign opera­
tions. The Federal Reserve Bank of New York acts as agent for
both the Treasury and the Federal Reserve System in the conduct
of foreign exchange operations.





under the swap line with the National Bank of Belgium;
the swap drawings in guilders and francs were quickly
repaid out of market purchases of these currencies. Again,
on September 3, the Federal Reserve sold $16.2 million of
marks from balances to check an abrupt decline of the
dollar. Otherwise, the Federal Reserve abstained from
intervention until early October.
By that time, an improving trend in United States
exports, up 40 percent from the year before, was cutting
into the sizable trade deficit caused by the $17 billion
jump in our 1974 oil import bill. Nevertheless, in early
October, the exchange markets were showing signs of
nervousness over the onset of a sharp decline in dollar
interest rates and over reports that surplus oil revenues
were beginning to be shifted out of dollars and sterling
into continental European countries. Short bursts of
selling pressure occurred in October. The Federal Reserve
intervened on six days, selling a total of $165.7 mil­
lion equivalent of marks, of which $62.1 million equiv­
alent was from balances and $103.6 million equivalent
was drawn under the swap line with the Bundesbank. The
German central bank bought similar amounts of dollars
in Frankfurt. Late in the month, when the dollar firmed
somewhat following discount rate cuts in Germany and
the Netherlands, the Federal Reserve began to acquire
in the market moderate amounts of marks against out­
standing swap indebtedness.
By early November, however, market sentiment toward
the dollar turned bearish. Mounting evidence of an
economic recession in the United States, more severe than
in most other countries, suggested to the market that
interest rates would fall faster here than abroad. That
possibility in turn reinforced fears of large-scale shifts
of funds out of dollars by some oil-producing countries,



C h a rt I

P e rc e n t

P e rce n t



^ P e r c e n t a g e d e via tion s of w e e kly a v e r a g e s o f New Y o rk noon offered rates
from N ew Y o rk noon o ffe re d rates on Ja n u a ry 2, 1974.

as did the ever-present risk of renewed hostilities in
the Middle East. At the same time, Germany’s continu­
ing strong trade performance rekindled revaluation rumors
for the mark, and Switzerland, having lifted barriers to
short-term capital inflows, experienced a new influx of
funds which bid up the franc rate sharply. The rise of the
franc and the mark tended to be mutually reinforcing and
set off a general upsweep of currency rates against the
dollar. On several occasions, the dollar rebounded in
response to concerted intervention by the Federal Reserve
and European central banks and the introduction of new
curbs on capital inflows by the Swiss authorities. Neverthe­
less, the vigorous public debate over economic policies
here and in Europe kept the market on edge, and the
dollar continued to slip through late November.
The Federal Reserve intervened, at times forcefully, on
seven days during November. In total, $187.9 million
equivalent of marks was sold, of which $164.3 million
equivalent was drawn under the swap line with the Bundes­
bank and the rest from balances. In addition, the System
sold $28.5 million equivalent of Dutch guilders drawn under
the swap line with the Netherlands Bank, $10.8 million of
Belgian francs, of which $10.4 million was drawn under
the swap line with the National Bank of Belgium and the
rest from balances, and $12.5 million equivalent of Swiss
francs purchased outright from the Swiss National Bank.
Late in November and early December, the pressures
on the dollar eased, as United States interest rates leveled
off. The Federal Reserve was able to purchase marks in

the market and repaid $82.8 million equivalent of swap
drawings on the Bundesbank. The System also purchased
sufficient amounts of guilders and Belgian francs to liqui­
date in full the November drawings in these currencies.
From mid-December to late January, the exchange
markets were subject to an almost unremitting diet of
bearish news for the dollar, and market forces drove dollar
rates lower almost every day. The economic downturn and
the slide of interest rates in the United States reinforced
expectations of a further widening of interest differentials
already adverse to the dollar. Gloomy forecasts emerging
in the debates over economic and energy policies in Wash­
ington further depressed the market. With individual oilproducing countries reportedly growing restive over the
dollar’s depreciation, market fears of an accelerated di­
versification of oil proceeds to other currencies intensified.
In such an atmosphere, the market ignored any favorable
news for the dollar, such as the underlying improvement
in the United States trade balance and the slackening in
our rate of inflation.
To cushion the dollar’s decline, the Federal Reserve
intervened on seventeen of the twenty-eight business days

Table I
In millions of dollars

Amount of facility
January 31, 1975

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


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


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


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


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


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


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


Bank of Italy



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


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


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


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


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


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


Bank for International Settlements:
Swiss francs-dollars ..........................................................


Other authorized European currencies-dollars .............






Table II
In millions of dollars equivalent
Drawings ( + ) or repayments (—)
Transactions with

System swap
January 1, 1974



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


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


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


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


Bank for International Settlements (Swiss francs)


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




f + 13.2
1 - 13.2


i — 82.8

I— 3.7

1 — 122.8







} - 0-

J + 38.0
1 - 34.8
J + 13.3
I - 5.9

System swap
January 31, 1975


f+ 19.3

1 -0-



I +130.4
1— 122.8



j -0 -


Note: Discrepancies in totals are due to rounding,

from mid-December through January 24. Over that
stretch, operating jointly with the Bundesbank, the
System sold a further $134 million equivalent of marks,
of which $103 million was drawn under the swap line
and the rest from balances. The Federal Reserve also inter­
vened in Swiss francs in December-January, and the Swiss
National Bank resumed spot intervention in Zurich on
January 6. The System’s sales of Swiss francs amounted to
$51.1 million equivalent, of which $32.5 million was drawn
under the swap line with the Swiss National Bank and
the rest purchased outright from that bank. In addition,
the Federal Reserve sold $9.6 million equivalent of Dutch
guilders and $2.9 million equivalent of Belgian francs
drawn on the swap line with the respective central banks.
Of these swap commitments, $5.9 million of Swiss francs,
$6.4 million of Dutch guilders, and the full amount of
Belgian francs were repaid through market acquisitions.
As the depreciation of the dollar continued, European
exporters became increasingly concerned over an emerg­
ing undervaluation of the United States dollar that would
leave them at a competitive disadvantage in world mar­
kets. By late January, this potential problem was also rec­
ognized by European government officials, who publicly
noted that the dollar had fallen to unrealistically low
levels in the exchange markets. Against this background,
the Federal Reserve, together with the Bundesbank, began
during the last week in January to intervene more force­

fully to resist the erosion of dollar rates. Operating on four
of the five days, the Federal Reserve sold a further $94.6
million of marks, drawn on the swap line, and the Bundes­
bank purchased a roughly equivalent amount of dollars.
In summary, in exchange market intervention during
the six-month period, the Federal Reserve sold a total
of $742.3 million equivalent of German marks, Swiss
francs, Dutch guilders, and Belgian francs. Of this, $619.2
million equivalent was in German marks, $465.5 million
draw n u nder the swap arrangem ent with the B u n d esb an k ,
and the rest from balances acquired in the market.
Liquidation of debt in marks, including the $64.6
million outstanding on August 1, amounted to $147.4
million equivalent, with the result that commitments in
marks stood at $382.7 million equivalent on January 31.
Intervention in Swiss francs amounted to $63.6 million
equivalent, of which $31.1 million was purchased
directly from the Swiss National Bank and the remain­
ing $32.5 million was financed by swap drawings.
With $5.9 million of Swiss francs having been repaid,
some $26.6 million equivalent of those drawings remained
outstanding on January 31. Of the guilders, $43.3 million
equivalent was sold in the market, all financed by swap
drawings, of which $3.2 million equivalent was outstanding
at the end of January. The $16.2 million of Belgian franc
intervention was financed out of $1.2 million equivalent of
balances and $15 million equivalent of swap drawings, all



of which had been repaid by the end of the period.
Also during the period, on August 21, the Bank of
Mexico drew the full $180 million available under the
swap arrangement with the Federal Reserve to cover a
temporary shortfall in reserves. This drawing was repaid
in November, prior to maturity.
As described in the December 1974 interim report, on
September 26 the Federal Reserve Bank of New York,
after consulting with the Board of Governors of the
Federal Reserve System, the United States Treasury, and
other Government agencies, acquired the foreign exchange
commitments of the Franklin National Bank. This action
was greeted with relief by market participants here and
abroad, and the subsequent news of Franklin’s insolvency
was taken in stride by the market with no adverse impact
on dollar rates. This Bank quickly balanced the Franklin
book and has met the forward commitments on maturity.
By the end of January, nearly $400 million of the original
$725 million of contracts had been liquidated.

During 1974 the German economy turned increasingly
sluggish, leading to a slackening of import demand and a
freeing of productive capacity for export. For a time, the
more buoyant economies of Germany’s major trading
partners provided continuing demand for German ex­
ports. But even after new demand weakened in the face
of the spreading worldwide recession, the huge backlog of
foreign orders received during previous years supported
a high level of production for shipment abroad. Thus,
although Germany like other industrial countries faced
a sharply increased oil bill—up $8 billion for 1974 as a
whole— the combined weakness of import demand and
rapid growth of exports widened Germany’s trade sur­
plus especially in the early months of the year. The sur­
prising strength of Germany’s trade position fostered a
speculative demand for the mark, which rose to as high as
$0.4188 in mid-May and turned around only after reports
that the Federal Reserve, the Bundesbank, and the Swiss
National Bank had agreed on a concerted intervention
plan to counter speculation against the dollar. A reflux
of funds out of marks then developed, as nonresidents
liquidated some of their large mark investments of previous
years, as German enterprises lent heavily abroad to finance
exports, and as the banking sector responded to the rise
in dollar interest rates relative to those in Germany. More­
over, market nervousness following the June 26 closing
of the Bankhaus I.D. Herstatt weighed on the mark. The
spot rate eased and, after the mark slipped to the bottom
of the European Community (EC) band, the Bundes­

bank began to sell substantial amounts of other EC cur­
rencies as well as dollars. The Federal Reserve was able
to acquire sufficient marks to reduce its swap drawings
from a peak of $381.6 million equivalent in early June
to $64.6 million by the end of July.
In view of the domestic slowdown and severe strains in
Germany’s credit markets following the Herstatt collapse,
the Bundesbank acted to maintain liquidity in the bank­
ing system by offsetting the outflows of funds abroad. The
authorities had not yet abandoned their restrictive mone­
tary policy, however, since Germany’s inflation rate of
6 to 7 percent per annum remained high by recent his­
torical standards although still far below the inflation rates
of most of Germany’s trading partners. In mid-August
the Bundesbank announced a 10 percentage point reduc­
tion in reserve requirements on domestic liabilities, and
interest rates in Germany held steady, while interest rates
in the United States and elsewhere rose to unprecedented
levels. The incentives for arbitraging funds out of marks
and into dollars and other currencies therefore widened,
and the mark eased in the exchange market. Consequently,
in August the Federal Reserve was able to buy sufficient
marks in the market to liquidate the remaining $64.6
million of its swap debt to the Bundesbank and to accumu­
late working balances as well.

C h a r t II



P e rc e n t

P erc ent









/J ~











V ^ -/






10 -



5 ___
Sm ith­
son ian
centra l


1 1 1 1







.... - 5

In this a n d the fo llo w in g cu rre n cy ch arts, m ovem ents in e x c h a n g e ra te s are
m e asu re d a s p e rce n ta g e d e v ia tio n s o f w e e k ly a v e r a g e s of N e w Y o rk noon
o ffe re d ra te s from the m id d le or central rates e s ta b lis h e d und(jr the
S m ith so n ia n a g re e m e n t of D ecem b er 18, 1971.






+ Central rate e s ta b lis h e d on Ju n e 2 9, 1973.


In two instances, however, the Federal Reserve found
it desirable to intervene to restrain sudden selling pressure
on the dollar. On August 8 and 9, when market uneasi­
ness during the transition of presidential authority in the
United States was compounded by release of discouraging
United States wholesale price figures for July, the Fed­
eral Reserve sold $20.8 million of marks from balances,
along with smaller amounts of Dutch guilders and Belgian
francs. Again, on September 3, after the German authori­
ties proposed to suspend their deposit requirement on
German residents’ borrowing abroad (the “bardepot” ),
the Federal Reserve sold $16.2 million of marks from
balances to check an abrupt decline in the dollar.
Over the next few weeks, the mark leveled off at about
$0.3735, 10 percent below its May peak. Meanwhile,
interest rates in the United States and the Euro-dollar
market were beginning to fall back sharply. Consequently,
the major share of continuing flows out of Germany was
deflected to other EC financial centers where interest rates
were either unchanged or easing only slightly. Thus, while
steady against the dollar, the mark continued to require
support at the bottom of the EC band and depreciated
significantly against the Swiss franc as well. By the end
of September, German reserves had dropped by $1.9
billion from end-of-May levels. Meanwhile, the German
authorities moved further to relieve the nervousness that
remained in the market in the wake of the banking failures
in Germany earlier in the summer. The Bundesbank and
the German Banking Association established additional
backstopping facilities for providing liquidity assistance to
banks. The Bundesbank announced a further 8 percent
cut in reserve requirements on September 26, and the
government imposed comprehensive limits on banks’ for­
eign exchange positions effective October 1.
In early October the balance in the exchange market
began to tip in favor of the mark. As United States inter­
est rates continued to decline and as fears of renewed
hostilities in the Middle East resurfaced, the markets
began to anticipate diversification of Organization of
Petroleum Exporting Countries (OPEC) funds out of
dollars and sterling into marks and other Continental
currencies. Moderately heavy selling of dollars devel­
oped in early October, and the Federal Reserve resisted
an excessive bidding-up of the mark rate by selling
a total of $36.1 million equivalent of marks from bal­
ances on October 3 and 4. The rate steadied briefly,
but on October 9, as the market assessed President Ford’s
anti-inflationary proposals, a large buy order for marks
pushed the spot rate up sharply, setting off a generalized
speculative selling of dollars. To maintain orderly market
conditions, the Federal Reserve sold $104.4 million


equivalent of marks, of which $26 million was financed
from balances and $78.4 million was drawn on the swap
line with the Bundesbank. In Germany the next day the
Bundesbank followed up by buying an even larger amount
of dollars and, to consolidate the ensuing improvement
in the dollar rate, the Federal Reserve sold an additional
$15.5 million of marks drawn on the swap line. The mark
rate then steadied at about 4 percent above earlySeptember levels.
The Federal Reserve intervened on only two other
occasions in October when the dollar suddenly came under
selling pressure against the mark— selling a total of $9.7
million equivalent on October 15 and 23, financed by swap
drawings on the Bundesbank. Late in October, with evi­
dence accumulating of a significant slowdown of the Ger­
man economy, the Bundesbank shifted to a somewhat less
restrictive monetary policy, cutting its discount and Lom­
bard rates lA percentage point. The mark then eased,
permitting the Federal Reserve to buy moderate amounts
of marks as cover against swap indebtedness, which
amounted to $103.6 million at the end of October.
In early November, however, market sentiment turned
even more bullish for the mark. In the United States, in­
creasing evidence that a severe recession was under way,
while promising to swing the United States trade accounts
into a smaller deficit than expected, gave rise to expecta­
tions of an accelerated and abrupt decline of interest rates
here. The German trade figures for September had shown
a renewed large surplus, which—with another substantial
surplus expected for October—rekindled speculation of
a revaluation of the mark rate. In addition, a sharp ad­
vance of the Swiss franc, which had begun in October,
was by November exerting an upward influence on the
mark. The large-scale capital outflows that had persisted
since the summer began partially to be met by offsetting
inflows. German banks sold some DM 1 billion of Ger­
man public authority notes to foreigners, of which one
third was placed with OPEC countries. Moreover, some
oil-exporting countries were arranging direct investments
in German industrial enterprises.
The exchange markets became, therefore, even more
sensitive to any developments likely to spur a further rise
in the mark. Consequently, following news of a jump
in United States unemployment, the mark was heavily
bid up on November 6 and 7. Both the Federal Reserve
and the Bundesbank intervened to moderate the rise,
with the System selling a total of $49.2 million equiv­
alent of marks, along with smaller amounts of Dutch
guilders and Belgian francs. The mark sales were financed
by a $25.6 million equivalent drawing on the swap line
and by the use of balances. When the Swiss franc eased



off toward midmonth, the mark followed suit and the Fed­
eral Reserve was able to acquire balances in the market.
Beginning on November 14, the mark itself became a
renewed object of speculation in the market following
press reports that the German government would not
oppose a further rise in the mark rate. The spot rate
was immediately bid up by almost 2 percent. The
Bundesbank and the Federal Reserve both intervened
on that day to resist the rise of the mark rate, the Sys­
tem selling $39.7 million equivalent drawn on the swap
line. Speculation over a mark revaluation continued, how­
ever, and over the weekend the German government de­
nied that it was considering measures to raise the mark
rate. Following this clarification, on November 18 the
Federal Reserve resumed forceful intervention not only
in marks, selling $56.7 million equivalent drawn on the
swap line with the Bundesbank, but also in Dutch guilders,
Belgian francs, and Swiss francs. The Bundesbank and
other European central banks followed up on the next day,
and the Federal Reserve sold an additional $16.2 million
equivalent of marks, again financed by a swap drawing.
The revaluation talk did not die down completely, how­
ever, and the mark was bid up once again on November 22
and 25. The Bundesbank and the Federal Reserve again
intervened to resist the rise in the rate, with the Federal
Reserve selling a total of $26.1 million equivalent drawn
on the swap line. Thereafter, the announcement of an un­
expected trade surplus for the United States for October
and a smaller than expected trade surplus for Germany,
coupled with a firming of Euro-dollar rates, brought a

brief respite. The mark eased, and the Federal Reserve
was again able to buy marks to cover swap indebtedness.
In early December, the Federal Reserve used these pur­
chases, together with existing balances, to repay $82.8
million equivalent of swap debt, reducing the total out­
standing to $185.1 million.
The exchange markets turned extremely thin during
December, as traders sought to square their books before
the year-end. The dollar came again on offer, as interest
rates in the United States and Euro-dollar markets re­
sumed their downtrend. For its part, early in the month
the Bundesbank stated that it would seek a somewhat
more rapid growth of the monetary base in the coming
year and, on December 19, announced a further V2 per­
centage point cut in its discount and Lombard rates to
6 and 8 percent, respectively. Nevertheless, a further rise
of the Swiss franc and the latest of a series of highly
publicized OPEC investments in major German industrial
firms dominated market psychology. The mark was grad­
ually bid up and, to dampen the rise, the Federal Reserve
intervened in modest amounts on seven business days
between December 16 and December 30. These sales
totaled $75.1 million, of which $31 million was from
balances and $44.1 million was drawn under the swap line.
As the new year opened, the mark had already been
bid up by some 11 percent from its September levels.
Even so, discouraging news on the United States economy
and the further drop in United States interest rates fos­
tered bearish sentiment toward the dollar, while renewed
revaluation rumors in Germany and the rising Swiss franc

Table III
In millions of dollars

Drawingi ( + ) or repayments (—)
Banks drawing on
Federal Reserve System

Drawings on
Federal Reserve
System outstanding
January 1, 1974




-0 -


Drawings on
Federal Reserve
System outstanding
January 31, 1975





-0 -

-O -


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

-0 -

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





{ + 65.0
1 - 65.0

J +129.0


-0 -

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

-0 -



J +245.0
1— 65.0


1-45 .0

-0 -



prompted further speculative demand for marks. Both
the Bundesbank and the Federal Reserve intervened in
modest amounts to limit the rise of the rate, but the mark
advanced a further 4 percent by January 24. Through that
day the Federal Reserve had intervened in marks on five
occasions in January, for a total of $58.9 million equiv­
alent financed by additional swap drawings. On Jan­
uary 27, the mark jumped by a further 1 percent to
$0.4356, the highest level since July 1973. By that time,
however, European government officials were expressing
increasing concern over the unrealistic levels to which
the mark had risen, and the Bundesbank and the Fed­
eral Reserve then began to intervene in heavier volume
to check the mark’s rise. During the week of January 27
the Federal Reserve intervened on four days, selling a
total of $94.6 million equivalent of marks, drawn on the
swap line, as the Bundesbank operated in similar magni­
tude in Germany. The market began to respond to this
more forceful approach, and the mark eased by 2 percent
from its highs to close at $0.4275. By the end of January,
the System’s swap commitments in German marks
amounted to $382.7 million equivalent.

In Switzerland during 1974, inflation was running at
nearly 10 percent, even though economic activity was
leveling off during most of the year. The Swiss National
Bank, therefore, kept bank liquidity under close rein,
while modestly easing reserve requirements and providing
liquidity to the market through swaps from time to
time in response to recurrent strains in Swiss capital
markets. In the exchanges, movements of the Swiss franc
continued to be dominated by hot-money flows and
shifting speculative sentiment. In the general decline of
the dollar from late January to early May, the franc had
been ratcheted upward by 23 percent to $0.3588. At that
point, a turnaround followed reports of agreement among
the Federal Reserve, the Bundesbank, and the Swiss
National Bank on a plan of concerted intervention to
counter any further erosion in dollar rates. The unwinding
of long positions in francs and further accommodation
of liquidity needs in Switzerland extended the decline of
the franc, which eased some 6 percent by the end of July.
Its drop was more gradual than that of some other
Continental currencies, however, since the market was con­
cerned that large short franc positions arising from the
foreign-currency losses disclosed during the preceding
months might still have to be covered.
With the dollar buoyant in August and early Septem­
ber, the Swiss franc continued to ease in a generally


quiet market, falling to as low as $0.3300 or some 8
percent below the May peak. Then, as dollar interest rates
began to drop back more rapidly than the comparable
rates for Swiss francs, the spot franc turned firm once
again. The Swiss National Bank provided some $1 billion
equivalent of liquidity assistance to the banks through both
short-dated and three-month swaps during September,
thus avoiding an even sharper run-up in the franc rate
before the quarter end. Nevertheless, demand for Swiss
francs continued to swell, partly on the covering of out­
standing short positions and partly in expectation that the
franc, like the German mark, would benefit from any
significant diversification of OPEC funds out of dollars
and sterling.
Following a further reduction in the banks’ required
reserves on October 8, the money market in Switzer­
land had become quite comfortable. The Swiss authori­
ties, therefore, took advantage of this opportunity to dis­
mantle yet another of their previously imposed barriers
against inflows by lifting the ban on interest payments to
nonresidents on October 16. By that time, however, traders
were increasingly concerned over possible diversification
of OPEC funds, and the franc was bid up sharply in a
thin market. In addition, political uncertainties elsewhere
in Europe and in the Middle East generated flows into
francs. The spot franc then began to advance sharply not
only against the dollar but also against the currency of
Switzerland’s largest trading partner, the German mark.
This persistent rise posed a policy dilemma for the Swiss
authorities, since intervention to halt the rise of the franc
in the exchange market— and thus avoid further erosion
of Switzerland’s competitive position— would augment
domestic liquidity and thereby undermine efforts to curb
inflation. The market began to sift every statement by Swiss
officials to anticipate the point at which the Swiss National
Bank might intervene in the exchange markets. Conse­
quently, the franc snapped sharply higher on November 7,
following news reports from Switzerland that the National
Bank was still unprepared to buy dollars, only to fall back
nearly 2 percent over the following days simply on reports
that the Federal Reserve, the Bundesbank, and the Swiss
National Bank were prepared to intervene in a con­
certed manner.
Just after midmonth, the franc came into demand once
again in the backwash of speculation over a revaluation
of the German mark. By November 18, the franc had
risen about 16 percent against the dollar from its Sep­
tember lows and 53A percent against the mark. As part of a
concerted intervention in marks, Swiss francs, Dutch guil­
ders, and Belgian francs that day and on the following day,
the Federal Reserve sold a total of $12.5 million of Swiss



francs, which had been purchased directly from the Swiss
National Bank. In response to this operation, the franc
fell back by 6 5/s percent over the next two days. The Swiss
National Bank followed up on November 20 by reimposing the negative interest charge, at 3 percent per quarter,
and a ban on interest payments, each on the increase in
nonresident deposits above October 31 levels. The central
bank also obtained authority to monitor banks’ forward
sales to foreigners and to use swap transactions if neces­
sary to enforce these new measures. These actions
prompted an even further scramble in the market to unload
francs, and the spot rate dropped a further 2 percent by
November 21.
Over the next weeks the market in Swiss francs was
thinner and even more volatile than before, as dealers
were sensitive to talk of new initiatives to discourage in­
flows. Under these circumstances, when mark revaluation
rumors resurfaced, the franc advanced a full 6Ys percent
by November 26 before settling back. The Swiss
National Bank then took further regulatory measures to
limit the rise of the franc. On November 28 it reactivated
the requirement that proceeds of foreign borrowings in
Switzerland be converted immediately into foreign cur­
rency. Four days later it raised banks’ reserve requirements

C h a r t III

M O V E M E N T S IN E X C H A N G E R A T E *
P e rc e n t

P e rc e n t

* S e e fo otn ote on C h a r t II.


against deposit liabilities to nonresidents. The National
Bank also announced it would again assist the banks with
their year-end positioning by providing swaps. Ultimately,
tne National Bank provided $1 billion of year-end
swap assistance and did an additional $500 million of
one- and three-month swaps outside the usual quotas to
influence market conditions. Even so, the market con­
tinued to push the rate up during December. On Decem­
ber 17, after the franc rose especially sharply, the Federal
Reserve again intervened in both German marks and
Swiss francs, selling a total of $26.5 million equivalent of
francs, of which half was purchased outright from the
Swiss National Bank and half was drawn under the swap
line with that bank. The franc eased over the next days,
and the Federal Reserve purchased francs in the market
to repay $5.9 million equivalent of the swap debt.
In the generally bearish atmosphere for the dollar, the
Swiss franc continued to advance even after year-end
positioning passed. On January 6, the Swiss National
Bank resumed outright intervention in the spot market
in Zurich, confirming its operation “to maintain orderly
exchange market conditions”. The Federal Reserve fol­
lowed up with similar intervention in New York, as part
of its concerted intervention in both francs and German
marks. These joint interventions continued over the fol­
lowing days, and at first the Swiss franc dropped back.
The demand for francs soon picked up again, however,
after it was reported that failure of a financial subsidiary
of an Italian company would leave a major Swiss bank
short of francs. As the market anticipated a large demand
to cover a substantial volume of this subsidiary’s con­
tracts maturing early in 1975, a more generalized specu­
lation in favor of the Swiss franc developed. The franc
was heavily bid up to new record levels, while the Swiss
National Bank continued to intervene, at times quite
heavily. The Swiss authorities then resisted further upward
pressure by severely tightening recently imposed curbs on
inflows of foreign funds. In particular, the ban on interest
payments was widened to apply to all nonresident bal­
ances, the negative interest charge was raised to 10 per­
cent per quarter, banks were required to balance all
foreign exchange positions daily, and provision was made
whereby the National Bank could block Swiss franc liquid­
ity resulting from dollar intervention.
These new measures at first drew a strong market re­
sponse, and the franc fell back. But, as the market grew
doubtful that these measures could prevent a further
rise in the franc as long as short franc positions over­
hung the market, the Swiss franc turned around and was
soon outpacing other European currencies. By January 27,
it had reached a new record of $0.4195, some 27 percent



above last summer’s lows. The Swiss National Bank then
tightened its November regulation, limiting Swiss banks’
sales of Swiss francs to nonresidents.
By this time, the immediate demands for Swiss francs
had slackened and the dollar had begun to recover in other
markets. Consequently, pressure in favor of the Swiss
franc let up, and the franc eased to $0.4014 by the end of
January. During the month the Federal Reserve, oper­
ating on six different occasions, sold a total of $24.6
million equivalent of francs. Of this amount, $5.3 million
was purchased outright from the Swiss National Bank
and $19.3 million was drawn under the swap line. Con­
sequently, System drawings in Swiss francs were increased
by $26.6 million equivalent as a result of the DecemberJanuary operations, bringing total Swiss franc indebted­
ness including that outstanding since 1971 to $997.8
million equivalent by the end of January.

Last summer, the United Kingdom was faced with severe
financial, economic, and balance-of-payments strains. In­
dustry was caught between high wage, raw material, and
financing costs, on the one hand, and statutory limits on
prices, on the other. The ensuing squeeze on profits and
corporate liquidity was restricting inventories, investment,
and output. With industrial production not fully recovered
from the disruption of the three-day workweek earlier in
the year, the new cutbacks threatened a more prolonged
stagnation and a rising unemployment rate while domes­
tic inflation continued at a rapid rate. Meanwhile, the
trade deficit had swelled to over $6 billion in the first
half of the year, of which close to $3 billion reflected
costlier oil imports. At the same time, the worldwide slow­
down of economic activity cast a shadow on export
Although the exchange market sentiment remained bear­
ish toward sterling, the pound depreciated on a tradeweighted basis only slightly during August and September
while slipping against the dollar some 2 percent to around
$2.33. Oil-related and other capital inflows roughly offset
the United Kingdom’s large current-account deficit and
helped bolster the spot rate. During the third quarter, oilexporting countries invested a net $2.2 billion in relatively
high-yielding sterling assets. Oil companies also accumu­
lated sterling, both spot and forward, in anticipation of
future tax and royalty payments and for investments in
North Sea exploration. The Bank of England operated on
both sides of the market in August and September to
smooth the impact of oil-related transactions.
By early October, however, the inflow of oil-related

funds tapered off, as concern over Britain’s economy con­
tinued and short-term sterling interest rates suddenly
declined. In addition, there was some temporary nervous­
ness ahead of the October 10 general election. The pound
therefore tended to weaken against many of the Con­
tinental currencies while holding roughly steady against
the dollar. The market soon came into better balance,
however, as new demand for relatively large October
oil payments in sterling counterbalanced continuing sales
by oil producers diversifying out of sterling. Following the
trend of other European currencies more closely, the spot
pound firmed to $2.35 by early November.
Meanwhile, adverse economic developments led to
some apprehension ahead of the November 12 budget
message. The worsening inflation had triggered successive
rounds of threshold wage increases, and recently negoti­
ated wage settlements had cast doubt on the effectiveness
of the government’s “social contract” to achieve a volun­
tary pay restraint. Prospects of rising unemployment were
increasingly underscored by news of further layoffs and
business failures. The market was somewhat reassured by
new budget proposals to alleviate corporate liquidity
strains without having an excessive overall stimulative
impact as many market participants had feared. Moreover,
the extension of the Bank of England’s supplementary
deposits scheme to allow the banks to help provide suffi­
cient corporate financing without encouraging a more rapid
growth of the money supply was also viewed positively.
The market was caught by surprise, however, by an



accompanying announcement from the Chancellor of the
Exchequer that the United Kingdom’s guarantee arrange­
ments on official holdings of sterling would be allowed to
expire in December. As these guarantees did not apply to
the large accumulation of sterling holdings since September
1973, the market had taken in stride Australia’s announced
withdrawal from its arrangement in September 1974. But,
since some dealers saw total abolition of guarantees as
possibly stimulating accelerated diversification out of ster­
ling, heavy selling pressure quickly materialized and the
spot rate dropped below $2.30. After substantial Bank
of England support, as well as renewed oil-related demand
for November royalty payments, the market steadied and
sterling moved narrowly against the dollar through early
December. Nevertheless, with other currencies advancing
against the dollar, sterling lost further ground against
the currencies of Britain’s major trading partners.
During October and November, half of the government’s
$2.5 billion Euro-dollar loan and $400 million of the
British Water Council’s loan from Iran were taken into
foreign exchange reserves, which increased on balance
about $650 million for the two months.
Just before mid-December, it was reported that Saudi
Arabia had informed the Aramco group that it wished
all future oil payments to be made exclusively in dollars.
The subsequent liquidation of sterling previously acquired
by Aramco members and prospects of even more diversi­
fication of OPEC funds largely into Continental currencies
triggered new selling pressure on the pound. The Bank of

England resisted the rate decline with substantial support.
Thereafter, Saudi Arabia reaffirmed publicly that it would
continue to invest in sterling assets, and other Middle East
sterling holders followed up with similar reassuring state­
ments. The market then steadied and, when a severe
squeeze developed in the Euro-sterling market, the pound
benefited from some covering of short sterling positions.
Over the remainder of the year, the spot rate traded
narrowly around $2.34 and the trade-weighted value of
sterling recovered from the record low set on December 12.
During January, sterling once again lagged behind the
strong advance of the major continental European cur­
rencies against the dollar. New fears about corporate
solvency in Britain and about possible diversification of
sterling balances exerted a drag on sterling. Later in the
month, the favorable impact of improved trade figures for
December was more than offset by successive reductions
in the Bank of England’s minimum lending rate to 11 per­
cent and corresponding declines in London money market
rates. Consequently, the pound weakened further against
major Continental currencies although rising somewhat
against the dollar to $2.38 by the month end. The Bank of
England provided further moderate support to check the
erosion. Over the two months of December and January,
official dollar sales, together with other foreign-currency
payments, were partly offset by additional drawings on the
United Kingdom government’s $2.5 billion Euro-currency
loan, but Britain’s reserves nevertheless declined by about
$1 billion.

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

January 1, 1974





January 31, 1975


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




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




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


t —127.3

Note: Swiss-franc-denominated security issued to the Bank for International Settlements
was reissued to the Swiss National Bank at its maturity in January 1974.
• Increase in amount outstanding reflects valuation changes through April 1974.

-0 -


-0 -

-O -





A $6 billion increase in Japan’s oil import bill in the
first half of 1974 and sharply higher commodity prices had
driven Japan’s current account into deep deficit early in
the year. This was largely financed by heavy short-term
borrowings by Japanese banks, both in the Euro-dollar
market and in the United States. By midsummer, however,
with the Euro-markets under unusual strains, some Japa­
nese banks were reportedly approaching credit limits and
facing increasing costs of funds there. The Japanese author­
ities requested the banks to refrain from excessive
borrowing, and then the demand for spot dollars in
Tokyo increased. By August 22, the yen had fallen over
10 percent from its late-March 1974 peak to $0.003294,
its lowest point since it was floated in February 1973. The
Bank of Japan from time to time intervened in the market
to avoid wide fluctuations in the yen rate, providing sup­
port through moderate sales of dollars. The authorities
also took a series of steps in August and early September
to relax impediments to inflows of foreign funds to Japan.
Controls were eased on net conversions of dollars into
yen by foreign banks, on prepayments for Japanese
exports, and on nonresident investments in certain Japa­
nese securities. In addition, reserve requirements on
nonresident “free yen” deposits were reduced to zero.
These measures helped relieve the pressure, and the yen
rate steadied above its lows.
Meanwhile, Japanese economic activity remained slug­
gish after a sharp decline early in the year. Upward pressure
on wholesale prices abated, but consumer prices continued
to rise rapidly. Therefore, the Japanese authorities main­
tained their highly restrictive monetary policy. With
domestic sales sagging and inventory financing becoming
increasingly burdensome, Japanese companies placed
greater emphasis on exports. As shipments abroad surged,
Japan’s trade balance, after a $2.7 billion first-half deficit,
swung decisively into surplus by late summer. Successive
reports of this turnaround contributed to the improvement
in market sentiment in September. After mid-September,
wire service reports that a $1 billion loan had been
arranged between an oil-producing nation and Japan
sparked active bidding for yen. Later in the month, figures
were released showing a current-account surplus for
August—the first since the escalation of oil prices the
winter before— and the yen was bid up further to a level
3 percent above its August lows.
By early October the yen had steadied around
$0.003333, but market uncertainties persisted and the yen
came under some renewed pressure in late October.
Trading then came into better balance during November

and early December, as the Japanese authorities further
relaxed restrictions on capital inflows from abroad. The
Ministry of Finance permitted Japanese corporations to
use the proceeds of certain foreign bond issues for domes­
tic purposes, and several companies quickly moved to
arrange new issues abroad. The Bank of Japan also asked
Japanese banks to reduce as much as possible the addi­
tional cost of their borrowings in the Euro-dollar market.
Continuing market concern over prospects for the yen
resurfaced in late December and early January. Pressure
on the yen gradually eased, however, as dealers reacted
to news of Japan’s strong export performance in Decem­
ber and as new Japanese corporate foreign borrowings
were converted into yen. Moreover, the market responded
favorably to the Bank of Japan’s reaffirmation of its policy
of restraint, until prices had stabilized, and to the generally
anti-inflationary thrust of the government’s draft budget.
By late January, the yen had begun to advance in sym­
pathy with the sharp rise of European currencies against
the dollar, reaching $0.003363, some 3 percent above the
August low.

In contrast to many other industrial countries, France
enjoyed real economic growth and relatively low unem­
ployment during the year. On the other hand, the
inflation rate remained relatively high, compared with
price trends in Germany and neighboring countries.



Moreover, the trade account, which had been in mod­
erate surplus throughout 1973, swung into deep deficit by
May. In part, this deterioration was in response to relatively
buoyant domestic demand. More importantly, it reflected
a $6 billion increase for 1974 in France’s oil import bill,
as well as the adverse shift in French terms of trade fol­
lowing the downward float of the franc early in the year.
To counter the worsening inflation and the weakening
trade position, the French government imposed progres­
sively more stringent economic policies. In June, the gov­
ernment adopted a new anti-inflation program containing
credit, tax, price control, and energy-saving measures.
In September, it followed up by renewing ceilings on credit
growth (except on credits to finance export production)
and announcing a stringent $ 11 billion limit on oil imports
for 1975. Meanwhile, around midyear, the Bank of France
had hiked its discount rate to a record 13 percent, stiffened
penalties for banks exceeding official credit ceilings, and
maintained a severely tight money market. As monetary
policies in other countries were gradually relaxed, sub­
stantial interest rate differentials in favor of the French
franc emerged. In response, short franc positions—built up
before the floating of the franc and the French presidential
elections in May—began to be covered and French enter­
prises stepped up their borrowings abroad.
The franc remained relatively firm during the late sum­
mer and early fall. Although it eased from its early-August
levels as the dollar strengthened around midmonth, its
decline was less pronounced than for most currencies.
Favorable interest rate incentives, together with news of
more bank failures and large exchange losses elsewhere
in Europe, prompted further repatriations of funds and
a building-up of franc balances by nonresidents. By the

end of August, the franc had resumed an uptrend which
gained momentum after mid-September, when discussions
of multilateral proposals and direct deals for financing
European oil deficits helped to dispel some of the market’s
concern over France’s large oil deficit. The franc at times
outpaced the German mark and other European curren­
cies in the general upswing of currencies against the dol­
lar, rising 4 percent to $0.2145 by November 7. To
moderate the rise of the franc, the Bank of France made
increasingly heavy purchases of dollars, thereby contrib­
uting to the $600 million increase in French reserves dur­
ing the three months to end-October.
Meanwhile, the economic climate in France was de­
teriorating. The high rate of inflation generated growing
labor unrest, and by early November a number of strikes
erupted that threatened to disrupt production. At the
same time, the government’s austerity measures were be­
ginning to bite, causing an abrupt slowing of output and
a jump in unemployment. Against this uncertain back­
ground, the rise in the franc faltered. Indeed, while holding
steady against the dollar through much of November, the
franc dropped to its lowest levels against the German mark
and other Continental currencies in five months. Following
reports of large-scale layoffs and short hours, the labor
strikes ended and pressure against the French franc
eased. Late in the month, market tone improved further
after President Giscard d’Estaing relieved growing con­
cern over unemployment by promising renewed economic
expansion for 1975 and providing special assistance to
industries most vulnerable to the slowdown.
By early December the franc was again in demand.
French interest rates remained near their peak levels with
the three-month Euro-franc rate some 8 percentage points
above the corresponding Euro-dollar rate. Moreover,
France’s trade deficit was narrowing far more rapidly than
had been forecast, as imports slackened in the face of
weakening domestic demand and lower energy require­
ments. In addition, news of a $1 billion loan agreement
with Iran and other successful Middle East negotiations
promised to bolster France’s external position in the
coming year. The franc climbed sharply, therefore,
again outpacing other currencies as the dollar declined in
December. The Bank of France resumed intervention,
buying dollars regularly to keep the franc’s rise in line
with other currencies.
After the first week in January, the French government
began gradually to relax its restrictive monetary policy.
The Bank of France cut its discount rate 1 percentage
point to 12 percent on January 9. In addition, minimum
reserve requirements were reduced on January 21, and the
regulation of bank credit was made more flexible. Never­



theless, French interest rates remained well above those
in most other markets and the French franc continued to
advance. Boosted further by news of a trade surplus in
December—the first monthly surplus since 1973— the
franc moved up to $0.2349 just before the end of January
to trade nearly 14 percent above its mid-August lows.

Midsummer 1974 marked a significant turning point in
Italian economic and balance-of-payments trends. During
the first half of 1974, inflation was continuing at a rate two
to three times faster than in most other major industrial
countries, as sharply higher costs for imported oil and
other commodities, production bottlenecks in some indus­
tries, and an expanding government budget deficit helped
perpetuate the inflationary spiral. The current-account
deficit had more than doubled under the weight of a $6
billion increase in oil imports for 1974, exerting persistent
pressure on the lira in the exchanges. The authorities had
intervened heavily to prevent a substantial depreciation of
the lira from worsening domestic inflation. The bulk of
this intervention had been financed by new foreign bor­
rowings, including EC short-term assistance, and by
midyear Italy’s medium-term indebtedness to the Euro­
dollar market stood at $8 billion. Meanwhile, to eliminate
the nonoil deficit, contain inflation, and rein in public
spending, the authorities progressively stiffened monetary
and fiscal policies and imposed an import-deposit scheme.
By midyear these measures were beginning to take hold.
A sudden weakening of domestic demand was narrowing
the nonoil component of the trade deficit, and declines
in world commodity prices promised an unexpected fur­
ther improvement. The severe tightening of domestic
liquidity was stimulating a substantial influx of short­
term funds, as Italian commercial banks borrowed heavily
in the Euro-dollar market to finance domestic lending.
Conversions of these borrowings had a steadying effect on
the Italian lira in the exchanges, and the Bank of Italy
had been able to add to its reserves.
By late July, the Italian authorities had become con­
cerned that the rapid growth of bank borrowing abroad
would frustrate the extremely restrictive monetary policy
and might aggravate existing strains in the international
capital markets. Therefore, the authorities instructed banks
to limit their net foreign indebtedness to July 19 levels, and
the net inflow of funds began to taper off in early August.
Then, after Italy’s severe liquidity crunch eased some­
what with the exemption of all agricultural products from
the import-deposit scheme, the repayment of foreign bor­
rowings picked up and continued throughout the next

several weeks. By the end of September, Italian banks had
reduced their net foreign indebtedness by almost $1 billion.
As these repayments coincided with the normal seasonal
slackening of tourist receipts, the lira periodically came
under some selling pressure during August and early Sep­
tember. The Bank of Italy provided occasional moderate
support for the lira rate to prevent it from weakening too
rapidly against other European currencies.
In the meantime, Italy obtained new official credits to
cover its current-account deficit. In early August, the
Italian authorities drew a total of $622 million equivalent
from the International Monetary Fund (IM F) against
its gold tranche and the first tranche of its $1.2 billion
standby. Later in the month, the Bank of Italy obtained $2
billion by way of a reciprocal gold-dollar deposit with the
Bundesbank. (In that transaction, the gold was valued at
80 percent of average recent market prices or about $120
per ounce.) Then, in mid-September, Italy borrowed $315
million from the IMF oil-financing facility and renewed its
European Monetary Cooperation Fund credit of $1,885
million. The government also announced a second take­
down of $540 million equivalent from Italy’s IMF standby
credit. The new borrowings, which were taken into official
reserves over the two months through the end of Septem­
ber, helped improve market sentiment, and the lira held
about 3 percent below its late-July levels until early



Meanwhile, the Italian economy had markedly slowed
down, with industrial output falling sharply. Domestic
price inflation continued to worsen, however. As Cabinet
disagreement over continuation of the government’s aus­
terity program surfaced, leading to Prime Minister
Rumor’s resignation on October 3, outflows of funds put
renewed pressure on the lira. The exchange rate slipped
about 1 percent against the dollar and 4 percent against
other EC currencies, while the Bank of Italy provided
heavy support in the first half of the month to moderate
the lira’s decline. Although selling pressures temporarily
subsided toward the end of October, the lira remained
relatively weak and did not participate in the general up­
surge of European currencies in November. By the end
of that month, the lira had depreciated by a further 1 per­
cent against the other EC currencies while holding steady
against the dollar. Over the two months, intervention sales
of dollars were mainly responsible for a $1.2 billion
decline in official reserves.
Market sentiment improved considerably in Decem­
ber, as the new government under Premier Moro moved
swiftly to implement its economic program. Monetary
policy was kept restrictive, although the Bank of Italy
made a modest cut in its historically high discount rate.
In addition, measures to discourage crude oil imports were
adopted and plans for expanded capital investments in
energy, agriculture, and public works were proposed. In
the exchanges, a significant reflow of funds, which had
been moved out of the lira at the height of the Cabinet
crisis, was reinforced by continuing tight money market
conditions. Furthermore, the slowdown of economic activ­
ity was dampening import demand. Thus, the lira rate
firmed almost 2 l/i percent during December.
After the year-end, however, the lira again came on
offer. The Bank of Italy relaxed its restrictive stance
somewhat further and, as liquidity strains in Italy eased
during January, short-term reflows slowed. In addition,
although Italy’s nonoil trade was improving, a seasonal
weakening in the trade balance and a bunching of oil pay­
ments depressed the rate. As on other occasions, more­
over, pressure on the dollar occasionally spilled over onto
the lira, and it lost substantial ground against the EC
currencies. The Bank of Italy again provided support, and
by the month end the immediate pressures had lifted. On
January 31, the lira rate stood at $0.001564, about 1
percent higher than at the outset of the reporting period.

The Netherlands strong current-account surplus in 1974,
together with expectations of further improvement in the

balance of payments in 1975, kept the Dutch guilder
strong against both the dollar and other European curren­
cies during the reporting period. Prospects for increased
natural gas exports blunted the impact of higher prices on
oil imports, while port and shipping services were improv­
ing the net invisibles balance. Reports of a continuing large
current-account surplus had spawned revaluation rumors
in late July. Speculative demand for guilders had been
countered by coordinated Netherlands Bank-Federal
Reserve intervention, and the rumors were spiked by an
official denial of any revaluation intentions. The guilder
then turned lower, dragged down by the declining German
mark, and substantial intervention against marks was
required to maintain the limits of the EC band.
The only Federal Reserve intervention in guilders late
in the summer came on August 9 when $5.3 million equiv­
alent was sold along with other currencies, as markets
were briefly unsettled during the period of transition of
presidential authority in the United States and after release
of disappointing United States wholesale price figures. The
sale of guilders was financed by a drawing on the swap
line with the Netherlands Bank and, as the guilder quickly
resumed its decline, sufficient guilders were acquired to
liquidate the swap commitment. By early September, the
guilder had fallen 3% percent to $0.3663.
Money market conditions in Amsterdam then tightened,
as seasonally heavy tax payments pushed up Dutch inter­
est rates at a time when a cut in reserve requirements in


Germany was adding to liquidity in Frankfurt. In addition,
the Dutch government announced, as part of its 1975
budget proposal, a steep increase in the price of natural
gas, estimated to add $500 million to the Netherlands’
1975 exports. Consequently, the guilder was again bid up
and, as the EC snake came under increased pressure, the
Netherlands Bank stepped up its purchases of marks. The
Dutch central bank also began to provide substantial
amounts of guilders through one- to three-month dollar
swaps with the commercial banks, lessening domestic li­
quidity strains. In the two months August-September,
Dutch official reserves increased by about $1 billion.
In October, the guilder participated in the upward
movement of continental European currencies against the
dollar, with little reaction to a percentage point reduction
in the Netherlands Bank’s discount rate to 7 percent late in
the month. In view of the relative positions of EC snake
currencies in November, when the European currencies be­
gan to advance more sharply, the Federal Reserve supple­
mented its intervention against marks by offering guilders
as well. The Federal Reserve sold $6.5 million equivalent
of guilders on November 7 and a total of $22 million
equivalent during the coordinated central bank interven­
tion of November 18 and 19. The Netherlands Bank fol­
lowed up in the Amsterdam market by purchasing
moderate amounts of dollars. The System’s sales were
financed by drawings on the swap line and were repaid
through market purchases when the guilder temporarily
declined. Dutch reserves increased another $550 million
during October and November, largely as a result of
continued dollar swap transactions with the Dutch banks.
By early December, the guilder strengthened again to
a level 6 V2 percent above its September low. Meanwhile,
the Dutch government, increasingly concerned about
rising unemployment and sluggish domestic economic
activity, particularly in the construction industry, had
announced new measures to stimulate the economy.
Taxes on wages and salaries would be cut as of
April 1, 1975, investment incentives were broadened,
and private sector payments for social services were re­
duced. Together with the planned deficit in the September
budget, these actions would provide substantial fiscal
stimulus while monetary policy would remain moderately
restrictive to counter inflationary pressures. Thus, Dutch
interest rates held above those in some other financial
centers and provided an incentive for funds to move
into guilders as the dollar generally remained on offer in
the exchanges in December. The Dutch authorities again
provided liquidity through dollar swaps with commercial
banks and also bought modest amounts of dollars outright
in the spot market. For its part, the Federal Reserve also


intervened in guilders in New York on December 17 and
27, selling a total of $9.6 million equivalent of guilders
along with other currencies to cushion the decline in
dollar rates. These sales were financed by additional swap
drawings, of which all but $3.2 million was repaid through
subsequent market purchases. The guilder nevertheless
was pulled sharply higher in January by the speculative
rise of the mark and Swiss franc. It reached a peak of
$0.4175 on January 27— 14 percent above its September
low— before dropping back somewhat on subsequent days
along with other currencies.

The slowdown in Belgium’s economy that set in around
mid-1974 was more gradual than in most other indus­
trial economies. The pace of domestic inflation, on the
other hand, remained high relative to that for Belgium’s
principal trade partners. Consequently, the authorities
maintained a restrictive monetary policy, with the result
that Belgian interest rates rose to levels above those pre­
vailing in most other Continental financial centers and
remained relatively firm throughout the second half of the
year. The pull of high yields in Belgium prompted both a
reflux of previous outflows and inflows of new short- and
long-term capital. These inflows, together with a current
account that was still in surplus despite higher imported
oil costs, provided a continuing buoyancy for the Belgian
franc in the exchanges.
Accordingly, the Belgian franc declined more gradually



against the dollar in August than most other European
currencies, while holding just below the top of the EC
band. The Federal Reserve sold $2.5 million equivalent
of Belgian francs, along with its sales of other currencies,
to forestall a sudden slippage in dollar rates on August 9.
Of this, $1.7 million was financed by a drawing on the
swap line with the National Bank of Belgium and the re­
mainder was drawn from System balances. The swap
commitment was promptly repaid as the Belgian franc
was pulled down by the German mark. In early September,
the commercial rate bottomed out at $0.025275, almost
4 percent below early-August levels.
After mid-September, however, the franc began to rise
again. Liquidity in Belgium was tightened further by tax
payments and by higher reserve requirements on call
deposits. Moreover, there was a shift of funds into francs
out of German marks in response to a tightening of for­
eign exchange restrictions both in Germany and Luxem­
bourg. In November, the rise of the Belgian franc acceler­
ated as pressure on the dollar generally intensified. To
dampen the franc’s advance and avert a buildup of pres­
sure within the EC snake, the National Bank of Belgium
frequently made modest purchases of dollars in Brussels.
In New York the Federal Reserve offered Belgian francs,
along with other European currencies, to smooth the de­
cline in dollar rates on November 7, 18, and 19 and
December 17. Total sales of Belgian francs amounted to
$13.7 million equivalent, of which $13.2 million was drawn
on the swap line and subsequently was repaid through
market purchases. The remainder was drawn from balances.
By the year-end the slowing pace of Belgian economic
activity had induced an easing of credit demands, and
Belgian interest rates turned down. Late in January, in
view of domestic and international interest rate trends, the
National Bank relaxed its credit policy by reducing the
discount rate by Vi percentage point to 8% percent, rais­
ing ceilings on credit growth, and releasing reserves against
bank time deposits. Nevertheless, the decline in Belgian
interest rates lagged behind those elsewhere. The Belgian
franc thus held at or near the top of the EC band, re­
quiring the central bank to purchase moderate amounts
of other participating currencies. As the European cur­
rencies generally strengthened against the dollar, there­
fore, the commercial franc advanced to $0.028600 on
January 31, and the National Bank purchased further
small amounts of dollars to resist the rise. At this level,
the commercial Belgian franc stood almost 13 percent
above its September low. As of January 31, System swap
commitments with the National Bank of Belgium totaled
$261.8 million equivalent of Belgian francs, all incurred
prior to August 15, 1971.


The gradual decline of the Canadian dollar that had
begun in June 1974 continued with only brief interruptions
during the six-month period under review. The downtrend
primarily stemmed from a progressive erosion of Can­
ada’s trade surplus during 1974 and an increasingly
pessimistic market assessment of prospects for 1975. Ex­
port growth fell off sharply as a result of the severe
slackening of United States demand and the break in world
commodity prices that tended to weaken Canada’s terms of
trade. By contrast, the deceleration of economic activity
in Canada was more moderate than elsewhere, with a still
buoyant investment demand sustaining imports of capital
goods. Consequently, many published Canadian forecasts
showed the Can.$706 million export surplus for the first
half of 1974 swinging into deficit by early 1975. Whereas
trade deficits in earlier years had been financed by large
capital inflows, prospects for long-term inflows were now
uncertain and short-term capital flows were largely
responding to the shifting interest rate incentives between
Canada and the United States.
In early August, when the near-record levels of dollar
interest rates yielded strong disincentives against Canada,
selling of Canadian dollars intensified as United States cor­
porations repatriated funds to their home offices. Labor
unrest in Canada further depressed the market. The spot
rate fell almost 1 percent to a low of $1.0109 by August
28. The Bank of Canada intervened to avoid too rapid a
decline and, during August, Canada’s reserves fell
$160 million. In September and October, as the retreat of
United States short-term rates was underscored by declines
in United States prime rates, the Canadian dollar recovered
somewhat. Positioning by Canadian banks in anticipation
of several conversions of foreign borrowings and of their
October 31 fiscal year-end also temporarily spurred de­
mand for the Canadian currency. But, by late October,
the spot rate was again easing.
Meanwhile, the sharp production cutbacks in United
States output were exerting an increasingly heavy drag on
the Canadian economy. As demand for credit weakened,
Canadian banks lowered their prime rates. In addition,
the Bank of Canada cautiously eased the restrictive stance
maintained during the first half of the year by reducing its
discount rate to 8 3A percent, the first cut from the peak
9 lA percent level established in July. Shortly thereafter,
chartered banks’ secondary reserve requirements were
lowered 1 percent to 7 percent. Then, on November 18,
the government announced a somewhat more stimulative
budget for the fiscal year beginning April 1975, featuring
cuts in the personal income tax. These actions were largely




C h a rt X

M O V E M E N T S IN E X C H A N G E R A T E *
P e rc e n t

P e rc e n t

----- \







8 6 -



4 -





2 !



1 1 1 II
















^ M e a s u re d as p e rc e n ta g e d e v ia tio n s from the $0.92'/2 officia l p a rity e s ta b lis h e d
in M ay 1962. The C a n a d ia n d o lla r has be en flo atin g sin ce Ju n e 1, 1970.

in line with market expectations, and the Canadian dollar
fluctuated narrowly between $1.01 and $1.0150 through
Late in the month, however, market sentiment toward
the Canadian dollar worsened again. News of a Can.
$149 million trade deficit for November confirmed expec­
tations of a continuing deterioration in Canada’s underlying
payments position, and the market was expecting another
cut in the central bank discount rate. As Canadian banks
added to their United States dollar positions and com­
mercial leads and lags worsened, the Canadian dollar fell
to a twelve-month low of $1.0004 on January 9. Several
days later, the Bank of Canada, having reduced secondary
reserve requirements by another percentage point in early
January, lowered its discount rate by another Vi percent­
age point to keep it in line with the general decline of
Canadian money market rates. Since exchange dealers had
actually counted on a larger cut and there were substantial
conversions of Canadian provincial foreign borrowings
that boosted the spot rate, the Canadian dollar briefly
rebounded to nearly $1.01. Once the conversions were
completed, the rate turned lower again. After the final
trade figures for 1974 were released, revealing a steep
erosion of Canada’s trade surplus to Can.$419 million
for the year—little more than a fifth of the 1973 level—
the Canadian dollar eased to $1.0008 on January 31.
This represented a 2 percent decline against the dollar
since August levels and a substantial depreciation against
virtually all other major currencies.

The Euro-currency markets continued to suffer from
the erosion of confidence that afflicted international bank­
ing following the failure of banks in several countries last
year. Persistent nervousness in the market was reflected in
new cuts last fall in credit lines to many market partici­
pants. In particular, smaller and even medium-sized banks
and those of certain countries under balance-of-payments
pressure remained subject to rather close and, in some
cases, increasingly tight credit ceilings by their traditional
suppliers. The multitiered rate structure that had emerged
last spring and summer, therefore, persisted. The strains in
the market gradually subsided, however, with the result
that the differentials between the rates charged to different
classes of banks narrowed and almost disappeared early
in 1975.
The improved market tone owed much to an announce­
ment by the Bank for International Settlements on Sep­
tember 10 that the central bank governors meeting at
Basle, following a discussion of the problems of a lender
of last resort in the Euro-markets, had concluded that
means are available for the provision of temporary liquid­
ity and will be used if and when necessary. The market was
further reassured when consortium banks responded to the
Bank of England’s request for firm commitments from
shareholders to support the banks’ operations if they ran
into problems at any time. Another boost to market con­
fidence was given by an official statement that “the Federal
Reserve is prepared, as a lender of last resort, to advance
sufficient funds suitably collaterialized to assure the
continued operation of any solvent and soundly managed
member bank which may be experiencing temporary li­
quidity difficulties associated with the abrupt withdrawal
of petrodollars— or any other deposits”.
After a fairly steep decline in outstanding deposits
last summer, the Euro-currency market resumed its
expansion in the final quarter of last year, albeit at a much
reduced rate. Its continued growth benefited greatly from
renewed placements of sizable OPEC deposits, which
brought the total for the year to an estimated $23 billion
or 40 percent of OPEC countries’ surpluses. Thus, the
market remained the major receptacle for those funds
that the oil-producing countries were unable to spend for
goods and services and did not employ for grants-in-aid
and loans to oil-importing countries. During the summer
and fall, the market also benefited from sizable advances
by United States banks to their branches, notably those
located in the Bahamas, which then passed on these funds
to a variety of bank and nonbank borrowers.
As OPEC and other major supplier countries added



further to their Euro-currency holdings, overall liquidity
in the market improved but the market continued to suffer
from a maldistribution of liquidity. The very large banks
in the market had ample funds at their disposal, often
more than they desired in view of their capital and sur­
plus positions. While the very large banks grew in strength

C h a rt X I

P e rce n t

T H R E E -M O N T H M A T U R IT IE S *

P e rc e n t

C h a r t X II

T H R E E -M O N T H M A T U R IT IE S *
P e rce n t

P e rc e n t

* W e e k ly a v e r a g e s of d a ily rates.


and importance, the role of some of the medium-sized
and smaller banks became stationary or diminished. A
few banks unable to command the relatively attractive
rates offered to their bigger competitors actually scaled
down their operations.
It was the medium-term Euro-loan market that was most
seriously affected by the strains in international banking.
Last summer and fall, the rate of increase in the volume of
medium-term loans slowed down considerably, as many
syndicate participants no longer were able to secure funds
at competitive interest rates. Consequently, the syndication
of balance-of-payments and project loans carrying very dis­
tant repayment schedules diminished significantly. Re­
duced competition permitted lenders to widen the spreads
of rates on loans over the rates they paid for funding these
loans and to tighten other terms and conditions, including
the shortening of average maturities for medium-term
loans funded with short-term funds on a floating-rate
basis. In more recent weeks, however, as money market
conditions in many parts of the world became easier,
spreads between loan and deposit rates were again narrow­
ing somewhat.
Interest rates in the market, after rising to virtually
unprecedented levels, dropped in September and October
in response to sharp across-the-board declines in United
States money market rates. The downtrend in Euro-dollar
rates stalled toward the end of November, as the decline
in United States domestic rates slowed and as year-end
positioning prompted some bidding for dollar funds. Early
this year, rates resumed their precipitous fall in response
to actual and expected declines in United States prime
rates and other interest rates. By end-January, three-month
rates had dropped below 8 percent, almost one half of the
peak levels reached last summer.



The Business Situation
By nearly every measure, the economic contraction has
deepened further in the new year. Industrial production
fell 3.6 percent in January, and new orders for manu­
factured durable goods declined precipitously. Moreover,
net new capital appropriations by the nation’s 1,000 largest
manufacturers were reported to have decreased in the
fourth quarter of 1974 after several years of heady gains.
There was a slim increase in personal income in January,
but it was largely attributable to higher transfer payments,
as income from salaries and wages declined $0.9 billion.
Labor market conditions have continued to reflect the
increasingly pervasive slack, with industrial work forces
substantially reduced. Nevertheless, the economy’s per­
formance is not completely devoid of hopeful signs.
Residential construction recovered a bit in January, as
housing starts registered a slight gain, and retail sales
posted a second consecutive monthly increase.
The reduced pace of economic activity in recent months
has succeeded in dampening inflation, and the price
outlook is more encouraging than it has been in some
time.* Wholesale prices declined in February for the third
time in as many months, led by sharp reductions in the
prices of farm products and related items. While industrial
wholesale prices increased, the rate of advance was con­
siderably below the inordinately rapid rate observed
throughout most of 1974. Furthermore, sluggish demand
and weak materials prices have begun to exert a restraining
impact on finished goods prices. At the retail level, the
vigorous promotional efforts which sparked retail sales
were accompanied by some price reductions, including the

* Revised estimates indicate that the gross national product
(G N P ) increased $13.9 billion on a seasonally adjusted annualrate basis in the fourth quarter o f 1974. However, while the esti­
mate of real GNP remained unchanged from the preliminary
figure, a decline of 9.1 percent, the annual rate of change of the
implicit price deflator for GNP was raised from 13.7 percent to
14.4 percent.

much-publicized price rebates on automobiles and some
consumer appliances. Partly as a result, the consumer
price index in January recorded its smallest monthly rise
in nine months.

On a seasonally adjusted basis, industrial production
declined 3.6 percent in January (see Chart I). Combined
with the revised 3.1 percent drop recorded in December,
this constitutes the sharpest two-month slide in industrial
output since the 1930’s. The January decrease, the fourth
in as many months, left the Federal Reserve industrial
production index at 113.7 (1967= 100). This is 9.5 per­
cent below its level at the end of September 1974 and 10.8
percent beneath its cyclical peak of November 1973.

C h art I

S e a s o n a lly a d j u s t e d ; 1 9 6 7 = 1 0 0
P e rc e n t

S o u rc e : B o ard of G o v e rn o rs o f the F e d e r a l R ese rv e System .

P e rc e n t



The January cutback in industrial output was wide­
spread, with sharp reductions in business equipment,
consumer goods, and industrial materials. The output of
business equipment fell 4.6 percent in January, after having
declined 3 percent in December. The production of con­
sumer durable goods was reduced by 6.1 percent, in part
because of the 9.5 percent cutback in automobile output.
Automobile assemblies in January proceeded at an annual
rate of 4.8 million units, down from 8.3 million units in
October when the auto manufacturers first announced their
intentions to reduce the scale of operations. In February,
automobile production declined even further to an annual
rate of 4.4 million units. Facing a large overhang of
inventories and weakening prices, producers of industrial
materials reduced their rate of output in January by
4.1 percent. This followed the 4.6 percent contraction in
December and brought the decline in industrial materials
production to 13.8 percent since September. In mild
contrast to the other manufacturing sectors, output in the
mining and utilities industries increased slightly in
January. The gain was attributable, however, to the large
increase in coal production during the period following
the settlement of the miners’ strike in December.

C h a r t I!

S e a s o n a lly a d ju s te d
lilli o n s o f d o lla r s

So u rc e : U n ite d Sta te s D e p a rtm e n t of C o m m e rc e , B u re a u of the Censv


Appropriations for new plant and equipment by the
nation’s 1,000 largest manufacturing firms declined by
24 percent in the fourth quarter of 1974, according to a
survey by The Conference Board, Inc. Total appropria­
tions in the fourth quarter were $12.5 billion, compared
with $16.4 billion in the third quarter. The petroleum
industry accounted for the largest changes in appropria­
tions in both the third and fourth quarters of 1974. In
the third quarter, firms in the petroleum industry increased
appropriations by 18 percent, compared with only a
4.6 percent increase in the other industries. In the fourth
quarter, however, firms in the petroleum industry reduced
their appropriations by 57 percent, while nonpetroleum
industries cut back only 7.4 percent.
New orders for durable manufactured goods declined
$1.1 billion in January, continuing the downtrend that
began last August (see Chart II). Most of the January
drop is attributable to a $1 billion fall in the orders for
primary metals. However, there were also sizable declines
in orders for transportation equipment and machinery.
Looking at marketing categories, bookings for household
durables inched up in January, but the important capital
goods group registered a $650 million decrease. The back­
log of unfilled orders for durable goods also fell in January,

by $3.6 billion. The latest decline, the fourth in a row,
was the largest percentage contraction in durable goods
orders backlogs since 1960.
Durable goods industries accounted for the entire in­
crease in total manufacturing inventories during January.
Inventories in the durable goods sector increased by
$1.2 billion, while they declined by $0.1 billion in the
nondurable goods industries. The breakdown of the Jan­
uary inventory advance by stage of fabrication implies
that much of the gain was unintentional. Of the total $1.1
billion increase, more than half— $620 million— was com­
posed of finished goods, while materials and supplies on
hand rose $260 million and work in progress increased
by $200 million.

Personal income rose $2.6 billion in January, down
from the $7 billion monthly rise averaged during 1974.
The January gain occurred despite a $0.9 billion decline
in wage and salary income; increases in dividends and
interest and in transfer payments offset the fall in wages


and salaries. Reflecting the sharp cutbacks in employment
and production, private industry payrolls decreased at a
$1.8 billion annual rate in January. The reduction was
concentrated in manufacturing, where payrolls have now
fallen 6.4 percent since October and are only 0.6 percent
above their level of January 1974. The weakness in manu­
facturing has been balanced somewhat by modest gains
in wages and salaries in service industries and in govern­
ment. In addition, transfer payments— social security,
unemployment, and welfare and veterans’ benefits—in­
creased at a $2.7 billion rate in January, following a very
large $6.3 billion increase in December. With the con­
tinued decline in farm prices, the income of farmers
recorded its fourth consecutive monthly decrease in Jan­
uary. Over the year ended in January, farm income fell
nearly 36 percent.
Spurred by unusually widespread clearance sales, retail
sales increased 0.9 percent in January to a monthly total
of $45.1 billion. This was the second successive increase
in retail sales, following sizable declines in the three
previous months. The dollar value of January’s sales was
4.9 percent above that of a year earlier. However, since
retail prices rose approximately 12 percent over this
period, there has been a substantial reduction in the real
volume of goods sold. Consumer spending on durable
goods, which has been quite depressed in recent months
by high interest rates and consumer pessimism, was 0.9
percent higher in January than in December. Most of the


increase reflected the 2 percent increase in automobile
sales that was motivated by the cash rebate programs
initiated in the middle of the month. Sales of new domestic
automobiles climbed to an annual rate of 6.6 million units
in January and to 7.2 million units in February. Sales
of nondurable goods were 1 percent higher in January
than a month earlier and were 7.8 percent above their
level of January 1974.
The residential construction industry showed tentative
signs of recovery during January. Housing starts increased
13 percent to an annual rate of 987,000 units, up from
December’s 875,000 units (see Chart III). The pros­
pects for further recovery remain clouded, however. The
issuance of new building permits, which is sometimes an
indicator of building activity in the following month or
two, declined in January to the lowest point on record for
the series, which dates to 1959. On the other hand, thrift
institutions have realized substantial net deposit inflows
during recent months. These inflows, combined with de­
clines in short-term interest rates, should increase the
supply of mortgage funds and eventually lead to lower
financing costs. Another positive factor is the recent de­
cline in the vacancy rate in multiple dwellings, which fell
0.2 percentage point during the fourth quarter of 1974
to 6 percent. The rental vacancy rate normally moves
quite slowly, and a decline of this size indicates a firmer
tone in the rental market which could stimulate new
construction in the coming months.

C h a r t III

S e a s o n a lly a d ju s t e d a n n u a l ra t e s
M illio n s o f u n its

Source: United State s D epa rtm en t of C o m m e rce , Bureau o f the C e n su s.

P e rc e n t

In recent months, prices at the wholesale and retail
levels provided further evidence that the rate of inflation
is abating. Wholesale prices in February declined at a
9.2 percent annual rate, the third consecutive monthly
decrease. While consumer prices in January increased at
a 7.7 percent annual rate, this was the slowest advance
since last April.
Contributing to the February decline in wholesale prices
was the sharp 41.1 percent annual-rate drop in prices
of farm products and processed foods and feeds. This
weakness in farm product prices, following substantial
declines in December and January, has led agricultural
experts to speculate that supply conditions in these markets
may have permanently improved and that food prices in
the near future may be weaker than they were previously
expected to be. The prices of industrial commodities at
the wholesale level increased at a 6.5 percent annual rate
in February. These prices over the past three months have
risen at a 4.3 percent annual rate, which stands in sharp
contrast to their performance during the preceding twelve



months when they rose 27.4 percent. The wholesale prices
of basic raw materials fell at a 1.1 percent rate in February
which, following their 19.4 percent rate of decline in Jan­
uary, suggests that final goods prices may soften in the
months ahead as the recent decreases in materials prices
work their way forward to advanced stages of production.
January marked the second consecutive month that the
rate of inflation at the consumer level has slowed. Retail
food prices increased at a 9.9 percent rate, slightly more
rapid than December’s advance. However, the acceleration
is attributable to hikes in the prices of restaurant meals;
grocery prices actually rose somewhat more slowly than
they had in December. The prices of nonfood consumer
items advanced at a 6.7 percent rate, as increases in the
prices of shoes, gasoline, and household durables more
than offset the decline in new car prices. In contrast, over
the year ended November 1974, the prices of nonfood
consumer items had risen 12.3 percent. The prices of
services increased at a 9.6 percent rate in January, with
household utility costs registering a substantial increase.

Labor market conditions deteriorated somewhat further
in February, although the unemployment rate remained
unchanged at 8.2 percent of the civilian labor force. Non-

agricultural employment declined by over 450,000 persons,
but this was more than matched by a fall in the labor
forcc. The February decline in employment was the fifth in
as many months, bringing the total decrease over the period
since September 1974 to more than 2.2 million workers.
Reflecting the reductions in industrial production, most
of the drop in employment has occurred among adult
males in manufacturing, while employment in the non­
manufacturing sector has fallen relatively little since
September. The sharp decline in the labor force in Febru­
ary reversed the growth of recent months. Indeed, over
the five months ended in February, the labor force de­
creased by nearly 340,000 workers. Taking a somewhat
longer perspective, over the year ended in February the
labor force climbed by 955,000, or 1.1 percent.
January’s labor turnover rates also reveal the degree
to which industry’s demand for labor has eroded in recent
months. The layoff rate jumped sharply to 3.5 percent,
up from 2.6 percent in December. This increase
brought the layoff rate in January to nearly three times
what it was in September, when industrial production
began to decline in earnest. Meanwhile, the scarcity of
job openings caused the number of workers voluntarily
leaving their jobs to decline to 1.4 percent. In September
the quit rate was 2.1 percent, and in January 1974 it was
2.6 percent.



The Money and Bond Markets in February
Short-term interest rates fell further in February, con­
tinuing the downtrend that began in the summer months
of 1974. The declines in most cases were modest, partic­
ularly in comparison with the sharp drops registered in
January. The Federal funds rate, however, fell substantially
further in February. For the month as a whole, the effec­
tive rate averaged 6.24 percent, its lowest level since Jan­
uary 1973. In addition, early in February the Board of
Governors of the Federal Reserve System approved a
reduction in Federal Reserve Bank discount rates from
IV 4 percent to 63A percent, the third reduction in three
months. And, effective March 10, the discount rate was
lowered from 63A percent to 6*4 percent at ten Reserve
Banks, including New York.
Private demands for short-term credit were sluggish
again in February. Business loans at major New York
City banks, for example, fell sharply for the second
consecutive month, despite several reductions in the banks’
prime lending rates. At the same time, however, the Trea­
sury borrowed heavily. Nevertheless, rates on United States
Government securities moved irregularly lower on balance
over the first three weeks of the period. Late in the month,
the Treasury announced plans to raise $7 billion in new
cash between mid-March and mid-April through sales of
coupon-bearing issues. Rates rose significantly in response
to this disclosure, finishing the month about unchanged
from end-of-January levels. Yields in the corporate and
tax-exempt bond markets initially declined but retraced
their steps toward the close of the month, as indications
that the Treasury would be borrowing substantial sums
tempered the interest rate outlook. Moreover, participants
in the tax-exempt bond market grew increasingly concerned
about the financial difficulties confronting the New York
State Urban Development Corporation (UDC).
Preliminary data indicate that the narrowly defined
money stock (MO expanded at a moderate pace in Feb­
ruary. Mt had actually declined in January and registered
only sluggish growth over the last six months of 1974. The
recent sharp drop in short-term market interest rates has
encouraged sizable flows into commercial bank consumertype time and savings deposits in the last several months.
These deposits advanced rapidly again in February and,

as a result, the more broadly defined money stock (M 2)
continued to expand at a faster pace than Ma.

Money market rates continued to fall in February, but
in most cases the declines were considerably smaller than
those experienced in the previous month (see Chart I).
The rate on 90- to 119-day dealer-placed commercial
paper, for example, closed the period at 6 V4 percent, a
drop of % percentage point over the month as compared
with the 234 percentage point decline registered in Jan­
uary. Similarly, after falling sharply in January, rates on
other maturities of commercial paper, on bankers’ accep­
tances, and on certificates of deposit (CDs) in the second­
ary market edged downward in February. In contrast,
the Federal funds rate moved substantially lower, although
the decline did not match January’s steep drop. For the
month as a whole, the effective rate on Federal funds
averaged 6.24 percent, 89 basis points below the level of
the preceding month.
From a longer perspective, money market rates have
fallen dramatically from the extraordinarily high levels
reached in the summer of 1974. In general, rates on money
market instruments have dropped by about 5 to 7 percent­
age points from their peaks. A decline in short-term rates
is, of course, normal during an economic contraction
when businesses and consumers curtail their borrowings
in the short-term markets and the monetary authorities
are pressing reserves on the banking system. In the current
economic downturn, however, the declines thus far have
been steeper than— and, except for the 1969-70 experience,
have been nearly twice as steep as— in any previous con­
traction in the postwar period. In part, the sharper drop in
short-term rates in the current episode reflects the rela­
tively high level at which rates peaked in 1974, as well as
the severity of the contraction in economic activity.
Duplicating the experience of previous postwar con­
tractions, the declines in commercial banks’ prime lending
rates have lagged the fall in other short-term market rates.
In February, most banks reduced their prime rates by V2



C h a rt 1

D e ce m b e r 1974 - F e b ru a ry 1975

D ecem be

J a n u a ry


F e b ru a ry


N o te :

D e ce m b e r

Ja n u a ry

F e b ru a ry

D a t a a re s h o w n fo r b u s in e s s d a y s o n ly .

M O N E Y M A R K E T R A T E S Q U O T E D : P rim e c o m m e r c ia l lo a n rote at m ost m a jo r b a n k s ;
o f fe r in g r a t e s (q u o te d in te rm s o f ra te o f d is c o u n t) on 9 0 - to 1 1 9 -d a y p rim e c o m m e r c ia
p a p e r q u o te d b y th re e o f the fiv e d e a le r s th a t r e p o r t th e ir ra t e s , o r the m id p o in t of
the r a n g e q u o t e d if no c o n s e n s u s is a v a i la b le ; the e f fe c tiv e ra t e on F e d e r a l fu n d s
(the ra te m o st r e p r e s e n t a tiv e o f th e tr a n s a c t io n s e x e c u t e d ); c lo s in g b id ra t e s (q u o te d
in te rm s of ra t e o f d isc o u n t) on n e w e s t o u t s t a n d in g th re e -m o n th T r e a s u r y b ills .
B O N D M A R K E T Y IE L D S Q U O T E D : Y ie ld s on ne v A a a - r a t e d p u b lic u tility b o n d s a r e b a s e d
on p r ic e s a s k e d b y u n d e r w r it in g s y n d ic a t e : , a d ju s te d to m a k e th e m e q u iv a le n t to a

to 3A percentage point. By the close of the month, most
were quoting a rate of 8 V2 percent, a substantial drop
from the record high of 12 percent which prevailed over
the July-September period. The decline in the commercial
bank prime lending rate in February narrowed the spread
between these and other money market rates, but the
prime rate remained relatively high nevertheless. As a
result, businesses continued to shift some of their borrow­
ings from banks to the commercial paper market. Reflect­
ing this shift, as well as the general weakness in short-term
credit demands, commercial and industrial loans at weekly
reporting banks fell by $956 million over the four weeks
ended February 26. Meanwhile, the volume of nonfinancial commercial paper outstanding rose $557 mil­

s t a n d a r d A a a - r a t e d b o n d o f a t le a s t tw e n ty y e a r s ' m a tu rity ; d a ily a v e r a g e s o f
y ie ld s on s e a s o n e d A a a - r a t e d c o rp o r a te b o n d s ; d a ily a v e r a g e s o f y ie ld s on
lo n g -term G o v e r n m e n t s e c u r it ie s (b o n d s d u e o r c a lla b le in ten y e a r s o r m ore)
a n d on G o v e r n m e n t s e c u r it ie s d u e in th re e to fiv e y e a r s , c o m p u te d on th e b a s is
o f c lo s in g b id p r ic e s ; T h u r s d a y a v e r a g e s o f y ie ld s on tw e n ty s e a s o n e d tw e n tyy e a r t a x - e x e m p t b o n d s (c a r r y in g M o o d y 's ra t in g s o f A a a , A a , A , a n d B a a ).
S o u r c e s : F e d e r a l R e s e r v e B a n k o f N e w Y o r k , B o a r d o f G o v e r n o r s o f the F e d e r a l
R e s e r v e S y s te m , M o o d y ’s In v e s to rs S e r v ic e , In c ., a n d T h e B o n d B u y e r.

lion over the same period. With the weakness in business
loan demand, banks withdrew from active bidding for
CD funds, and the volume of CDs at New York City
weekly reporting banks dropped over the four statement
weeks of the month by $967 million. Member bank bor­
rowings from the Federal Reserve rose by $38 million
over the four weeks ended February 26, averaging $149
million for the period (see Table I).
In February, the Board of Governors announced re­
visions to the money stock and related measures to
incorporate data obtained from nonmember banks in the
October 1974 call reports and from reports from foreign
agencies and branches. The revisions raised the levels
of the money stock measures slightly beginning in May



1974 but did not change the overall pattern of growth. In
particular, the new data for Mi— private demand deposits
adjusted plus currency outside banks— still show a sub­
stantial deceleration in growth over the last six months of
1974 and a sharp decline in the level of Mi in January
of this year. In February, however, Ma developed renewed
strength, rising at a seasonally adjusted annual rate of 6.9
percent from the four weeks ended January 29 to the
four weeks ended February 26. Notably, the demand
deposit component of Mx rose over this period at a mod­
erate pace, after contracting sharply in January. The
renewed growth of Mx over the four statement weeks in
February partly offset January’s decline and left Mx about
unchanged from its level of thirteen weeks earlier (see
Chart II).
Over the last several months, M2— which adds to Mi
time deposits less large CDs— has been much more buoy­
ant than Mi, as declines in market rates have encour­
aged flows into time and savings deposits. In February this
pattern continued, with M2 rising at a seasonally adjusted
annual rate of 10.1 percent over the four statement weeks
in February from its average level over the previous four
weeks. However, the adjusted bank credit proxy— member
bank deposits subject to reserve requirements plus certain
nondeposit liabilities— remained unchanged over this pe^
riod, in part reflecting a decline in CDs as well as a drop in
member bank liabilities to their foreign branches.

Table I
In millions of dollars; (-f) denotes increase
and (—) decrease in excess reserves

Changes in daily averages—
week ended






“ Market” factors
Member bank required reserves ..................

+ 528 +

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


Federal Reserve float ................................

+ 178 — 164

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

+ 392 +1.146



—1,209 —1,160


673 +1,015

51 +1.065



31 4- 273
463 —1.502



— 427

Gold and foreign a c c o u n t..........................

— 71


98 +


Currency outside banks ............................

— 52 — 597

879 +



and c a p ita l....................................................

— 396





Total “ m arket" factors ............................

+ 579

+ 1.738




-L I.144

— 974



Other Federal Reserve liabilities
613 +


Direct Federal Reserve credit
— 690 —1,898



Treasury securities ....................................

_ 433 —1.866


246 +

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


10 —


Federal agency o b lig atio n s........................

— 16 —


Treasury securities ....................................

— 248 +

32 +

Bankers’ acceptances..................................

-f- 28 —

62 +

Federal agency o b lig atio n s........................

_ 31


Open market operations (subtotal) ..........
Outright holdings:













Repurchase agreements:


Interest rates on Government securities moved irregu­
larly in February. Strong demand dominated the market
as the month began, and rates on all maturities declined.
Subsequently, concern over the potential size of Treasury
borrowing led to upward pressure on rates, especially
around midmonth. The downtrend later reemerged but
was again interrupted toward the end of the month.
February was marked by unseasonably large Treasury
sales of Government securities. A total of $3.4 billion
in new cash was raised by the Treasury. On February 19,
$3 billion in new cash was raised through the auction of
two notes, $1.5 billion of two-year maturity and $1.5 bil­
lion maturing in eighteen months. The minimum denomina­
tion in each case was $5,000. Competitive tenders of $5.8
billion were received, and the average yield for
the two-year issue was set at 6.09 percent, while a yield
of 5.94 percent was established on the eighteen-month
Late in the month the Treasury announced its intention
to raise $7 billion in new cash from mid-March to midApril through the sale of coupon-bearing issues, while fur-

Member bank borrowings ..............................
Seasonal borrowings f ................................
Other Federal Reserve a s s e ts ! ......................
Total ........................ ....................................
Excess reservest ..............................................


— 46 —



186 + 386
31 _L







4- 139
1 +








-f- 349 — 159





-f- 192 — 326


131 —


— 557



Daily average levels

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






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






Excess reserves ................................................
Total borrowings ............................................









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






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








___or deficit24(—) | |155
Net carry-over, excess
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.
5 Average for four weeks ended February 26, 1975.
|| Not reflected in data above.

26 -



ther amounts might be raised in bills. An additional $1.2
billion in coupon issues would be raised to repay maturing
debt. Of the $7 billion in new cash, $1.75 billion
would consist of notes due November 15, 1981, $1.5
billion of notes maturing May 31, 1976, $1 billion of twoyear notes maturing March 31, 1977, $1.25 billion of
bonds maturing May 15, 1990, and $1.5 billion of notes
due November 30, 1976. The $1.2 billion refunding will
consist of two-year notes maturing March 31, 1977. There
was some indication that an additional amount of new
cash ranging between $11 billion and $21 billion would
be required before the end of June.
The market was quick to react to the announcement of
the Treasury’s financing plans. The rate on three-month
bills, for example, which had fallen about 38 basis
points on balance over the first three weeks of the month,
rose 10 basis points during the week following the an­
nouncement. Rates set at the fourth weekly Treasury
auction of February were slightly higher, as well, than
those set at the previous week’s auction (see Table II).
Similarly, after the Treasury’s announcement, rates on
intermediate-term coupon issues advanced from 5 to 15
basis points, while yields on long-term bonds rose 4 to 7
basis points. These increases appeared short-lived, how­
ever, as Treasury bill rates and yields on intermediate
Government securities declined in the last two days of
the month. For the month as a whole, rates on most Trea­
sury issues changed little.
Yields in the market for Federal agency securities dis­
played the same pattern in February as those on Treasury
securities, although movements were not so sharp. Sales
of short-term notes by the Department of Housing and
Urban Development for local public authorities were well
received. First, early in the month, a 3.49 percent average
interest rate was set on $680.2 million of tax-exempt notes
with an average maturity of 8.3 months. Then, at midmonth
an average interest rate of 3.57 percent was established
for a $418 million tax-exempt issue of urban-renewal notes
with an average maturity of IV 2 months. The average yield
on commitments to buy Government-backed mortgages
auctioned by the Federal National Mortgage Association
fell below 9 percent for the first time since last April and
continued to fall at the second such auction in February.
The Federal Home Loan Banks successfully sold at
the start of the month $300 million of 8% -year bonds
partially to replace $1.2 billion maturing on February 25.
A 7% percent coupon was placed on this issue. The
Federal Home Loan Mortgage Corporation (FHLMC)
introduced a new type of security with a $300 million
issue of guaranteed-mortgage certificates due March 15,
2005. It was offered to yield 8.20 percent. An option for the

investor to resell the issue to the FHLMC at the issue
price in fifteen years was included. The farm credit agen­
cies entered the market at midmonth with a $391.6 million
Banks for Cooperatives (BC) offering due September 2,
1975 and a $897 million Federal Intermediate Credit
Banks (FICB) issue due December 1, 1975. The respec­
tive yields of 6.05 percent and 6.15 percent were substan­
tially below the 7.05 percent paid in January on a similar
issue. At the end of February, the BC and the FICB offered
an additional $75 million of short-term bonds, with cou­
pons ranging from 7.40 percent to 9.45 percent.

Yields in the corporate bond market continued to de­
cline at the beginning of the month but began to stabilize
soon afterward, partly as a result of dealers reducing

C h a r t II

S e a s o n a lly a d ju s t e d a n n u a l rates
P e rc e n t

P e rcen t

N o te: G ro w th ra te s a re co m p uted on the b a s is o f fo u r-w e e k a v e r a g e s of d a ily
fig u re s for p e rio d s e n d e d in the statem ent w eek p lotted , 13 w e e k s e a rlie r an d
52 w e e ks e a rlie r . The la te s t statem e nt w eek plotted is F e b ru a ry 2 6 , 1975.
M l = C u rre n cy p lu s a d ju s t e d dem an d de p o sits h e ld b y the p u b lic.
M 2 = M l plus co m m e rcial b a n k sa v in g s an d time d e p o sits held by the p u b lic , less
n e g o tia b le ce rtifica te s of d e p o sit issu e d in d e n o m in a tio n s of $ 10 0,0 00 or more.
A d ju ste d b an k credit p ro x y = Total m em ber b a n k d e p o sits subject to re se rve
re q u ire m e n ts p lus no n d e p o sit so u rce s of fu nds, such a s E u ro -d o lla r
b o rro w in g s an d the p ro ce e d s of co m m e rcial p a p e r issue d by b a n k h o ld in g
c o m p a n ie s or o ih e r a ffilia te s.
S o u rc e : B o a rd of G o v e rn o rs o f the F e d e ra l R e se rve System .


inventories that had built up in January. The calendar
was heavy in February, but new issues were generally well
received. As the yields of recently offered Aaa-rated bonds
initially fell, investor interest spread to seasoned corporate
bonds and those of less than top quality. In light of the
strong demand for corporate bonds evidenced at the begin­
ning of the month, some borrowers advanced the dates
of their issues. Near the close of the period, however,
yields backed up sharply, retracing some of their earlier
declines, in response to the Treasury’s announcement of
future borrowing and the growing supplies of corporate
and tax-exempt issues.
During the first week of February, a utility successfully
sold $35 million of Aa-rated first-mortgage bonds yielding
8.67 percent in thirty years. This represented the lowest
return on a new long-term high-grade utility bond in
almost a year, significantly below the record 10.6 percent
yield registered in late 1974. In the same vein, a second
utility sold $100 million of A-rated thirty-year bonds at a
yield of 9.55 percent, 3.45 percentage points lower than
the yield associated with an issue it offered last September.
By midmonth, however, the sharp decline in yields on
utility bonds reduced their attractiveness relative to indus­
trial bonds. This development was partly responsible for
the slow-paced sale of $125 million of thirty-year firstmortgage bonds of Commonwealth Edison Company at
that time. A $300 million issue of thirty-year Aaa-rated
debentures by Mobile Alaska Pipeline Company, on the
other hand, sold out at 8.45 percent.
The last several days of the month witnessed sharp price
reductions among recently offered and seasoned corporate
bonds while newly issued corporate bonds were accorded
mixed receptions, in light of the Treasury announcement
of large offerings of Government securities by mid-April.
The announcement that the Treasury planned to sell $1.25
billion of long-term bonds to raise new cash weighed
particularly heavily on the market. The yield on the Com­
monwealth Edison bonds jumped 23 basis points after
being released from syndicate restrictions. However, a
thirty-year Aaa-rated bond issue of Dallas Power and
Light Company sold well at a yield of 8.78 percent, sig­
nificantly lower than those of earlier issues.
Retail demand for tax-exempt issues was also strong
as the month began, and both short- and long-term issues
benefited. A $103.5 million offering of various maturities
by the New York State Housing Finance Agency, priced
to yield 4.5 percent in 1975 to 7.6 percent in 2006, quickly
sold out. Reflecting the recent decline in short-term
interest rates, the one-year bond yielded 2 percentage
points less than it had in a similar offering in October
while the longest maturity bond yielded only a 0.35 per-

Table II

In percent

Weekly auction dates— February 1975

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













Monthly auction dates— December 1974-February 1975

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







Interest rates on bills are Quoted in terms of a 360-day year, with the discounts from
par as the return on the face amount of the bills payable at. maturity. IJond yield
equivalents, related to the amount actually invested, would be slightly higher.

centage point less. A $290 million issue of one-year notes
by New York City offered in the first week of the month
yielded 7.25 percent, substantially below the 9 percent
obtained in the city’s two previous note issues. The market
became more cautious toward the end of February in ex­
pectation of a large volume of future offerings in addition
to the large backlog of unsold municipals. A $125 million
bond offering by Massachusetts required some price re­
duction before it was sold, with yields ranging from 3.6
percent in 1976 to 6.3 percent in 2025, while $40 million
of an Illinois issue was released from syndicate restrictions
and declined sharply in price, bringing it more closely in
line with the Massachusetts issue.
The state and municipal markets were directly affected
by the UDC’s financial problems. The corporation was
unable to raise the required money to redeem $104.5
million of maturing short-term notes. In reaction to this,
yields rose considerably in the tax-exempt market during
the last several days of the month, and there was height­
ened concern about the quality of issues. Yields on new
issues of the states of Connecticut and Louisiana were set
above prevailing market rates. The issues, Aaa- and Aarated, respectively, were well received at the higher yields,
The Bond Buyer index of twenty municipal bond yields
fell 14 basis points over the first three weeks of the
month but then rose 15 basis points in the final week
to close at 6.55 percent. The Blue List of dealers’ ad­
vertised inventories stood at $652 million at the month
end, having risen by $91 million for the month as a whole.



Sixtieth Annual Report
The Federal Reserve Bank of New York has published its sixtieth Annual
Report, reviewing major economic and financial developments in 1974 and the
highlights of the Bank’s operations.
The Report commented that “a combination of severe, and in some respects
unprecedented, economic strains caused deep concern throughout much of the
industrialized world in 1974”. It noted that the “United States shared many of
the economic woes which beset the rest of the world”. The Report further stated
that, “while the symptoms of economic contraction began to become pronounced
and general in the domestic economy only relatively late in 1974, inflation was an
acute problem throughout the period. . . . far worse than it had been in the
preceding year”. Although “it is difficult to provide a wholly adequate explanation
for the price inflation”, the Report listed several factors that contributed to it,
including the Federal budget deficit over the past several years, fuel and food supply
shortages, and depreciation of the dollar. With regard to monetary policy, the
Report said that open market operations were used as the primary instrument in
1974 “to moderate the rate of monetary expansion”. At the same time, “the mone­
tary authorities were fully aware that an abrupt slowing in monetary growth was
not desirable”.
In his letter presenting the Report to the member banks, Alfred Hayes, President
of the Bank, observed that “economic policy makers face a very difficult environ­
ment in 1975. A strengthening of international financial cooperation is clearly
required.” He pointed out that, in the United States, “we must attempt to arrest
the marked rise in unemployment and to lay the groundwork for a resumption of
sustained economic growth”. In addition, Mr. Hayes stated that “we must be
careful to avoid overly stimulative policies which could add . . . to the costs of
achieving . . . price stability. Striking the proper balance in pursuing these objectives
is no easy task.”
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.