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FEDERAL RESERVE BANK OF NEW YORK

215

The Business Situation
Business developments during the past month were
overshadowed by announcements of several measures in­
tended to restrain inflationary pressures in the economy,
and to alleviate the strains in the nation’s credit markets.
Meanwhile, the economy continued to advance along a
broad front and demand pressures remained excessive.
Moreover, there were indications that the threat of upward
price pressures arising from labor cost increases in excess
of productivity growth was intensifying.
In a policy statement issued September 1, the Federal
Reserve System urged a moderation in the rate of bank
loan expansion, and particularly in the expansion of busi­
ness loans.1 The statement, while reminding financial mar­
kets that the Reserve Banks’ “discount windows” are
available as always to meet seasonal or unusual strains,
observed that “the aggregate total of credit-financed busi­
ness spending has tended towards unsustainable levels
and has added appreciably to current inflationary pres­
sures”. It went on to note that exceedingly rapid growth
of bank credit to business could contribute to strains in
other sectors of the credit markets.
A week later, the President asked Congress to sus­
pend certain tax benefits applicable to business capital
investment, indicating that such action was desirable in
order to relieve excessive pressures on capital goods pro­
ducers as well as on the financial markets. Moreover, the
President stated that he intends to cut back “lower-priority”
Federal expenditures by some $3 billion, and he warned
that additional fiscal actions might be needed to prevent im­
balances in the domestic economy and to offset further
growth in defense outlays. Though there is a great deal of
uncertainty about the magnitude of future military require­
ments, it is now expected that the growth of defense outlays
during the second half of 1966 will run considerably
ahead of the quarterly advance of $2 billion (annual rate)
that was incorporated into most projections made early in
the year.

In a further action taken during September, new inter­
est rate ceilings for various types of time and savings
deposits were established late in the month by the Federal
Reserve Board and other regulatory bodies, acting under
powers newly granted to them.2 These ceilings are intended
to limit the further escalation of interest rates by institu­
tions competing for consumer savings.
Although the overall economy has been buoyant, the
scarcity of mortgage credit—coming in the wake of ad­
justments to earlier overbuilding—has had a depressing
effect on home-building activity. The rate of housing starts
declined sharply from March through July and then was
about unchanged in August—at a level nearly one-third
lower than the pace in the late winter. It is possible
that the various measures taken and proposed during the
past month will expand the supply of mortgage credit,
which could improve the outlook for residential construc­
tion.
With respect to business capital spending, considerable
time will probably have to pass before the proposed tax
measures have any substantial impact on the rate of out­
lays. However, the President’s tax proposals, coupled with
the other measures taken during the past month, may have
served to dampen inflationary expectations. Such expecta­
tions have been fed by the persistent rise in prices, particu­
larly at the consumer level where the price index ad­
vanced sharply once again in August. Despite the fact
that nonfood commodity prices were unchanged on bal­
ance, the overall consumer price index rose by one half
of a percentage point, to 113.8 per cent of the 1957-59
average. Food prices showed an exceptionally large in­
crease, while the prices of services continued to rise at the
substantial rate of previous months. At the wholesale level
as well, food prices registered a further sharp rise in Au-

2 For details regarding these rate ceilings, see this Review (Octo­
ber 1966), footnote 2 on page 221.
At the same time, Congress raised to 10 per cent, from the pre­
vious 6 per cent, the maximum reserve requirements that the Fed­
1 See this Review (September 1966), page 209, for the full text eral Reserve is authorized to establish for commercial bank time
and savings deposits.
of the statement.




MONTHLY REVIEW, OCTOBER 1966

216

Chart I

WHOLESALE PRICES
1 9 5 7 -5 9 = 1 0 0

Per cenf

billion, representing an advance of 17 per cent over the
1965 figure. An increase of that magnitude would be well
ahead of last year’s 1516 per cent gain, and would make
this the fifth consecutive year of capital spending growth.
According to the Commerce-SEC survey, spending in
the fourth quarter is expected to reach an annual rate
of $63Vi billion (seasonally adjusted), more than 50 per
cent greater than the spending rate in the final quarter of
1963—only three years previously. The very strong growth
of demand for new facilities during the past several years
has put increasing pressure on the productive capacity of
capital goods producers and of certain sectors of the con­
struction industry. Evidence of such pressures has been
seen in labor shortages, delivery delays, increased back­
logs of orders, mounting imports, and rising prices. Dur­
ing the past year, moreover, credit to finance investment
projects has become increasingly scarce and its cost has
risen. In these circumstances, it is perhaps not surprising
that business plans for capital spending in the second half
of 1966, as reported in August, were virtually identical
to those indicated by the previous survey in May—in
contrast to the pattern of the past few years when upward

^ In c lu d e s all items other than farm prod ucts a n d p ro c e sse d foods.

C hart II

Source: United States B ureau of L a b o r Statistics.

ACTUAL AND ANTICIPATED PLANT
AND EQUIPMENT SPENDING
B illions of do lla rs

S e a s o n a lly adjusted a n n u a l rate

B illions of d o lla rs

gust (see Chart I). As a result of price declines for various
industrial raw materials, however, the overall industrial
price level was unchanged in August. Partial information
on wholesale prices in September indicates that agricul­
tural prices rose once again while the industrial index
appears to have remained stable.
B U S IN E S S IN V E S T M E N T

The emphasis on business capital spending in the policy
measures announced during September in part reflects the
very rapid growth of such expenditures over the last three
years. The latest Commerce Department-Securities and
Exchange Commission survey of business capital spending
plans—taken in August, prior to the President’s request for
legislation suspending the investment tax credit and
accelerated depreciation allowances—confirmed the earlier
indications that 1966 would witness another very strong
advance in business outlays for new plant and equipment
(see Chart II). If business spending plans for the re­
mainder of this year attain the level anticipated in the Au­
gust survey, total outlays in 1966 will amount to $61




Note: Figures shown for the final two quarters of 1966 are estimates from the
A u g u st Com m erce-SEC survey.
Sources: United States Departm ent of Commerce; Securities an d Exchange Com m ission.

FEDERAL RESERVE BANK OF NEW YORK

revisions were almost invariably reported by each suc­
cessive survey. The restraining effects of supply problems
coupled with credit tightness are helping to limit 1966 in­
vestment programs to the exceptionally high level already
projected in May.
It is very difficult to estimate the effects on capital
spending that might result from a suspension of the 7 per
cent investment tax credit and accelerated depreciation
allowances. Over the near term, the volume of capital
spending would probably be little affected, since projects
already under way would almost certainly be completed.
However, spending in 1967 would be reduced to the
extent that businessmen decide to cancel some investment
programs—or, as is more likely, to postpone or stretch
them out. It could be expected that the suspension of the
investment tax credit would have a more immediate im­
pact on the volume of new orders received by the capita]
goods industries. To be sure, ever since spring the total
volume of durables new orders has shown little buoyancy,
but this moderation has been largely concentrated in in­
dustries other than those oriented to capital goods produc­
tion. A slowing of the order inflow to capital goods pro­
ducers would moderate the growth of their unfilled order
backlogs and might well enable them to work down some
part of the very large backlogs now on their books. It
would be a welcome development if such an orders slow­
down were to lead to some reduction in the currently
intense pressures on capacity and labor resources in the
capital goods industries. Even if the production rate in
those industries were not appreciably affected, a slowing
of new orders and moderation of backlog growth might
be expected to result in an atmosphere less conducive to
price increases. On the other hand, a significant slowing
of business fixed investment would have a dampening
effect on productivity growth.
At the same time that spending for fixed capital invest­
ment has expanded vigorously, manufacturers have sub­
stantially increased their investment in inventories. Since
early this year, durables producers have made progres­
sively larger monthly additions to their inventories, and
the ratio of inventories to sales in that sector has risen
noticeably. Nondurables manufacturers have also been
expanding their stocks at a rate generally more rapid than
previously, but their stock-sales ratio has remained at
about the low level reached last year. During the second
quarter, according to the Commerce Department’s August
quarterly survey of inventory and sales expectations, both
durables and nondurables manufacturers reported an ap­
preciable advance in the proportion of inventory evaluated
as “high” relative to sales and unfilled orders. Durables
manufacturers reported the highest such percentage of the




217

current expansion, except for the reading in September
1965 when strike-hedge steel stockpiles were at a peak.
According to the August expectations survey, thirdquarter accumulation by durables producers was running
well ahead of the pace projected last May. In the fourth
quarter, however, the growth of durables inventories is
expected to slow sharply. Though actual inventory invest­
ment by durables producers in the past two years has
generally exceeded the anticipations reported in the quar­
terly surveys, the expectation of a substantial drop in the
accumulation rate in the fourth quarter may nevertheless
reflect a degree of caution in inventory policy. When
coupled with their sales forecasts, the durables producers’
inventory anticipations point to a modest decline in their
inventory-sales ratio by year-end.
PR O D U C T IO N , IN C O M E , A N D C O N S U M E R D E M A N D

Continued substantial growth of output in most indus­
trial categories carried the Federal Reserve’s production
index (seasonally adjusted) up by a further nine tenths
of a percentage point in August, to 158.3 per cent of the
1957-59 average. Automobile output registered a further
sharp decline in August, but overall production outside the
motor vehicle industry continued to expand at the sub­
stantial June-July pace. Once again, the strongest output
gains were centered in the equipment industries, reflecting
the sustained high rate of growth in demand for capital
goods as well as for military hardware. Production of in­
dustrial materials also grew appreciably in August, despite
a drop in steel output and a lack of buoyancy in construc­
tion materials output that apparently reflected the recent
decline in home building. With the exception of automo­
biles, production in consumer goods industries continued
to expand moderately in August.
Even after a seasonal adjustment that made a rough
allowance for the production slack during the annual
model changeover, automobile output declined in Au­
gust by a further 6 V2 per cent to a seasonally adjusted
annual rate of about IV4 million units. Temporary prob­
lems apparently hindered the start-up of new-model pro­
duction, with the result that the month’s assembly sched­
ules were not fulfilled. By early September, all assembly
plants were in full operation turning out the 1967 models
in preparation for their sales introduction at month end.
Though production continued to fall somewhat below
scheduled volume during the first half of the month, full
September output resulted in a substantial advance in the
seasonally adjusted assembly rate. A further rise is indi­
cated by October production schedules.
The weakening of auto production in the spring and

218

MONTHLY REVIEW, OCTOBER 1966

summer months had some dampening effect on activity in
the steel industry. Though other sources of steel demand
have reportedly shown steady strength, with growing de­
fense requirements apparently taking up some of the
auto slack, ingot production (seasonally adjusted) moved
gradually lower during the late spring and summer months.
In September, however, steel production registered a
slightly more-than-seasonal rise, amounting to a seasonally
adjusted gain of about IV2 per cent.
August witnessed a rather sharp drop in the volume of
new orders received by durables producers. Part of the
August decline apparently reflected the return, following a
sharp July spurt, to a more normal level of orders for
“miscellaneous transportation equipment” (which includes
such items as vessels and railroad equipment). Aircraft
orders, which are generally volatile, also dropped in Au­
gust. Outside the transportation equipment industries, a
reduced orders volume was also reported by producers of
steel and electrical equipment. On the other hand, there
was a sizable advance in the bookings of nonelectrical
machinery producers, whose operations are largely
oriented toward capital goods production. The August de­
cline in aggregate new orders for durables brought them
to a level not far above the volume of shipments. As a
result, the further rise in the overall backlog of unfilled
durables orders was relatively modest by comparison with
the very high rates of growth in the earlier months of the
year. Nevertheless, the backlog of durables orders at the
end of August was fully 25 per cent larger than it had
been a year earlier, and was equal to 3.2 months of ship­
ments, up from a figure of 2.7 months in August 1965.
Reflecting the persistent growth of output in the equip­
ment industries, the expansion of manufacturing employ­
ment in August was especially strong in those durables
industries oriented to production of capital goods and de­
fense equipment. In turn, the expansion of wage pay­
ments in those industries contributed substantially to the
August rise in total personal income. The overall income
advance was the largest of the year, owing to a sharp boost
provided by social security medical care payments. The
jump in these payments reflected the fact that August was
the first month in which Medicare payments were made
in any significant amount. Once the program has passed
through its initial months and is in full operation, such
payments can be generally expected to show only modest
changes from month to month. In contrast to the sharp
boost provided to income growth in August by the start
of sizable Medicare payments, income growth this year
had previously been dampened by rises in the level of
social security contributions—in January, when the con­




tributions tax rate was raised, and in July, when premium
payments for voluntary medical insurance were begun.
The recent uptrend in sales volume at retail stores
continued in August, as a strong advance carried that
month’s total past the record high established in
March. Sales at stores concentrating in nondurables,
which have moved steadily upward this year, registered
a sizable further advance in August with increases reported
in most lines of trade. A further recovery in automotive
dealers’ sales also contributed appreciably to the overall
gain, though such sales remained below the peak reached
prior to the April-May slump. Aggregate sales volume
at all other durables outlets was about unchanged in Au­
gust, and similarly remained below the early spring peak.
The sales performance of new domestically built cars
was quite strong in the closing months of the 1966 model
year, registering a seasonally adjusted annual rate of about
8V2 million units in August and close to 9 million in Sep­
tember. The largely successful closeout of the old models
provided a generally optimistic atmosphere for the intro­
duction of the new models in the final days of September.
Industry spokesmen reportedly look for sales of the 1967
models to be about equal to the 1966 model total of ap­
proximately SV2 million units, provided that orderly eco­
nomic expansion and a high degree of consumer confidence
are maintained. It is still too early to gauge the strength of
consumer response to the 1967 cars, however, and the
future trend of auto sales remains a major element of
uncertainty in the outlook for consumer spending.

M O N E Y , B A N K I N G , A N D C R E D I T IN
EASTERN EUROPE

The Federal Reserve Bank of New York has pub­
lished a new study of the credit and banking systems
of seven communist countries by George Garvy,
Economic Adviser. The 167-page book, “Money,
Banking, and Credit in Eastern Europe”, examines
the role of banking and credit policy in these coun­
tries and focuses on developments arising from the
recent changes in economic policy.
Copies are available from the Publications Sec­
tion, Federal Reserve Bank of New York, New
York, N.Y., 10045 at $1.25 each. Educational in­
stitutions may obtain quantities for classroom use at
65 cents per copy.

FEDERAL RESERVE BANK OF NEW YORK

219

The Money and Bond Markets in September
The improved atmosphere which had emerged in the
bond markets at the end of August generally persisted in
September. Although an undertone of considerable ner­
vousness reappeared several times during the month, it
ended on a strong note. In the early part of Sep­
tember, market participants were hopeful that bond yields
had reached their peaks in August, and that a period of
greater interest rate stability lay ahead for the capital mar­
kets. The resulting rally in bond prices fed on reports
that a move to raise Federal taxes and curtail the sale of
Government assets was in the wind. The bond markets
responded favorably when President Johnson, on Septem­
ber 8, announced a fiscal program to combat inflation and
alleviate some of the pressures which had recently beset
the credit markets.1 In the wake of the President’s state­
ment, the Treasury announced that certain types of Gov­
ernment agency financing would be curtailed over the
remainder of the year.
Subsequently, renewed uncertainties appeared in the
bond markets when participants began to feel that credit
demands would nevertheless remain heavy. A sharp rise in
Treasury bill rates during the first two thirds of the month
also had a restraining effect upon the bond markets. In the
last third of the month, however, these markets strength­
ened considerably. Among the factors contributing to the
improvement were the spreading view that further tax ac­
tion would be requested after the November elections and
that prospects for peace in Vietnam had improved. In addi­
tion, the much more relaxed tone which emerged in the
money market during this period strengthened dealers’
confidence in their ability to carry positions in Government
securities and other obligations.
The steep rise in Treasury bill rates during the early
part of September occurred in a highly nervous atmosphere.
Participants were quite concerned about the prospects for
a sharp expansion in direct Treasury borrowing in the bill
sector as a result of the curtailment of Government agency

i r The program is outlined in this Review (October 1966), page
215.




financing. In addition, the tight money market con­
ditions then prevailing stimulated both expanded com­
mercial bank bill sales and more aggressive professional
offerings, while dealers expected that substantial pressures
would beset the bill sector over the midmonth corporate tax
date. These pressures did not materialize, however, and the
tone of the bill market improved markedly in the last third
of the month when bills came under heavy demand from a
wide range of sources.
The money market was taut during the first half of
September. Most Federal funds trading occurred at rates
ranging from 5% per cent to 6 per cent, and the basic
reserve positions of banks in the leading money centers
moved into relatively deep deficits. A more comfortable
tone emerged after the September 15 corporate tax payment
date had passed without giving rise to any severe pressures
in the money market. During the rest of the month, Federal
funds traded mainly in a AV2 to 5% per cent range, and
average member bank borrowings from the Federal Re­
serve Banks declined. The reserve positions of banks in the
central money market improved in the final statement period
of September, while over the month as a whole these banks
were quite successful in replacing most of their maturing
time certificates of deposit.
T H E G O V E R N M E N T S E C U R IT IE S M A R K ET

As the month opened, participants in the market for
Treasury notes and bonds were optimistic about the pos­
sibility that the Administration might take fiscal action
to cope with inflation and moderate the upward spiral of
interest rates. Market attention was drawn particularly to
a Treasury officiars assertion that further economic re­
straint, if needed, would have to be applied by fiscal
rather than monetary means. The market also responded
favorably to the President’s Labor Day remarks which
suggested that nonessential Government spending and the
sale of Government agency obligations might soon be
curtailed. Thus, although an undertone of caution per­
sisted, prices of intermediate- and long-term issues gen­
erally climbed from % to IV2 points during the first week

220

MONTHLY REVIEW, OCTOBER 1966

SELECTED INTEREST RATES*
M O N E Y MARKET RATES

July

August

Ju ly -S e p t e m b e r 1 9 6 6

September

BO N D MARKET YIELDS

July

August

Per cent

September

N ote: D a ta are shown for bu siness d a y s only.
^ M O N E Y M A R K E T R AT ES Q U O T E D : D a ily ran g e of rates p osted b y m ajor N e w Y o rk City b an ks

point fro m 'u n d e rw ritin g syndica te reoffering yield on a g ive n issu e to m arket y ie ld on the

o n new call lo a n s (in Fed e ral funds) se cured by United States G o ve rn m e n t securities (a point

sa m e issue im m ediately after it h a s been re le ase d from syndicate restrictions); d a ily

indicate s the a b se n c e of a n y range); offering rates for directly placed finan ce c o m p a n y pap er;

a v e ra g e s o f y ie ld s on lo n g-term G o vernm ent securities (b o n d s d u e o r c a lla b le in ten y e a r s

the effective rate on Federal funds (the rate m ost representative of the transactions executed);

o r more) a n d of G ove rn m e n t securities due in three to five y e a r s , com puted on the b a s is o f

c lo sin g b id rates (quoted in terms of rate of discount) on new est ou tsta n d in g three- a n d six-m onth

c lo sin g bid prices; T h u rsd a y a v e ra g e s of yie ld s on twenty se a so n e d twenty-y e a r t ax-e xem pt

T re a su ry b ills.
B O N D M A R K ET Y IE LD S Q U O T E D : Y ie ld s on new A a a - a n d A a -ra te d p ublic utility b o n d s are plotted
a ro u n d a line sh ow ing d a ily a v e ra g e y ie ld s on se a so n e d A a a -ra t e d c o rporate b o n d s (arrow s

in September, and prices of shorter term obligations rose
from 2 2 to 2%2. (The right-hand panel of the chart illus­
/s
trates the decline in yields which accompanied this rise
in prices.)
The coupon sector responded favorably when, on Sep­
tember 8, President Johnson outlined his program to deal
with the problems of inflation and credit stringency. The
subsequent announcement that offerings of participation
certificates and Government agency obligations for the
purpose of raising new cash would be curtailed for the
remainder of the calendar year also initially buoyed senti­
ment in the market for Treasury notes and bonds. The
market buoyancy quickly subsided, however, when the
view spread that the Administration’s program, though a
move in the right direction, might not be sufficient to stem




b o n d s (carrying M o o d y ’s ratings of A a a , A a , A , a n d Baa).
So urces: Federal R eserve B a n k o f N e w Yo rk, B o a rd of G o v e rn o rs o f the F e d e ra l R eserve System ,
M o o d y ’s Investors Service, a n d The W e e k ly B ond Buyer.

the upward tide in interest rates. The coupon market was
also adversely affected by the weak tone in the Treasury
bill sector where participants were becoming increasingly
concerned that the available market supply of bills would
increase over the corporate tax date, and when the Trea­
sury filled its fall cash needs. In general, bond market par­
ticipants seemed to feel that bill yields could not continue
to rise without exerting upward pressures on longer term
interest rates as well. Investor selling of coupon issues
expanded reflecting some switching out of long-term Gov­
ernment securities into higher yielding corporate bonds,
and offerings of intermediate-term maturities by commer­
cial banks and savings institutions. Investment demand
was quite limited, and trading was dominated by profes­
sionals. Against this background, prices of Treasury notes

FEDERAL RESERVE BANK OF NEW YORK

221

atmosphere developed in the bill sector. Investor demand
remained quite light, and bill offerings from commercial
banks and other sources expanded sharply. Dealers be­
came more aggressive in their offerings, especially in
preparation for the pressures which they expected would
emerge in the bill market over the September corporate
dividend and tax payment period, and rates on most out­
standing bills rose sharply to record highs. At the regular
weekly auction on September 12, average issuing rates
on the new three- and six-month bills soared by 29 and
27 basis points, to 5.447 per cent and 5.926 per cent,
respectively (see Table III on page 222). At the next
weekly auction, rates rose by an additional 14 and 11
basis points, respectively, to 5.586 per cent for the new
three-month bill and 6.039 percent for the six-month issue.
The bill market weathered the midmonth tax date rather
easily when the anticipated severe pressures failed to de­
velop, and a somewhat steadier tone emerged over the
September 21 statement week. At the end of that period,
the Treasury announced that it would auction, on Sep­
tember 27, for payment on September 30, $900 million
of new Treasury bills maturing in September 1967, and
an additional $500 million of bills maturing in June 1967.
The proceeds of the joint sale were to be used to redeem
the $1.0 billion of one-year bills scheduled to mature on
September 30 and to raise $400 million in new cash. The
Treasury indicated that the sale marked the start of a
program to auction both nine- and twelve-month bills
2 On September 21, President Johnson signed into law a bill which each month. The bill market strengthened over the re­
provided regulatory agencies with increased power and flexibility
to establish ceiling rates on time deposits and savings accounts. mainder of the month. The demand for bills from com­
Acting under the new authority, the Federal Reserve Board, the mercial banks and other sources expanded sharply, and
Federal Deposit Insurance Corporation, and the Federal Home
Loan Bank Board announced a series of new interest rate ceilings this increase in investment demand generated a good deal
on time deposits and savings accounts, which generally went into of short covering. The more comfortable atmosphere in
effect on September 26. The maximum rate of interest which both
Federal Reserve member banks and nonmember banks insured by the money market during this period also had an affir­
the Federal Deposit Insurance Corporation may pay on any indi­ mative influence on the bill market. Against this back­
vidual time deposit of under $100,000 was reduced from 5Vi per
cent to 5 per cent. ( All other interest rate ceilings on savings and ground, bill rates generally declined from September 20
time deposits at insured commercial banks—including multiple through the end of the month. At the final regular weekly
maturity time deposits—remained unchanged.) The Federal Home
Loan Bank Board imposed rate ceilings on the deposits of all auction of the month on September 26, bill rates re­
member institutions of the Federal Home Loan Bank System, ceded from their peaks. The new three-month bill was
except those savings banks having deposits insured by, and there­ sold at an average rate of 5.503 per cent, and the sixfore subject to, the new 5 per cent rate ceiling imposed by
the Federal Deposit Insurance Corporation. Member institutions month issue was sold at an average rate of 5.804 per cent.
subject to the Federal Home Loan Bank Board regulations gen­ At the Treasury’s September 27 auction of new nine- and
erally may pay up to 43 per cent on passbook savings accounts
A
with the following exceptions: Those institutions now paying more twelve-month bills, average issuing rates were set at 5.807
than 43 per cent on such accounts may pay a return as high as, but per cent and 5.806 per cent, respectively.
A
not exceeding, 5 per cent. In addition, institutions in Alaska, Cali­
In the market for United States Government agency
fornia, and Nevada may pay rates as high as 5lA per cent on pass­
book savings accounts. For member institutions paying no more obligations, attention focused early in the month on re­
than 43 per cent on passbook accounts, the Board imposed a limit
A
of 5lA per cent on certificate accounts carried for at least six months. ports that a large expected September offering of par­
However, institutions paying more than 43 per cent on passbook ticipation certificates by the Federal National Mortgage
A
accounts will not be permitted to pay more than 5 per cent on
savings certificates, with one exception: Institutions in Alaska, Cali­ Association might not, in fact, materialize. Prices of out­
fornia, and Nevada will be allowed to renew existing certificate standing agency issues moved higher in anticipation of
accounts at rates up to 53 per cent if these funds were received
A
the conjectured cancellation. On September 8, the Federal
before September 22, 1966.
and bonds moved irregularly lower from September 12
through September 19.
Subsequently, the coupon sector responded favorably to
renewed discussion of a possible income tax increase, to
preliminary proposals by the President calling for the sale
of new Treasury savings notes, to the imposition of new
interest rate ceilings on consumer-type time deposits,2 and
to reports of peace moves in Vietnam. The market for
Treasury notes and bonds was also encouraged by the
better tone emerging in the Treasury bill market. Against
this background, prices of coupon issues rebounded dur­
ing the last third of the month, in response to good in­
vestor and dealer demand.
In the Treasury bill market, the cautious tone which
had been evident through most of August deepened dur­
ing the first half of September. The bill sector generally
welcomed the Administration’s program to combat infla­
tion. However, the subsequent announcement that agency
new cash financing in the open market would be curtailed
for the remainder of the calendar year gave rise to con­
siderable apprehension that this action would necessitate
an increase in the Treasury’s direct financing in the bill
market. Largely in reflection of this apprehension and of
the very firm tone of the money market, a very heavy




MONTHLY REVIEW, OCTOBER 1966

222
Table I

Table n

FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES* SEPTEMBER 1966

RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS
SEPTEMBER 1966

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

In millions of dollars

Sept.
28*

Average
of four
weeks
ended
Sept.
28*

29
161

41
113

— 66
1,121
1,187

224
1,195
971

Daily averages—week ended
Factors affecting
basic reserve positions

Changes in daily averages—
week ended
Net
changes

Factors
Sept.

Sept.

Sept.

14

21

28

Member bank required reserves* . . . . . . .
Operating transactions (subtotal) . . . . . .

— 41
— 379
— 21

Treasury operations-}- .............................

H- 124
+ 11
— 559

— 385
4 -4 1 6
4 - 160
4 - 184
+
2
4 - 33

457
4-1,054
+ 571
+ 205
4
—
+ 212

- f 88
— 462
— 288
— 406
— 10
4 -2 9 1

Sept.
14

Sept
21

Sept.

7

Sept.
7

Eight banks In New York City

“ Market” factors

Currency outside banks* ................
Other Federal Reserve

-}- 68
Total “ market” f a c t o r s ......... ............

-j- 53

+

72

— 420

4-

+

597

31

— 795
4 -6 2 9
4 -4 2 2
- f 87
—
1
— 23

48

+ 145

— 374

— 166

—

Direct Federal Reserve credit
transactions
Open market instrum ents
Outright holdings:
Government securities ....................
Repurchase agreements:
Government securities ..........................

4 - 380
__

_

—
—

82
2

+

370
2

Member bank b o r r o w in g s.................... ........
Other loans, discounts, and ad v a n ces.. .
Total

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

Excess reserves* ...................................................

4 - 41
_

4 - 58

4 - 139

__ 117

4-

3

+

6

4 - 438

4 - io o

-

+

4 - 131

+

—
—

—

18

32
2

_

41

—

!
20
90
Reserve excess or deficiency(—)t
26
Less borrowings from Reserve Banks
111
159
21
Less net interbank Federal funds
29
431
purchases or sales(—) ...................... .
502
Gross purchases ................................ 1,028
1,239 1,392
Gross sales ........................................
999
737
961
Equals net basic reserve surplus
or deficit (—) .............................. ........... - 31 - 523 - 5 6 5
Net loans to Government
380
448
481
securities dealers ......................... ........

— 104
—
2

_
1

—
— 41
4 - io

521

— 154

— 137

76

— 528

-

66

-2 9 6

359

417

Thirty-eight banks outside New York City
7
Reserve excess or deficiency(—) t ......
36
86
12
35
Less borrowings from Reserve Banks.
198
284
156
13?.
193
Less net interbank Federal funds
789
979 1,031
1,034
purchases or sales(—) ..........................
958
1,817
1,695 1,928 1,976
1,854
Gross purchases ...............................
942
1,028
716
897
896
Gross sa le s.............................. ........ .
Equals net basic reserve surplus
~ 950 —1,177 -1 ,1 7 4 -1 ,1 6 0 —1,115
or deficit(—) ................................... .
Net loans to Government
250
207
298
182
securities dealers .............................. .
234

— 303

—

— 121
+

Note: Because of rounding, figures do not necessarily add to totals.
* Estimated reserve figures have not been adjusted for so-called “ as of** debits
and credits. These items are taken into account in final data,
t Reserves held after all adjustments applicable to the reporting period less
required reserves and carry-over reserve deficiencies.

Daily average levels

Table III
AVERAGE ISSUING RATES*
AT REGULAR TREASURY BILL AUCTIONS
Member ban k :

Total reserves, including vault c a s h * ....

22,700
22,323
377
749
— 372
21,951

23,216
22,708
508
888
— 380
22,328

23,749
23,165
584
771
— 187
22,978

In per cent

23,133
23,077
56
650
— 594

7655
— 383§

22,483

22,4355

23,200§
22,818§
381§

Weekly auction dates—September 1966

Changes in Wednesday levels

Sept,
2
Three-month .................................

Sept.
12

Sept.
19

5.155

5.447

5.586

5.503

5.657

Nonborrowed reserves* .................................

5.926

6.039

5.804

Sept.
26

Monthly auction dates—July-September 1966

System A ccou n t holdings of Government
securities maturing in :

Less than one year ....................................

July
26

More than one y e a r .............................
Total

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

September
27

4.964

5.844

5.807
5.806

- f 473

N o te: Because of rounding, figures do not necessarily add to totals.
* These figures are estimated,
t Includes changes in Treasury currency and cash.
X Includes assets denominated in foreign currencies.
5 Average for four weeks ended September 28.




August
25

Nine-month
One-year ....

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

FEDERAL RESERVE BANK OF NEW YORK

Land Banks floated a $302 million offering of ten-month
bonds, refunding $219 million of maturing obligations
and raising $83 million in new money through direct sales
to Treasury trust accounts. The bonds, which were re­
offered at par and carried a 6.05 per cent coupon, were
accorded an excellent investor reception.
The September 10 announcement that the anticipated
September offering of participation certificates would not
be forthcoming, and that no additional new money would be
raised through the sale of Government agency obligations
in the open market during the remainder of 1966, further
bolstered the intermediate- and long-term maturity areas
of the agency sector. However, the short-term maturity
area remained quite sensitive to movements in Treasury
bill rates, reflecting the very narrow yield spreads between
bills and agency issues. On September 15, the Federal
Home Loan Banks offered $650 million of 6.25 per cent
one-year bonds replacing a $500 million maturity with
$400 million offered to the public and $250 million
placed directly with Treasury trust accounts. The bonds
were priced to yield 6.20 per cent and were accorded a
fairly good reception. Jn the later part of September,
prices of outstanding agency issues generally rose through­
out the maturity spectrum, and refinancing issues were
well received.

223

tories to $242 million on September 9, the lowest level
in over six years. Beginning around midmonth and for
some time afterward, prices of corporate and tax-exempt
bonds generally receded somewhat in response to many
of the same factors restraining the Government bond
market. Subsequently, however, a better tone also reap­
peared in the corporate and tax-exempt sectors and prices
rebounded again over the remainder of the month.
During the month as a whole, the average yield on
Moody’s seasoned Aaa-rated corporate bonds rose by 1
basis point to 5.45 per cent, while The Weekly Bond
Buyer's series for twenty seasoned tax-exempt issues (car­
rying ratings ranging from Aaa to Baa) fell by 21 basis
points to 4.03 per cent (see the right-hand panel of the
chart). These indexes are, however, based on only a lim­
ited number of seasoned issues and do not necessarily
reflect market movements fully, particularly in the case of
new and recent issues.
THE MONEY M ARKET AND BANK RESERVES

The money market was quite taut in the first half of
September, but a more comfortable atmosphere developed
later in the month. Market conditions varied considerably
from day to day in response to changes in aggregate
nationwide reserve availability (see Table I), shifting pat­
terns of reserve distribution within the banking system,
O TH E R SE C U R IT IE S M A R K E T S
and the willingness of individual banks to bid aggressively
In the markets for corporate and tax-exempt bonds, the for Federal funds.
atmosphere continued to improve during the early part of
The reserve positions of commercial banks in the lead­
September. Investor demand expanded considerably and ing money centers deteriorated substantially over the first
prices of many issues moved higher in moderately ac­ half of the month (see Table II). The worsening basic
tive trading. In the corporate sector, gains following the reserve positions of city banks partly reflected the rather
disclosure of the Administration’s plan for combating in­ large Treasury Tax and Loan Account withdrawals early
flation boosted prices of many recent offerings from four in the month, the heavy volume of negotiable certificates
to six points above either their recent low points or their of deposit reaching maturity, and the increase in reserve
original reoffering levels. At the same time, new corporate requirements against certain time deposits which began to
offerings—a considerable portion of which were convert­ go into effect on September 8. As banks sought funds to
ible bond issues—generally drew good investor receptions. fill their substantial reserve needs, they bid strongly for
The Federal Reserve System’s September 1 policy state­ Federal funds which traded predominately in a 5% to 6
ment3 also had an affirmative effect on bond market per cent rate range during the first half of the month. For
sentiment, especially in the tax-exempt sector. Net price the first time some trading also took place at a 6lA per
gains of as much as four points were recorded by tax- cent rate, 1% percentage points above the Federal Re­
exempt bonds during the three weeks ended September 14. serve discount rate. In addition, the banks turned to the
The surge in demand for state and local issues during this “discount window” to fill their residual reserve needs.
period reduced the Blue List of advertised dealer inven- Rates posted by the major New York City banks on call
loans to Government securities dealers generally remained
in a high
per cent to 6% per cent range, thus con­
tributing to the stresses evident in the Treasury bill market
where yields were rising sharply.
8 For details of the statement, see this Review (September 1966),
A somewhat more comfortable tone emerged after the
page 209.




224

MONTHLY REVIEW, OCTOBER 1966

midmonth corporate tax date passed without giving rise
to any real stress in the money market. Federal funds
traded mainly in a 4 Vi to 53 per cent range in the second
A
half of the month, rates on bank call loans to Government
securities dealers eased somewhat and were generally
quoted in a 5Vi to 6 V2 per cent range, while member
bank borrowings at the Federal Reserve discount window
contracted. The loan expansion over the tax date was of
relatively moderate proportions, while banks in the cen­
tral New York City money market replaced a larger
portion of their maturing certificates of deposit than had
generally been anticipated, although mainly with very
short maturities.
Approximately $5.3 billion of certificates of deposit
outstanding at all reporting banks—or about one third




of the total of such certificates outstanding—matured in
September. Roughly, $1.2 billion of the total amount ma­
turing fell due on September 15, the corporate tax date.
About one half of the nationwide maturities over the
month as a whole, and over the tax date as well, was out­
standing at the New York City reporting banks. The New
York banks managed to roll over approximately three
fourths of their maturing certificates in the four weeks
ended September 28, partly reflecting the temporary in­
vestment in time certificates of funds involved in a merger
financing. However, an increasing proportion of the newly
issued certificates was placed at the short end of the ma­
turity scale. During the month, banks continued to pay
the 5 V2 per cent ceiling rate on all maturities of new
negotiable time certificates of deposit of $100,000 or more.

FEDERAL RESERVE BANK OF NEW YORK

225

Recent Developments in International Capital Markets*
Developments in international capital markets during the European market in foreign securities has derived from
last year have been dominated by the appearance on the United States measures to reduce capital outflows, it seems
European market of a new group of borrowers, the inter­ likely that many of the institutional and distributional
national affiliates of United States companies.1 These bor­ changes that have accompanied this expansion will survive
rowers have been led to issue securities in Europe on a the eventual elimination of capital outflow restrictions in
large scale by the United States balance-of-payments pro­ the United States. If this is the case, the market for for­
gram. As a result, the combined volume of international eign issues should be broader and more competitive, which
security issues2 in the United States and Europe, which will be to the advantage of both international borrowers
had been increasing at the rate of about $300 million a and lenders.
year since 1962 and amounted to $2.6 billion in 1965,
totaled more than $2 billion in the first half of 1966 alone.
C U R R E N C IE S O F ISS U E
The new American borrowers have increased the rela­
All of the growth in international security issues over
tive importance of international security issues in Europe.
This growth has been confined to issues denominated in the past three years has been due to an expansion of
dollars, German marks, and units-of-account which gen­ offerings in Europe.8 As shown in Table I, the volume
erally stand outside of national controls over security of foreign securities issued in New York has declined
issues. Increasing underwriting opportunities have attracted slightly since 1963. Consequently, the proportion of issues
investment bankers from the United States, Italy, and distributed in Europe—although not necessarily to Euro­
Switzerland, who have entered into competition with peans—has risen from 28 per cent of all international
bankers from the United Kingdom and several Common security issues in 1963, to 49 per cent in 1965, and to 62
Market countries already active in the European new- per cent in the twelve months ended in June 1966. All
issue field. In their efforts to tap broader sources of funds, of the growth in foreign issues in Europe, both in absolute
the borrowers have shown considerable initiative in adapt­ and relative terms, has been accounted for by the expan­
ing the type and terms of securities issued to market de­ sion of issues denominated in dollars, German marks,
mands. The rapidly expanding volume of dollar and and units-of-account.4 As noted above, these issues, un­
German mark issues in Europe has also led to a steeper like other international offerings, are not subject to the
rise in interest rates for these issues than the already strict issue controls which apply to local currency issues in
substantial increases in most other long-term bond rates most European markets.
in Europe and in the United States. Both higher interest
Although all European countries exercise fairly close
rates and the broader range of securities offered have control over issues denominated in their national currencies,
stimulated the interest of many European investors.
foreign currency issues are largely exempt from similar
While much of the impetus for the expansion of the controls. In the case of Germany, controls apply to Ger-

* Dorothy Christelow, Economist, Foreign Research Division,
had primary responsibility for the preparation of this article.
1 The affiliates of United States companies floating securities in
Europe are usually incorporated in Luxembourg or Delaware.
2 The term “international security issues” is used in this article
to describe all issues floated outside the country of residence of the
borrower.




3 The data cited in this article are derived from a variety of
published sources and refer to both public issues and private
placements. While these data are incomplete in some respects, they
are probably not misleading.
4 For a discussion of the development of these issues, see “Re­
cent Innovations in European Capital Markets”, this Review (Jan­
uary 1965), pages 9-15.

226

MONTHLY REVIEW, OCTOBER 1966

man mark issues by German residents but they do not
apply to German mark issues by foreign borrowers.
Purchases of international securities by European finan­
cial institutions are, however, restricted to some degree. In
some countries government institutions play a large role in
collecting savings and generally confine their investments to
national undertakings. Regulations governing the opera­
tions of private financial institutions sometimes limit hold­
ings of foreign securities. On the other hand, security pur­
chases by individuals are formally subject only to foreign
exchange regulations, which are negligible in many cases.
Britain guards against capital outflows on security account
by requiring that foreign security purchases be financed
with the proceeds of foreign security sales. However, in the
Common Market countries, Switzerland, and Austria, for­
eign security purchases may generally be made freely. Thus,
in spite of institutional limitations, securities denominated
in dollars, German marks, and units-of-account, issued
without important restrictions by any national authority,
achieve a wide distribution among the European and other
clients of European bankers. In this way, large and wellknown borrowers can draw European and other funds
from the capital markets of Europe even though they might
not be permitted to borrow in the national currency of the
country from which the funds are drawn.
Foreign security offerings in the currencies of those

Table I
INTERNATIONAL SECURITY ISSUES
BY CURRENCY OF ISSUE
In millions of dollars equivalent

1
Currency

1963

1964

1965

1965

1966

BORROW ERS
First
half

Second
half

First
half

815

Dollars (distributed
in New Y o rk )...

1,441

1,150

1,312

766

546

Dollars (distributed
in Europe)............

119

609

622

210

412

804

German m arks......

40

236

320

168

152

245

Sterling/
German mark ....

_

11

64

50

Units-of-account ....

48

10

—

—

—

50

Swiss francs.............

135

96

87

46

41

55

8

78

22

56

130

18

9

9

Dutch guilders........

—

Sterling* ................

164

24

14

24

|

20

—

107

Italian lire........

24

Other ........................

39

28

61

23

38

45

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

2,010

2,278

2,586

1,294

1,292

2,141

* Net of redemptions.




—

European countries applying strict national issue controls
have, since 1963, remained below the $300 million to $600
million levels registered in the preceding five years. Flota­
tions in Swiss francs, Dutch guilders, sterling, and Italian
lire have nevertheless been significant at one time or
another during the later period (see Table I). Changes in
the relative importance of foreign issues in the controlled
national European markets have for the most part reflected
the receptiveness of the authorities to such issues, which
has generally depended on domestic capital market condi­
tions and the balance-of-payments position of the country
in question. Thus, the Dutch market was practically closed
to foreign borrowers in 1963-64, while foreign issues in the
Italian market have expanded recently as Italy’s balance of
payments has moved into a strong surplus.
Despite the growth of Europe as a distribution center
for international issues, the dollar remains unchallenged as
the principal currency of issue. In 1965, approximately three
fourths of all international security issues were denomi­
nated in United States dollars and this proportion appears
to have changed little so far in 1966. The continued
dominance of dollar issues in international markets is due
to a number of factors. First, dollar issues in New York,
while a smaller proportion of the total than in 1963 and
before, remain a major segment of the market. Second,
the affiliates of American companies have borrowed largely
through dollar issues, although they have borrowed in
other currencies as well. But dollar issues are also favored
where neither American borrowers nor American lenders
are involved owing to the relative freedom of such issues
from European issue controls and—the most important
consideration of all—the dollar’s advantages as an interna­
tional medium of exchange.

—

The rising importance of Europe as a market for inter­
national securities is principally due to the migration to
that market of borrowers affected by the United States in­
terest equalization tax (IET), and the appearance of the
international affiliates of American companies in the
European markets. The IET in effect raised by 1 percent­
age point the interest cost of security flotations in the
United States for residents of developed and certain other
countries. Most of the major borrowers affected by the
IET—i.e., those from the European Economic Community
(EEC), the United Kingdom, the Scandinavian countries,
Australia, New Zealand, South Africa, and Japan—shifted
their borrowing from New York to Europe after the tax
was proposed in 1963 (see Table II). Scandinavian bor­
rowing in Europe was particularly heavy in 1964 and 1965.

FEDERAL RESERVE BANK OF NEW YORK
Table II
INTERNATIONAL SECURITY ISSUES
BY BORROWER AND BY MARKET
In millions of dollars equivalent
1965
Borrower
Market

1963

1964

1965

1966

First
half

Second
half

First
half

351
351

119
119

232
232

353
353

27
27

80
41
121

—

By borrowers affected by BET
EEC countries, (including EEC
organizations)

60
230
290

14
270
284

Europe .........................................
Total ................................ .............

155
16
171

7
7

80
68
148

Scandinavia (excluding Finland)
New York .....................................
Europe ...........................................
Total ................................. .......... -

114
68
182

255
255

206
206

130
130

76
76

78
78

10
30
40

5
60
65

20
45
65

20
21
41

24
24

27
27

Europe ............................... ..........
Total ..............................................

200
59
259

216
216

62
25
87

42
25
67

20

—

20

—

Australia and New Zealand
New York ....................................
Europe ................................ .
........
Total ..............................................

30
90
120

35
35

83
83

25
25

28
40
58
58 _ 68_
_

United States international affiliates
New York ............................. ......
Europe ................................ ........
Total ..............................................

—

—

—

—

334
334

28
28

306
306

649
649

ADI borrowers affected by IET
New York ................................. .
Europe
..........................................
Total ..............................................

569
493
1,062

26
836
862

162
1,112
1,274

62
375
437

100
737
837

28
1,147
1,175

699
46
745

Total

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

United Kingdom

Rest of Europe
New York ....................................
Total ..............................................
Japan

__

By borrowers not affected by IET
Canada
New York ....................................
Europe ..........................................
Total ........................................... .
Latin America and Western
Hemisphere
New York ................................
Europe ..........................................
Total ..............................................
International organizations
New York .....................................
Europe ..........................................
Total ............................................ .
Other
New York ................... ......... .
Europe ..........................................
Total ......................................... .
All borrowers not affected by BET
New York ................................... .
Europe ...........................................
Total ..............................................

734

725

734

339

395

734

725

734

339

395

54

250

60

52

8

54

250

60

52

8

5
137
142

200
107
307

181
107
288

19

—

19

89
89

84
76
160

142
157
299

156
55
211

132
46
178

24
9
33

37
18
55

1,722 1,150
294
162
1,416 1,312

704
153
857

446
9
455

787
179
966

766
528
1,294

546
746
1,292

815
1,326
2,141

—

872
76
948

51
26
77

All international security Issues
New York .................................. . 1,441
Europe ..................................... .
569
Total .............................................. 2,010




1,148 1,312
1,130 1,274
2,278 2,586

227

In 1965 Japanese borrowers returned to the New York
market after special provision was made whereby $100
million of Japanese government and government-guaranteed
bonds would be exempted each year from the provisions
of the IET. Since 1963, British borrowers have distributed
their new issues almost evenly between the two markets.
Borrowing abroad by residents of the EEC countries—
Belgium, France, Italy, Germany, Luxembourg, and the
Netherlands—has been largely concentrated in Europe
both before and after the introduction of the IET.
A new group adding its demands to the European
market, and also largely covered by the IET, has been
the international affiliates of American companies. Their
issues, amounting to $955 million in the twelve months
ended in June 1966, are almost entirely responsible for
the increase in total international security issues since mid1965. Guidelines issued in February 1965 by the United
States Department of Commerce to 500 corporations oper­
ating in industrialized foreign countries, requested these
firms to help improve the United States balance of pay­
ments. Further guidelines, issued in December 1965,
doubled the number of participating companies, expanded
the overseas areas covered to include the Middle Eastern
oil countries, and emphasized direct investment outflows
from the United States. Participating companies were re­
quested to plan their 1966 foreign investment program in
such a way that the 1965-66 average annual direct invest­
ment flows of funds from the United States to the coun­
tries specified, plus undistributed profits of affiliates in
those same countries, would amount to no more than 90
per cent of the sum total of the two items during the threeyear period of 1962-64.
In view of the fact that direct investment in 1965 was
already higher than in the base period and was expected
to rise further in 1966, the firms concerned were thus
encouraged to borrow abroad the funds needed to
finance foreign investments. It should perhaps be noted
that financing abroad is by no means new for for­
eign affiliates of United States firms; in fact such financing
amounted to $2.7 billion in 1964, much in the form of
bank loans and trade credits. But reliance on public se­
curity issues was insignificant until mid-1965, when these
were undertaken on a large scale in order to reduce direct
investment flows from the United States. All in all, security
flotations in the European market by borrowers affected
by the IET and the United States guidelines on direct in­
vestment outflows totaled $493 million in 1963, $836
million in 1964, $1,112 million in 1965, and $1,147 mil­
lion in the first half of 1966.
Other borrowers, not affected by the IET or the direct
investment guidelines, have also turned to the European

228

MONTHLY REVIEW, OCTOBER 1966

markets. International organizations, particularly the In­
ternational Bank for Reconstruction and Development
and the Inter-American Development Bank, borrowed
more than $100 million in 1964 and again in 1965. In
addition, borrowers from Finland, Mexico, Jamaica,
Canada, and other countries have on the average bor­
rowed about another $90 million a year in Europe from
1964 to mid-1966.
As for the American market, Canadian borrowers con­
tinued to take about $735 million each year during 196365. In addition, the borrowers deflected from New York
by the IET have to a large extent been replaced by a
varying group of borrowers from nations not covered by
the IET, including Latin American countries, the Philip­
pines, and Finland.

funds have led to modification in the type and maturity of
international securities offered in Europe. Since the be­
ginning of 1966, American borrowers have relied heavily
on convertible bonds, with about 60 per cent of the se­
curities floated by affiliates of American companies offer­
ing convertibility into the shares of the parent corporation.
Mexican, Italian, and British companies have recently
made or are making similar offerings. When the supplies
of longer term funds have temporarily dried up, or when
such funds have become available only at very high rates
of interest, borrowers have turned to issues of five years
or less to maturity. About one third of the non-United
States security issues placed in Europe so far in 1966 have
been of this relatively short-term type. Since May, the
affiliates of United States companies have also issued $100
million of such obligations.

R E C E N T M A R K E T D E V E L O P M E N T S IN E U R O P E

With one new group of borrowers following fast on the
heels of another, the market in Europe has at times be­
come congested, and planned issues have had to be re­
duced in size or postponed. Most recently, foreign affiliates
of some of the less widely known American firms have
had to forego proposed European issues. In other in­
stances, however, reduction or elimination of borrowing
by residents of some countries has been related partly
or entirely to other factors. In 1964 Japanese industrial
borrowers in Europe reduced their borrowing plans when
the convertible securities which they had issued became
depressed in response to security market conditions in
Tokyo. This year Japanese borrowers have moderated
their borrowing as credit conditions in Japan have eased.
In Denmark, the inflationary impact of heavy borrowing
abroad by local governments and utility companies in
1964 led the authorities to call a temporary halt to such
borrowing.
For borrowers remaining in the international securities
market, interest rates have climbed sharply since the en­
trance of American borrowers in 1965. For example, the
average yield on four long-term Scandinavian dollar bonds
quoted in London—which is roughly representative of
trends in yields on European dollar issues—rose from
5.53 per cent in February 1965 to 6.81 per cent in August
1966, as the prices of these securities dropped by nearly
20 per cent. This 1.28 percentage point rise in yields was
markedly steeper than the 0.64 percentage point rise in the
average yield on United States Government bonds or the
0.82 percentage point rise in the average yield on govern­
ment bonds in the Common Market countries and Switzer­
land during the same period.
Rising interest rates and the search for new sources of




SOURCES OF FUNDS

There is very little reliable information regarding the
sources of funds flowing into the international security
markets. In the United States market, the percentage of
total foreign issues purchased by Americans has increased
from 86 per cent in 1962 to 92 per cent in the first half
of 1966. The decline in foreign participation in foreign
issues floated in New York may reflect the fact that dollar
bonds have been issued in Europe at higher interest rates
than on comparable instruments in the United States.
Similarly, foreign securities issued in Switzerland, and
denominated in Swiss francs, have probably been taken
up primarily by Swiss residents because their yields are
competitive with domestic issues in this market but not
competitive with yields on European dollar bonds. But
little can be said about the sources of funds used to pur­
chase dollar, unit-of-account, and German mark issues in
Europe.
Balance-of-payments data for the United Kingdom and
the Common Market countries show substantial purchases
of securities from foreigners, but these are slightly out­
weighed by sales of securities to foreigners. However,
sizable European and non-European purchases of interna­
tional securities are made through Swiss banks, which are
reported to have purchased for the account of their clients
as much as 50 per cent of many recent dollar issues. In the
absence of information on sources of capital channeled
through Switzerland, it is impossible to judge the extent to
which the European capital markets have served to export
European capital to the rest of the world and the extent to
which they have merely served as intermediaries between
non-European lenders and borrowers. At any rate, the
broader range of securities offered in late 1965 and 1966

FEDERAL RESERVE BANK OF NEW YORK

229

quired to pay a stamp tax of 1.2 per cent of the nominal
value of the issue, and a coupon tax, payable annually,
equal to 3 per cent of the interest paid on all securities
issued in Switzerland.
In 1965, however, provision was made for the elimina­
tion of the coupon tax effective January 1967, and a con­
U N D E R W R IT E R S
sortium of Swiss banks has recently been formed to par­
The adaptation of international security issues to ticipate in international underwriting syndicates. The Swiss
rapidly changing issue controls and financial requirements National Bank has agreed to a $10 million underwriting
has been greatly aided by the leadership exercised by a participation by the Swiss consortium in a $25 million
number of national groups of investment bankers. During issue, but reportedly on the condition that the issue not
1963 and 1964 bankers in Britain, Belgium, and Luxem­ be advertised in Switzerland and that 50 per cent of the
bourg took the lead in developing the market for European portion underwritten by Swiss banks be placed with for­
dollar and unit-of-account bonds. German banks actively eigners.
cultivated the market for foreign German mark issues and,
in 1965, sponsored one parallel loan—the simultaneous
C O N C L U D IN G R E M A R K S
offering in several European markets of local currency
International security issues are basically of two types:
tranches of one international loan. Prior to the passage
of the IET, United States investment bankers had for many those which are subject to the strict control of national
years placed with foreigners substantial portions of securi­ issue authorities and those which are largely free of such
ties issued in New York by European and British Com­ controls. Nearly all the major financial centers have felt
monwealth borrowers. With the large scale entry of United constrained to impose some degree of capital issue control,
States borrowers in mid-1965, the scope of American especially with regard to foreign issues in their national cur­
bankers’ European operations was greatly increased. Thus rencies. The largely control-free sector of the market, cen­
during the first six months of 1966, United States invest­ tered in issues denominated in dollars, German marks,
ment bankers participated in the underwriting of almost and units-of-account, constitutes both a safety valve and a
limited channel of communication between national capital
all dollar issues in Europe.
Italian banks are also achieving a more important posi­ markets. Given institutional restraints within each market,
tion in the underwriting of international issues thanks to the existence of this unrestricted market has not served to
the investment interest of their clients. Dutch and Swiss eliminate interest rate differences between national mar­
banks, which were predominant as underwriters in 1960-62 kets. But it has given large borrowers an alternative to their
when their governments permitted a larger volume of for­ domestic markets. This, combined with the already exist­
eign security issues, have played lesser roles since 1963. ing international mobility possessed by security purchasers,
The failure of Swiss bankers to assume the underwriting has served to reduce the barriers tending to isolate these
function on other than Swiss franc issues, in spite of large markets. Ideally, however, the relaxation of issue controls
purchases of many other issues by their clients, was in the major financial markets and the reduction of other
governed by the attitude of the Swiss authorities and by institutional barriers to international capital movements
certain tax disadvantages on foreign issues underwritten remain the best means to achieve an improved interna­
in Switzerland. Foreign borrowers in Switzerland were re­ tional distribution of capital resources.
is reported to have stimulated European interest, although
the recent drop in prices on outstanding international
securities may have dampened this interest in the last
few months.