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Treasury and Federal Reserve Foreign Exchange Operations’1
By C h a r l e s A. C o o m b s

In 1970, the official settlements balance of the United
States swung into a deficit of $10.7 billion from a surplus
of $2.7 billion in 1969. This deterioration was primarily
attributable to short-term capital outflows in response to
interest rate differentials. As United States money rates
and credit conditions progressively eased in 1970, Euro­
pean rates lagged well behind and short-term money
flowed in heavy volume from the United States to the
Euro-dollar market and on from there to the national
money markets and central bank reserves of Europe.
These outflows of dollars were naturally attracted to
the highest foreign bidders. Through most of the period,
German short-term rates exerted the strongest pull, with
the result that German banks and industrial firms in seek­
ing an escape from stringent credit conditions in Germany
borrowed well over $6 billion abroad in 1970, thereby
more than accounting for the $6.3 billion reserve gain
of the German Bundesbank. Other major recipients of the
overflow from the Euro-dollar market were the United
Kingdom, France, Italy, Belgium, the Netherlands, and
Financing by the United States of the unusually high
official settlements deficit in 1970 was facilitated by the
fact that a substantial part of dollar reserve gains abroad
favored those countries which were in the process of re-

* This report, covering the period March through September
1971, is the nineteenth in a series o f ‘reports by the Senior Vice
President in charge of the Foreign function of the Federal Reserve
Bank of New York and Special Manager, System Open Market
Account. The Bank acts as agent for both the Treasury and Federal
Reserve System in the conduct of foreign exchange operations.

building depleted dollar reserves or were content to
accumulate dollars in anticipation of scheduled debt re­
payments to United States agencies or to the International
Monetary Fund (IM F). As of the end of 1970, Federal
Reserve swap debt amounted to no more than $810 mil­
lion. Market confidence in the dollar was surprisingly well
Early in 1971, however, the international financial
markets began to sense an impending crisis of the dollar.
As interest rate differentials between the United States
and Europe widened out still further, outflows of short­
term funds to the European markets accelerated and forced
most European currencies hard against their ceilings. De­
spite Federal Reserve and Treasury efforts to slow down or
offset the repayment of United States bank debt to the
Euro-dollar market, $3.3 billion more of such debt was
repaid during the first quarter of 1971. Even more omi­
nous, the severe slump of the United States trade surplus
during late 1970 persisted into early 1971 and aroused
increasing apprehension of a loss of United States compet­
itive strength in world markets. As the weekly figures of
dollar reserve gains abroad confirmed the generalized
weakness of the dollar and the prospect that the United
States deficit was rising well above the abnormally high
level of 1970, overt speculation began to appear in the
exchange markets in March, further swelling the torrent
of dollars flowing to foreign markets.
Although the developing weakness of the dollar was
generalized across the European currency exchanges, the
German mark was particularly exposed to speculative
buying pressure in view of the continuing strength of Ger­
many’s trade surplus, a severely restrictive credit policy
which kept German interest rates well above international
levels, and the lack of restraints on German industrial


borrowing abroad. During the period February-April
1971, German corporate borrowing abroad amounted to
roughly $2.5 billion, nearly equivalent to total business
lending by the entire German banking system over the
same period. In February, the Bundesbank tried to squeeze
out the interest-arbitrage incentive to short-term capital
inflows by driving the forward mark to a sizable discount
through forward sales conducted through the agency of
the Federal Reserve Bank of New York. This experiment
proved excessively costly and was quickly abandoned. With
speculation beginning to appear in late March and early
April, the Bundesbank initiated a new program of forward
mark sales in Frankfurt, with the objective of reassuring
the market on the stability of the mark parity. This opera­
tion succeeded in temporarily restoring a fragile measure
of confidence, but the German government remained
confronted with the dilemma of how to make its re­
strictive credit policy effective while simultaneously allow­
ing its business corporations unfettered access to the
Euro-dollar market.
Early in May, a report by the main German economic
research institutes, recommending either a floating of the
mark rate or revaluation as the best solution to this and
other policy dilemmas, was greeted sympathetically by cer­
tain high-ranking German officials. The market seized on
this apparent shift of policy, and speculative funds flooded
into Germany. The Bundesbank was forced to buy dollars
in mounting volume, more than $1 billion on May 3-4 and
a further $1 billion in the first forty minutes of trading on
May 5, at which point it withdrew from the market.
To protect themselves against the backwash of the
German move, the central banks of the Netherlands,
Switzerland, Belgium, and Austria similarly terminated
official support of the dollar that same morning. Over
the weekend, the Swiss franc and the Austrian schilling
were revalued by 7.07 percent and 5.05 percent, respec­
tively, while the German mark and Dutch guilder were
allowed to float. The Belgian market was reopened on the
basis of the previous intervention limits, but with a further
separation between the official and financial franc markets.
The revaluations of the Swiss franc and Austrian schilling
did little, however, to bring about a spontaneous return
flow of speculative funds as the foreign exchange markets
remained highly nervous. In particular, the flotation of the
mark and guilder aroused widespread fears in the market
that other countries might take similar action. Furthermore,
as the mark and guilder floated upward (see Chart I),
they tended to become barometers of weakening confi­
dence in the dollar. Meanwhile, current statistics on the
performance of the United States economy failed to mea­
sure up to earlier hopes, and the foreign trade balance


slipped into a deepening deficit in April and subsequent
months. According to Department of Commerce figures,
the trade deficit for the second quarter was $1.0 billion,
while the overall United States payments deficit for the first
half of the year soared to $11.6 billion on an official settle­
ments basis. In July and early August, events moved in­
exorably toward their climax as speculative anticipations
reached throughout the full range of trade and investment
decisions in the market.
On Friday, August 6, a Congressional subcommittee re­
port asserted that the dollar had become overvalued and
called for corrective action through a general exchange rate
realignment. That same day, the United States Treasury
reported a loss of gold and other reserve assets totaling
more than $1 billion, mainly as a consequence of British
and French repayment of debt to the IMF. Over the fol­
lowing week, the flight from the dollar sharply accelerated
as $3.7 billion moved across the exchanges and into
central bank hands. On Sunday, August 15, President
Nixon announced a major new program of domestic and
international economic measures. Using powers avail­
able under the Economic Stabilization Act of 1970,
the President ordered a ninety-day freeze on wages and
prices and, in order to stimulate a more rapid expan­
sion of production and employment, recommended new
tax measures. With respect to international payments, the
President introduced a 10 percent temporary surcharge on
dutiable imports into the United States, and announced
a temporary suspension of convertibility of the dollar into
gold and other reserve assets.
The major European governments kept their exchange
markets closed all of the following week, as they sought
to develop some joint policy response to the United States
measures. These negotiating efforts failed, and on Mon­
day, August 23, European governments reopened their
exchange markets on an uncoordinated basis. While each
government continued to adhere to its pre-August 15
parity, all but the French government suspended their
commitments to defend the previous upper limits of their
exchange rates. Such continuing intervention by the Bank
of France was confined, however, to a segregated market
for commercial transactions, while all other transactions
were diverted to a financial franc market which was
allowed to find its own level. The Japanese government
initially sought to maintain the rate for the yen by con­
tinuing to intervene at the ceiling, but was swamped by
an inflow of dollars, which by the month end had swollen
official reserves by $4.4 billion. On August 28, official
intervention at the ceiling for the yen was suspended, and
the yen immediately rose 4.7 percent; in subsequent
weeks the yen moved gradually higher. By October 8, the



C hart I


S eptem ber 1970 to Septem ber 1971

N ote: A solid line indicates weekly averages of noon rates during periods when a foreign central bank was intervening w ithin the prescribed
limits. Rate movements in periods when a currency was allowed to float, or was effectively floating, are indicated as follow s:



rates of the major trading currencies of the world had
moved to the following percentage premiums over their
former official ceilings:1

Prem ium over ceiling

German mark ......................................................
Japanese yen ......................................................
Dutch guilder ......................................................
Canadian dollar
Belgian franc:
Financial ...........................................................
Sterling .................................................................
Italian lira .............................................................
Swiss franc ...........................................................
French franc:
Commercial ....................................................
Financial ...........................................................


The exchange rate structure thus emerging after Au­
gust 15 was, in most instances, the product of controlled
rather than free floating. Many central banks continued to
intervene on an ad hoc basis, while the market was fur­
ther strongly influenced by a wide variety of new exchange
controls, the United States import surcharge, and sharply
conflicting official appraisals of an appropriate realignment
of parities.
During the period under review, the Federal Reserve
made frequent and sizable drawings on several of the
swap lines in order to absorb temporarily foreign official
dollar gains that might otherwise have been converted
into gold or other reserve assets. (See Table I for the list­
ing of the swap arrangements and Table II for the swap
operations described in this report.) As of the beginning
of 1971, Federal Reserve debt under the swap lines
amounted to $810 million. Through August 13, new
drawings amounted to $3,565 million, while repayments
of $1,330 million were effected through Treasury sales
of gold and special drawing rights (SDRs), United States
borrowings from the IMF, Treasury issuance of foreign
currency securities, and use of foreign currency balances.

The residual swap debt commitments outstanding as of
August 13 thus amounted to $3,045 million. No further
drawings on the swap lines either by the Federal Reserve
or foreign central banks have been made since August 13.
As individual swap drawings have matured they have been
rolled over, except for a $35 million Belgian franc draw­
ing that was repaid in early October with francs purchased
in the market. Thus, as of October 14, $3,010 million of
swap debt remained outstanding. Most of this debt was
incurred to offset speculative flows of funds which in due
course will presumably reverse themselves and so permit
repayment of the swap debt outstanding.
Of the Federal Reserve’s total swap commitments,
$1.6 billion is outstanding under the Swiss franc swap
lines with the Swiss National Bank and the Bank for
International Settlements (BIS). As of the beginning of
1971, Federal Reserve swap debt to the Swiss National
Bank amounted to $300 million and rose further to $450
million on March 1. This debt was fully liquidated in
early March through a Treasury sale of gold and Swiss
franc securities to the Swiss National Bank, together with
an outright purchase of Swiss francs by the Federal Re-

Table I
October 14, 1971
In m illions of dollars

Amount of facility

A ustrian N ational Bank .........................................................


N ational B ank of Belgium





Bank of C anada .............

N ational Bank of D enm ark ...................................................
Bank of England
Bank of France






G erm an F ederal Bank .............................................................


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


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


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

1 The appreciation of floating currencies is measured throughout
this report as the percentage premium of the midpoint between bid
and offered rates over the former official ceiling, all in cents per unit
of foreign currency. Since the currencies concerned had been at, or
close to, the official upper intervention limits for some time before
being allowed to float, this is the most meaningful measure of the
actual appreciation of the rates. Many reports covering the recent
period have used the percentage premium over parity as the com­
mon point, and a reasonable approximation of that value can be
calculated by adding 0.75 percentage point to the premiums quoted
in this report. In the case of the Swiss franc, however, 1.8 per­
centage points should be added.


N etherlands Bank



Bank of N orw ay



Bank of Sweden


Swiss N ational Bank .



Bank for International Settlem ents:
Swiss francs-dollars .............................................................


O ther authorized E uropean curren cies-d o llars...........






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

System swap
outstanding on
January 1, 1971


N ational Bank of Belgium ..............................................................


System swap
outstanding on
October 14,1971



(+ 335.0
1 -1 2 5 .0

(+ 125.0
1 -2 0 5 .0



G erm an Federal B ank .......................................................................


N etherlands Bank ................................................................................


(+ 130.0
{ -3 0 0 .0


1 -4 5 0 .0


Bank for In ternational Settlem ents (Swiss francs) ................
B ank for In tern atio n al Settlem ents (Belgian francs) ..............

- 35.0


(+ 120.0
1 -2 5 0 .0

Swiss N ational B ank ..........................................................................



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


October 1-14

Total .



+ 60.0













serve from the Swiss National Bank. No further drawings
on the Swiss National Bank were made until May 17,
when the Federal Reserve made a $250 million equiv­
alent drawing in order to assist return flows to the New
York market of speculative funds that had moved into
Switzerland in anticipation of the revaluation of the Swiss
franc on May 9. During the first half of August, the
Swiss National Bank was forced to absorb a massive
inflow of dollars. In response to a Swiss request, the
Federal Reserve drew the remaining $350 million equiv­
alent available under the $600 million swap line with the
National Bank and, after that facility had been enlarged
to $1 billion on August 12, drew in full the additional
$400 million of Swiss francs thus provided. Furthermore,
the System drew the entire $600 million equivalent avail­
able under the Swiss franc-dollar swap line with the BIS,
thereby increasing System commitments in Swiss francs
to a total of $1.6 billion.
As of October 14, $600 million of Federal Reserve
drawings in Belgian francs remained outstanding on the
swap lines with the National Bank of Belgium and with
the BIS. Such swap debt stood at $355 million on Jan­
uary 27 but was reduced to $230 million on January
29 by a United States Treasury drawing of $125 million
of Belgian francs from the IMF. As Euro-dollar rates fell


1 -8 7 5 .0

(+ 555.0
1 -4 5 5 .0


- 35.0


sharply during the first quarter, an influx of short-term
funds into Belgium necessitated new Federal Reserve
drawings which rose to a total of $450 million equivalent
by early April. The speculative crisis culminating in the
floating of the mark in early May forced the Federal
Reserve to draw an additional $95 million on the Belgian
franc swap line, which was offset to the extent of $55
million by repayments financed by United States Trea­
sury sales of SDRs to the National Bank. On June 21,
the Belgian franc swap debt of the Federal Reserve was
reduced from $490 million to $340 million through a
United States Treasury drawing of $150 million of Bel­
gian francs from the IMF. Again in late July and August,
however, heavy speculative flows of funds into Belgium
necessitated $160 million of new drawings by the Federal
Reserve, thereby exhausting the $500 million line with
the National Bank. On August 12, the facility was en­
larged to $600 million and the additional $100 million
of Belgian francs thus made available was fully drawn.
Finally, on August 13, the Federal Reserve drew $35
million of Belgian francs from the BIS under the $1 bil­
lion reciprocal line which provides for swaps of dollars
against certain European currencies other than Swiss
francs. This drawing brought the Federal Reserve swap
commitments in Belgian francs to $635 million equiv­



alent. Then, in October, the Federal Reserve liquidated a
maturing swap drawing of $35 million by purchasing the
necessary francs in the exchange market, thereby reducing
the debt outstanding to $600 million.
As previously noted, the German Bundesbank ini­
tiated in early April 1971 a series of forward mark oper­
ations in an effort to strengthen market confidence in the
mark parity. The Federal Reserve Bank of New York,
dealing for System account, participated in these forward
mark sales to the extent of $75.7 million. Cover for these
Federal Reserve commitments to the market was provided
partly by balances on hand and partly by swap drawings
totaling $60 million equivalent on the Bundesbank. These
drawings remained outstanding as of October 14.
The remaining $750 million of Federal Reserve swap
debt is accounted for by a drawing in this amount on the
swap line with the Bank of England, executed on August
13. Here again, this swap debt remained outstanding as of
October 14.
Finally, the Federal Reserve was indebted as of the
beginning of 1971 to the full extent of the $300 million
available under the swap line with the Netherlands Bank.
During the first quarter of 1971, this $300 million of
Federal Reserve debt, plus another $25 million of sur­
plus dollars on the books of the Netherlands Bank, was
fully liquidated in a series of special transactions involv­
ing (1) a Federal Reserve sale of $75 million equivalent
of German mark balances to the Netherlands Bank, (2) a
United States Treasury sale of $25 million of gold and
$100 million of SDRs to the Dutch authorities, and (3) a
United States drawing of $125 million equivalent of
guilders from the IMF. Again in the late spring, how­
ever, the speculative crisis leading up to the floating of

the mark as well as other factors necessitated new Fed­
eral Reserve drawings on the Netherlands Bank in the
amount of $250 million equivalent. When the Dutch gov­
ernment allowed the guilder to float on May 10, the
Netherlands Bank, in accordance with prior understand­
ings governing the swap arrangement with the Federal
Reserve, immediately sold sufficient guilders to the Sys­
tem to enable it to liquidate the $250 million equivalent
swap commitment. This repayment procedure naturally
added to the uncovered dollars on the books of the Neth­
erlands Bank, and the United States Treasury subsequently
absorbed an equivalent amount of such dollars through a
$150 million sale of SDRs on May 21 and a drawing
of $100 million equivalent of guilders from the IMF on
June 21.
Despite such heavy swap drawings by the Federal Re­
serve during the period under review, the United States
stocks of gold and other reserve assets were severely eroded
by the flow of dollars into foreign central banks. From
January 1 through mid-August a total of $3.1 billion in
such assets was paid out, including $864 million of gold,
$394 million of foreign exchange, $480 million of SDRs,
and $1,362 million taken down against the United States
IMF position.
This substantial use of reserve assets was supplemented
by new issues of United States Treasury foreign-currencydenominated securities (see Table IV ). In March the
Treasury issued $249.7 million of Swiss-franc-denominated
certificates of indebtedness to the Swiss National Bank in
order to help repay System swap commitments of $450
million, and in August it issued a $333 million equivalent
note to that bank to cover the Swiss National Bank’s dol­
lar purchases of August 13. As of October 14, the total

Table in
In millions of dollars
Drawings ( + ) or repayments (—)
Banks drawino on
Federal Reserve System

Drawings on
Federal Reserve
System outstanding
on January 1, 1971

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

Drawings on
Federal Reserve
System outstanding
September 3 0,1971



t+ 21.0
t —21.0

f + 6.0
1 - 6.0


1+ 21.0

{ + 6.0
1 - 6.0






Table IV
In millions o f dollars equivalent
Issues ( + ) or redemptions (—)
outstanding on
January 1, 1971

Issued to

outstanding on
October 14,1971




G erm an F ederal B ank ..............................................................................



G erm an banks ..................




Swiss N ational Bank ...................................................................................


Bank fo r In tern atio n al Settlem ents* ..................................................


Total ....



J - 7 9 0 .5 t


f - 1 5 0 .0 t
+ 249.7

f —940.5f
I +989.31


+ 333.0


N ote: There were no issues or redem ptions during the period O ctober 1-14.
D iscrepancies in totals result from m inor valuation adjustm ents and from rounding.
* D enom inated in Swiss francs.
t Transactions related to activation by the Swiss N ational B ank of the revaluation clause covering all
outstanding Sw iss-franc-denom inated securities of the U nited States Treasury at the tim e of the
Swiss fran c ’s revaluation in May.

of such securities outstanding amounted to $2,006 million.
The Treasury’s only swap operation during the period
was under a special $100 million facility with the National
Bank of Belgium, entered into and drawn upon in full in
May and liquidated at maturity in early August.
As shown in Table III, drawings on the Federal Reserve
by its swap partners during the period were confined to
purely routine use by the BIS of one of its lines in con­
nection with overnight cash needs.

Inflationary trends in Germany, reflecting both demand
and wage-push pressures, have been a major concern of
the German government since early 1970. Although some
fiscal measures were introduced in the second half of
1970, the major burden of the anti-inflationary effort was
assumed by the monetary authorities, who used both in­
terest rates and reserve requirements to restrain monetary
and credit expansion. With domestic credit demand press­
ing against the restricted supply of domestic funds, Ger­
man banks began early in 1970 to repatriate foreign
balances and to borrow additional funds from abroad to
meet their customers’ needs. Starting in the spring of 1970
the German Bundesbank had moved to curb such inflows,

largely through marginal reserve requirements on the
growth of the banks’ foreign liabilities, and these measures
were strengthened over the course of the year. Full free­
dom remained available, however, for German business
corporations to borrow directly abroad, particularly in the
Euro-dollar market, to meet their credit needs. These in­
flows of short-term funds are estimated by the Bundes­
bank to have totaled some $6.6 billion for the year, more
than Germany’s reserve gain of $6.3 billion for that
In early 1971, the continuing decline in Euro-dollar
rates opened wider arbitrage incentives in favor of the
mark (see Chart II) and German corporations further
increased their heavy recourse to foreign financing. By late
January the Bundesbank was again absorbing substantial
amounts of dollars from the market. Toward the end of
February, the uncovered arbitrage incentives in favor of
Germany stood at around 2 percentage points on a threemonth comparison while the discount on the forward mark
was only about \V\ percent per annum. As an alternative
to cutting domestic interest rates, but still seeking to
close this differential, the Bundesbank in late February
asked the Federal Reserve Bank of New York to offer
three-month forward marks in the New York market for
the account of the Bundesbank. This operation had the



immediate effect of moving the spot mark rate away from
its ceiling and halting the spot inflow into German re­
serves, and within a few days the forward mark discount
widened to nearly 2 percent. In the meanwhile, however,
the underlying interest differential had also widened to
around 2 Vi percent, mainly owing to a further decline of
Euro-dollar rates, and it soon became clear that massive
sales by the Bundesbank would be required to maintain the
forward mark at a sufficient discount. Accordingly, the
operation was phased out by mid-March after $537
million of forward mark sales. As the spot rate moved
back to its ceiling, the Bundesbank was again forced
to take in dollars.
On March 31 the Bundesbank Council, in a longawaited move, cut the central bank’s discount and “Lom­
bard” rates by 1 full percentage point to 5 percent and
6 V2 percent, respectively, effective April 1. At the same
time, however, the Council reinforced credit restraint
by reducing the banks’ rediscount quotas by 10 percent.
With little easing of domestic liquidity conditions thus
in prospect, bidding for marks surged with strong spec­
ulative overtones. Within three days, the Bundesbank
took in more than $1.3 billion in holding the spot mark
at the ceiling and swapped some $600 million of this
inflow out in the market for three months’ delivery.
In this atmosphere of mounting apprehension, the
Bundesbank sought to reassure the market by initiat­
ing on April 2 a new series of forward operations, of­
fering three-month marks at the spot ceiling rate. The
Federal Reserve Bank of New York, dealing for System
account, joined in the operation by offering forward marks
at the same rate in New York after the Frankfurt market
had closed. This concerted intervention had a calming
effect on the market over the next few weeks, and the
spot rate for the mark soon moved away from the ceiling
as funds began to flow out of Germany on a covered basis.
The earlier influx had helped to produce ample liquidity
conditions in Germany and, with short-term money mar­
ket rates declining there while Euro-dollar yields were
now turning upward, near-term arbitrage incentives
shifted in favor of Euro-dollar placements. Underlying
market nervousness surfaced from time to time during the
month, however, and the Bundesbank and the Federal
Reserve continued the operation through most of April,
offering forward marks on the same basis and doing
business nearly every day. By late April, these forward
sales by the Bundesbank had reached $1.5 billion
equivalent, while those by the Federal Reserve amounted
to $75.7 million. Cover for these Federal Reserve com­
mitments to the market was provided partly by balances
on hand and partly by swap drawings totaling $60 million

equivalent on the Bundesbank. On April 28, the Bundes­
bank Council decided that the time had come to withdraw
its offer of forward marks at a fixed rate and to let the
forward rates reach their own level. The market, already
beset by rumors of a developing rift among European
Economic Community (EEC) nations following a meet­
ing of the Finance Ministers a few days earlier, reacted
sharply, and both spot and forward marks were heavily bid.
On April 30, German reserves stood at $16.7 billion,
representing a gain of nearly $3.0 billion for the first
four months of 1971, while the forward dollar contracts
of the Bundesbank had risen to $2.7 billion. Over the
same period, German corporations raised close to $4
billion abroad, representing roughly half of their total
credit needs.
On Monday, May 3, the main German economic re­
search institutes issued a report calling for a prompt
floating or revaluation of the mark. Sympathetic reactions
to this report by high-ranking German officials persuaded
the market that some such move would soon be forthcom­
ing. In holding the spot rate at the ceiling, the Bundes­
bank was accordingly flooded with offers of dollars
against marks. Over the two days May 3-4, the bank had
to absorb more than $1 billion, and on the morning of
Wednesday, May 5, a further $1 billion was taken in
within the first forty minutes of trading. At that point
the Bundesbank suspended its market operations. Al­
though German banks were legally free to continue to
deal if they wished, there was no official fixing and trading
virtually ceased in the Frankfurt market for the rest of the
week. The mark was still traded elsewhere during the three
days, however, and in New York the rate rose to around
$0.2800, or some 1.6 percent above the previous ceiling.
On Sunday, May 9, after an inconclusive meeting of
the EEC Finance Ministers, the German authorities an-

Chart II


Three-m onth m aturities; w eekly averages of daily rates






F ra n k fu rt In te rb a n k


E uro-dollars \






1 1 I






\ ~9





l V /



1 1


1 1 !





nounced that, as an anti-inflationary measure, the trading
limits for the mark would be suspended temporarily—
effectively allowing the mark rate to float— although
the official parity was to remain unchanged. It was also
announced that other measures to fight inflation were
being prepared; these included the reimposition of a ban
on interest payments on large deposits held by nonresi­
dents, the barring of foreigners from buying German
money market paper, and the freezing of some Federal
and state government spending. The Frankfurt market re­
opened on May 10 and the mark traded well above its
former ceiling, fluctuating sharply in response to both facts
and rumors. Traders generally doubted that the rate would
return to within its old limits, and the possibility was
widely discussed that the German authorities would begin
to sell dollars in the market at rates well above the former
official ceiling. By May 24 the spot mark had risen to a
premium of 3.7 percent above the previous ceiling but
then began to settle back, as rising Euro-dollar rates in­
creased the cost of holding speculative mark positions.
On June 1 the spot rate dropped sharply but, when the
mark weakened further on the morning of June 2 in
Frankfurt, the Bundesbank offered to sell dollars in small
amounts at the equivalent of about $0.2803. This led to
an abrupt reversal in the market, but the Bundesbank
nevertheless began to sell dollars the next morning. These
sales were not at fixed levels but on the basis of the most
acceptable rates to the Federal Bank at any given point
of time. The operation was pursued over the following
weeks, resulting in a progressive ratcheting upward of the
mark rate. By mid-June, the authorities had sold $1.7
billion, considerably more than they had taken in under
maturing forward contracts from the operations in
February-March, and the spot mark had advanced to a
3.6 percent premium over the former ceiling.
The heavy outflow of funds from Germany helped to
tighten domestic money market conditions considerably,
and this tightening was supported by other actions,
including a substantial increase in the banks’ minimum
reserve requirements. On June 2, requirements against
domestic liabilities were raised across the board by 15
percent, while the requirements against foreign liabilities
were lifted to twice the level of the new domestic rates.
With large tax payments reducing domestic liquidity fur­
ther, German interest rates advanced sharply, and by
late June, when the stringency had become acute, they
moved above Euro-dollar rates for comparable maturities,
maintaining a substantial edge through July. These arbi­
trage considerations, along with the continuing view in
the market that the prospects were still strong for an even
further rise in the mark rate, kept the rate buoyant, and

it sometimes moved above levels at which the Bundes­
bank was then willing to sell dollars. Beginning in midJuly, however, the Bundesbank progressively lowered
its selling rate for dollars and the mark rate spiraled up­
ward. Overall, from June 3 through the end of July, the
Bundesbank sold $4.8 billion in the spot market while it
took in a total of $2.7 billion through maturing forward
contracts. Thus, on balance, its reserves fell by some $2
billion to $17.0 billion at the end of July.
By late July the spot mark had leveled off again, to
around $0.2890, a 4.9 percent premium. But a new up­
surge in the rate developed in early August, when general­
ized speculation against the dollar developed in full force.
As the mark rose, the Bundesbank stopped offering dol­
lars. On August 12, with the market beset by rumors of
a new parity being set at even a higher level, the rate
jumped to a premium of 7.6 percent, and the Bundes­
bank stepped in on the other side of the market and pur­
chased a modest amount of dollars.
After President Nixon’s address on August 15, formal
exchange dealings were suspended in Germany through
the full week of August 16-20. During the week, consulta­
tions proceeded within the EEC countries as to the basis
under which the markets would be reopened. With no
agreement reached among the EEC members on a com­
mon exchange policy, the German government reopened
the market on August 23 with the mark rate floating as
before. With trading volume continuing at generally re­
duced levels, the mark rate fluctuated closely around a
premium of 7 percent until mid-September, after which
it rose sharply to as high as a 10 percent premium prior
to the IMF meeting. The Bundesbank then began to
intervene in both spot and forward markets to moderate
the rise in the rate. By early October the mark rate had
backed off somewhat to a premium of around 9.5 percent.

Sterling showed increasing strength as 1971 began, with
the spot rate moving in January from below parity to near
its $2.42 upper limit. Britain’s current-account balance of
payments was still in surplus, and seasonal factors are
favorable early in the year. The dominant source of
demand for sterling, however, was a growing inflow of
interest-sensitive funds, coupled with the pressures arising
from heavy tax payments against the background of a
severe credit squeeze and reduced corporate liquidity.
Domestically, economic activity had turned sluggish, but
at the same time the United Kingdom authorities were
faced with sharply rising wages and prices. To counter the
inflationary pressures, the authorities had been maintaining


Chart III

Three-m onth m aturities; weekly averages of d a ily rates


9 - E u ro-dollars







U nited K in g d o m
lo c a l au th o rity
/s /\
v \v








A /




/V ///

/ v«\

i i


v» *» A y






' Percent



iX . 5

a firm grip on domestic monetary conditions, and British
interest rates moved up in early 1971. At the same time,
interest rates elsewhere were declining, particularly in the
United States and in the Euro-dollar market. By late 1970,
Euro-dollar rates already had moved below rates on com­
parable sterling instruments, and the further decline in
early 1971 widened the gap even more (see Chart III).
In January, the British authorities moved to reduce the
resulting inflows of funds by modifying the exchange con­
trol regulations so as to restrain new foreign currency
borrowings by British corporations for domestic use.
Throughout the first quarter, with persistent rumors that
the Bank of England’s discount rate would be cut (it had
been held at 7 percent since April 1970), heavy demand
developed for British government securities, while sea­
sonal tax payments further absorbed liquidity. The inflows
from abroad continued and, with sterling holding near its
upper limit, the Bank of England took in a large volume
of dollars through February and March.
From the reserve gains in the first quarter, the United
Kingdom authorities were able to repay more than $1.6
billion of international credits, thereby fully liquidating
their indebtedness to all monetary institutions other than
the IMF. Among the repayments made during the quarter
were the remaining $226 million of credits under the 1966
Basle arrangement (of this, $76 million was shared equally
by the United States Treasury and the Federal Reserve)
and $99 million to the same United States agencies repre­
senting the last portion of sterling which had been held
on a covered or guaranteed basis. In addition, on March
31 the United Kingdom liquidated prior to maturity $685
million of its obligations to the IMF. Even after these very
large repayments, British official reserves rose during the
first quarter by $190 million, excluding the $299 million
allocation of SDRs and $500 million that was transferred


into later months through special arrangements.
On March 30, the British government presented to
Parliament a moderately expansionary budget, which was
generally well received in the market. The fiscal measures
were to be accompanied by a small relaxation of the
ceilings on bank credit expansion. Subsequently, on April
1, the Bank of England cut its discount rate from 7 per­
cent to 6 percent. The bank noted that the move was
intended to bring British domestic yields into closer har­
mony with rates abroad (which had fallen substantially
since the beginning of the year). British interest rates
immediately came down and, with Euro-dollar rates simul­
taneously firming, the gap between domestic and interna­
tional rates was sharply reduced. The subsequent easing
in the spot sterling rate was only short-lived, however, as
demand arising from oil royalty and tax payments soon
pushed the rate to the ceiling again.
Meanwhile, the United Kingdom’s current-account
position was improving strongly, from the strike-reduced
$82 million surplus of the first quarter to a record of $792
million for the second quarter. Although this swing re­
flected in part a distortion of the trade figures as a result
of strikes, such deferred commercial demand for pounds
kept sterling buoyant at a time when it usually begins to
ease with the passing of favorable seasonal factors. Fluctu­
ations in the sterling rate during that period mainly re­
flected the changing relationship between domestic interest
rates and rates in the Euro-dollar market. With interest
rates holding fairly steady in London, the tightening of
the Euro-dollar market late in May exerted some down­
ward pressure on the pound, but when Euro-dollar rates
moved lower in June sterling came into demand again.
During the second quarter, British reserves posted a
further gain of $303 million, while $1.2 billion was shifted
into later months again through special arrangements.
These gains, and the continued strength of sterling, en­
abled the United Kingdom to make a further paydown on
its IMF obligations. On July 19, Chancellor Barber an­
nounced that the United Kingdom would repay the re­
maining $614 million owed to the IMF under the June
1968 drawing. The repayment was carried out on August
9, concurrently with a large French repayment to the
Fund. This left outstanding only the $1 billion drawn by
the United Kingdom under the 1969 standby arrangement
with the IMF.
Trading in sterling remained orderly in July, but in
the first days of August the pound was caught up in the
general wave of speculative demand that hit all major
foreign currencies. With the sterling rate pressed against
its upper limit, the Bank of England had to absorb large
amounts of dollars from the market. To provide cover for



this inflow, on August 13 the Federal Reserve activated
the swap line with the Bank of England, drawing $750
million equivalent of sterling.
On the Monday following President Nixon’s statement
of August 15, the British authorities closed their market
by prohibiting their banks from dealing in foreign exchange,
and the prohibition was extended each day of that week.
As an interim measure, however, the Bank of England
allowed banks to lend foreign currencies to residents for
payment to nonresidents. During that week trading in
sterling was very thin in New York and on the Continent,
with wide swings in quotations. On Monday, August 23,
the London market was reopened on the basis of the
$2.42 upper limit being suspended temporarily, while the
parity of the pound and the lower limit remained un­
changed. On subsequent days, with trading gradually
recovering, the sterling rate moved to as high as $2.4830
on August 26, a premium of 2.5 percent over the ceiling,
before backing off.
Following the floating of the Japanese yen, the British
authorities feared a renewed speculative influx into sterling.
Consequently, the Bank of England announced on August
27 new measures to deter hot money inflows. These in­
cluded a prohibition of interest payments by banks in the
United Kingdom on increases in sterling balances held by
nonsterling-area depositors, and a complete ban on addi­
tional nonresident deposits with other financial institutions
and local authorities. Nonresidents were also prohibited
from purchasing additional sterling certificates of deposit
as well as government, government-guaranteed, and local
authority securities maturing before October 1, 1976. Fi­
nally, permission for the banks to swap foreign currency
deposits into sterling for lending to residents was with­
drawn. The sterling rate fell sharply after that to around
$2.45Vi, about 1.5 percent above the previous ceiling. On
the following Thursday, September 2, the Bank of Eng­
land reduced its discount rate from 6 percent to 5 percent.
(On the same day, the reserve figures for the end of
August were released, indicating a gain of $937 million
after the $614 million repayment to the IMF.) The bank
rate cut was followed by a drop in domestic interest rates,
but Euro-dollar rates fell even more rapidly. This may
have contributed to keeping sterling firm, the spot rate
fluctuating around $2.46 until mid-September. By that
time the volume of current commercial business had re­
covered, but transactions related to capital movements,
in contrast, had practically dried up. With the approach
of the IMF meetings, however, the sterling rate strength­
ened, and in September British official reserves rose by
$206 million. Also in September the British Treasury
announced the renewal for two years of the $2 billion

second sterling-balances arrangement of 1968 with the
BIS, under which the Bank of England can obtain credits
to offset reductions in the sterling balances (both official
and private) of sterling-area countries.
The upswing in the sterling rate continued into early
October, when, in active trading, the spot rate rose above
$2.49 to a 3 percent premium over the previous ceiling.
On October 6, the British authorities announced a further
tightening of the exchange controls introduced at the
end of August. The earlier ban on additions to the hold­
ings by nonsterling-area residents of specified securities
was extended to all such securities, irrespective of ma­
turity, as well as to sterling acceptances, commercial bills,
and promissory notes. After a brief dip in response to
these steps, sterling moved back close to the $2.49 level.

The Swiss franc rate rose steadily in early 1971, as
strong domestic credit demand absorbed bank liquidity
while a continuing decline in Euro-dollar rates reduced
the incentive to place funds abroad. By late February
the franc rate reached the ceiling and the Swiss Na­
tional Bank had to absorb $150 million. To provide cover
for this intake, on March 1 the Federal Reserve drew an
equivalent amount of francs under the swap arrangement
with the Swiss National Bank; since $300 million drawn
under the swap line in October 1970 was still outstanding,
this brought the System’s Swiss franc commitments to
$450 million. This debt was liquidated in early March
through a combination of a United States Treasury sale
of $75 million of gold and $250 million of Swiss-francdenominated securities to the National Bank, which also
agreed to sell outright $200 million equivalent of Swiss
francs to the Federal Reserve. The System was thereby
able to pay off the entire $450 million equivalent of swap
drawings outstanding.
Even after the injection of liquidity resulting from the
National Bank’s purchase of dollars in late February, the
Swiss franc rate remained strong throughout March. Late
in the month, the National Bank helped the Swiss banks
meet their quarter-end needs by entering into a total of
$470 million of swaps and also rediscounting domestic
paper for them. Despite this assistance, however, the spot
rate moved to the National Bank’s intervention point by
the end of the month.
When the German mark became subject to speculative
pressure in the first days of April, speculative demand de­
veloped for the Swiss franc as well. On April 1 the Swiss
Parliament transferred to the government the authority to
change the franc’s parity, and there were rumors that the


government would immediately avail itself of this new
power by revaluing the franc. As a result, the National
Bank had to purchase $390 million, net, in the first half
of the month, before tensions moderated somewhat. The
easing was short-lived, however, as the exchange market
atmosphere deteriorated sharply late in April when the
Swiss franc was caught up in the wave of speculation cen­
tered on the mark.
Since a large share of Swiss trade is with Germany,
the prospect of a further possible revaluation of the mark,
or of a rising floating rate, led many traders to expect that
the Swiss government, already struggling with inflation,
would follow a German move. With the spot franc driven
to the ceiling in early May, the National Bank’s dollar
purchases mounted rapidly. On the morning of May 5 the
National Bank took in $600 million and, when the Ger­
man Bundesbank suspended its operations, the Swiss
authorities immediately did the same. Later that day, in
New York, the spot franc rose in heavy trading to around
$0.2400 and fluctuated widely over the following two
days, as the market awaited the decisions that might
emerge over the weekend.
On Sunday, May 9, the Swiss authorities announced a
7.07 percent revaluation of the franc to a new par value
of $0.2448Vi, the first change of the franc’s external value
in thirty-five years. The new intervention limits were for­
mally set at $0.2403% and $0.2493%, or at 1.8 percent
on either side of the new par. The change in the Swiss
franc’s parity activated the revaluation clauses on all
Swiss-franc-denominated United States Treasury securities
issued to the Swiss National Bank, either in its own name
or that of the Swiss Confederation, and to the BIS. Con­
sequently, the National Bank sold to the United States
Treasury SF4,110 million at the franc’s old ceiling
($0.2328V4) for $956.9 million. The Treasury, in turn,
redeemed all its Swiss-franc-denominated securities, and
replaced them simultaneously with new securities for the
same Swiss franc amounts, selling the franc proceeds to
absorb $989.3 million from the National Bank.
When the market reopened on May 10, the spot franc
traded just below the new parity, but there was no reversal
of the earlier large inflows. The exchange markets re­
mained very uneasy and, despite extremely liquid mone­
tary conditions in Switzerland, Swiss banks were reluctant
to shift funds into the Euro-dollar market. In view of the
potentially wide swings of the spot rate, uncovered place­
ments were risky, while forward cover was not available
in large amounts at attractive rates. Under these condi­
tions, the National Bank sought means of exerting a
calming influence on the market and of absorbing excess
Swiss franc liquidity.


As a first step, an arrangement was worked out between
the National Bank and the Federal Reserve, using the
BIS as intermediary. On May 17, the National Bank sold
$250 million to its commercial banks on a three-month
swap basis, on the understanding that the banks would
deposit these funds with the BIS which, in turn, would
invest them in certificates of deposit (CDs) of United
States banks, thereby avoiding an increase in the supply
of Euro-dollars. Cover for this operation was provided by
means of a Federal Reserve swap drawing of $250 million
equivalent on the line with the Swiss National Bank. (The
National Bank was not authorized at that time to under­
take forward market operations on its own account; a bill
authorizing it to do so had been proposed to Parliament
and was subsequently passed in late June.) Late in May,
the National Bank gave assurance to the banks that it
would maintain an effective ceiling for the Swiss franc of
$0.2463 and a floor of $0.2433 (0.6 percent above and
below par, respectively). With their potential spot ex­
change risks thus reduced, the banks began to purchase
substantial amounts of dollars from the central bank.
Moreover, with Euro-dollar yields rising sharply toward
the month end, additional funds flowed out of Switzerland,
and the franc rate dropped sharply until it almost reached
the informal lower intervention level on June 1.
On June 2, however, after the German Bundesbank
offered to sell dollars at a rate well above the previous
mark ceiling, the Swiss franc rebounded along with other
European currencies and held close to par until mid-June.
Then, as some covering of short dollar positions devel­
oped, an easier tone set in and the spot rate declined
markedly. (Following its normal practice, the National
Bank provided swaps to assist the banks over the midyear
statement period, the total in June reaching $607 million.)
Nevertheless, the rate did not reach the point at which
the National Bank had indicated it would sell dollars.
During that month, and again in July, in two transactions
of $50 million each the United States Treasury sold gold
to the National Bank to absorb some of the dollars the
bank had purchased in May.
There was little change in the market atmosphere in
July. Overall, in the two months that followed its revalu­
ation, the Swiss franc had been little affected by the
various speculative forays in other exchange markets, but
this relative quiet was broken in early August. With other
major Continental currencies partly insulated by either
exchange controls or floating rates, the Swiss franc began
to bear the brunt of the speculative attack against the
dollar. On August 4, after the French authorities moved
to halt inflows to their country, demand for Swiss francs
surged and the rate moved quickly from par to the level



at which the Swiss National Bank was prepared to buy
dollars. Demand swelled further on the following day,
and the National Bank took in a total of more than $400
million. Meanwhile, however, the National Bank had ne­
gotiated an agreement with the Swiss banks under which,
in the event of massive speculative inflows, it could pro­
hibit the payment of interest on additional short-term
deposits in francs by nonresidents and require the banks
to hold up to 100 percent reserves against such funds;
this arrangement was to go into effect on August 20.
On Monday, August 9, the National Bank announced
that the franc proceeds of any further dollar sales to it
would be placed in blocked accounts for ten days— that
is, until the agreement with the banks to sterilize inflows
would be implemented—but the Swiss authorities were
faced with further massive offers of dollars on every day
that week, during which they absorbed a further $1.7
billion. In response to the National Bank’s request to
cover these inflows, the Federal Reserve drew the remain­
ing $350 million equivalent available under the $600 mil­
lion swap line with the National Bank and, after that
facility had been enlarged to $1 billion on August 12,
drew in full the additional $400 million of Swiss francs
thus provided. Furthermore, the System drew the entire
$600 million equivalent available under the Swiss francdollar swap line with the BIS. These drawings raised Sys­
tem commitments in Swiss francs to a total of $1.6 billion.
Finally, to absorb the National Bank’s intake of August
13, the Treasury issued to it a $333 million Swiss-francdenominated note.
After the United States measures of August 15, the
Swiss National Bank suspended its exchange operations
during the week of August 16-20, although commercial
banks carried on limited dealings among themselves for
immediate needs. When the other European markets were
opened on August 23, the Swiss National Bank kept its
market officially closed; this left the Swiss franc effectively
floating, since the commercial banks remained free to
trade in foreign currencies. In the general uncertainty and
nervousness that prevailed in the markets, the franc rate
rose sharply to 3 percent over the previous informal ceil­
ing by August 26. That day the National Bank announced
it had reached an agreement with the three large Swiss
banks to discourage speculative inflows. Under the terms
of this agreement, the banks would buy a daily maximum
of $2 million from any one customer when the spot rate
was between $0.252514 and $0.2531% and $1 million at
rates of $0.2531% or higher. The franc proceeds of any
sale in excess of these amounts would be blocked in
noninterest-bearing accounts for three months. The follow­
ing day the National Bank reached an agreement with the

Swiss Bankers Association to extend the interest payment
ban on foreign funds that had flowed into Switzerland
since July 31 to all franc placements; originally, the ban
had applied only to funds with a maturity of less than
six months. These and earlier restrictions on dealing in
francs, along with the uncertainties generated by an effec­
tively floating rate, kept both the size and number of
transactions far below normal. Speculative flows espe­
cially were sharply curtailed by the National Bank’s regu­
lations. In addition, with the rise in Euro-dollar rates and
the downward drift of the German mark, the spot franc
backed away sharply, reaching by September 1 the $0.2500
level. On September 8 the Swiss government asked
Parliament for emergency authority to take various addi­
tional measures to defend the franc if this should again
become necessary, including the power to impose nega­
tive interest rates on hot money inflows and to declare the
present voluntary agreement with the large banks to be
legally binding on all Swiss banks. The franc rate firmed
in mid-September, but trading remained generally quiet
through early October.

In 1970 the Dutch economy continued to suffer from
inflationary wage and price trends, leading to a deteriora­
tion in the current account of the balance of payments.
As in other European countries, the Dutch authorities had
relied heavily on monetary policy to curb excess domestic
demand. While credit conditions were thus kept tight in
the Netherlands, interest rates in the Euro-dollar market
were declining. On several occasions during the autumn
and winter months, the short-term uncovered interestarbitrage comparison shifted in favor of guilder place­
ments. Moreover, in the second half of 1970, heavy
foreign demand had developed for guilder-denominated
bond issues being floated in the Dutch and international
capital markets. Therefore, even though the Dutch cur­
rent account was moving into deeper deficit, a massive
inflow of both short- and long-term capital held the spot
guilder rate at or near its ceiling through most of the
second half of 1970, and Dutch official reserves grew by
$551 million in that period. As was related in the preced­
ing report, the Federal Reserve provided cover for the
central bank’s dollar intake by drawing, during the second
half of 1970, the full $300 million equivalent available
under the swap facility with the Netherlands Bank. In
view of the sustained strength of the guilder during the
course of the first quarter of 1971, this $300 million of
Federal Reserve debt— plus another $25 million of surplus
dollars on the books of the Netherlands Bank— was fully


liquidated in a series of special transactions involving (1)
a Federal Reserve sale of $75 million equivalent of Ger­
man mark balances to the Netherlands Bank, (2) a United
States Treasury sale of $25 million of gold and $100
million of SDRs to the Dutch authorities, and (3) a
United States drawing of $125 million equivalent of guil­
ders from the IMF.
Early in 1971, liquidity in the Dutch market remained
tight, contrary to the usual seasonal easing, and the spot
guilder rate held close to the ceiling. Under these circum­
stances the Netherlands Bank initiated a new series of
swaps with Dutch commercial banks, offering to buy
dollars spot against sale for delivery in three months’ time
at rates favorable to the banks. These market swap trans­
actions were continued into early March and amounted
to some $380 million. At that point the Amsterdam money
market turned more liquid and, with Dutch interest rates
falling sharply in mid-March while Euro-dollar rates sta­
bilized, the uncovered arbitrage incentives shifted sub­
stantially against guilder placements, leading to a softening
of the spot rate.
Even though the Netherlands Bank was thus able to
avoid intervening in the spot market for a considerable
period of time, it acquired a substantial amount of dollars
on March 31 when, in connection with the United King­
dom’s repayment to the IMF, the Bank of England pur­
chased $110 million of guilders from the Dutch authori­
ties. At that time, the Federal Reserve reactivated its
swap line with the Netherlands Bank, drawing $130 mil­
lion of guilders to provide cover both for the dollars
bought from the Bank of England and for $20 million of
balances which were in excess of the Netherlands Bank’s
usual level of uncovered holdings.
In early April, when bidding for German marks surged,
with strong speculative overtones, the guilder also came
into demand. The spot guilder returned to the ceiling,
and the Netherlands Bank was obliged to intervene. The
Federal Reserve covered the intake through an additional
swap drawing of $40 million equivalent. In order to reduce
the incentive for further inflows, effective April 5 the
Netherlands Bank lowered its discount rate from 6 percent
to 5Vi percent. With the Amsterdam money market highly
liquid following the earlier influx, the spot guilder moved
away from its $0.2783Vi ceiling and traded at lower levels
for a few weeks. This liquidity began to be reabsorbed,
however, when Dutch banks had to pay guilders over to
the central bank at the maturity of the swaps entered into
early in the year; although the guilder exchange rate
firmed as a result, the central bank did not have to pur­
chase dollars outright.
In tlie last days of April, however, the guilder was caught


up in the spreading speculative demand for European
currencies. The spot guilder rose to the ceiling, and on
May 3-4 the Netherlands Bank absorbed dollars on a
rapidly rising scale. These were covered by a Federal
Reserve drawing of $80 million, which brought System
swap commitments to the Netherlands Bank up to $250
million. In the heavy trading of the morning of May 5, the
Netherlands Bank purchased $240 million before halting
market intervention. Formal trading remained suspended
in the Netherlands for the remainder of the week, while in
New York the guilder floated to a slight premium over its
On Sunday, May 9, the Dutch government, following
a similar move by Germany, announced that the Nether­
lands Bank was temporarily withdrawing its buying and
selling rates for the dollar, effectively allowing the guilder
to float. Simultaneous with the Dutch government’s de­
cision to float the guilder, the Netherlands Bank, in ac­
cordance with understandings governing the swap arrange­
ment with the Federal Reserve, sold sufficient guilders to
the System to enable it to liquidate the $250 million
equivalent of swap commitments. This repayment proce­
dure added to the uncovered dollars on the books of the
Netherlands Bank, and the United States Treasury subse­
quently absorbed the dollars through a $150 million sale
of SDRs on May 21 and a drawing of $100 million equiv­
alent of guilders from the IMF on June 21.
When the Dutch exchange market reopened on May 10,
the guilder began trading at a premium of 1.8 percent over
the previous ceiling but, even though the Amsterdam
money market was extremely liquid, virtually no unwind­
ing of speculative positions took place. In the next few
weeks the guilder moved in sympathy with the German
mark, although at much smaller premiums, fluctuating
in the New York market between 1.0 percent and 2.0
percent over its previous ceiling. Late in May, with the
Dutch money market remaining easy and Euro-dollar rates
rising sharply, the guilder rate eased back toward its pre­
vious ceiling. At that time the major Dutch banks agreed
to cease paying interest on nonresident demand deposits,
and on June 1 the Dutch authorities moved further to
discourage inflows of foreign short-term funds by barring
nonresidents from purchasing Dutch Treasury paper and
guilder-denominated bankers’ acceptances.
When the German Bundesbank entered its market as
a seller of dollars early in June, the guilder strengthened
in sympathy with the sharp upward reaction of the mark
rate. The Netherlands Bank remained out of the exchange
market, however, and the guilder rate thereafter fell back
even though the mark moved progressively higher. After
further fluctuations, the guilder rate settled at around 0.7



percent above the former ceiling from mid-June through
early July.
By that time the Netherlands Bank still held nearly
$250 million of surplus dollars, most of which had been
purchased on May 5. In order to absorb part of these
dollars the United States Treasury sold to the Dutch au­
thorities $100 million of SDRs on July 16, and it absorbed
a further $150 million in connection with a larger draw­
ing of guilders from the Fund on August 9. On that day,
the British and French repayments to the IMF included a
large allotment of Dutch guilders, amounting to $297 mil­
lion equivalent, which would be purchased from the
Netherlands Bank and would result in a further increase
in the bank’s dollar reserves. Consequently, the Treasury
agreed to draw a total of $447 million equivalent of
guilders from the Fund.
In July and early August, with the general deepening
of uncertainties in the exchanges, the guilder rate began
to rise again, reaching 4.3 percent over the previous
ceiling on August 13. In the week of August 16-20,
the Dutch exchange market was closed, and Dutch and
foreign banks dealt guilders only in limited amounts to
meet customers’ immediate needs. In New York, the rate
touched $0.2950, 5.3 percent over the ceiling at one point.
The Dutch authorities continued to permit the guilder rate
to float when the Amsterdam market reopened on August
23, but under an agreement between the Netherlands and
Belgium the central banks of the two countries stood
ready to intervene in order to maintain the cross rates be­
tween their currencies within the limits of 1.5 percent on
either side of the official parities. By early September, the
guilder rate was holding at just over $0.2900— some 4.2
percent above the former ceiling— while, operating under
the new agreement providing for the linking of the
Benelux currencies, the Netherlands Bank supported the
cross rate by buying Belgian francs.
In September the Dutch authorities took additional
steps to discourage capital inflows. Effective September 6,
a so-called “closed circuit for bonds” was introduced,
whereby purchases by nonresidents of guilder-denominated
bonds can be effected from residents only with guilders
obtained through the sale of such bonds by nonresidents
to residents. Effective September 15, the Netherlands Bank
lowered its discount rate by Vi percentage point, to 5
percent, explaining that the reduction had been made
in support of the measures directed at countering foreign
capital inflows. The spot guilder rate nevertheless rose
strongly in the second half of September, moving up along
with most other European currencies, and it held around
$0.2975, almost 7 percent over the former ceiling, through
early October.


Through most of 1970, the Belgian franc had been
bolstered by a growing payments surplus on current ac­
count and by an influx of short-term funds. The Belgian
authorities, struggling to contain inflation, kept interest
rates firm in the face of declining rates abroad. Late in the
year, however, the National Bank cut its discount rate
twice, but in early 1971 the renewed decline of Euro­
dollar rates again opened wide interest differentials in
favor of Belgium. The Belgian authorities then moved to
absorb, mainly through domestic borrowings by the Bel­
gian Treasury, some of the domestic liquidity which was
being created by the capital inflows, and took the oppor­
tunity to reduce further Belgium’s official borrowings in
foreign currencies. The National Bank’s dollar reserve
gains continued, however, and the Federal Reserve cov­
ered these gains by drawings on the swap arrangement.
As noted in previous reports, the System had initiated
drawings on the Belgian franc line in June 1970, and at the
year-end such drawings stood at $210 million. After
rising to $355 million by January 27, the System’s swap
debt was reduced to $230 million on January 29 through
use of $125 million equivalent of Belgian francs drawn
by the United States Treasury from the IMF. By early
March, the System’s swap commitments had again risen
to $420 million equivalent.
By that time, however, the value-added tax, introduced
in Belgium at the beginning of the year, started to have
its expected effects on Belgian trade. Prior to the tax, im­
porters had run down their inventories and now they were
rebuilding them, with the result that the trade account
had swung into deficit in February. Moreover, the large
injections of liquidity resulting from capital inflows had
eased domestic money market conditions and, with Euro­
dollar rates bottoming out in mid-March, demand for
Belgian francs eased somewhat. On March 24, the Na­
tional Bank of Belgium moved to limit future inflows of
funds— and their effects on domestic credit expansion—
by reducing its discount rate V2 percentage point to 6
percent, by asking the banks to exercise restraint in en­
larging their net external liability positions, and by extend­
ing through September its quantitative restrictions on the
expansion of short-term bank credit.
Late in March, however, the Belgian franc was caught
up in the general speculation in European currencies, and
the National Bank again began to absorb dollars from the
market. On April 7 the Federal Reserve drew an addi­
tional $30 million equivalent on its swap line with the
National Bank to cover part of the inflow, thereby in­
creasing total drawings to $450 million. In addition, the


National Bank acquired $50 million through a sale of
Belgian francs to the Bank of England, which needed the
francs in connection with a debt repayment to the IMF on
March 31. The United States Treasury absorbed these
dollars by selling $25 million of SDRs and $25 million of
gold to the National Bank.
Exchange market uncertainties led to new inflows in
the latter part of April and in early May. The underlying
situation had not changed—Belgian trade was still in defi­
cit on a customs basis—but leads and lags built up in
favor of the franc, holding the official rate at the National
Bank’s intervention point and adding to official reserve
gains. The pressures came to a head on Wednesday, May
5, when the National Bank took in $100 million before
joining several other continental European central banks
in suspending trading. The Brussels market remained
closed until the following Tuesday when the Belgian au­
thorities announced modifications in the two-market ex­
change system for the franc, resulting in a complete sepa­
ration of commercial and financial transactions. The Na­
tional Bank would maintain the existing official interven­
tion levels for commercial transactions, but all capital
flows, whether inward or outward, as well as private trans­
fers and tourist transactions were to pass through the
financial franc market, which would not be supported.
(Previously, capital imports could be converted through
either the official or the financial franc markets, although
capital exports by residents were permitted to move only
through the latter.)
Meanwhile, there was the question of dealing with the
reserve gains of the National Bank in late April and early
May, which amounted to more than $250 million. This was
accomplished through a series of transactions between May
10 and May 24: (1) the United States Treasury sold $55
million of SDRs and $85 million of gold to the National
Bank of Belgium; (2) the Treasury established and drew
in full a special $100 million swap facility with the Na­
tional Bank; (3) the Federal Reserve made two swap re­
payments and one new drawing which resulted in a $10
million net increase in drawings outstanding. Then at the
end of the month, when there was a further inflow of funds
to Belgium, the System made an additional drawing of $30
million, bringing total swap commitments outstanding un­
der the Federal Reserve line to $490 million equivalent.
Market expectations of a revaluation of the Belgian
franc were on the wane at the end of May. Moreover,
ample liquidity conditions in Brussels began to exert a
drag on the franc rate and, as Euro-dollar rates rose, very
large uncovered differentials opened up over Belgian
money market rates. Then, on June 3, the National Bank
requested that any increase in the Belgian commercial


banks’ net external liability positions above the levels pre­
vailing at the end of May be matched by noninterestbearing Belgian franc deposits with it. The Belgian banks
accordingly began to shift funds abroad as offsets to their
liabilities. In the official market the spot franc rate dropped
to par by June 17, at which point the National Bank inter­
vened in the market with a small sale of dollars to halt the
decline. The financial franc, which had commanded a pre­
mium of roughly 1 percent over the official franc ceiling in
mid-May, fell even further until it was trading at par with,
and at times below, the official franc rate.
The Belgian franc rate stayed below the ceiling through
early July. Trading was very thin, however, and did not
provide an opportunity for a reduction in the Federal Re­
serve’s swap drawings. In order to enable the Federal
Reserve to liquidate some of its commitments, the United
States Treasury acquired on June 21, in a multicurrency
drawing from the IMF, $150 million of Belgian francs;
these francs were used to reduce System swap drawings on
the National Bank to $340 million equivalent.
The wave of speculation that hit the exchanges later in
July and continued into the first half of August spilled
over into the Belgian franc market and, with the franc
rate pushed back to the ceiling, the National Bank of Bel­
gium was obliged to absorb nearly $350 million. Moreover,
on August 9, the British and French repayments to the IMF
included a large allotment of Belgian francs, amounting to
$315 million equivalent. Since the francs would be pur­
chased from the National Bank, thereby increasing the
bank’s dollar reserves, the Treasury agreed to absorb
the dollars by a simultaneous drawing on the Fund. The
Treasury also agreed to repay at the same time the $100
million equivalent drawn in May under its special swap
line with the National Bank, using additional francs drawn
from the IMF, so that the total Fund drawing amounted
to $415 million. To cover the National Bank’s large dollar
intake from the market, the System drew $65 million on
the swap line in late July and a total of $95 million in
early August, thereby exhausting the $500 million line
with the National Bank. On August 12 the facility was
enlarged to $600 million, and the additional $100 million
of Belgian francs that thus became available was drawn in
full. Finally, to cover the dollar gains of the National Bank
on August 13, the Treasury sold $50 million of SDRs and
the Federal Reserve drew $35 million of Belgian francs
from the BIS, under the $1 billion reciprocal line which
provides for swaps against certain European currencies
other than Swiss francs. This drawing brought the Federal
Reserve’s swap commitments in Belgian francs to $635
million equivalent.
Following President Nixon’s speech on August 15 the



Belgian authorities closed their exchange market, and it
remained closed for the following week. After the EEC
decision to open markets again on August 23, the Belgian
government decided to allow the official franc as well as
the financial franc to float. Once the market opened, the
rates in the two tiers tended to come together for an
effective appreciation above the former official ceiling of
a little more than 2.5 percent. In addition, Belgium en­
tered into an agreement with the Netherlands to limit the
variation in the cross rate between the Belgian franc and
the guilder to 1.5 percent on either side of their official
Trading in the Belgian franc turned quieter during the
remainder of August and through mid-September. In view
of the changed conditions since the floating of the Belgian
franc, the National Bank suspended on September 15 its
request of last June that any increase in the Belgian com­
mercial banks’ net external liability positions be matched
by noninterest-bearing Belgian franc deposits with it, and
the funds that had been blocked under that measure were
returned to the banks. Similarly, the earlier request, made
in March, that the banks exercise restraint in their foreign
borrowing was also suspended. A few days later, the Na­
tional Bank announced that the quantitative restrictions
on the expansion of short-term bank credit, which in
March had been extended through the end of September,
would be allowed to expire at that time since the risk of
inflationary excess demand for goods and services had
been sharply reduced. Finally, the National Bank low­
ered its discount rate from 6 percent to 5 Vi percent, effec­
tive September 23. In the latter part of September the
franc rate advanced to a premium of around 6 percent
over the former ceiling, largely in response to the general
bidding-up of European currency rates as a hedge against
a possible realignment of currency values during the IMF
annual meeting, and remained firm in early October. On
October 12, the Federal Reserve reduced its swap indebt­
edness to the National Bank by $35 million, to $565
million equivalent, using francs purchased in the market.

The French balance of payments on a cash basis had
been in sizable surplus in 1970, on both current and
capital accounts, and continued strong as 1971 began.
Although the repatriation of French funds from abroad
had tapered off over the course of last year, additional
inflows had developed in response to favorable interestarbitrage incentives. The French authorities had moved
cautiously to ease monetary policy but, with Euro-dollar
rates falling sharply, wide differentials opened on several

Chart IV


Three-m onth m aturities; w eekly averages of daily rates






P aris In te rb a n k
Euro-dollars ' s.



1 1 1




\\^ J \





- 7









occasions in favor of franc placements over Euro-dollars.
In late 1970 and early 1971 the Bank of France re­
peatedly reduced its domestic intervention rates to narrow
the interest-arbitrage spreads. Even so, the combination
of the strong underlying payments position and the con­
tinuing inflows led to fairly persistent demand for French
francs in the exchanges in the early months of 1971. The
franc rate fluctuated in a narrow range near its upper
limit throughout the first quarter, during which French
reserves rose by $369 million, excluding the allocation
of SDRs.
An easier tone developed for the franc in early April,
as the French authorities allowed the rise in Euro-dollar
rates to reduce the arbitrage incentives in favor of franc
placements (see Chart IV ). Toward the end of April,
however, the usual month-end demand for francs was
augmented by hot money inflows, reflecting mounting ten­
sions in the exchange markets. The spot franc rate was
pushed to the ceiling and the central bank had to absorb
dollars in mounting volume. Nevertheless, the rush into
francs was not overwhelming, mainly reflecting leads and
lags, and the Bank of France did not withdraw from the
exchange market on May 5 when several other conti­
nental European central banks suspended intervention
in their markets. On subsequent days the flows halted
and, as Euro-dollar rates rose sharply, some reflux of
funds developed. With francs now offered on the market,
the spot franc dropped away from the ceiling. On May
10, on the basis of the large reserve gains since the
preceding fall, France made a further repayment to the
IMF against earlier drawings. The repayment amounted
to $375 million (with a substantial portion, $282 million,
required in gold which was purchased from the United
States Treasury), and France’s indebtedness to the Fund
was thereby reduced to a little over $600 million.


During May, the French authorities took a series of
steps to ward off renewed speculation in the franc and to
absorb excess domestic liquidity created by earlier inflows.
On two occasions, the Bank of France raised its reserve
requirements for French banks. Moreover, the National
Credit Council authorized the Bank of France to raise
reserve requirements on nonresidents’ deposits to 100
percent, if this became necessary, and warned that it had
the power to prohibit or limit the payment of interest on
such deposits. These moves, along with the clearly stated
intention of the French authorities not to revalue the
franc or allow it to float, prevented speculative pressures
from developing at that time. Consequently, with arbitrage
incentives still well in favor of Euro-dollars, the Bank of
France raised its own rates on discounts and secured ad­
vances by X percentage point to 6 3 percent and 814
percent per annum, respectively. The French franc never­
theless had a softer tone through the rest of May and
into June. For the second quarter as a whole, French
reserves rose by a further $165 million.
In the last days of June and in early July, there was a
dramatic shift in the market atmosphere and the franc
came into heavy demand. At first the pressure reflected
the movement of funds in response to yet another reversal
of interest differentials in favor of France and to the usual
bunching of export proceeds around the month end. Then,
after an inconclusive meeting of the EEC’s Finance Min­
isters on July 1-2, rumors began to circulate in the market
that the French government might agree to a widening
of the trading margins of all EEC currencies against the
dollar. For the first time during the prolonged period of
unsettlement, the speculative focus now shifted to the
French franc and, as the spot rate was driven to the ceil­
ing, the Bank of France had to absorb dollars from the
market on a large scale. To deal with these flows, the
Bank of France lowered its domestic intervention rates
considerably—thereby pushing French money market
yields well below similar Euro-dollar quotations— and
raised its minimum reserve requirements further. Never­
theless, the strong demand continued through July, and
the Bank of France recorded a reserve gain of $498 mil­
lion for the month. On August 9 France prepaid in
full its remaining indebtedness to the IMF, totaling $609
million. In discharging this obligation, the Bank of France
purchased $191 million of gold from the United States.
In early August the French authorities took further
steps to counteract the domestic effects of the latest inflows
and to ward off further flows. Reserve requirements were
again raised, and there was some relaxation of existing
exchange controls. In addition, on August 4 the banks
were instructed not to increase their net external indebted­


ness or decrease their net claims vis-a-vis nonresidents
from the levels prevailing on August 3. In this connection,
the banks were expected to refrain from selling francs to
nonresidents whose motivation for buying francs appeared
to be speculative. With the franc already in strong de­
mand, this measure was immediately seized upon by the
market as evidence of the French authorities’ unwilling­
ness to accumulate additional dollars, and, in the confu­
sion, quotations for francs in markets outside France
moved above the official ceiling. On August 5, the Bank
of France quickly moved to clarify the instructions and
the market quieted somewhat. At that time the banks
agreed to stop paying interest on nonresident deposits of
less than ninety-one days, and this ban was later made
mandatory by the authorities. Nevertheless, in the general
run on the dollar taking place at the time, the demand for
francs was unrelenting, and the Bank of France continued
to take in dollars on a daily basis through Friday, August
Following President Nixon’s speech, the French ex­
change market was closed for the week of August 16-20.
The French government reopened the market on Monday,
August 23, on the basis of a two-tier exchange system.
The Bank of France would defend the franc at the pre­
scribed intervention points only in the official market,
through which trade and trade-related service transactions
would be effected. All capital transfers, as well as tourist
and most other nongovernmental service transactions,
would henceforth be strictly segregated in a financial
market where the franc rate would be allowed to find its
own level. At the same time, measures were taken to pre­
vent leads and lags from developing in the future, includ­
ing a requirement that imports (other than equipment
goods) be paid for within three months from their entry
into France, and importers were given one month to com­
ply with this new rule. Given the complexity of these
exchange regulations, trading in the official franc market
was very limited at first, with wide spreads in quotations,
but commercial business picked up fairly rapidly. Trading
was slower to develop in the financial franc market, where
the rate moved to a 2.5 percent premium over that of the
official franc. In the wake of the floating of the yen on
August 27, renewed demand developed for the official
franc—the only major currency still kept within its pre­
scribed limits— and the Bank of France again had to
absorb dollars. French official reserves rose by $1,087
million in August.
In September, there was some reversal of the previous
flows into francs, as the French exchange regulations,
which were further elaborated, began to bite. In particular,
French exporters and importers had to unwind some of



the leads and lags built up prior to mid-August. With the
official franc rate dropping below the ceiling, the Bank
of France sold substantial amounts of dollars over the
course of the month, and reserves declined by $333 mil­
lion for September as a whole. The financial franc rate,
which had reached a premium of 4.0 percent over the
official rate, gradually eased off to a premium of 2.1 per­
cent in early October.

The lira continued its recovery through the first months
of 1971, drawing its strength from large capital inflows,
including sizable Euro-dollar borrowings by Italian cor­
porations and official entities. Labor unrest remained a
major concern in Italy, however, and with export produc­
tion still sluggish the current account showed little under­
lying improvement. The Bank of Italy, which had already
moved toward a somewhat easier monetary policy in the
fall of 1970, took advantage of the sustained capital in­
flow to encourage business activity by reducing its rate
on secured advances in January and its discount rate in
early April, both from 5 V2 percent to 5 percent. Demand
for lire remained strong in April, however, and for
the first four months of the year as a whole official re­
serves rose by $794 million, excluding the new allocation
of SDRs.
While the lira was also affected by the growing specu­
lation in European currencies leading up to the crisis of
early May, Italy’s continuing domestic difficulties served
to dampen the demand for lire, and the pressures con­
sequently were not as great as in other major currencies.
Thus, when several continental European central banks
suspended operations on May 5 and some governments
subsequently floated or revalued their currencies, the
Italian authorities kept the lira market open and rode
through the storm. Later in May the Italian lira rate be­
gan to ease, as Euro-dollar rates rose relative to domestic
interest rates. With labor unrest mounting anew and
provincial elections adding new uncertainties, the lira
fell to around par in early June. The lira developed a
better tone toward the end of June, however, and held above
par through July. Nevertheless, even though the currentaccount trend in the balance of payments was improving,
Italian reserves declined on balance by $103 million in
the May-July period.
Early in August, the lira was caught up in the mounting
speculation against the dollar; the spot rate rose to the
ceiling on August 9, and the Italian authorities had to in­
tervene on a number of days during that week. After
President Nixon’s speech on August 15, the Italian au­

thorities also kept their exchange market closed during the
week of August 16-20, while intensive consultations took
place within the EEC. The lira rate moved up substan­
tially in New York, but trading was extremely thin and
the range between bid and offered rates very wide. When
Italy reopened its exchange market on August 23, the au­
thorities announced that they would no longer intervene
at the official limits, although they might enter the market
at other rates if this seemed advisable. Demand for lire
was quite strong at first as the tourist season was in full
swing, receipts had been backed up during the week of
August 16-20, and leads and lags had shifted in Italy’s
favor. The lira rate held at a premium of roughly 1.5
percentage points over the official ceiling, before settling
back somewhat. For the month as a whole, Italian re­
serves rose by $424 million.
In mid-September, in view of the high rates prevailing
in the Euro-dollar market at that time, the Italian Elec­
tricity Authority (ENEL) decided to prepay in November
the $300 million Euro-dollar loan it had contracted in
May 1970. Additional Euro-dollar loans of minor amounts
were also beginning to be repaid by Italian entities, which
had been very heavy borrowers during the preceding year
and a half. This imparted a somewhat softer tone to the
lira market, and the rate remained fairly steady even
though other European currencies rose strongly against
the dollar later in September.

For several years leading up to 1971, Japan had
experienced balance-of-payments surpluses on the order
of $1-2 billion, based largely on a growing trade sur­
plus. Japanese exports had proved to be increasingly
competitive in world markets, with particular success in
the United States (exports to this country rose by 20
percent in 1970 alone) but also with significant inroads
into European markets as well. Japan’s overall balance-ofpayments surplus amounted to $1.4 billion in 1970 and
would have been even larger except for efforts by the
Japanese authorities to trim the total. In 1970, along with
some easing of trade restrictions and capital controls, the
authorities had encouraged Japanese banks and trading
companies to shift away from dollar financing to yen fi­
nancing of imports. One technique employed by the
authorities was to make special credit facilities available
to Japanese banks under terms which enabled the banks to
offer yen financing at preferential rates. Moreover, the
Japanese government made some $200 million of addi­
tional funds available to the World Bank and other inter­
national lending agencies for development aid. Even with


these efforts, however, there was a growing belief in the
markets that the yen was fundamentally undervalued.
A slowdown in the rate of growth of the Japanese
economy, which began in mid-1970 and became more
pronounced in early 1971, came at a time when other in­
dustrial countries were struggling with inflationary pres­
sures and served to aggravate the international imbalance
in the early months of this year. Import growth slowed
but exports expanded even more rapidly than before. On
the domestic front the Japanese authorities turned to
more stimulative policies, and the Bank of Japan made a
further cut in its lending rates in January. Even so, the
decline in Japanese interest rates did not match that in the
United States and in the Euro-dollar market. Consequently,
there was a risk that the earlier yen shift might be reversed
and the Japanese authorities took further measures to
preclude this, including a doubling of the availabilities to
the Japanese banks to cover 30 percent of their import
credits. The authorities also eased some of the controls
on outflows of funds, and constructed additional barriers
against inflows. Demand for yen remained strong, how­
ever, and Japanese reserves rose by $931 million in the
first quarter, not counting the allocation of SDRs.
With market expectations of a possible yen revaluation
already strong, the Japanese currency was also caught up
in the wave of speculation that hit the European markets
in late April and early May. Leads and lags resulted in a
large influx of funds to Japan; in particular, there were
sizable yen prepayments for ships under construction in
Japanese yards. The Japanese authorities kept the market
open, however, and moved to deal with the problem by
tightening their exchange regulations and reducing domes­
tic interest rates further. (Effective May 8, the Bank of
Japan lowered its rates on discounts and secured advances
by V a percentage point to 5 Vi percent and 53 percent,
respectively.) With demand for yen continuing strong in
both the spot and forward markets, amounts actually
transacted were constrained by Japan’s exchange control
mechanism. Under the circumstances, it became difficult
for Japanese exporters, whose receipts were almost en­
tirely denominated in dollars, to obtain forward cover.
In June, the authorities moved to alleviate this shortage
of cover, again through the technique of placing dollars at
the disposal of the foreign exchange banks, in two allot­
ments totaling $500 million. Despite the efforts of the
Japanese authorities to curb the demand for yen, official
reserves rose by $1,902 million in the second quarter. As
in the year before, the Japanese government made addi­
tional funds available to the World Bank, amounting to
$200 million in the first half of 1971.
The demand pressure for yen continued unrelenting in


July, and on July 22 the Ministry of Finance made a further
deposit of some $300 million with the Japanese banks.
Moreover, effective July 28, the Bank of Japan cut its
discount rate by a further V* percentage point to 5V4 per­
cent. Japanese official reserves nevertheless rose by an­
other $328 million in July.
The worldwide speculation against the dollar building
up in late July and early August led to even greater
demand pressures on the yen than before. Even though
the Bank of Japan was holding the yen rate at its upper
limit by absorbing dollars daily, the exchange control
apparatus left much of the demand for yen unsatisfied, and
the apparatus itself was subjected to great strain. Because
of the time difference, when President Nixon announced
the United States measures on Sunday night, August 15,
it was already Monday morning in Tokyo and the market
was open for trading. The Japanese authorities neverthe­
less kept the market open the remainder of that day and
through the rest of the week as well.
With dealers all around the world now convinced more
than ever that a revaluation of the yen was imminent, the
Bank of Japan had to absorb dollars on a massive scale
over the following days, despite reinforcement of exchange
control policies. Japanese banks, in particular, liquidated
their long positions in dollars by converting into yen the
dollars they were borrowing from every possible source
in the United States as well from the Euro-dollar market.
Finally, after further very large exchange gains on August
26 and 27, the Japanese authorities decided to “suspend
temporarily the existing fluctuation margin for buying and
selling quotations of foreign exchange, while maintaining
the present parity of the yen”. The vast inflow during
August was reflected in a $4.4 billion gain in official re­
serves for the month as a whole.
In Tokyo, on August 28, the spot yen immediately rose
to a premium of 4.7 percent over the ceiling. The rate
pushed gradually higher through September, despite sub­
stantial further purchases of dollars by the Japanese authori­
ties and some additional tightening of exchange control
measures. With the tightening of the controls, Japanese
banks found themselves unable to accept yen payments into
the so-called free-yen accounts of foreign banks on their
books and, in some cases, reportedly felt it necessary to
convert balances in such accounts into dollars. This meant
that the foreign banks in many cases were involuntarily
short of yen and were unable to meet their commitments to
customers on maturing forward contracts or to guarantee
delivery on new spot transactions. With this failure in the
payments meehanism, trading in Japanese yen dropped to
nominal levels in New York, and in early September the yen
was suspended from official trading in Frankfurt, Germany.



The Japanese authorities subsequently eased their restric­
tions slightly, but some payments problems persisted
through September. By early October, the yen rate had
risen to a premium of almost 8 percent over the previ­
ous ceiling.

The Canadian dollar continued strong early in 1971,
largely on the basis of a still buoyant trade surplus and
substantial long-term capital inflows. Furthermore, with
the fall of interest rates in the United States, uncovered
arbitrage incentives opened in favor of Canada, while the
decline in Euro-dollar rates may have led to some repatri­
ation of previous outflows to that market from Canada.
The spot rate—floating since June 1970—moved above
$0.99 in late January, and there were widespread expec­
tations in the market that it might rise above parity with
the United States dollar. Meanwhile, the Canadian au­
thorities were in the process of stimulating the domestic
economy and were reluctant to see the Canadian dollar
rate advance much higher. Among other measures, the
Bank of Canada cut its discount rate in February and,
by mid-March, Canadian interest rates had moved below
corresponding rates in the United States, which were
beginning to turn around. At the same time Euro-dollar
rates also leveled off and, although the Canadian dollar
continued to fluctuate above $0.99, the market seemed
to move into better balance.
The Canadian dollar was little affected by the turmoil
in the Continental exchanges in late April and early May.
The market was active, but no cumulative rise in the
Canadian dollar rate developed. Instead, the subsequent
rise in Euro-dollar and United States interest rates in May
further widened the arbitrage incentives against place­
ments in Canadian instruments, and the Canadian dollar
rate drifted downward. Moreover, continued large wage
settlements in Canada had already raised fears of a revival
of inflationary pressures, and there were market rumors
that an expansionary budget would be presented in midJune. Indeed, when the rate dropped below the $0.99
level at the end of May, commercial firms and banks
began to reduce their long Canadian dollar positions, or
even in some cases to go short, and these sales of Ca­
nadian dollars added to the downward momentum of the
rate. By June 10 the spot rate had fallen below $0.98
in heavy trading and, less than a week later, it reached
$0.9755, the lowest point in eight months. On June 18,
Finance Minister Benson presented a moderately expan­
sionary budget, which was well received in the market.
Subsequently, the Canadian dollar held fairly steady

through the end of June and into July.
In the latter part of July, with the onset of the period
of seasonal strength for Canada’s balance of payments,
the spot rate began to firm, moving again above $0.98.
Early in August the Canadian dollar began to respond to
the general turmoil in the exchange markets and, with
heavy advance covering by Canadian exporters, the spot
rate moved close to $0.99 by August 13. On
August 16, following announcement of President Nixon’s
new economic program, the rate rose further, with trad­
ing active in New York as well as in the Canadian ex­
changes, which stayed open. After surging to $0.9943
on the morning of August 17, the rate eased sharply,
falling to $ 0 .9 8 ^ one week later as the market became
increasingly concerned over the possibility that the 10
percent import surcharge imposed by the United States
Government might cut deeply into Canada’s exports. In
a move aimed at softening the blow of the United States
import surcharge on domestic business activity and em­
ployment, the Canadian government announced on Sep­
tember 7 the establishment of a Can.$80 million fund
from which payments of up to two thirds of the surcharge
would be made to individual companies meeting certain
conditions. During September and early October the rate
held mainly in a range of $0.98V^ to $0.991

With only brief interruptions, Euro-dollar rates declined
fairly steadily throughout the second half of 1970 and in
early 1971. Although many factors contributed to this
slide, it reflected mainly the marked easing of liquidity
conditions and domestic credit demand in the United
States. With short-term interest rates falling sharply here,
United States banks rapidly repaid Euro-dollar borrow­
ings that they had built up through their branches during
the previous period of monetary stringency in this country.
Outstanding liabilities of United States banks to their for­
eign branches, which had reached a peak of $15 billion
in October 1969, were reduced to less than $8 billion at
the close of 1970 and continued to fall in early 1971.
(See Charts V and VI.)
Meanwhile, most European countries were still pursu­
ing policies of monetary restraint and were reluctant to
allow domestic rates to decline, or at least to fall as
swiftly as rates in the United States or in the Euro-dollar
market. Consequently, wide interest-arbitrage incentives
opened in favor of domestic European markets over both
the United States money market and the Euro-dollar
market, and large amounts of dollars were taken up by
European borrowers—banks and nonbanks— for conver­


sion into local currencies. German business firms in partic­
ular were heavy borrowers, but there were sizable flows to
other countries as well. With many currencies at or near
their upper intervention points, European central banks
were obliged to absorb the dollars offered on the ex­
changes, which added to their international reserves while
simultaneously expanding domestic liquidity and thereby
tending to negate their policies of restraint. As described
above, several central banks reduced their discount and
lending rates and tried other techniques either to prevent
the inflows by regulation or to absorb the domestic liquid­
ity generated by the inflows.
For their part, the United States authorities attempted
to moderate the pace of repayment by United States banks
and to prevent these repayments from adding further to

Chart V



Chart VI

Billions of dollars

^ W e e k ly averages of daily rate*.
W ednesday data.

Billions o f dollars


the reserve gains of foreign central banks. At the end of
November 1970, the Federal Reserve raised its marginal
reserve requirements against such borrowings in excess of
reserve-free base levels, thereby inducing the banks
to take a second look at the possible cost of borrowing
should they need to have recourse to the Euro-dollar
market in the future. The banks’ repayments resumed after
the year-end, however, and in January and February the
Export-Import Bank offered to the foreign branches of
United States banks $1.5 billion of special three-month
securities which the banks could count toward mainte­
nance of their reserve-free Euro-dollar bases. Thus, while
United States banks continued to cut back their recourse
to Euro-dollar financing—banks’ liabilities to their own
foreign branches fell by almost $5 billion in the first
quarter to just under $3 billion— the securities issued
reduced the amount of funds actually repaid to the market
by about $1.5 billion.
Euro-dollar rates bottomed out in March. During that
month, United States short-term interest rates leveled off
and then began to rise once again. At the same time the
considerably higher yields available in the British and Ger­
man money markets continued to exert upward pressure
on Euro-dollar rates. Consequently, Euro-dollar quota­
tions, which for three-month deposits reached as low as
5 percent per annum in early March, began to turn up­
ward. Rates tended to rise further on quarter-end demand,
and this strength was maintained into early April as the
pace of repayment by United States banks began to slow.
In addition, the United States Treasury followed up the
Export-Import Bank’s earlier borrowings by itself issuing
$1.5 billion of three-month certificates of indebtedness
to the foreign branches of United States banks.
By this time, however, the growing uncertainties in the
exchanges began to be reflected in the Euro-dollar market.
In normal times, the Euro-dollar market serves as an
international intermediary both for depositors seeking
higher rates of return on their money and for borrowers
seeking lower cost credit than they can obtain at home;
such flows, which depend on the expectation of orderly
international financial relations, had been the dominating
factor through 1970 and early 1971. At other times, the
Euro-dollar market has served as a staging area for inter­
national currency speculation— with funds pouring in from
currencies which are expected to fall in value or moving
out to currencies which are expected to appreciate.
In late March and early April the flows out of the Euro­
dollar market began increasingly to assume a speculative
character. At that point several foreign central banks cut
their discount rates and, with Euro-dollar rates on the
rise, interest-arbitrage spreads in favor of domestic Euro­



pean markets were narrowed or even reversed. Even so,
the increasing expectation of drastic changes in currency
relationships led to snowballing purchases of most Euro­
pean currencies. Much of this flow reflected leads and
lags or consisted of direct transfers of funds, particularly
out of the United States. But some of these flows were
financed by borrowing Euro-dollars at short term, with
the dollars sold against other currencies and the Euro­
dollar borrowings subsequently rolled over as long as the
short positions were maintained. At the same time, there
was a great deal of discussion of the possibility that indi­
vidual governments would place controls on their own
banks’ operations in the market. Rumors also developed
that central banks, which were reviewing the role of their
own placements in the Euro-dollar market, would come to
an agreement which would have the effect of pushing up
Euro-dollar rates. Consequently, as currency speculation
swelled in April and early May, Euro-dollar rates moved
up sharply, with wide day-to-day fluctuations reflecting the
volatile moods in the exchanges: the three-month rate
climbed to around IV 2 percent and overnight rates at
times to 45 percent or more. Euro-dollar yields receded a
bit through mid-May after the speculative onslaught abated
but, in the absence of any significant reversal of specula­
tive positions, the rates remained at levels well above those
prevailing before the run-up.
By late May, however, there were growing expectations
that the Euro-dollar market would tighten further. In part,
this was based on continuing rumors of coordinated cen­
tral bank efforts to raise Euro-dollar rates. At the same
time, United States money market rates were rising, and
United States banks’ liabilities to their foreign branches
had leveled off at between $ 1 V2 billion and $2 billion.
(With the United States Treasury beginning to take over
maturing Export-Import Bank notes, and later renewing
its own obligations as well, the full $3 billion of official
United States borrowings in the Euro-dollar market was
still outstanding.) The tightening of the Euro-dollar mar­
ket pushed the three-month rate briefly to as high as 8 per­
cent by June 1. On June 2, however, the German Bundes­
bank began offering to sell dollars in the exchange mar­
ket. This move provoked a sharp reaction in the Euro­
dollar market, and rates immediately broke downward.
Subsequent spot sales by the Bundesbank soon exceeded
the amounts being taken in by the German authorities
under maturing forward contracts, thus augmenting the
supply of Euro-dollars. By mid-June, the three-month rate
had fallen back to just over 7 percent per annum.
From their discussions, the central banks reached a
common view of some of the features of the Euro-dollar
market, including the role of official placements. On June

14, Dr. Jelle Zijlstra, President of the Netherlands Bank,
addressing the annual general meeting of the BIS in his
capacity as President of that institution, said:
It is becoming increasingly clear that the Euro­
currency market needs guidance and supervision. The
group of Governors meeting regularly in Basle de­
cided to set up a study group under my chairman­
ship to analyze the problem and to work out terms
of reference for a standing group which might sug­
gest policies to be adopted by the Governors. I am
confident that the Governors will be able to bring
the Euro-currency market into better harmony with
the proper functioning of the international monetary
system. I may say, in fact, that we have already de­
cided for the time being not to place additional offi­
cial funds in the market and even to withdraw funds
when such action is prudent in the light of market
The gradual falling back of Euro-dollar rates was
halted briefly in the last days of June, when the usual
midyear squeeze developed. The decline nevertheless
resumed through the first half of July, with the threemonth rate dropping below 6 Vi percent. Meanwhile, the
Bundesbank had been selling substantial amounts of dol­
lars virtually daily, often in amounts larger than were
being taken in under maturing forward contracts.
Late in July and into early August, the Euro-dollar
market was again caught in the backwash of currency
speculation as there was substantial use of the Euro-dollar
market to finance conversions into European currencies
or Japanese yen. With little money coming into the Euro­
dollar market, rates were bid up strongly and, on August
17 (the settlement date for currencies purchased on Fri­
day, August 13), three-month deposits were at 10 per­
cent per annum, seven-day funds at 20 percent, and over­
night funds reached above 40 percent at one point. After
these heavy commitments were met, Euro-dollar rates
receded somewhat. Nevertheless, with the widespread un­
certainties over the ultimate outcome of the negotiations
to resolve the many issues raised by the United States
measures of August 15, investors were unwilling to make
new placements in Euro-dollars, and the rates remained
several percentage points above those on comparable in­
vestments in major financial centers. An acute squeeze
developed at the month end, with quotations on over­
night Euro-dollars driven briefly as high as 200 percent.
With Euro-dollar rates at relatively high levels, there
was further liquidation of borrowings in the Euro-dollar
market. In August the United States Treasury began


to repay the $3 billion of special certificates it had
placed with the foreign branches of United States banks.
By mid-October, only some $550 million of the Trea­
sury’s certificates remained outstanding. Not all of this
was returned to the Euro-dollar market, however, since
United States banks reabsorbed some of the funds by
increasing their own liabilities to branches from about
$1.5 billion in early August to around $2.5 billion by the

end of September. Among European borrowers, the Italian
Electricity Authority (ENEL) announced in September
it would repay $300 million of its earlier longer term
borrowings in the Euro-dollar market. Toward the end of
September, however, the various quarter-end pressures
subjected the market to a further squeeze before rates
eased early in October, when the three-month rate dipped
to around 7 percent.

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The Business Situation
The Administration’s new domestic economic policy to
restrain wages and prices and to stimulate aggregate
demand signaled a major change in the strategy of
fighting the nation’s twofold problem of inflation and
high unemployment. Although it is far too early to assess
the full impact of the new policy, it has helped to restore
consumer and business confidence. The price freeze,
combined with the proposed removal of the excise tax
on automobiles, has been met by a rise in new car
purchases. However, other fiscal steps designed to stimu­
late business activity will require more time to have their
The initial impact of the price freeze is evident in the
latest data on wholesale prices, which declined in Sep­
tember in sharp contrast to the rapid increases of other
recent months. The persistence and severity of inflation in
recent years make it clear, however, that wide public sup­
port of Phase Two policies is essential if cost and price
pressures are to be substantially reduced.

The wage-price freeze was necessitated by the failure
of sluggish demand conditions to retard price increases.
Between November 1969 and November 1970, the
months tentatively designated by the National Bureau
of Economic Research as the period of recession, indus­
trial wholesale prices rose at a 3.6 percent seasonally
adjusted annual rate— a rise nearly as fast as the gain
in the preceding twelve months. In contrast, industrial
prices had generally stabilized during previous postKorean war downturns (see Chart I). Moreover, since
the trough these prices have risen at an even more rapid
rate of 4.8 percent. Indeed, data for July and August—
which because of survey timing excluded virtually any
effect of the freeze—indicated industrial wholesale prices
averaged an alarming IV 2 percent annual rate of advance.
The continuation of sharp inflation in the face of a reces­
sion and the subsequent sluggish recovery appears to
have resulted largely from the fact that the excess demand
which kicked off the inflation in mid-1965 was reinforced,

and eventually superseded, by widespread and severe cost
pressures. At least as important, these pressures continued
for so long that the expectations of further price rises
became firmly entrenched and generated an inflationary
force of their own. It should be noted, however, that there
has been a high level of demand in some areas. Better
than one fourth of the overall rise in the index of industrial
wholesale prices (not adjusted for seasonal variation)
through August was caused by the run-up in costs in the
residential construction area, which has been ex­
panding rapidly since its low in the first quarter of 1970.
Prices of lumber and other construction materials rose
at a 20 percent annual rate in the first eight months of
Under the freeze, the rise in industrial wholesale prices
came to an abrupt halt in September. In fact, the index
actually eased fractionally despite a few cases of increase.
Most of these advances— such as that for iron and steel
scrap— apparently resulted from the provision that firms
had the choice of setting prices either at the level recorded
on May 25, 1970 or at any level charged in the thirty
days preceding the President’s announcement. These
small price increases were outweighed chiefly by a decline
in wholesale automobile and truck prices, which reflected
manufacturers’ rebates to dealers for 1971 models. Agri­
cultural prices dropped substantially in September, and
thus the total wholesale price index fell at an annual rate
of over 4 percent.
The behavior of consumer prices through August of
this year was better than that of wholesale industrial
prices. This performance, however, resulted largely from
the rundown in mortgage interest rates that reflected
Government subsidy programs and the general easing
earlier in the year in the capital markets. In the first eight
months of the year, the total consumer price index rose
at a 3.9 percent seasonally adjusted annual rate, substan­
tially less than the 5.5 percent rise in 1970 and the 6.1
percent in 1969. Excluding mortgage rates from the index,
however, consumer prices rose at a 5.0 percent rate
through July, much closer to the 1970 rate of advance.
In August, the total index also rose at a 5.0 percent sea-


Chart I


Seasonally adjusted



-1 2













N o te : The b usin e ss-cycle tro u g h s , as id e n tifie d by the N a tio n a l Bureau o f
E con o m ic R esearch, are A u g u st 1954, A p ril 1958, F e b ru a ry 1961, a nd
N o ve m b e r 1970 (tentative).
S ource: U n ite d States D e p a rtm e n t o f Labor, Bureau o f S ta tis tics .

sonally adjusted annual rate, reflecting increases in a
number of items. This survey was almost entirely com­
pleted before the imposition of the wage-price freeze on
August 15. Even over the September-November period,
however, the consumer price index is likely to show some
increase since several items included in the series— such as
sales and property taxes and some foods— are not covered
by the freeze. Further, some of the components of the
index are priced on a quarterly or semiannual basis. For
these items, increases which took effect before August 15
will show up in the coming months.

The Administration’s policies designed to promote the
recovery of economic activity are aimed at stimulating
consumption and investment. To concentrate the stimulus
on the domestic economy, the President imposed a tem­
porary surtax of up to 10 percent on dutiable imports.
Another major method of stimulating consumption is
the recommended removal of the 7 percent Federal excise
tax on automobiles retroactive" to August 15. The im­
mediate impact of the President’s recommendations was
to boost sales of both domestically produced and foreignmade cars, since the surtax did not apply to those imports


already in inventory or in transit at the time of the an­
nouncement. Aside from this short-run phenomenon, the
stimulus should be largely confined to domestically pro­
duced automobiles, since the import surtax—which is 6 V 2
percent on automobiles—will about cancel out the effect
of the excise tax removal on prices of imported cars.
Led by increased sales at automotive outlets, retail
sales in August advanced by 1.7 percent, according to the
preliminary report. Sales of imports jumped to a 1.8
million unit seasonally adjusted annual rate in August,
compared with the already high 1.6 million unit rate
averaged over the first seven months of 1971. This surge,
however, probably reflected a rush to avoid the surtax
or higher prices that would result from realignments in
exchange rates. In September the depletion of stocks on the
West Coast that resulted from the dock strike there sharp­
ly reduced sales to a 1.3 million unit seasonally adjusted
annual rate. Data for domestic cars indicate the sales pace
rose to a 9Vi million unit rate in September, compared
with 8 V 3 million in the first eight months of the year.
Part of this increase in sales of domestic automobiles
doubtless reflected attempts by some consumers to avoid
future price increases.
In addition to the price freeze and the removal of the
excise tax on automobiles, consumption may be stimulated
by the boost to disposable income from the proposed
acceleration to 1972 of the increases in the personal in­
come tax exemption and the standard deduction that had
been scheduled to take effect in 1973. Personal income
growth has been moderate this year, aside from special
factors such as the Federal Government pay raise in
January, the increase in social security benefits in June,
and the postal workers’ pay raise in August.
The Administration’s chief proposal to stimulate in­
vestment was the recommendation of an investment tax
credit for business spending on domestically produced
machinery and equipment, which has been a particularly
weak area. The effects of the credit will in all likelihood be
spread over a long period since there is often a long
lead time between the initial planning stage and the start
of actual production on major capital projects. In the near
term, such factors as continued low capacity utilization
and poor profits are likely to hold down spending on plant
and equipment.
Among other components of investment, the outlook
for residential construction continues buoyant while pros­
pects for a pickup in inventory spending seem to have im­
proved. The rebound in home building brought activity to
record levels during the summer months. In both July and
August, total private housing starts ran at a record 2.2
million unit seasonally adjusted annual rate, compared



with 1.9 million in the first half of 1971 and 1.5 million for
all of 1970. The volume of building permits issued by local
authorities also was very strong during the midsummer
months, though the August figure was a bit below July’s
record pace. These trends, together with the continued
availability of funds in the mortgage markets, suggest home
building will continue at a rapid rate in the near term.
Inventory investment could also become an expan­
sionary force in the months ahead. Inventory positions—
as indicated by inventory-sales ratios— appear to be in the
best shape in over two years. The inventory-sales ratio did
rise in August in durables manufacturing, where the prob­
lem of excess stocks had been centered. However, the rise
stemmed largely from a sharp decline in steel shipments,
while the overhang of steel inventories that had been ac­
cumulated in anticipation of a steel strike was gradually
being worked off. Aside from this factor, the inventories
of most durables manufacturers appear to be in reasonable
balance with sales.
The realignment of inventories with sales resulted from
businesses holding inventory accumulation to a moderate
rate for the six quarters that ended in June. On a bookvalue basis, inventory accumulation in all of 1970 and
in the first half of 1971 ran at an annual rate of
about $6Vi billion— substantially less than the $10
billion and $11 billion increases recorded in 1968 and
1969, respectively. Inventory spending at all levels of
business remained quite moderate in July. August data,
which are currently available for manufacturing only,
indicate there was also no accumulation by manufacturers
in that month. With the ratios of stocks to sales at rela­
tively low levels, any improvement in the sales outlook
can be expected to generate a step-up in the rate of

covery in aggregate demand and a startling leakage into
imported goods. The business-cycle downturn coincided
with a broad and prolonged cutback in the defense sector
but, excluding this component, industrial production in
August was still only 3.0 percent above the trough (see
Chart II). The reduction in defense output was neverthe­
less pronounced, bringing production back down roughly
to its level at the time of the Vietnam buildup— a decline
in output of close to one third.
Another factor depressing the production index in
July and August was the inventory situation in the
steel industry. For the first half of 1971, steel output
expanded rapidly in response to inventory stockpiling
demand by users who feared a strike this summer. Pro­
duction began to decline in July, as the firms banked
furnaces in anticipation of a strike. In August steel output
fell by one fourth, accounting for almost three quarters
of the decline in the overall production index that month.
Data on raw steel ingot production, however, suggest
there was a substantial recovery in steel output in Sep­
The volume of new orders received by manufacturers

Chart II


Seasonally adjusted; 1967=100



It is still too early for the improved prospects for
demand to have had a measurable effect on production
and employment activity, where the recovery has been
feeble. Indeed, industrial production was about unchanged
in June and declined in both July and August to a level
only 2.4 percent above the November 1970 trough.
Moreover, even this gain is overstated since the General
Motors strike depressed November output. Nine months
after the 1961 cyclical trough, industrial production had
risen 11.4 percent, and over the corresponding period
after the 1958 cyclical low the rise in output totaled 14.5
percent. While some special factors— notably in the de­
fense and steel industries— have dampened production, the
underlying sluggishness indicates an unusually weak re­

Note-. The N a tio n a l Bureau o f Econom ic Research has te n ta tiv e ly p la ce d the pea k
a n d tro u g h p oin ts o f the recession a tN o v e m b e r 1969 a n d N o v e m b e r 1970,
re sp e ctively. D a ta fo r la te st fo u r m onths are subject to re visio n .
Source: Board o f G o ve rn o rs o f the F e de ra l Reserve System.


of durable goods through August did not imply much
improvement in the outlook for production. While there
have recently been some erratic movements, total book­
ings were still being received at about the same pace as
in the first quarter.
Conditions in the labor markets have fared little better
than industrial production. In contrast to past re­
coveries, the expansion of payroll employment since the
trough has been weak. In the November 1970-September
1971 period, total nonfarm employment rose by 900,000
compared with a 1.4 million advance in the ten-month
period following the trough of the 1960-61 recession. Pay­
roll employment registered a strong rise in September
which accounted for one third of this recent ten-month
gain. Moreover, the September increase included a sizable
advance in manufacturing employment, where the sluggish­
ness has been centered. Even with last month’s rise,
manufacturing employment is still only 86,000 above No­
vember 1970, a level fully 1.7 million below its July
1969 peak.
There has been no improvement in the overall unem­
ployment rate during the recovery, contrary to the be­
havior in other post-Korean war upturns (see Chart III).
Thus, in September the unemployment rate was still 6.0
percent, the same as the average rate prevailing since the
November 1970 trough. The failure of the unemployment
rate to decline cyclically was chiefly the result of the small
advance in employment, since labor force growth from the
November trough has on balance been slow. This increase
would have been even smaller but for the effect on the


civilian labor force of the ongoing cutbacks in armed
forces personnel. Since June, unusual problems of seasonal
adjustment have distorted the underlying pattern of civilian
labor force growth, but it does appear that the rate of
expansion has picked up in the past two months.



The Money and Bond Markets in September
Bond prices retreated during much of September from
the peaks reached in the wake of the President’s midAugust announcement of his new economic program,
but prices rose sharply late in the month as investors
stepped up their buying of new corporate and municipal
issues. The large volume of such financing contributed to
the very cautious atmosphere around midmonth, as did
concern about how strong Phase Two of the Government’s
anti-inflation program would be. Administration reassur­
ances that Phase Two would have “teeth” contributed
to the improvement in market atmosphere late in the
month. The continuing moderation in the growth of the
money supply also strengthened market expectations that
a decline in short-term interest rates— and ultimately long­
term rates—would follow. Preliminary data for September
indicate that the narrow money supply (M i) recorded its
first decrease since February 1970 and that the broader
measure of the money supply (M 2) rose only slightly.
To widen the base of System open market opera­
tions and to add breadth to the market for agency
securities, the Federal Open Market Committee announced
on September 16 that it had authorized outright purchase
and sale transactions in securities of Federal agencies.
Prior to this, open market operations in Federal agency
issues had been confined to repurchase agreements with
securities dealers. Prices of agency issues rallied sharply
in response to this news. The System conducted such
operations for the first time one week later.

Rates on most money market instruments were little
changed in September, except for declines in Euro-dollar
and Federal funds rates. Euro-dollar rates had risen
sharply amidst the turmoil in the international currency
markets during the first half of August (see Chart I). The
three-month Euro-dollar rate, which had briefly reached
10 percent in mid-August, dropped to 7nAe percent by the
end of September, still well above the average of about
6 V2 percent which had prevailed in July. The rate on

Federal funds averaged 5.67 percent during the first half
of September, compared with an average of 5.56 percent
in August, but declined to 5.44 percent on average over
the remainder of the period. Rates on bankers’ acceptances
were reduced by Vs percentage point at the end of Sep­
tember, while rates on dealer-placed commercial paper
were raised by Vs percentage point during the month. A
number of banks also raised their offering rates on large
negotiable certificates of deposit (CDs) by about Vs per­
centage point early in the month. However, a strong influx
of CD funds after midmonth induced some banks to roll
back the rate increases around the end of September.
Pressure on the reserve positions of member banks
lessened considerably in September. During the first
two statement weeks the net reserve position showed little
change from August, but there was a sizable decline in
member bank borrowings at the Federal Reserve discount
window as the month progressed. For the month as a
whole, net borrowed reserves fell to $265 million (see
Table I) from an average of more than $600 million
in the preceding two months, largely as a result of a de­
cline in average borrowings of some $290 million from
the August level.
After several months of rapid advance, M ± reached
a plateau in the third quarter (see Chart II). Based on
preliminary data, Mi actually declined at an annual rate
of approximately 4 percent on a seasonally adjusted basis
in September. This brought the annual rate of growth of
Mi to about 3 percent over the three months that ended in
September and about 7 percent over the six months ended
then. This represents a substantial moderation from the
10 percent annual growth rate of
over the first half
of the year and is considerably more in keeping with a
healthy economic expansion.
The decline in Mx during September was reflected in a
marked slowing of the growth of M2, which adds to Mx
commercial bank savings and time deposits other than
large CDs. M2 grew at a seasonally adjusted annual rate
of only about 1 percent in September. This brought the
annual rate of growth of M2 to about AV2 percent over



C h a rt I

J u ly-S e p te m b e r 1971


Ju ly

A ugust

S e p te m b e r

Note: Data are shown fo r business days only.
MONEY MARKET RATES QUOTED: Bid rates for three-m onth Euro-dollars in London; offering
rates for d irectly placed finance com pany paper; the effective rate on Federal funds (the
rate most representative of the transactions executed); closing bid rates (quoted in terms
o f rate o f discount) on newest outstanding three-m onth Treasury b ills .
BOND MARKET YIELDS QUOTED: Yields on new A a-ra te d public u tility bonds (arrows point
from u n derw riting syndicate reoffering yield on a given issue to m arket yield on
the same issue im m ediately after it has been released from syndicate restrictions);

the third quarter and 8 V2 percent over the six months
that ended in September. In contrast, M2 had increased
at an annual rate of 15 Vi percent during the first half
of the year.
While the growth of the money supply measures has
moderated in recent months, the growth of the adjusted
bank credit proxy accelerated in August and continued
rapid in September. The credit proxy increased at a
seasonally adjusted annual rate of about 9 percent over
the third quarter and about 7% percent over the six
months ended in September. While the greater increase
in the credit proxy compared with M2 during August
was mainly attributable to a substantial rise in Govern­


J uly

A ugust

S e p te m b e r

d a ily averages of yields on seasoned A aa-rated corpo rate bonds; da ily averages o f yields
on long-term G overnm ent securities (bonds due or callable in ten years or more) and on
Governm ent securities due in three to five y ears, computed on the basis o f closing bid
prices; Thursday averages of yields on tw enty seasoned tw enty-year tax-exem pt bonds
(carrying M o o d y’s ratings of A aa, A a , A, and Baa).
Sources: Federal Reserve Bank of New York, Board o f Governors o f the Federc Reserve System,
M o o d y’s Investors Service, and The W eekly Bond Buy er.

ment deposits, which are included in the proxy but not in
M2, a very substantial increase in large CDs accounted for
much of the September divergence. As shown in Chart III,
large CDs have expanded rapidly in recent months while
the rate of growth of other time and savings deposits has
slackened from the rapid pace of the first half of the year.

In the United States Government securities market,
participants became more cautious in early September as
they began to focus on the difficulties of formulating a
national program to follow the wage-price freeze. Investor



buying receded and dealer selling exerted upward pressure
on yields. Congestion in the corporate bond market also

Table I
In m illions o f dollars; (+ ) denotes increase
(—) decrease in excess reserves

Changes in daily averages—
week ended






— 175

— 450


4- 195

— 320

+ 51
— 205
— 45

— 233
4- 102
— 76

4 - 314
— 36

“ Market" factors
Member bank required


— 709

Operating transactions

Gold and foreign account ..



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

— 190

4 - 26
— 187




4 - 296


— 435
— 731
— 242
4- 614

4 173
— 773
4 655

Other Federal Reserve

— 81



+ 179


Total “ m arket” f a c t o r s ....

— 124

— 683

4 339

4 525

- f 446

4- 411

— 79

4 . 282


liab ilities

and capital




— 755




Direct Federal Reserve credit
Open market operations
Outright holdings:
Treasury securities .............
Bankers’ acceptances .........
Federal agency obligations.

— 130


Repurchase agreements:
Treasury securities .............
4 - 117
Bankers’ acceptances .........
4- 20
Federal agency obligations. i + 27
Other Federal Reserve




— 447



— 3
— 20
— 308


— 411
— 51
— 75
— 129

4- 742

4 1 ,0 7 3

4 . 332
4 . 52

4 . 666


4- 263
— 345


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


4- 40

4 . 77



4 - 40


■ 4 - 431



4_ 510

— 310

— 547

4- 881

4- 965

4- 233

— 119

4- 42



4- 126

4- 262




Daily average levels
Member bank:
Total reserves, including
vault cash ........................................






Of) 4 0 +
OU, 7Q0+

Required reserves





on 79Q






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

on D
ou, u**






— 382

— 560

— 210

— 101

— 73






— 265*









Free, or net borrowed ( — ),
Nonborrowed reserves ................
N et carry-over, excess or



§ ...............................

N ote: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,

t Includes assets denominated in foreign currencies.
t Average for five weeks ended September 29.
§ Not reflected in data above.

contributed to the downward drift in prices. Subsequently,
Administration reassurances, a pickup in the corporate
market, and a decline in the Federal funds rate contributed
to a marked upsurge in prices.
The Federal Open Market Committee’s statement on
September 16 that it had authorized the outright purchase
and sale of Federal agency securities by the Federal Re­
serve Bank of New York for the System Open Market
Account had an immediate bullish effect in the agency
market. When actual purchases were made a week
later, that market again responded positively. In the ac­
companying initial guidelines, the Committee stated that
the operations are not designed to support individual
sectors of the market or to channel funds into issues of
particular agencies. System holdings will be limited to
issues outstanding in amounts of $300 million or over if
maturing in five years or less and $200 million or over if
maturing in more than five years. In addition, System
holdings of any issue are not to exceed 10 percent of the
amount of the issue outstanding. No new issue will be pur­
chased in the secondary market until at least two weeks
after the issue date. While no specific limit was set for the
System’s total holdings of the issues of any one agency, as
an initial objective the System will aim at building a
modest portfolio of fully taxable issues for which there is
an active secondary market. Purchases of agency issues
will be an integral part of total System open market oper­
ations to supply bank reserves, with the amount and tim­
ing of acquisitions designed to avoid undue market effects.
As the month opened, prices of intermediate Treasury
issues declined somewhat in response to some selling of
the new 6V4 percent “when-issued” note of 1976, which
was auctioned on August 31, as well as some sales of
other issues by dealers who were positioning themselves
for the new note. Prices soon steadied and then began
to move higher on most intermediate- and long-term notes
and bonds over the next few trading days. Participants
were generally optimistic about the near-term outlook be­
cause of the reduction in the British bank rate from 6
percent to 5 percent and the overall trend of domestic
rates in recent weeks. Prices of coupon issues began to
drift lower on the Wednesday following Labor Day, when
some profit taking emerged, and dropped still further over
the remainder of the week after President Nixon’s speech
to the Congress promising a termination of the wageprice freeze on November 13 but providing no details re­
garding a substitute program. Prices of coupon issues
continued to decline in mainly professional trading after
the weekend, affected to some extent by investor resistance
to lower yields in the corporate bond markets.
At the lower price levels some demand began to emerge



tional factors were major influences during September.
Bill rates had declined during August in large part be­
cause of the substantial demand from several foreign
central banks. These banks had accumulated sizable dollar
holdings and had invested them in marketable and nonmarketable United States Treasury issues. With the con­
traction of this demand, upward pressure on bill rates
was almost inevitable during September since alternative
sources of demand of equal magnitude were unlikely. In
addition, because of the high Federal funds rate relative
to the return on bills, dealers were unwilling to hold heavy
inventories and exerted selling pressure much of the time
during the first half of the month. With the rise in bill rates
and the concomitant easing of their borrowing costs as
the Federal funds rate declined, dealers were in a more
comfortable position in the final half of the month. As the
period drew to a close, however, there was some increased
concern among participants about the possibility that for­
eign central banks might soon redeem a large part of the
United States Treasury obligations that they had recently
purchased. Since the Treasury would need to substitute
domestic funds for foreign should this occur, a cautious
tone emerged with regard to this possible future pressure
on the market. In addition, there was discussion of the
Treasury’s seasonal cash needs during the period ahead
and the probability of bill sales to meet these. Rates on
most bills due within three months rose by 5 to 26 basis
points in September, while longer bills were 21 to 33
basis points higher.

at midmonth, especially for issues in the intermediate
maturity range, and a firmer tone developed as selling
pressures also subsided. Weekly banking statistics showing
a slower growth in the money supply and the President’s
statement that Phase Two would also be strongly antiinflationary provided further support to the coupon mar­
ket’s improvement at this time. The rally did not extend
beyond the weekend, however, and the market resumed
its decline during most of the week of September 20.
Demand was again insignificant at the start of that week,
and dealers had to reduce their prices in order to elicit
some investor interest. Following President Nixon’s Sep­
tember 23 remarks giving further clues about his Phase
Two plans, the market firmed somewhat and then im­
proved substantially during the final week in response
to significant investor interest in all sectors of the bond
market. Over the month as a whole, yields on most
coupon issues declined by 3 to 30 basis points.
The bill market reacted in much the same fashion to
outside events as did the coupon market, but two addi­

As the month of September opened, the corporate bond
market was congested with the sizable unsold balances of
bonds floated unsuccessfully at the end of August. How­
ever, sparked by rumors of an imminent cut in the prime
rate at commercial banks following the full percentage
point reduction in the British bank rate, the market rallied
in unusually heavy preholiday trading on the Friday pre­
ceding Labor Day, and the unsold balances were reduced
substantially. Hoping to capitalize on the increased in­
vestor receptivity, underwriters priced $35 million of
Aa-rated utility bonds at a yield of 7.45 percent on the
Tuesday following the holiday, the lowest return on such
an offering since early April. Many investors balked at this
aggressive pricing and also refused on the next day to
purchase another similarly rated issue which provided a
return only 2 basis points higher. The addition of these
bonds to unsold inventories from other recent flotations
had a dampening effect on the market, and corporate
bond prices fell on September 9 after President Nixon an­



nounced the termination date for the wage-price freeze
without detailing Phase Two. The price decline continued
into the next week when, faced with the heaviest weekly
schedule since May, underwriters released from price
restrictions three issues with balances amounting to
about $150 million. Upward yield adjustments as high
as 36 basis points resulted, and the market began to stabi­
lize in response to these and other price reductions. Inves­
tors remained selective, however, and no overall enthusi­
asm developed until the President assured the nation that
Phase Two of his domestic economic program would con­
tain “teeth”. The market rallied late on the afternoon of
September 16 following the President’s press conference
and continued to gain on the following day. During the
next week, however, participants were again confronted
by a heavy new supply with little retail demand and,
despite a rise in yields on new Aa-rated utility bonds to
8 percent, strong buying interest did not emerge until the
period drew to a close. Then, some short covering oc­
curred and increased demand from institutional investors
also emerged. The corporate bond market was further
buoyed at that time by the last of President Nixon’s eco­
nomic pronouncements during the month, and yields de­
clined toward the end of September amid strong investor
demand. While corporate bond yields rose on balance
over the month, they closed well below the levels which
prevailed just prior to the President’s August 15 address.
The pattern of price behavior in the market for taxexempt bonds was quite similar to that in the corporate

Table II
In percent

Weekly auction dates— September 1971








Six-m onth







Monthly auction dates— July-September 1971









Nine-m onth


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

C hart


B illio n s o f do lla rs


S easonally adjusted

Billions of d o lla rs


Note: Data for September 1971 are prelim inary estimates.
Source: Board of Governors of the Federal Reserve System.

market during much of September, despite the fact that
there was a very moderate schedule of new municipal
issues until late in the month. The similarity of behavior
resulted from the aggressive pricing by underwriters in
both areas, with subsequent adjustments required by
investor resistance, and from the high degree of respon­
siveness of these markets to the same rumors and news
reports. Largely as a result of substantial gains in the
final week, however, municipal bond yields declined over
the month as a whole. The Weekly Bond Buyer's index
of yields on twenty municipal bonds fell to 5.24 percent
on September 30 from 5.39 percent on September 2,
reaching its lowest level since April.
At the start of September, the municipal bond market
also was burdened with some slow-selling issues which had
been marketed on the last day of August. As was the case
in the corporate bond market, it was not until the reduc­
tion in the British bank rate and the ensuing rumor about
a probable decline in the domestic prime rate that dealers
were able to retail the remainder of these bonds, which
then moved to a premium in secondary trading. Prices on
tax exempts held steady in light trading on the Tuesday
after Labor Day, as most participants awaited pricing of
the week’s two largest offerings on Wednesday. These were
a $100 million Aa-rated state of California issue and $75
million of state of New Jersey Aaa-rated bonds. Priced to
yield substantially less than bonds floated the week before,
the new California and New Jersey obligations encoun­
tered a chilly response from investors, and only about one
third of each issue had been sold by the following week


when underwriters consented to price reductions on them.
While the tone of the municipal market had already
improved with the repricing of the California and New
Jersey bonds and the sellout of $98 million of New York
State Power Authority term bonds, a further boost was
temporarily provided by the President’s press conference
remarks on September 16 concerning a strong Phase Two.
Again, however, the positive effect of these remarks did
not last beyond the weekend, and prices resumed their
downtrend over the next several days. Uppermost in the


minds of many participants was the record-breaking cal­
endar of new tax exempts scheduled for the week begin­
ning September 27; close to $1 billion of bonds was
slated for competitive sale at that time. The largest items
included were $335 million of New York City bonds and
$258 million of housing authority bonds. When the bonds
were actually marketed, investors responded quite favor­
ably to many of them despite a reduction in their yields
of some 15 to 20 basis points from comparable issues the
week before.