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1914 FIFTIETH A NN IVERSA RY 1964 MONTHLY R E V I E W SEP TEM B ER 1964 Contents Treasury and Federal Reserve Foreign Exchange Operations, by Charles A . Coombs. .. 162 The Business Situation ............................................ 172 The Money Market in August .............................. 175 Recent Capital Market Developments in the United States.............................................. 178 Federal Reserve Anniversary Year— Early Problems of Check Clearing and Collection..... 182 Volume 46 MONTHLY REVIEW, SEPTEMBER 1964 162 T rea su ry an d F ed era l R e s e r v e F o reig n E x c h a n g e O p e r a tio n s By C h a r l e s A. C o o m b s During the six-month period M arch through August 1964, international credit facilities, both bilateral and multilateral, were again frequently called upon to cushion the impact upon gold and foreign exchange reserves of pay ments imbalances among the major trading nations. Offi cial operations in the forward markets helped to smooth temporary swings during the period, while the Gold Pool arrangements continued to operate effectively. Transfers of gold among the central banks also fulfilled their cus tomary role of helping to settle payments imbalances, but the volume of such official gold transfers declined still further. The decline reflected both a tendency toward narrowing of payments imbalances as well as economies in the use of gold made possible by the development of international credit facilities. A t the short-term end of the credit spectrum, the Federal Reserve swap network had been broadened by late 1963 to include twelve foreign official institutions, in volving reciprocal credit lines totaling $2,050 million (see Table I ) . During the period under review the short-term credit needs of the various central banks concerned were readily accommodated under the existing swap lines and other central bank credit facilities. From M arch through late August, drawings under the System network by the Federal Reserve and by three foreign central banks amounted to $262 million. From the inception of the swap network in M arch 1962 through late August 1964, total central bank drawings amounted to $1,870 million. Of this amount $1,753 million (or 94 per cent) was repaid, generally within six months (see Table II for data through June 1964). The Federal Reserve shifted from a peak net debtor position of $342 million on December 13, 1963 to a net creditor position of $44.5 million in late August 1964. Drawings on the Federal Reserve swap network outstanding in late August included $80 million by the Bank of Japan, partially offset by Fed eral Reserve use of $28 million drawn on the Netherlands Bank and $7.5 million on the National Bank of Belgium. The Federal Reserve and United States Treasury in co operation with foreign central banks also conducted short term forward operations in sterling, German marks, Swiss francs, and Canadian dollars, in order to restrain short term money flows arising either from speculation or interest arbitrage. Over the period, the Treasury reduced its com mitments in the forward markets from $248 million to $82.5 million, all in Swiss francs, on August 31, while the Federal Reserve position on market transactions was Table I FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS August 31, 1964 Amount of total facility (in millions of dollars) Institution Bank of France ................................................. Bank of England ............................................................ Netherlands Bank ........................................................... National Bank of Belgium ...................................... Bank of Canada ............................................................. Bank for International Settlements ........................... Swiss National Bank .................................................. German Federal Bank ................................................... * This is the fifth in a series of reports by the Vice President Bank of Italy ................................................................. in charge of the Foreign Department of the New York Reserve Bank Austrian National Bank .................................. who also serves as Special Manager, System Open Market A c Bank of Sweden ............................................................. count. The Federal Reserve Bank of New York acts as agent for Bank of Japan .............................................................. | 1 both the Treasury and the Federal Open Market Committee of the Federal Reserve System in the conduct of foreign exchange operations. Total swap facilities .............................................. 100 500 100 50 250 150 150 250 250 50 50 150 2,050 Term of arrangement (in months) 3 12 3 6 12 6 6 6 6 12 12 12 FEDERAL RESERVE BANK OF NEW YORK 163 Table n OPERATIONS UNDER FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS, 1962-64 In millions of dollars 1962 institution 1964 Total 1 Bank of France: Drawings .................................. Repayments............................... 1963 II 50.0 IV 1 II 50.0 Bank of England: Drawings .................................. Repayments............................... 50.0 Netherlands Bank: Drawings .................................. Repayments............................... 10.0 National Bank of Belgium:! Drawings .................................. Repayments............................... Bank of Canada: Drawings .................................. Repayments............................... III 25.0 50.0 40.0 50.0 10.0 10.5 10.5 20.0 5.0 10.0 30.0 32.5 III IV 1 12.5 9.0 12.5 9.0 25.0* 25.0 25.0* 10.0 10.0 50.0 40.0 50.0 60.0 20.0 55.0 10.0 5.0 15.0 15.0 15.0 15.0 17.5 250.0* 60.0 10.0 Swiss National Bank: Drawings .................................. Repayments............................... 20.0 15.0 50.0 9.5 45.5 100.0 5.0 50.0 80.0 5.0 50.0 German Federal Bank: Drawings ................................... Repayments............................... 150.0 Bank of Italy: Drawings ................................... Repayments............................... 50.0 Austrian National Bank: Drawings .................................. Repayments............................... 50.0 125.0 110.0 15.0* 210.0 210.0 25.0 100.5 100.5 270.0 270.0 113.0 136.0 113.0 50.0* 15.0 130.0 230.0 230.0 25.0 100.0 155.0 155.0 55.0 115.0 341.0 341.0 100.0* 200.0 200.0 150.0* 50.0 50.0 50.0 50.0 Bank of Japan: Drawings .................................. Repayments............................... Total: Drawings .................................. Repayments............................... 71.5 71.5 20.0 20.0 250.0* Bank for Internationa] Settlements: Drawings .................................. Repayments............................... II 50.0 50.0* 1 50.0 310.0 160.5 170.5 150.0 270.0 55.0 152.0 240.0 138.0 I 112.5 193.0 480.0 200.5 155.0 209.0 90.0 405.0 1,803.0 1,738.0 * Drawings and repayments made by foreign central banks.. t Data represent disbursements and repurchases under the $50 million arrangement which has remained fully drawn since its inception. A total of $45 million in disbursements was initiated by the National Bank of Belgium. in balance on the latter date. The central banks of Ger many, Canada, Switzerland, and Italy also operated from time to time in the forward markets, and in each case achieved the desired effect on the flow of funds. As noted in the report of the Deputies of the Group of Ten, “these demonstrations of close central bank coopera tion are themselves an effective deterrent to speculative movements. Their informality, speed, and flexibility make them especially suitable as a first line— and short-term— defense against sudden balance-of-payments pressures. Over the past several years, they have mobilized massive resources in a short time to combat and limit speculative and crisis situations. Their success has greatly reduced the threat to official reserves from disequilibrating movements of pri vate short-term capital.”1 In the medium-term segment of the international credit spectrum, the United States Treasury issued an additional $474 million of bonds in the foreign currency series, while redeeming $200 million for a net addition of $274 million equivalent. The total of foreign currency securities now outstanding amounts to $1,035 million, distributed as shown in Table III. Of the $474 million of foreign currency bonds issued during the period under review, $70 million was employed 1 Ministerial Statement of the Group of Ten and Annex Pre pared by the Deputies, August 10, 1964. 164 MONTHLY REVIEW, SEPTEMBER 1964 to fund indebtedness previously incurred by the Federal Reserve by drawings upon the swap network. Of total Federal Reserve repayments of swap drawings since the incep tion of the network, $120 million (or roughly 9 per cent) has been so financed. Also in the medium term credit area, the United States drew $250 million of foreign currencies during the first eight months of the year under a $500 million stand-by agreement with the International Monetary Fund (renewed for another year in July 1964) in order to facilitate repay ments to the Fund by other member countries. In other sizable Fund transactions, the Bank of Italy in M arch drew $225 million, while that same month Japan was granted stand-by facilities in the amount of $305 million. In August, the United Kingdom renewed its stand-by arrangement of $1,000 million with the Fund. Liquid resources for cushioning payments imbalances have thus continued to be flexibly provided through the in ternational credit machinery. As noted in the report of the Deputies of the Group of Ten, “a country’s liquidity is no longer measured solely by the level of its reserves in the form of gold and reserve currency balances (pri mary reserves). There is now a variety of ways in which monetary authorities can, at need, replenish their balances of the currencies used for operations. Primary reserves are thus supplemented by a broad spectrum of other resources and facilities. A t one end of this range come ‘other reserves’ of only slightly less liquidity but of un questioned availability; at the other end of the range are negotiated credits, including those which will only be available when an international institution is satisfied that the borrower will employ effective adjustment processes to correct his deficit.” Table III UNITED STATES TREASURY BONDS DENOMINATED IN FOREIGN CURRENCIES August 31, 1964 Amount (in millions) Issued to Foreign currency Austrian National Bank ............. National Bank of Belgium ........... German Federal Bank ................ Swiss National Bank .................... Bank for International Settlements .................................... Total ........................................ 1,300 Austrian schillings 1,500 Belgian francs 2,500 German marks 1,112 Swiss francs 300 Swiss francs United States dollar equivalent 50.3 30.1 623.2 257.3* 69.5 1,035.4 * Includes a $30 million equivalent one-year certificate of indebtedness. S T E R L IN G In early February, sterling came under some speculative selling pressure. The main factors involved seemed to be uncertainties generated by expectations of a general election in the spring, by publication of January trade data showing an unusually large trade deficit, and by market rumors of a revaluation of the Germ an mark. These speculative pressures were resisted by Bank of England intervention in the exchange markets and, in a minor way, by Federal Reserve purchases of sterling in New York. On February 27 the Bank of England raised its dis count rate from 4 per cent to 5 per cent. This decisive ac tion produced an immediate strengthening of m arket con fidence in sterling, and the sterling rate recovered sharply. Following the increase in the discount rate the British Treasury bill rate rose to a level about 0.60 per cent per annum over the United States bill rate, but the forward dis count on sterling promptly widened and the covered arbi trage margin on Treasury bills settled at about zero. Almost simultaneously with the British discount rate increase, the Federal Reserve and United States Treasury joined forces with the German Federal Bank in both spot and forward operations in German marks. As detailed elsewhere in this report, these operations seemed to achieve their objective of dispelling market rumors of a possible change in the m ark parity, and thereby also helped relieve the pressure on sterling that had been coming from this source. In early April, sterling strengthened further following the announcement that the British general elections would not be held until October. Immediately thereafter, com mercial interests that had previously postponed their purchases bought sterling to cover their near-term require ments, and the spot rate for the pound sterling rose to $2.8002 by the end of the month. Demand from this source, together with the continued strength of the pay ments positions of the overseas sterling area, bolstered sterling during April and most of May. In the last few days of May, however, sterling once again came under pressure as the covering of commit ments was completed and as very tight conditions in several Continental money markets, as well as in the Euro-dollar market, drew funds from London. Moreover, toward the end of June the usual midyear “window dress ing” by Continental banks put additional temporary pressure on sterling. To temper the impact of these move ments of funds on official reserves, the Bank of England on June 30 drew $15 million against its $500 million swap line with the Federal Reserve. The drawing was re paid on July 13. Also in June, the Federal Reserve Bank of FEDERAL RESERVE BANK OF NEW YORK New York purchased for United States Treasury account approximately $6 million in sterling. As the credit squeeze in Continental money market centers continued into July, sterling was subject to re current selling pressure and the spot rate on sterling moved downward with a minimum of official support to a low for the month of $2.7874 on July 20. In a market aware of British Government determination to defend the sterling parity with the ready support if needed of the IM F stand-by arrangement, the Federal Reserve swap line, and credit facilities at other central banks, the decline of the spot rate was taken in stride with no speculative reaction developing. Moreover, as the spot rate declined, the technical position of sterling was correspondingly improved by the increasing risk of a rebound of the spot rate and consequent loss to those with short positions in sterling. Again reflecting the underlying strength of market confidence in the sterling parity, the discount on forward sterling also tended to narrow as the spot rate declined. The strength of the forward sterling rate, while gratify ing to all concerned, nevertheless created certain compli cations. As the discount on forward sterling tightened, the covered interest arbitrage differential favoring London on Treasury bills became correspondingly more attractive and by July 13 had reached the level of 0.44 per cent per annum. To forestall private covered outflows in response to this arbitrage inducement, the Federal Reserve, with the agreement of the British authorities, intervened in the m ar ket to widen out the discount on forward sterling and thereby reduce the arbitrage differential. This intervention, amounting to a total of $28 million equivalent during a five-day period, was accomplished by swap transactions in the New York market, with the Federal Reserve Bank of New York for System account buying sterling spot and selling sterling forward against United States dollars. At the same time, on July 20, the United States Treasury an nounced that it was offering an additional $1 billion of Treasury bills to help strengthen United States bill rates. By July 23, the arbitrage margin on Treasury bills in favor of London had been reduced to 0.32 per cent and inter vention was discontinued. In mid-August, sterling once again came under pressure in the spot market as Continental holders apparently shifted funds from sterling into the Euro-dollar market. Spot ster ling reached a low in New York of $2.7839 on August 27, but the forward rate stayed relatively firm as market confidence in the sterling parity remained undisturbed. On M arch 31 the Federal Reserve sold to the United States Treasury $10 million equivalent of sterling, which was used by the Treasury, together with $5 million equiv alent of its own sterling holdings, to acquire $15 million 165 equivalent of Swiss francs through a sterling-Swiss franc swap with the Bank for International Settlements (B IS). System and Treasury swaps of this nature— involving the exchange of one foreign currency for another— have now included five European currencies and amounted to a total of $115 million equivalent. Of this total, $51 million equiv alent remained outstanding at the end of August— $13 million equivalent for System account and $38 million equivalent for Treasury account— all involving the pur chase of Swiss francs against sterling. GERMAN M ARKS During 1963, there was almost continuous upward pressure on the German mark. The pressure mainly re flected a substantial increase in the German foreign trade surplus, large inflows of long-term capital, and occasional inflows of short-term funds in response to tight money market conditions or hedging operations. Although the Federal Reserve frequently drew upon its $250 million swap line with the German Federal Bank in order to cush ion these pressures, all drawings effected during 1963 had been repaid by January 9, 1964 through operations sum marized in the preceding report in this series. In late January and February 1964, buying pressure on the mark resumed in even greater force, with indica tions of speculative overtones developing. To counter these pressures, the German Federal Bank intervened strongly in Frankfurt, buying dollars at rates just below the ceiling on the mark. In addition, the Federal Reserve made sizable new drawings on the swap line to support market intervention in New York and to absorb dollars taken in by the German Federal Bank. During the first half of M arch, Federal Reserve drawings totaled $55 million equivalent. These operations in the spot market were reinforced by a resumption— for the first time since 1961— of joint operations by the United States Treasury and the German Federal Bank in the forward market in an effort to dispel rumors of a prospective change in the mark parity. Sales of three-month forward marks amounted to approximately $21 million equivalent between the end of February and the middle of M arch at rates ranging between 0.96 and 0.75 per cent per annum premium on the mark. All these contracts were liquidated without difficulty at maturity. On M arch 23 an important turning point occurred, as the German Government announced its intention to pro pose to Parliament the imposition of a 25 per cent with holding tax on the interest income of nonresidents. This action not only checked the long-term capital inflow, but actually induced liquidation of a considerable volume of 166 MONTHLY REVIEW, SEPTEMBER 1964 foreign investments in German fixed-interest securities. Earlier, on M arch 10, the German Federal Bank had al ready taken steps to encourage an outflow of German funds into dollar investments by providing dollars on a swap basis— selling dollars spot and repurchasing them 90 to 180 days forward— to German commercial banks for pur chases of United States Treasury bills at a preferential dis count of 0.50 per cent per annum on the forward dollar. This compared with a m arket discount at the time of more than 0.75 per cent. By April 15 the total of such dollar investment swaps outstanding had risen to $186 million. As a consequence of the outflows on both short- and long term capital account, the exchange market moved into a much closer balance that continued to prevail during April and May. In these circumstances, the Federal Reserve Bank of New York was able in late M arch to acquire for System account $20 million equivalent of marks and thereby to reduce its swap drawings from $55 million to $35 million equivalent. This remaining drawing was liquidated on March 31 by pur chase from the Bank of Italy of $35 million of marks, origin ating in an Italian drawing of marks from the IM F. On the same date, the United States Treasury acquired $45 million equivalent of marks from the same source. The Treasury subsequently employed the bulk of these mark funds to absorb dollars taken in by the German Federal Bank. These exchange transactions illustrate how the United States, because of the reserve currency role of the dollar, now responds to the ebb and flow of the payments bal ances of foreign countries. During the winter months of 1963-64 the large surplus in the German balance of pay ments was accompanied by a very large deficit in Italian payments. This imbalance within the Common M arket brought about a simultaneous weakening of the lira and a strengthening of the m ark against the dollar, the currency in which both the Bank of Italy and the German Federal Bank customarily settle their international accounts. These exchange market pressures were intensified by widespread rumors of a revaluation of the m ark and a devaluation of the lira. As a short-run defensive measure, recourse to central bank credit, in the form of Bank of Italy drawings of dol lars from the Federal Reserve and Federal Reserve draw ings of marks from the German Federal Bank, served to temper these potentially disturbing market pressures with benefit for all concerned. Consequently, when the Italian Government had recourse to the IM F, it was entirely appro priate for the Federal Reserve and the United States Treas ury, which had operated to cushion the immediate impact of both the Italian deficit and the German surplus, to liqui date their mark commitments by acquiring marks drawn by Italy from the IM F. A second aspect of United States involvement in the German-Italian payments imbalance was the repayment by the United States Treasury of $200 million of lira bonds issued to the Bank of Italy in 1962 and the issuance to the German Federal Bank of $200 million equivalent of mark bonds. In effect, medium-term foreign currency bonds, pre viously acquired by the Bank of Italy in partial settlement of the surplus in its balance of payments, were transformed — as had been originally understood— into a usable reserve asset as Italy shifted from a creditor to a debtor position. The lira bonds were redeemed and, in practice, transferred to the German Federal Bank, becoming an attractive in vestment medium denominated in marks in which Ger many could hold a part of its balance-of-payments surplus. The rationale of this operation had been foreshadowed in a joint central bank report published in this Review in August 1963, which suggested: Even after the United States has regained equilib rium in its payments accounts, certain countries will from time to time move into a strong creditor position which will, in turn, expose the United States, as banker for the international financial sys tem, to the risk of net drains upon its gold stock. We have previously suggested that informal under standings should be sought whereby the creditor countries might attempt, either through greater flexibility in their gold policy or through more ex tensive use of forward exchange and related opera tions, to avoid causing a net drain upon the United States gold stock. To round out such a system of minimizing net losses of gold by the United States as a result of pronounced surplus and deficit posi tions in other countries, the United States might also find it useful on occasion to provide the credi tor country with an investment outlet for its sur plus in the form of special bonds denominated in the creditor’s currency.2 Still a third aspect of the pivotal role of the United States in the international financial mechanism was a sale of $200 million of gold by the Bank of Italy to the United States Treasury in order to replenish the dollar reserves of the Bank of Italy. The Treasury immediately resold this gold to the German Federal Bank in recognition of the 2 “Conversations on International Finance”, by C. A. Coombs, M. Ikle (Banque Nationale Suisse), E. Ranalli (Banca d’ltalia), and J. Ttingeler (Deutsche Bundesbank), this R eview, August 1963, p. 120. FEDERAL RESERVE BANK OF NEW YORK fact that the Italian deficit and German surplus were, to a considerable extent, opposite sides of the same coin* No further operations in German marks for either Fed eral Reserve or Treasury account occurred until early June when a brief revival of speculation concerning a mark revaluation was met by sales on the New York m arket of $5 million of marks for Federal Reserve account and $6 mil lion for United States Treasury account. The German Fed eral Bank simultaneously supported the dollar with sizable operations in Frankfurt, and on June 3 the Treasury em ployed $40 million equivalent of mark balances acquired at the time of the Italian drawing on the IM F to absorb dollars taken in by the German Federal Bank. Buying pressure on the m ark was further intensified in mid-June by commercial bank window-dressing operations and $150 million of the resultant inflow to the German Fed eral Bank was absorbed by an additional Treasury issue of mark-denominated bonds. This latest issue raised the total of such mark bonds outstanding to $628 million equivalent. On July 9, the German Federal Bank announced an in crease in commercial bank reserve requirements effective August 1. The mark again was subject to upward pressure, and the United States Treasury sold a total of $4 million equivalent of marks in New York on July 9 and 10. To counter possible repatriation of short-term bank funds, the German Federal Bank on July 13 reduced the investment swap discount on forward dollars from 0.50 to 0.25 per cent per annum. The demand for marks then eased and no further operations were undertaken by the Federal Reserve or the United States Treasury through the end of August. IT A L IA N L IR A The Italian lira came under increasingly heavy selling pressure during the winter of 1963-64 as a result of a widening payments deficit on current account, capital out flows, and repayments of foreign indebtedness by Italian commercial banks. To deal with the situation, the Italian authorities initiated various corrective policy measures which were expected to take effect over a period of months. Meanwhile, as heavy drains upon the Bank of Italy’s re serves continued, the need for short-term credit and other assistance became clear. Under the $250 million swap line with the Federal R e serve, the Bank of Italy made three successive drawings of $50 million each in October 1963, January 1964, and M arch 1964. Acquisition of lire by the United States authorities for eventual repayment of $200 million equiva lent of lira bonds issued to the Bank of Italy in 1962 also helped the Bank of Italy to replenish its liquid reserves. 167 In anticipation of such repayments, the United States Treasury had purchased $67 million equivalent of lire from the Bank of Italy in the early fall of 1963. Of this total, $17 million was temporarily employed in a swap against Swiss francs with the BIS. This program of advance acquisition of lire to meet prospective maturities of lira bonds was earned further by Federal Reserve purchases of $50 million equivalent of lire in December 1963, another $50 million in January 1964, and a final purchase of $33 million in M arch. These lire were simultaneously sold forward to the United States Treasury, which redeemed one $50 million lira bond at its first maturity on M arch 9, and on April 1 prepaid the re maining $150 million of lira bonds outstanding. These Federal Reserve and Treasury operations totaling $350 million cushioned the decline in the Bank of Italy’s re serves and thereby helped restrain speculative pressure. During the week of M arch 9 to 14, 1964, an Italian delegation-—headed by Governor Carli of the Bank of Italy— visited Washington to discuss with the World Bank and the IM F various possible sources of financing for Italy’s longer term investment requirements and its ex pected further balance-of-payments deficits. In the midst of these discussions, the lira was suddenly struck by a burst of speculation, which brought heavy pressure not only on the spot rate but also on the forward rate, which for a three-month maturity moved to a discount of 7 per cent per annum. In this dangerous situation, an immediate and massive reinforcement of the Italian reserve position was clearly called for, and within forty-eight hours the Italian authorities were able to announce that approximately $1 billion of external assistance was at their disposal. This credit package included: (a ) a $100 million swap arrange ment with the United States Treasury (in addition to the partly drawn swap facility with the Federal Reserve Sys tem ), (b) a $200 million stand-by credit from the ExportIm port Bank, (c) $250 million in credits of up to three years from the United States Commodity Credit Corpora tion, and (d) short-term credit facilities of $250 million from the Bank of England and the German Federal Bank. Had time permitted, other foreign official sources of short term credit could readily have been tapped. Announcement of this credit package immediately broke the speculative wave. As market confidence in the lira revived, the Bank of Italy temporarily withdrew its support from the spot market and allowed the lira to de cline to a level close to par, where it settled in relatively orderly and balanced trading. At the same time, the dis count on the three-month forward lira narrowed from 7 per cent to 3 per cent per annum, further reflecting the improve ment in market confidence. 168 MONTHLY REVIEW, SEPTEMBER 1964 At the end of March, the Italian Government made a lire to 75 per cent of the Italian quota. Thus, Italy’s obliga drawing of $225 million on the IM F in various currencies. tion to the Fund has been completely liquidated. As reported in previous articles in this series, the Of this total, $80 million equivalent of German marks was immediately sold to the Federal Reserve and the United States Treasury in January 1962 had undertaken United States Treasury, and $20 million equivalent of to share with the Bank of Italy contracts to purchase guilders to the Federal Reserve. These transactions en forward dollars that that institution had entered into with abled the Federal Reserve to settle outstanding commit Italian commercial banks in order to encourage a re ments in the respective currencies and provided marks to export of dollars during the period of heavy balance-ofthe Treasury to meet possible future operational needs. payments surpluses. The initial value of the contracts In June, against the background of substantial earlier taken over by the United States Treasury in January 1962 movements of funds from Italy to Switzerland, the Bank amounted to $200 million. Total United States commit of Italy negotiated a $100 million equivalent lira-Swiss ments to supply forward lire rose to a peak of $500 million franc swap with the Swiss National Bank. In this instance, in August of that year, and thereafter— with some fluctua too, the entire Swiss franc proceeds were sold by the tions— generally declined as Italian commercial banks Bank of Italy to the Federal Reserve for dollars. (The reduced their dollar holdings. The last of the contracts System then employed these Swiss francs to liquidate out were reacquired by the Italian authorities in M arch of standing Swiss franc indebtedness to the Swiss National this year, thus fully liquidating the Treasury’s forward B ank.) With its dollar reserve position reinforced not only lira commitments. by bilateral credits and the Fund drawing, but also by net accruals of dollars in the exchange market, the Bank of S W IS S F R A M C Italy proceeded to repay during the second quarter of the Very heavy inflows of short-term funds into Switzerland year all its previous drawings of $150 million on the Federal Reserve as well as the short-term credit drawn under the at the end of 1963 reflected the usual window-dressing facility provided by the German Federal Bank. In addition, operations by Swiss commercial banks. To absorb part of about one third of the $100 million credit from the Swiss the resultant accummulation of dollars on the books of the National Bank had also been repaid by the end of August. Swiss National Bank, the Federal Reserve increased its (No drawings had been made under the credit facilities swap drawings in Swiss francs on the BIS from $95 million made available by the United States Treasury or the Bank to $145 million equivalent and on the Swiss National Bank of England. N or has there as yet been any utilization of from $55 million to $75 million, for a combined total of the credits made available by the Commodity Credit Cor $220 million. Prior to this year-end bulge, outstanding poration or the Export-Im port Bank, although use of these drawings during most of the last quarter ranged around $150 million. During the autumn, the Treasury had also credits is expected to begin shortly.) One of the most satisfactory aspects of this display of entered into forward transactions in Swiss francs of nearly international cooperation in beating back a speculative $150 million equivalent. attack on the Italian lira was that the provision of massive Some easing of the Swiss franc developed after the credit assistance to Italy more or less coincided with a year end, but continuing inflows of capital during the first turning point in the Italian economic and financial scene. quarter limited the usual seasonal weakening. Moreover, During the first quarter of 1964, the Italian balance of pay interest rates in Switzerland had risen rapidly from the fall ments had registered a deficit of $436 million. This turned of 1963 through the first quarter of 1964. The rate paid by into a surplus of $226 million in the second quarter, as the Swiss banks on three-month time deposits, which had corrective policy measures previously initiated by the ranged from about 2.65 per cent to 3 per cent during most Italian authorities began to take effect and as a reversal of 1963, moved up to 3.25 per cent in M arch, while Euroin the leads and lags brought about the covering of short Swiss franc deposit rates, which closely reflect credit con positions in lire. In early July, a governmental crisis gene ditions in Switzerland, advanced V2 of a percentage point rated a temporary speculative flurry, but forceful opera to 3.62 per cent during the first quarter. Consequently, tions in the forward market by the Bank of Italy through opportunities for the Federal Reserve to acquire Swiss the agency of the Federal Reserve Bank of New York francs for settlement of its outstanding Swiss franc indebted provided reassurance and speculation quickly subsided. ness developed more slowly than expected, and by midIndeed, Italy gained reserves during the summer, and on April only $45 million equivalent of its drawings on the September 1 repaid $65 million of its $225 million IM F BIS had been paid off. drawing. This repayment reduced the Fund’s holdings of In April a severe tightening of the Swiss credit market FEDERAL RESERVE RANK OF NEW YORK pushed interest rates up further and drove the Swiss franc to the ceiling once more, and the Swiss National Bank was forced to take in a sizable amount of dollars at that level. Part of this inflow was absorbed when the Federal Reserve made a new drawing of $25 million equivalent on its swap line with the Swiss National Bank, thus putting the Federal Reserve debt in Swiss francs back to $200 million. In order to curb inflationary pressures in the Swiss economy, the Swiss Government in M arch had placed re strictions on construction activity and had authorized the Swiss National Bank to introduce measures limiting credit expansion by banks and discouraging the inflow of for eign funds. Similar arrangements between the central bank and the commercial banks had been in effect for several years on a voluntary basis. The gentleman’s agree ments concerning restrictions on domestic credit growth took on legal force in May 1964. In an effort to halt the heavy inflow of foreign capital and the rise in dollar holdings of the Swiss National Bank, restraints on the inflow of funds from abroad were implemented at the end of M arch. All Swiss banking institutions were forbidden to pay interest on foreign deposits received after January 1, 1964 and were required to invest in foreign currency assets or deposit with the Swiss National Bank any net in crease after January 1, 1964 in their Swiss franc liabilities to foreigners. While these measures were successful in halting fur ther inflows of foreign funds, they did not of course pre vent the repatriation by Swiss banks of funds already held abroad. Since the credit squeeze in Switzerland was continuing, there seemed little likelihood of an early re versal of the previous inflow of funds. As a result, follow ing the Federal Reserve swap drawing in April, the Swiss and United States authorities agreed on a combination of special measures to liquidate all the Federal Reserve swap drawings and reduce the Treasury’s outstanding forward contracts. The first step was taken in May, when the United States Treasury issued to the BIS a $70 million Swiss franc bond. To acquire the Swiss francs, the BIS had issued threemonth promissory notes to Swiss banks. The Swiss franc proceeds of this bond issue were then sold to the Federal Reserve, which immediately repaid an equivalent amount of its Swiss franc debt to the BIS. The second step came in June when, as previously noted, the Bank of Italy entered into a $100 million lira-Swiss franc swap agree ment with the Swiss National Bank. The Bank of Italy sold the Swiss francs it acquired to the Federal R e serve, which retired the remainder of its Swiss franc debt to the Swiss National Bank. At the end of June the Federal 169 Reserve paid off the remaining $30 million of its swap drawings with the BIS with francs obtained in conjunction with a sale of gold to the Swiss National Bank by the Treas ury. The Federal Reserve swap arrangements with both the BIS and the Swiss National Bank thus reverted to a stand-by basis. Meanwhile, interest rates in Switzerland had risen still further as the heavy demands imposed on the Swiss money and capital markets by the continuing high level of eco nomic activity further squeezed the liquidity position of Swiss banks and firms. The interest rate on three-month deposits reached 3Yi per cent in June, an increase of about % per cent over the previous year, while the average yield on government bonds moved up to 4.05 per cent, compared with 3.15 per cent a year earlier. To relieve the squeeze on their liquidity positions, and to satisfy midyear window-dressing needs, the Swiss commercial banks made further sizable repatriations of funds during June. These commercial bank operations caused the Swiss National Bank once again to take in a sizable amount of dollars. In July the unwinding of some window-dressing operations and an easing of the Swiss money m arket brought about only a partial reversal of the previous inflows. In these circumstances, the United States Treasury issued to the Swiss National Bank on August 4 an additional Swiss franc bond in the amount of $52 million equivalent and used the proceeds to absorb an equivalent amount of dol lars on the books of the Swiss National Bank. At the same time, the Swiss National Bank placed with the Swiss com mercial banks an equivalent amount of “sterilization rescriptions” (a form of short-term paper issued by the Swiss Confederation) to reduce excess domestic liquidity. As noted above, the United States Treasury during the latter half of 1963 had sold in the market a total of nearly $150 million equivalent of three-month forward Swiss francs in order to encourage outward investment flows by the Swiss commercial banks. By the end of the year, the Treasury’s forward commitments had been re duced to $121 million. Additional sales of $9 million equivalent occurred in January, and the outstanding con tracts were rolled over at maturity until May 1964, when $9 million equivalent was paid off. An additional $19 million was liquidated in June, and in August, at United States Treasury initiative, a further $19 million was paid off at maturity. This left a total of $83 million still outstanding. In addition, there was outstanding $38 million equivalent in Treasury Swiss franc liabilities, arising from swaps of sterling for Swiss francs with the BIS. During this period, a $17 million swap of lire for Swiss francs was liquidated and a $15 million sterling-Swiss franc swap was sub stituted. 170 MONTHLY REVIEW, SEPTEMBER 1964 Taking the Federal Reserve swap drawings and Treasury forward commitments together, temporary financing had reached a maximum of nearly $350 million at the end of 1963. By the end of August 1964, the swap drawings had been entirely paid off and, as indicated above, Treasury for ward commitments in the market had been reduced to $83 million. A good part of this reduction in short-term Swiss franc commitments, however, was achieved through the issuance of $122 million equivalent of Swiss franc bonds, the sale of $30 million in gold to the Swiss National Bank, and the purchases of Swiss francs from the Swiss National Bank, thereby increasing that Bank’s dollar holdings. N E T H E R L A N D S G U ILD ER The Netherlands guilder declined during the first two months of 1964 as the Dutch trade position began to weaken, and toward the end of M arch the Federal Reserve Bank of New York was able to purchase for System account $5 million equivalent of guilders from the Netherlands Bank. A t about the same time, the System acquired $20.1 million equivalent of guilders from the Bank of Italy, which had taken guilders as part of its drawing on the IM F. With these guilder funds, the Federal Reserve on April 2 paid off at maturity its outstanding $25 million equivalent swap drawing from the Netherlands Bank, thus placing the entire $100 million swap arrangement on a stand-by basis. During most of the second quarter the guilder con tinued to decline as the Dutch trade deficit increased. In early June the Netherlands Bank raised its discount rate by V2 per cent to AV2 per cent. The money market then began to tighten, and in July Dutch commercial banks repatriated funds, causing a strengthening of the spot guilder. The Netherlands Bank took in dollars in m oderat ing the rise in the rate, and during the first week in August the Federal Reserve drew $20 million equivalent of guilders under the swap line and immediately used the guilders to absorb some of the Netherlands Bank’s dollar accruals. On August 10, the Federal Reserve drew another $10 million equivalent of guilders in anticipation of possible market operations. Subsequently, the System sold $8 mil lion equivalent to the Netherlands Bank to mop up addi tional dollars held by that Bank. JA PA N E SE YEN During most of the first half of 1964 the Japanese yen remained at or close to its floor, as a continuing increase in Japan’s deficit on current account was covered only in part by long- and short-term capital inflows. The Japanese authorities had initiated a series of restraint measures be ginning in October 1963, and in M arch of this year the Bank of Japan raised its discount rate from 5.84 per cent to 6.57 per cent. In order to avoid further deterioration in their reserve position until the restraint measures should bring about the desired effect, as well as to support con fidence in the yen in connection with the acceptance by Japan on April 1 of Article V III status under the IM F Articles of Agreement, the Bank of Japan on April 30 drew $50 million under the $150 million swap arrange ment with the Federal Reserve— the first use of this facil ity since its inception in October 1963. The pressure on reserves continued over the summer months; on July 30 the Bank of Japan renewed the $50 million drawing for another three months, and on July 31 drew an additional $30 million under the swap arrangement. In August, how ever, Japanese reserves registered an increase. C A N A D IA N D O L L A R S The spot market for Canadian dollars was relatively quiet through the first half of 1964, but there was con siderable activity in the forward market as a result of grain sales to the Soviet Union. These sales generated heavy demands on the part of grain dealers for Canadian dollars against United States dollars for future delivery. (The contracts with the USSR called for payment in United States dollars, whereas the grain companies had to purchase the wheat from the Canadian W heat Board with Canadian dollars.) After meeting the grain dealers’ de mand— and after covering these forward sales to some ex tent through spot purchases— commercial banks attempted to balance their positions by engaging in swap transactions, selling Canadian dollars spot against forward purchases timed to meet likely calls on their forward commitments to the grain dealers. Consequently, the forward Canadian dollar advanced to a premium while the spot rate tended to decline. In order to offset some of these pressures, the Bank of Canada sold United States dollars spot and purchased them forward, thus providing some counterpart to the commer cial banks’ swap needs. Despite such operations on a sub stantial scale by the Bank of Canada, the forward Canadian dollar remained at a premium and the incentive to move funds from the United States to Canada on a covered basis as measured by the differential on three-month Treas ury bills rose to about 0.34 per cent in the latter part of March. The situation became a source of concern to the United States authorities when it became evident that funds actually had been moving to Canada in some volume and, with the agreement of the Canadian authorities, the Federal FEDERAL RESERVE BANK OF NEW YORK Reserve began in late M arch to sell Canadian dollars for ward against spot purchases. As it turned out, the pressures on the forward Canadian dollar temporarily subsided, and Federal Reserve swaps in the m arket amounted to only $2 million. The matching of forward exchange commitments with shipment deliveries in connection with the very large grain sales continued to dominate the forward market in Ca nadian dollars through the end of June. Although the threemonth forward Canadian dollar widened to a premium of well over Va of 1 per cent per annum, the covered differen tial in favor of Canada held below 0.40 per cent as Cana dian short-term interest rates declined, and no further operations by the United States authorities were necessary. By the end of July, Canadian grain shipments to the Soviet Union had been pretty well completed and pres sures on the forward market consequently eased. Then during August, a series of developments actually reversed the pressures in the Canadian dollar market. There was some buying of spot Canadian dollars by Continental in terests at the time of the Viet Nam crisis, and as the spot rate rose in a thin market, Canadian exporters proceeded to sell out United States dollar balances. Also, there were new grain purchases by several Eastern European countries, the effect of which was felt mainly in the spot market. At about the same time, there was a tightening of the Canadian money market and a flow of funds into Canada from the United States. The incentive for interest arbitrage flows was soon eliminated, however, by a sharp rise in the spot Canadian dollar rate and a decline in the forward rate. At the close of the period, the market was in balance. O T H E R C U R R E N C IE S Throughout most of the second quarter, the Belgian franc moved narrowly in a m arket that was essentially in balance, and there was no occasion for either the Federal Reserve or the National Bank of Belgium to employ the swap balances held under the fully drawn swap arrange ment. Early in July, however, the Belgian franc strength ened following the announcement of new measures de signed to curb the growth of credit in Belgium. On July 3 the National Bank of Belgium raised its discount rate by V2 percentage point to 4 % per cent and announced that effec tive August 17 it would impose a cash reserve requirement against commercial bank deposits for the first time. Early in August the Federal Reserve used $7.5 million equivalent of Belgian francs drawn under the swap to absorb dollars on the books of the National Bank of Belgium. The French franc held firmly at its ceiling throughout most of the period, as the French balance of payments con tinued in surplus and there were no Federal Reserve or 171 Treasury operations in the market. As indicated in the fol lowing section, however, the Treasury did effect certain sales of French francs to various countries for repayment to the IM F. These repayments were spread out over a pe riod of several months. Since the Treasury did not wish to leave sizable franc balances uninvested, a swap arrange ment was entered into with the Bank of France, with pro vision for gradual reductions of the swap as the francs were required. There were no Federal Reserve or Treasury operations in Swedish kronor or Austrian schillings during the M archAugust period. IM F D R A W IN G In addition to the exchange operations discussed above, since the beginning of the year the United States Treasury has sold foreign currencies to sixteen different countries— including Canada, India, and a number of Latin American nations— for use in making repurchases from the IMF. (With the F und’s holdings of dollars now in excess of the dollar portion of the United States subscription, the Fund cannot at this time accept further dollars in repayment.) The United States Treasury acquired the foreign currencies sold— predominantly German marks and French francs— through two drawings on the IM F, on February 13 and June 1, in the amount of $125 million equivalent each under the $500 million stand-by agreement with the Fund announced by President Kennedy in July 1963. Of this $250 million equivalent drawn by the United States, the bulk had been utilized by the middle of August. Pending disbursement of remaining balances from the second drawing, the marks were invested by the Treasury in German Treasury bills, and the French francs were returned to the Bank of France by means of the dollar-French franc swap mentioned above. On July 23, the original stand-by agreement expired, and the Treasury announced that it had made a further stand-by arrangement with the IM F for an other year, restoring the amount available to $500 million. The first drawing under the new stand-by arrangement was made on September 1, when the United States drew $50 million in five European currencies. This drawing was occa sioned by Italy’s repayment to the Fund of $65 million. G O LD M A R K E T A N D U N IT E D S T A T E S GO LD T R A N S A C T IO N S Throughout the first eight months of 1964 the London gold m arket was generally stable with prices seldom in excess of $35.09. There were brief periods when political uncertainties generated some speculative buying. In Janu- MONTHLY REVIEW, SEPTEMBER 1964 172 Table IV UNITED STATES NET MONETARY GOLD TRANSACTIONS WITH FOREIGN COUNTRIES AND INTERNATIONAL INSTITUTIONS January-June 1964 In millions of dollars at $35 per fine troy ounce; United States net sales (—), net purchases (-f) First quarter Second quarter — 32.1 1.0 - 101.3 - 200.0 + 200.0 — 23.2 + 28.1 - 101.3 — _ — 1.2 + 109.3 1.2 - 30.0 + 15.0 + 220.9 — 14.5 - -f 95.0 Country Austria .......................................................... Brazil ............................................................ France ......................................................... Germany ...................................................... Italy .............................................................. Switzerland .................................................. Turkey .......................................................... United Kingdom ........................................ All other ...................................................... Net sales or purchases...................... 27.5 ary, for example, private demand for gold picked up in large part because of unsettled conditions in Cyprus and Viet Nam. Early in March, these pressures were rein forced by buying from Italy and gold-fixing prices ad vanced to a high of $35.0986. The pressures quickly abated, however, and in the latter part of March, when the Soviet Union again appeared in the m arket as a seller of gold in connection with renewed grain purchases from the West, the price receded to $35.0586. Although the Soviet Union withdrew from the m arket by the end of April, market supply generally continued to exceed de mand. Early in August the military flare-up in Viet Nam and Cyprus again touched off a brief surge of speculative buying, but these tensions also faded quickly. During the first half of the year, the United States con tinued to acquire sizable amounts of gold through the op eration of the London Gold Pool. Such acquisitions are included in net gold purchases from the United Kingdom, indicated in Table IV, though the Gold Pool component in this figure will vary from one period to the next. Also shown in the table is the triangular gold transaction mentioned earlier, in which $200 million of gold sold to the United States by the Bank of Italy was immediately resold to the German Federal Bank. France, which had a continuing surplus in its balance of payments, remained the largest purchaser of gold from the United States; during the first half of the year French reserves rose some $280 mil lion. On balance, after taking account of sales to domestic users of about $40 million, total United States gold hold ings— including Stabilization Fund holdings as well as the Treasury gold stock— increased by $27 million during the first six months of the year. T h e B u s in e s s S itu a tio n The economy has posted a further good advance since midyear and most newly available evidence continues to be consistent with widely held expectations of further gains to come. In July, industrial production and retail sales each registered rather substantial gains, while significant rises also took place in nonfarm payroll employment and in personal income. At the same time, new orders received by manufacturers of durable goods rose sharply and unfilled orders climbed again. The unemployment rate showed a substantial decline in July to the lowest level since February 1960, but a part of this improvement was reversed in August. Fragmentary data for August show little change in steel ingot production, a slight rise in the rate of automobile assemblies, and an apparent further expansion in retail sales. Several recently com pleted surveys point to continued strength in two sectors of demand. The Commerce Department-Securities and Exchange Commission’s August survey of business capi tal spending plans over the balance of the year shows a further slight rise from the considerable increases over 1963 projected earlier, and the National Industrial Con ference Board’s survey of capital appropriations by large manufacturers reveals a substantial second-quarter rise. In addition, a Census Bureau survey taken in July indicates that consumer buying plans were stronger than a year ago. In the residential construction area, however, leading in dicators continue to suggest a slippage from earlier peak demands. FEDERAL RESERVE BANK OF NEW YORK Although negotiations in the automobile industry for a new labor contract remain unsettled, the old contract has been extended by a few days to September 9, which may enhance the possibility of a settlement without a work stoppage. Such a development would, of course, remove one of the significant uncertainties from the economic horizon. The contract terms which finally emerge from the present negotiations will have an important influence on over-all price stability and thus on the pace and order liness of economic expansion. With regard to the recent past, the index of wholesale prices, after trending down ward over the first half of the year, moved up by 0.4 per centage point in July, but early indications for August on balance suggest little further change. In the retail sector, the consumer price index in July edged up by 0.3 percent age point to reach 108.3 per cent of the 1957-59 average. So far this year, the consumer price index has advanced by 0.8 per cent from the average for the final quarter of 1963, compared with a rise of 0.9 per cent in the corre sponding 1963 period over the final quarter of 1962. 173 C h art I RECENT BUSINESS INDICATORS S e a s o n a lly a d ju ste d P e rc e n t P e rc e n t P R O D U C T IO N , N EW O R D E R S , A N D E M P L O Y M E N T Industrial production, as measured by the Federal R e serve’s seasonally adjusted index, advanced by a full per centage point in July, marking the eleventh month in a row in which a gain has been registered and bringing the index to 132.7 per cent of the 1957-59 average (see Chart I ) . The over-all gain since December amounts to 4.7 per cent, compared with about 5.5 per cent in the comparable period a year earlier. In July, gains were scored by all major industry groups except utilities, where there was a slight decline. The durables sector, however, provided the largest push, mostly reflecting a markedly better than seasonal performance in steel ingot production and stepped-up activity in equipment-producing industries. Production data for August pointed to a modest rise in the rate of automobile assemblies after allowance for sea sonal influence, as producers pushed hard to stock dealers with an adequate supply of the 1965 models which will go on sale in late September. The better than seasonal performance in steel ingot production may also have con tinued into August. One favorable factor in the near-term outlook for pro duction was the substantial 6.6 per cent rise (seasonally adjusted) in new orders received in July by manufacturers of durable goods, following some slippage in May and an essentially unchanged June figure (see Chart I) . The June sluggishness in these orders had reflected reduced book ings in the aircraft and parts industry, which are heavily defense oriented and tend to show erratic month-to-month 1962 1963 1964 Sources: Board of G overnors of the Fedorai Reserve System; United Stotes Departments of Commerce and Labor. movements. This decline in June almost counterbalanced gains posted by most other industries. In July, on the other hand, new orders received by the aircraft and parts industry jumped, accounting for over two thirds of the gain in new durables orders. Sizable advances were also posted, however, in the steel and electrical machineryproducing industries. With new orders above shipments in July, the backlog of unfilled durables orders rose by 2.8 per cent (seasonally adjusted) to mark the seventh con secutive m onth of advance. According to the August Commerce Departm entSecurities and Exchange Commission survey, business plans for plant and equipment spending for the year as a whole are now projected at a level 12.7 per cent above such outlays in 1963, while the corresponding M ay survey had indicated a gain of 12 per cent. Most of the small upward revision in spending is planned for the final quar ter of the year. Also, the National Industrial Conference Board reports that capital appropriations of large manu facturing corporations rose sharply, by 21 per cent, be 174 MONTHLY REVIEW, SEPTEMBER 1964 tween the first and the second quarters. This advance more than offset a first-quarter decline and pushed the level of capital appropriations to a record high. The back log of such appropriated but unspent funds, moreover, also rose strongly, for the third consecutive quarter. Nonfarm payroll employment, seasonally adjusted, ad vanced by 138,000 persons in July, the eighth consecutive monthly gain (see C hart I ) . The rate of increase in July was somewhat below the average monthly advance for the first half of the year— a slowdown that partly reflected less push from manufacturing industries and the govern ment sector. Nevertheless, in combination with a decline in the labor force, the unemployment rate dropped in July to 4.9 per cent from 5.3 per cent in June. This was the first time that the rate had gone below 5 per cent since October 1957, except for February 1960, and all major unemployment rate categories shared in the July improve ment. In August, according to the Census Bureau’s house hold survey, total farm and nonfarm employment registered a modest decline, while the civilian labor force rose slightly. As a result, the unemployment rate increased to 5.1 per cent; nevertheless, the August rate continued within the range that has prevailed over the previous three months, which in turn represents a distinct improvement over the earlier months of the year. total retail sales, largely on strength from the automotive group. Fragmentary data for August suggest that sales in that month may have moved up further, as new car dealers strove to liquidate an unusually high inventory of 1964 model automobiles. With regard to near-term prospects for further expan sion in retail sales, it is noteworthy that consumer inten tions to spend within the next six months continue to appear strong (see Chart II ). According to the latest survey by the Census Bureau, the proportion of con sumers planning as of mid-July to buy new cars was essen tially the same as in January and April, and appreciably above July of 1963. Plans to buy household durables, moreover, were above the reading of a year ago, and July 1964 marked the first time since 1959, when the survey was first taken, that such plans did not show a decline between April and July. The continued, though moderate, expansion in personal income, which rose by $1.5 bil lion in July, combined with the relatively high rate of personal savings and slower rate of increase in consumer instalment credit, would seem to suggest that consumers have the financial support to carry out their current buy ing plans. Chart II R E SID E N T IA L . C O N S T R U C T IO N A N D R E TA IL S A L E S Recent developments in residential construction con tinue to suggest some leveling-off in demand in this sector. After a strong performance in the first quarter, such leading indicators of residential construction activity as nonfarm housing starts and building permits moved substantially lower in the second quarter. Moreover, both nonfarm housing starts and building permits also declined in July, with starts off by 4.8 per cent to the lowest level since August 1963 and permits down by 6 per cent. R e flecting the recent movements in starts and permits, out lays for residential construction in the second quarter, at an average seasonally adjusted annual rate of $26.9 billion, were significantly below the average of $27.5 bil lion for the first quarter. The seasonally adjusted annual rate for July-August was about equal to the average for the second quarter. After moving down by 0.5 per cent in June, retail sales showed renewed strength in July, rising 1.2 per cent to reach $21.9 billion (seasonally adjusted), a new high. Durables sales recouped a good part of their June decline to account for nearly three fifths of the July advance in CONSUMER INTENTIONS TO BUY NEW AUTOMOBILES AND HOUSEHOLD DURABLES WITHIN SIX MONTHS Per cent Per cent Note: Buying plans are expressed as the ratio of the number of families who indicate they intend to buy to the total number of families in the survey. Source: United States Department of Commerce, Bureau of the Census. 175 FEDERAL RESERVE BANK OF NEW YORK T h e M o n e y M a rk et in A u g u st The money market was comfortable during the opening days of August, but a generally firm tone prevailed there after. The slightly easier tone at the beginning of the month, which had carried over from the end of July, largely re flected an easing of reserve pressures at the major money center banks. Subsequently, however, these banks again came under pressure, as they expanded their loans to Gov ernment securities dealers whose financing needs were sharply enlarged in connection with the Treasury’s late July and early August financing operations. Member bank borrowings from the Federal Reserve, after having averaged on the low side in the final weeks of July and the first week of August, were somewhat higher over the rest of the month. Federal funds traded predominantly at 2>Vz per cent during the month, while rates posted by the m ajor New York City banks on new and renewal call loans to Gov ernment securities dealers were generally in a 33A to 3% per cent range. Offering rates for new time certificates of deposit issued by leading New York City banks were little changed in August. After having edged lower around the end of July, the rates at which three- and six-month certificates of deposit traded in the secondary market tended slightly higher early in August and fluctuated nar rowly thereafter. Treasury bill rates rose irregularly at the beginning of the month in a somewhat cautious atmos phere. However, a more confident tone soon reappeared when good demand materialized at the slightly higher yield levels. Rates fluctuated narrowly during most of the last two thirds of the month, tending downward toward the close. After advancing in July, prices of Government notes and bonds continued to rise in early August. Subsequently prices moved in a narrow range, despite international po litical tensions. Toward the close of the month, most prices drifted lower, reflecting domestic economic buoyancy and renewed concern regarding the United States balance of payments. Elsewhere in the bond market, prices of cor porate issues and tax-exempt bonds were little changed over the month. BANK RESERVES M arket factors absorbed $554 million of member bank reserves, on balance, over the four weeks ended August 26. Reserve drains were concentrated in the first two weeks of the period when currency outside banks, Treas- CHANGES IN FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, AUGUST 1964 In millions of dollars; (+ ) denotes increase, (—) decrease in excess reserves Daily averages— week ended Factor Operating transactions Treasury operations* .................................... Federal Reserve float .................................... Currency in circulation ............................... Gold and foreign account ........................... Other deposits, and other Federal Reserve accounts (n e t) t ............................. Aug. 5 Aug. 12 Aug. — 55 — 166 — 71 __ 5 — 188 - f 94 — 229 __ 4 + 41 -f- 470 41 __ 4 + 4- 7 T o ta l.................................. — 289 Direct Federal Reserve credit transactions Open market operations Purchases or sa lesj Government securities .................... .. Bankers' acceptances ........................... Repurchase agreements Government securities ......... .. Bankers' acceptances ........................... Member bank borrowings ........................... Other loans, discounts, and advances . . - f 623 Aug. 26 19 + ^^2 + 115 Net changes — 4— — 200 93 1loQ*4 13 25 5 ni — 11U .L — 303 + 513 *»— JUOU -f- 117 — 242 __ 1 + 74 __ 2 + 572 __ 2 + 122 — 39 — 18 4 - 150 41 + 1 64 — 29 + + 81 2 - f 168 47 ■f 116 — 2 — 300 — 25 __ 98 + 677 - f 407 — 666 -f- 245 + 663 - f 388 — 153 4 - 104 — 66 — 153 + 137 — + 44 79 + 295 — 3 Totai reserves§ ................................................... .. + 235 Effect of change in required re*erves§ . . — 252 + 38 -j- 87 — 16 — 69 + + 35 51 -j- 292 — 183 Excess reserved 17 + 125 — 85 + 86 + 109 260 351 91 376 476 100 278 391 113 T o t a l............................ Member bank reserves W ith Federal Reserve Banks .............. Cash allow ed as reserves! . . . . . . . . . . . . . ................................................. Daily average level of member bank: Borrowings from Reserve B anks ............. E xcess reserves § ............................................ Free reserves § .......................................... .. — 4- + 51 1 Note: Because of rounding, figures do not necessarily add to totals. * Includes changes in Treasury currency and cash, t Includes assets denom inated in foreign currencies. % May also include redemptions. § These figures are estim ated. J| Average for four weeks ended August 28, 1964. 329 477 148 31111 424|| 113|| 176 MONTHLY REVIEW, SEPTEMBER 1964 ury deposits with the Federal Reserve Banks, and required reserves all expanded. In contrast, during the week ended August 19 m arket factors provided a substantial volume of reserves primarily as a result of the sharp midmonth rise in float coupled with a reflux of currency to the banking system. In the final statement period of the month, market factors again absorbed reserves as float contracted. Moving counter to fluctuations in market factors, Sys tem open m arket operations provided reserves in early August, withdrew reserves over the midmonth period, and supplied reserves in the final week of the period. Over the four-week period as a whole, the weekly average of System outright holdings of Government securities rose by $572 million, while average holdings of Government securities under repurchase agreements declined by $39 million. Average total System holdings of bankers’ acceptances de creased by $20 million. From Wednesday, July 29, through Wednesday, August 26, System holdings of Government securities maturing in less than one year rose by $2,025 million, while holdings maturing in more than one year contracted by $1,758 million, largely reflecting an exchange of holdings of the maturing August 15 issues and maturity shifts within the portfolio. From August 5 through August 12, a somewhat more hesitant atmosphere briefly emerged in the market, partly in response to developments in Southeast Asia and in the M editerranean area. The cautious tone also reflected re newed uncertainty over the balance-of-payments outlook and future domestic price stability. Slightly expanded offerings encountered only modest investment demand, and prices of notes and bonds receded. Selling pressure remained very moderate, however, and price losses were small. Declines centered in the 2 Vi per cent wartime issues — which were in supply on swaps into higher coupon issues — and in selected long-term bonds. With the immediate concern over the international situation subsiding toward midmonth, an improved tone emerged in the market. Offerings contracted and a fairly good investment demand developed for high coupon issues, particularly for the 4Vs per cent bonds of 1973, which were in demand both out right and on switching transactions. Moderate interest in the new 3% per cent notes of 1966 was also evident. Accord ingly, from August 13 through August 21, prices of notes and bonds edged irregularly higher in light trading. There after, a more hesitant tone crept into the m arket as invest ment demand receded as often happens in August. Contrib uting to the change in atmosphere were further signs of continuing strength in the domestic economy and some T H E G O V E R N M E N T SE C U R IT IE S M A R K E T concern about balance-of-payments developments. In the m arket for Government notes and bonds, prices In the Treasury bill market, rates moved irregularly edged higher during the opening days of the month in a upward through August 11. A hesitant m arket undertone carry-over of earlier investment demand favoring the during this period largely reflected expectations that in active 2V£ per cent wartime issues, the new 4V& per cent vestor interest in bills would contract substantially in bonds of 1973, and the recently reopened 4% per cent August following the heavy reinvestment demand for bills bonds of 1987-92. During this period, the atmosphere generated by the Treasury’s July refunding. With market continued favorable for the August refinancing in which supplies enlarged as a result of the Treasury’s late-July bill the Treasury sold for cash new 3% per cent eighteen- auctions, professional sources were willing sellers of bills month notes to replace securities maturing on August 15.1 at slightly higher rates. A t these yield levels, however, a The terms of the financing, announced late in July, good demand appeared, particularly from public funds, were in line with market expectations and had little ef and over the midmonth period bill rates first steadied and fect on prices of outstanding obligations. Following then receded. In the latter part of August, investment de the close of subscription books on August 3, the Treasury mand moved progressively from shorter maturities, in which announced that subscriptions had totaled $14.9 billion, of some scarcities developed, out beyond the three-month which approximately $4 billion was accepted. Subscrip- area. Longer bills attracted little interest and tended to edge tions from states, political subdivisions, public funds, the higher in rate, partly because of strong corporate interest in Federal Reserve, and other official accounts aggregated $1.9 the auction on August 26 of $1 billion of tax anticipation billion and were allotted in full. Subscriptions from other bills dated September 2 and m aturing on M arch 22, 1965. sources were allotted in full up to $100,000, while larger On August 31, the Treasury announced that it would add subscriptions were subject to a 15 per cent allotment but an additional $100 million to the 91-day bill issues offered assured of a minimum award of $100,000. in the next four weekly auctions and rates backed up slightly after the announcement. Over the month as a whole, rates on most outstanding short-term bills were 2 basis points 1 The details of the offering were discussed in last month’s R eview , lower to 10 basis points higher, while longer bills were p. 149. generally 7 basis points lower to 11 basis points higher. FEDERAL RESERVE BANK OF NEW YORK Bidding was cautious in the August 25 auction of $1 billion of new one-year bills, which resulted in an average issuing rate of 3.688 per cent, compared with an average issuing rate of 3.644 per cent on the comparable issue sold in July. In contrast, bidding was aggressive the next day for $1 billion of new tax anticipation bills, which sold at an average issuing rate of 3.580 per cent. A t the last regular weekly auction of the month held on August 31, average issuing rates were 3.512 per cent for the new three-month issue and 3.629 per cent for the new six-month bill, in each case approximately 4 basis points higher than the average rates at the final weekly auction in July. The newest out standing three-month bill closed the month at 3.50 per cent (b id ), as against 3.47 per cent at the end of July, while the newest outstanding six-month bill was quoted at 3.63 per cent (bid) on August 31, compared with 3.57 per cent at the close of the preceding month. O T H E R S E C U R IT IE S M A R K E T S Prices of new and seasoned corporate bonds were largely unchanged during the month in a quiet “summer m arket”. The volume of new corporate offerings reach ing the market remained seasonally light and underwriters continued to bid aggressively for the scarce supply of new corporate flotations. Subsequent investor demand for these issues was selective, and late in the month, with the approach of September’s heavier calendar, several slowmoving issues were released from syndicate price restric tions. In contrast, several negotiated corporate offerings met with excellent receptions. In the tax-exempt sector, prices of new and outstanding bonds declined slightly early in the month. With investment demand quite limited, dealers’ advertised inventories, swollen by July’s heavy flow of new issues, held close to their high point for the year. Subse 177 quently, however, demand for tax-exempt bonds expanded moderately in response to slight price concessions, and dealers were able to make some progress in reducing their inventories. Toward the end of the month, two negotiated offerings of revenue bonds— one very large and the other medium sized— were enthusiastically received by investors. At the same time, the fairly heavy calendar of forthcoming issues exerted a restraining influence on the market in gen eral. Over the month as a whole, the average yield on Moody’s seasoned Aaa-rated corporate bonds rose by 1 basis point to 4.41 per cent, while the average yield on similarly rated tax-exempt bonds declined by 1 basis point to 3.08 per cent. (These indexes are based on only a limited number of issues.) The volume of new corporate bonds floated in August amounted to approximately $170 million, compared with $230 million in the preceding month and $255 million in August 1963. There were no large corporate issues offered during the month. New tax-exempt flotations in August totaled approximately $705 million, as against $835 million in July 1964 and $710 million in August 1963. The Blue List of tax-exempt securities advertised for sale closed the month at $611 million, compared with $725 million on July 31. The largest new tax-exempt bond issue during the pe riod and one of the largest tax-exempt issues of recent years, a $314 million A -rated issue, consisted of approximately $208 million of 3% per cent term bonds maturing in 2003, and $106 million of serial bonds m aturing from 1970 through 1986. Both the term bonds, which were reoffered to yield 3.85 per cent, and the serial bonds, which were re offered to yield from 3 per cent in 1970 to 3.70 per cent in 1986, were immediately sold and the term bonds moved to a premium bid. Other new corporate and tax-exempt issues floated in August were accorded mixed investor receptions. MONTHLY REVIEW, SEPTEMBER 1964 178 R e c e n t C ap ital M a rk et D e v e lo p m e n ts in t h e U n ited S t a t e s The first eight months of 1964 have been characterized by marked stability in interest rates, despite the steadily growing credit needs of an expanding economy. Indeed, interest rates are currently at levels almost identical to those prevailing at the end of 1963 (see Chart I ) . This stability has been due, among other things, to the con tinued ready availability of bank credit, to the ability of businesses to finance much of their recently increased capital expenditures from internal sources of funds, and to the high rate of financial savings by individuals. Also, Ch art I THE STRUCTURE OF INTEREST RATES IN THE UNITED STATES 1958 I 1 1 1959 1 1 I I 1960 l l I I 1961 1 I I 1962 I 1 1 I 1 1963 I I 1 1 1964 Note: Bank loan d a ta are plotted through June 1964; all other series through A ugust. Sources: Board of G overnors of the Federal Reserve System; First N ational City Bank of New Yo rk; Moody's Investors Service. market expectations have helped to stabilize interest rates this year. A brief and moderate expectations-induced rise in interest rates did occur around the time of the tax cut, reflecting the widespread belief that the resulting stimulus to the economy would lead to a surge of demands in the capital markets, but this rise was reversed when such a surge failed to develop. Since then, a considerable measure of confidence has prevailed in existing interest rate levels. B U S IN E S S C R E D IT D E M A N D S The continuing growth in business sales, coupled with the need to modernize plant and equipment facilities, has resulted in greatly expanded business spending on new productive facilities. Such spending reached an estimated annual rate of $43 billion (seasonally adjusted) in the first half of 1964, exceeding the rate for the same period last year by almost 15 per cent. Nevertheless, business de mands on the credit and equity markets have again been moderate this year as a rising volume of internally generated funds kept pace with the growth of capital ex penditures. Funds available internally— roughly equal to depreciation charges plus retained profits— are estimated, in the case of nonfinancial corporations, to have exceeded total capital expenditures by 6 per cent in the first half of this year. While this percentage excess is smaller than that prevailing over the past two calendar years, it con trasts markedly with earlier years of high capital expendi tures, such as 1956-57, when internally generated funds actually fell short of capital spending by almost 18 per cent. The present high level of internally generated funds is due in part to the growth of both profits and depreciable fixed assets, but businesses are also continuing to benefit greatly from two tax measures adopted in 1962. These measures permitted firms to depreciate many assets over a shorter number of years and to deduct from their current profits tax liability up to 7 per cent of the cost of most types of newly purchased equipment. The 1964 reduction in the corporate profits tax rate from a maximum of 52 per cent to FEDERAL RESERVE BANK OF NEW YORK Chart II COMMERCIAL AND INDUSTRIAL BUSINESS INVESTMENT AND FINANCING B illio n s of d o lla rs 1957 1958 B illio n s o f d o lla rs 1959 1960 1961 1962 1963 1964 Note: A ll figures are seaso n ally adjusted annual rates. Second-quarter 1964 figures 'are preliminary estimates. O Indicates net total of bond and stock issues for periods of net stock redemptions. Source: Board of Governors of the Federal Reserve System. a maximum of 50 per cent did not directly benefit corporate cash positions in the first half of this year, however, be cause Federal taxes on profits earned during the first half of a calendar year are not remitted until the second half. But this tax rate reduction and the scheduled further reduc tion to 48 per cent in 1965 have added to expected future cash flows and may, therefore, have eliminated some cur rent borrowing for future needs that would otherwise have taken place. Because of their ability to generate internally the funds needed for expansion of plant and equipment and working capital, nonfinancial corporations have continued to make only moderate demands on the bond and stock markets. Though net bond and stock issues by these corporations have risen this year, both remain at about the same levels as those reached back in 1957 and 1958 when capital spending was much lower (see Chart I I ) . Despite the recently higher volume of corporate bond 179 financing, the offering yields on new issues continue at historically low levels relative to the yields on United States Government bonds (see Chart I ) . This reflects, in part at least, the relatively small increases in the supply of corpo rate issues and the ever-growing demand for them by in stitutional investors, such as insurance companies and pension funds. These institutions have increasingly domi nated the corporate bond m arket in the postwar period. On the other hand, purchases of corporate bonds by in dividual investors have diminished in importance. New stock issues by nonfinancial corporations in the first and second quarters of this year increased sharply from 1963 when repurchases of shares by these corporations exceeded gross new issues. However, the rise this year reflected two special new issues— the $1.2 billion “rights” offering by the American Telephone and Telegraph Com pany and the $200 million offering by the newly formed Communications Satellite Corporation. Together, these two issues account fully for the total net increase in common stock in the first half of this year. Thus, there was no gen eral return by corporations to the stock market for new funds, despite the fact that stock prices now far exceed the levels prevailing during the 1957-61 period when new stock issues were an important element in corporate finance (see Chart II ). Business demand for short- and intermediate-term credit has also been moderate this year, due to the con tinuing absence of rapid inventory accumulation. Since investment in inventory is typically financed initially by short-term credit, the slow rate of accumulation has again restrained business demand for bank loans— the primary source of inventory financing (see Chart II ). C O N S U M E R FIN A N C E ;! Individuals this year have continued to borrow heavily to finance purchases of homes and consumer goods. With the rise of personal incomes and the cut in income taxes, however, new borrowings have not increased quite so rapidly as in the past two years, and repayments on old debts have accelerated somewhat. Also, individuals this year again added to their financial investments at a sub stantial rate, with some indications that their investment in credit and equity m arket instruments was increasing. Due to rapid increases in consumer instalment debts over the past few years (see Chart III), total repayments on these debts now equal a record 14 per cent of personal disposable income, nearly a full percentage point more than at the beginning of the current business expansion. Never theless, these debts continue to grow, suggesting that households are finding the current burden of repayments 180 MONTHLY REVIEW, SEPTEMBER 1961 to be of manageable proportions. This conclusion also seems to be borne out by the data compiled by the Ameri can Bankers Association on consumer loan delinquencies at commercial banks. Loans with payments past due by thirty days or more now average less than 1.7 per cent of the total, near the low end of the range prevailing in recent years, and markedly below the rate attained in the late 1940’s and early 1950’s, when total consumer debt repay ments ran considerably lower relative to total disposable income and average family income was less. One im portant factor in the continued growth of con sumer credit may be the use of this form of financing by more households. Information in this area is limited to Chart III CONSUMER BORROWING PATTERNS Billions of dollars Billions of dollars Per cent Average of five series * ---------Direct automobile loans Billions of dollars Billions of dollars 25 Expenditures on new residential construction 1* 20 25 15 11 10 Increase in home mortgage debt 5 1957 1958 1959 1960 1961 1962 1963 1964 Note: AH figures except instalment credit and delinquency rates are seasonally adjusted annual rates. ♦ Direct and indirect automobile loans, home appliance, property improvement and personal loans. +1964 figures are preliminary estimates. Sources: Board of Governors of the Federal Reserve System; Department of Commerce; American Bankers Association. surveys of relatively small groups of families— and these can be subject to considerable error— but such studies by the University of Michigan’s Survey Research Center indi cate that the proportion of all households having instal ment debts may have increased by as much as 4 or 5 percentage points from early 1962 to early 1964. If true, this would mean that the increased volume of consumer credit has been spread over more households, or, in other words, that the average indebtedness of debtor households has not increased so much as total outstanding credit. Additional Michigan Survey data do in fact suggest that debtor families are generally not much further in debt relative to their incomes now than they were a few years ago. Thus, the rise in the aggregate repayments ratio mentioned earlier does not appear to be indicative of sub stantially increased borrowing per family. The ready availability of mortgage credit and the rela tively liberal terms offered by lending institutions have made possible further substantial growth in home mort gage debt (see Chart II I). Net borrowing has again increased relative to households’ expenditures on newly constructed residences as lenders continued to finance large percentages of the purchase prices of homes. How ever, other factors, such as borrowing on homes to finance m ajor nonhousing expenditures and the refinancing of older homes at higher prices, are doubtlessly also contrib uting to the sustained growth in home mortgage debts. Despite the strong demand for mortgage credit, the supply of mortgage funds continues to be quite ample. The contract terms on mortgage loans— including interest rates, required downpayments, and years allowed for re payment of loans— all continue to be quite favorable to borrowers. M arket rates of interest on F H A mortgages have held constant this year at the level established in the spring of 1963 following a three-year decline (see Chart I ) . There has been some flattening out this year in the growth of time and savings deposits at commercial banks and savings and loan associations, and this has tended to lessen somewhat the availability of mortgage loans from these im portant sources. Insurance companies have in creased their participation in the market, however, thus helping to offset any tightening of mortgage credit that might have otherwise occurred. The tapering-off in the rate of deposit growth at some savings institutions during the first half of this year co incided with, and may have been partly due to, an increase in the rate of individuals’ purchases of stocks, bonds, and mortgages. These purchases in total ran almost $1.5 bil lion higher in the first half of the year than in the same period last year. Investment in common stock was par ticularly large by comparison with recent years, reflecting FEDERAL RESERVE BANK OF NEW YORK the large offerings by the American Telephone and Tele graph Company and the Communications Satellite Cor poration mentioned earlier. These two issues together ab sorbed about $1 billion of funds from individuals. Finally, the available data indicate that consumers again increased their holdings of demand deposits at a substantial rate in the first half of this year. Together with the lessened but still substantial rate of increase in savings deposits, this suggests that individuals are maintaining a high degree of liquidity, which is a favorable element in the outlook for consumer spending on goods and services. G O V E R N M E N T FIN A N C E State and local governments borrowed slightly less in the bond markets in the first half of this year, with total new issues estimated at about 5 per cent less than the volume marketed in the first half of 1963. Since retirements and repayments rose this year, the net increase in the securities of state and local governments fell about 8 per cent short of the increase during the same period last year. Yet, despite the decline, borrowing by these governments continues at a high level. Two developments that might have been expected to weaken the market for state and local securities occurred during the first half of 1964. First, commercial banks sharply reduced their participation in the market, as indeed they had begun to do toward the end of 1963. These banks, which absorbed fully three fourths of the net in crease in the supply of municipal bonds in 1963, purchased only about 40 per cent of the net increase in the first six months of this year, the lowest share for any half-year period since 1960. Second, the passage of the Federal in come tax reductions early this year tended to lessen some what the attractiveness of the tax-exempt feature of these bonds to both corporate and individual investors. Never theless, the market for municipal securities among high tax-bracket individuals apparently remained broad enough to counter any upward pressures on yields that these developments might have produced. Yields on state and local government securities this year have actually shown only narrow fluctuations about the level existing at the close of 1963. Moreover, the ratio of yields on prime grade municipals to yields on prime grade corporates has con tinued at about 70 per cent, the same relationship that pre vailed on average through 1962 and 1963. The operations of the United States Treasury in the capital markets have been of significant proportions this year. Although publicly held Federal debt actually de clined by almost $2 billion through July, the advance re funding of outstanding issues— that is, the swapping of new IB] long-term securities for outstanding issues with shorter re maining lives— has been used extensively to lengthen the average maturity of the debt.1 Through these operations, the Treasury this year extended the maturity of $12.3 billion of Federal debt, $6.3 billion of which was refunded with new securities having maturities of nine years or more. Due to these advance refundings, the average maturity of marketable Federal debt was lengthened from five years and one month at the beginning of the year to five years and four and one-half months at the end of July — the longest average maturity since 1956. These advance refundings have met with considerable success. The July advance refunding— the largest offer ever made by the Treasury— was accorded an unusually good reception, with subscriptions from the public totaling $9.3 billion or 34.7 per cent of their eligible holdings.2 T H E R O L E O F T H E B A N K IN G S Y S T E M Throughout this year commercial banks have continued to play an im portant though somewhat reduced and changed role in the markets for longer term funds. The decline of bank participation in the market for the obliga tions of state and local governments has already been noted. On the other hand, commercial banks have con tinued to acquire mortgage loans at the record high rate established in 1963. Seasonally adjusted commercial and industrial loans expanded at an annual rate of $4.1 billion (nearly 8 per cent) through July, exceeding the growth rate for the comparable portion of 1963. This, on the whole, is still a modest performance for business loans during a period of economic expansion, reflecting, it ap pears, the already-noted reduced need for external financ ing by these borrowers rather than any unwillingness by banks to extend such loans. Bank loans to consumers rose somewhat less through July of this year than last year, but not significantly so. Again, this seems to reflect a moderate slowing of the growth of demand for these loans, a development which appears to be related to the recent cut in personal income tax rates rather than to any change in bank lending resources or preferences. An im portant factor shaping commercial bank lending 1 For a fuller discussion of the Treasury’s advance refunding op erations, see Ernest Bloch and Joseph Scherer, “Advance Refunding: A Technique of Debt Management”, this Review, December 1962, pp. 169-75. 2 See ‘T h e Money Market in July”, this R eview, August 1964, pp. 148 - 4 9 . 182 MONTHLY REVIEW, SEPTEMBER 1964 and investing practices this year has been the decline of time and savings deposit growth, from 14.7 per cent in 1963 to 10.8 per cent (on a seasonally adjusted annual rate basis) in the first seven months of this year. This slowdown has resulted in part from recent in creases in the interest rates paid by competing savings in stitutions— mostly by mutual savings banks. In this con nection, it will be recalled that regulations of the Federal Reserve Board and the Federal Deposit Insurance Cor poration currently permit commercial banks under their supervision to pay no more than 3Vi per cent on savings deposits of less than one year, and no more than 4 per cent on one-year savings deposits and time certificates and other time deposits with maturities of ninety days or longer. One important reaction by banks to this slackening in time deposit growth has been, as noted earlier, to restrict purchases of state and local obligations. But, on balance, banks still continue to be important investors in the capital markets, where their participation in recent years has had an im portant influence on interest rates. F iftie th A n n iv e r sa r y o f t h e F e d e r a l R e s e r v e S y s t e m E arly P r o b le m s o f C h eck C lea rin g an d C o lle c tio n * The use of checkbook or deposit money was firmly established in this country by the time the Federal Reserve Banks began operations in 1914. Five years earlier a National M onetary Commission study estimated that 95 per cent of the deposits received by banks was in the form of checks. The system of clearing and collecting checks nevertheless left much to be desired. In most m ajor cities the banking community had estab lished adequate facilities for clearing and collecting local checks. But problems arose when checks had to move from one city or region to another. Many banks levied exchange charges on these out-of-town checks— “nonpar collection”. These charges were defended on the ground that payment of out-of-town checks involved costs, in cluding maintenance of out-of-town balances with other banks and the shipment of currency. In an effort to avoid such charges, banks would often send checks to banks with which they had par collection agreements (collection at face value), rather than to the banks on which the checks were drawn. In extreme cases, the results were ludicrous. For example, Governor W. P. G. Harding, one of the original members of the Federal Reserve Board, gave the following illustration: I recall an instance where a national bank in Rochester, New York, sent a check drawn on a bank in North Birmingham, Alabama, to a corre spondent bank in New Y ork City, by which it was sent to a bank in Jacksonville, Florida, which sent it for collection to a bank in Philadelphia, which in turn sent it to a bank in Baltimore, which for warded it to a bank in Cincinnati, which bank sent it to a bank in Birmingham, by which bank final collection was m ade.1 Such circuitous routing was costly for the banking sys tem as a whole, since the intermediate banks were bur dened with unnecessary expenses in the handling of checks. Moreover, some bank customers, confident that checks would wander around for a week or more, drew checks on nonexistent deposits in the expectation of de positing the money before the checks were presented. After the new Reserve Banks opened for business, the necessity of establishing an efficient national clearing and collection facility was quickly recognized, and p ar collec tion became one of the System’s m ajor operational goals. To achieve this end, the costs regarded by banks as justi- * The ninth in a series of historical vignettes appearing during 1 W. P. G. Harding, The Formative Period of the Federal R ethe System’s anniversary year. serve System (Boston, 1925), p. 51. FEDERAL RESERVE BANK OF NEW YORK fieation for exchange charges had to be minimized or eli minated. Since each member bank had to maintain a balance (reserve account) with its Reserve Bank, checks could easily be paid by debiting these accounts, thereby reducing the member bank’s need for correspondent bal ances and cutting the related costs. Thus, with the crea tion of the Federal Reserve System and its centralization of reserve balances, one im portant reason for exchange charges was eliminated in the case of member banks. The Federal Reserve Banks, nonetheless, moved only cautiously toward the goal of actually requiring par col lection. By June 1915, each Federal Reserve Bank had established a system of par check collection for its mem bers. But participation in these clearing systems was vol untary, and by the end of 1915 only 25 per cent of the member banks had agreed to par collection. In 1916 the Reserve Banks began to absorb the charges on currency shipments from member banks to cover re serve deficiencies caused by check clearance. This elimi 183 nated a second cost justification for exchange charges. Thereupon and in the same year the Federal Reserve Board adopted a regulation requiring member banks to pay at par all checks drawn upon themselves and pre sented by the Reserve Banks. To broaden the par collection system further, Congress amended the Federal Reserve A ct in 1917 to permit a nonmember bank to use the System’s collection facilities, provided it maintained a clearing balance at its district Reserve Bank and paid at par checks received from the Reserve Bank. These early efforts to establish a national par collec tion system were quite successful. By 1921, all member banks and 91 per cent of some 20,000 nonmember banks were paying checks at par. Today, in addition to the 6,100 member banks, there are 5,800 nonmember banks clearing at par, 125 of which keep clearing balances at a Reserve Bank. There are still some 1,600 nonmember banks which do not remit at par.
@FedFRASER