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MONTHLY R E V I E W
SEPTEMBER

1966

Contents
Treasury and Federal Reserve Foreign
Exchange Operations, by Charles A . Coombs. .. 191
The Business Situation ............................................... 199
The Money and Bond Markets in August .............. 203
Federal Reserve System Policy Statement ............ 209

FEDERAL RESERVE BANK OF NEW YORK

191

T reasu ry and Federal R eserve Foreign Exchange Operations*
By C ha r les A. C o o m bs

During the past six months, the international financial
system was again subjected to considerable buffeting,
particularly during the first three weeks of July when
speculation against sterling reached major proportions.
The impact of these pressures was cushioned, however, by
use of the Federal Reserve reciprocal currency network
and other central bank credit arrangements which, in the
case of sterling, provided the time needed by the British
Government to plan and put into effect the sweeping cor­
rective program announced on July 20. By late August,
the sterling and other exchange markets had settled down
to reasonably well-balanced and orderly trading but in an
atmosphere of continuing anxiety.
Against this background of market uncertainty, the
Federal Reserve broadened out earlier discussions of in­
creases in several of the swap lines to negotiation of a
general expansion of virtually the entire network. The gen­
eral objective of these negotiations was to increase the
reciprocal credit facilities available, both to the Federal
Reserve and to its central bank partners, to levels well
above the size of any routine drawings that might rea­
sonably be expected and thus to create a broad margin
of safety against any unforeseeable threats to international
currency stability. As a result of these negotiations, the
Federal Reserve swap network has been enlarged from
$2.8 billion to $4.5 billion.
Partly due to the backwash of the speculative pressures
on sterling and partly reflecting seasonal payments pat­
terns, the Federal Reserve made several drawings on the

reciprocal currency lines during July and August in order
to absorb flows of dollars to certain continental European
central banks. A total of $150 million equivalent of Swiss
francs was drawn in July under the arrangements with the
Swiss National Bank and the Bank for International Set­
tlements (BIS); drawings also were made under the
arrangements with the Netherlands Bank in the amount
of $65 million equivalent, with the National Bank of
Belgium for $30 million equivalent, and with the Bank of
Italy for $225 million equivalent. In late August the entire

Table I
FED ER AL RESERVE RECIPROCAL CUR R EN C Y A R R ANG EM ENTS
A N D COMMITMENTS
Amount of facility
Institution

February 28,
1966

September 15,
1966

System
commitments
August 31,
1966

in millions of dollars equivalent
Austrian National Bank .........................

50

100

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

100

150

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

250

500

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

750

1,350

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

100

100

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

250

400

20

600

250

450

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

100

150

Bank of S w e d e n ........................................

50

100

Swiss National B a n k ...............................




450

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

* This is the ninth in a series of reports by the Vice President in
charge of the Foreign function of the Federal Reserve Bank of
New York and Special Manager, System Open Market Account.
The Bank acts as agent for both the Treasury and the Federal Re­
serve System in the conduct of foreign exchange operations.

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

150

200

75

Bank for International Settlements. ..

300*

400*

75

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

2,800

4,500

65

235

* H all is available in Swiss francs and half in other European currencies.

192

MONTHLY REVIEW, SEPTEMBER 1966
Table II
O U T ST A N D IN G U N IT E D STATES TR EA SU R Y SECURITIES
FO REIGN CUR R EN C Y SERIES
In millions o f dollars equivalent

Issued to

Amount
out­
standing
January 1,
1966

Austrian National Bank.......

1

II

JulyAugust

— 25.2

100.7

N ational Bank o f Belgium....

Redemptions— 1966

75.5*

30.2

German Federal Bank .......

602.1

Bank o f Italy .........................

30.2
— 100.6

— 50.3

349.5

— 23.2

257.3

— 100.6

— 23.0

211.1

— 148.9

— 73.3

883.8

124.8

Swiss N ational Bank............
Bank for International
Settlem entsf .............................

1,207.8

124.8

92.6

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

Amount
out­
standing
August 31,
1966

92.6
— 100.6

Note: D iscrepancies in amounts are due to valuation adjustments
and rounding.
* $25.2 million equivalent redeemed September 6.
f Denominated in Swiss francs.

drawing on the Bank of Italy was repaid from a United
States drawing of lire from the International Monetary
Fund (IM F), and a repayment of $10 million was made
on the drawing from the National Bank of Belgium. As
of August 31, therefore, the total outstanding drawings
by the Federal Reserve amounted to $235 million.
During the course of the late spring and summer
months, the Bank of England drew on the swap line with
the Federal Reserve, and $300 million remained outstand­
ing as of August 31. With the increase in the Federal
Reserve-Bank of England facility to $1,350 million, there
thus remains available to Britain somewhat more than $1
billion of unused credit facilities under this arrangement.
Moreover, on September 13 the Bank of England an­
nounced the negotiation of new facilities with other cen­
tral banks. Apart from the new facilities the Bank of
England still has at its disposal important unused facilities
arranged previously. Finally, in August the BIS drew
$75 million from the Federal Reserve under the recipro­
cal credit facility providing for drawings against Euro­
pean currencies other than Swiss francs.
In April and May, before the exchange markets became
disturbed by flows of volatile funds, the United States
Treasury also made further substantial progress in retiring
outstanding obligations in the foreign currency series.
Beginning in the summer of 1965, a good start had been
made in repaying German mark-denominated obligations
of the Treasury as the German balance of payments
moved into deficit, and further progress continued through




July 1 by which time the total mark obligations outstand­
ing had been reduced from a peak of $679 million to $350
million. In addition, opportunities appeared to acquire
Swiss francs and Austrian schillings, and repayments of
$46 million of Swiss franc securities and $50 million of
Austrian schilling securities were effected. As a result,
such Treasury foreign currency obligations were reduced
on balance by $400.2 million equivalent from the peak
of $1,259.1 million in July 1965 to $858.9 million equiva­
lent on September 6, 1966. Since the Treasury regards
such foreign currency obligations only as a means of fi­
nancing temporary balance-of-payments deficits, it natu­
rally takes advantage of every market opportunity to retire
such obligations at maturity or, in certain circumstances,
to effect repayment in advance of maturity.
During the period under review, the Bank of Italy con­
tinued its cooperative efforts to minimize the impact
on world financial markets of Italy’s heavy balance-ofpayments surplus. As previously noted, the Federal Re­
serve made drawings of $225 million in Italian lire on
the swap line of the Bank of Italy in July and early Au­
gust, and this swap drawing was liquidated in August. The
lire needed to repay the Bank of Italy were acquired by
a United States Treasury drawing of $250 million equiva­
lent of lire from the IMF. In order to insure that the
Fund’s supply of lire would be adequate to finance such a
United States drawing, the IMF, whose regular lira hold­
ings were at a low level, arranged to borrow from Italy
the lire needed for the United States drawing. This trans­
action was of material benefit to the United States and
Italy and demonstrates the flexible manner in which the
Fund can assist reserve currency countries as well as other
countries in financing their balance-of-payments surpluses
and deficits.
ST E R LIN G

Sterling enjoyed a six-month period of recovery, follow­
ing the announcement of new international support for the
pound on September 10, 1965. As dollars flowed back to
the Bank of England between September and February
1966, the bank repaid in its entirety $890 million in short­
term credit received from the Federal Reserve and the
United States Treasury and, in addition, succeeded in
liquidating a substantial part of its forward exchange
commitments. Beginning in late February, however, ster­
ling began to weaken once again, and by July the pressures
had reached crisis proportions. Indeed, even when the
British Government reacted to the massive attack on the
pound by announcing on July 20 a profound and farreaching austerity program, the exchange markets were

FEDERAL RESERVE BANK OF NEW YORK

so demoralized after two years of almost continuous
tension that there was no immediate recovery in sterling.
To be sure, the intense selling wave was stemmed, but
market sentiment remained extremely cautious and after
a brief upward surge the sterling rate again declined. By
early September, however, there was evidence that the
British Government’s determination to defend sterling
would receive broad public support and that the program
was already beginning to show results.
At the end of February the sterling rate moved be­
low par for the first time since September 1965, as the
exchange markets became more cautious in view of the
disappointing January trade results and the impending
British general election scheduled for late March. These
uncertainties were reflected particularly in a reduced
volume of sterling trading and an increased vulnerability
of the spot rate to any downward pressures. When the
sterling rate dropped very sharply on March 9, to
$2.7930, the Federal Reserve entered the market with
heavy bids for sterling. This reminder of continued
United States official support quickly reassured the mar­
ket, and sterling rebounded to about $2.7960 on the
following day. Over succeeding weeks, however, the
pound again eased, as the uncertainties generated by the
approaching election were reinforced by an increasing
stringency in the Euro-dollar market— a development that
was to intensify in coming months and exert recurrent
pressure on sterling as funds flowed from London.
The Labor Party’s decisive victory at the polls on
March 30 produced little reaction in the exchange markets
since this result had long been anticipated. Indeed, the
markets remained relatively quiet throughout April, await­
ing Chancellor Callaghan’s new budget. When the budget
was announced, however, the market interpreted it as
being only moderately restrictive, with the principal pro­
visions not taking effect until the fall, and initially there
was some selling of sterling. With support from both the
Bank of England and this Bank, the market soon re­
gained its equilibrium, but it remained vulnerable to any
new setbacks.
In this atmosphere, the outbreak of the British seamen’s
strike in mid-May was a devastating blow. Sterling quickly
declined to about $2.7900 in heavy trading and, as
the strike dragged on, the market became increasingly
apprehensive. The announcement of a large reserve de­
cline in May heightened the general tension, and the first
of a series of intensive and prolonged selling waves began
on June 3. Relief from these pressures was provided
temporarily by the announcement in mid-June that the
short-term credits from European central banks which
had formed part of the September 1965 arrangements in




193

support of the pound had now been placed on a continuing
basis, this time including French participation. The Fed­
eral Reserve and United States Treasury participation in
the September 1965 arrangements continues to be avail­
able to the United Kingdom alongside these other facilities.
The respite for sterling provided by the announcement
of this arrangement was short-lived, however, as increas­
ing stringency in the Euro-dollar market left British interest
rates not fully competitive, with consequent outflows from
London in late June. While spot sterling came under
pressure, forward sterling quotations narrowed and a
sizable arbitrage incentive in favor of the United Kingdom
developed in relation to short-term instruments in the New
York market. Consequently, the Federal Reserve Bank of
New York, with the agreement of the Bank of England,
undertook market swap transactions in which, for System
and Treasury accounts, it bought a total of $66.6 million
equivalent of sterling spot and sold it for delivery onemonth forward. This operation both reduced the arbitrage
incentive to shift funds from New York and at the same
time eased exchange market pressures and bolstered spot
sterling quotations.
As the maritime strike continued and the situation in
Rhodesia remained unresolved, market sentiment steadily
deteriorated. Despite a 9 per cent rise in exports in the
five months prior to the outbreak of the strike, the United
Kingdom’s trade account had not improved significantly
over the corresponding months of 1965 as import demand
had remained abnormally high. Moreover, the figures re­
leased at the end of June indicated that in the preceding
four months, British reserves had declined $372 million,
even after recourse to central bank assistance. In addition,
uneasiness was heightened by evidence of dispute within
the Labor Party over the proposed tightening of the
incomes policy, an important element in the long-term
resolution of Great Britain’s payments difficulties. The
resignation from the government of Mr. Frank Cousins, a
veteran trade union leader, proved particularly disturbing
to market confidence.
Selling pressures on sterling intensified, reaching very
heavy proportions in mid-July. In the face of these sales,
the Bank of England continued to provide firm support
for the pound in both spot and forward markets, and on
July 14 raised its discount rate from 6 per cent to 7 per
cent and doubled the special deposits required of the
London and Scottish banks. The market, however,
shrugged off the bank rate increase as merely a technical
adjustment to rising interest rate levels abroad. That same
afternoon Prime Minister Wilson, in speaking to Par­
liament, confirmed that Britain was faced with a new
financial crisis and warned that additional measures would

194

MONTHLY REVIEW, SEPTEMBER 1966

be taken by the government. As tension mounted, ster­ early March, when the Swiss franc fell to $0.2304Vs, the
ling was heavily sold in both the spot and forward mar­ Swiss National Bank sold dollars to moderate the rate
kets, but determined resistance by the Bank of England decline and replenished its dollar holdings by selling Swiss
prevented the market situation from getting out of hand. francs to the Federal Reserve and United States Treasury.
From February through early April, the United States
Against this background, the British Government on
July 20 introduced a massive austerity program that called authorities bought a total of $118 million equivalent of
for a wage freeze, restraint on prices and dividends, addi­ Swiss francs. With these francs, the Federal Reserve
tional taxes, reduced travel allowances, and further curbs System fully repaid its $40 million equivalent German
on public expenditures both at home and overseas. The mark-Swiss franc swap with the BIS, while the United
new program clearly strikes at the problem of excessive States Treasury liquidated a similar swap for $15 mil­
domestic demand and, given adequate time, should prove lion equivalent (see this Review, March 1966). The
effective. Reflecting the confidence of the United States System temporarily added $46 million equivalent to its
Government that the British program could accomplish its Swiss franc balances, simultaneously selling these Swiss
objectives, the Federal Reserve moved into the sterling francs forward to the Treasury for delivery on May 16 and
market shortly after the British Government’s announce­ July 20, on which dates the Treasury repaid at maturity
ment on July 20 in order to stem, and if possible reverse, two Swiss franc-denominated securities issued to the Swiss
the drain on the Bank of England’s reserves. By July 22, National Bank as fiscal agent for the Swiss Confederation.
the sterling rate had recovered from $2.7866 immediately (These repayments reduced the amount of such commit­
before announcement of the new program to a level above ments from $349.9 million to $303.7 million equivalent.)
At the same time, the Treasury added $17 million equiv­
$2.7900.
In the final week of July and the beginning of August, alent to its Swiss franc balances. In addition, the Treasury
the sterling rate held fairly steady, but no vigorous recovery purchased $18 million in gold from the Swiss authorities.
developed as the market waited to see whether the British
During April, monetary conditions in Switzerland tight­
Government would succeed in carrying through so drastic ened and the Swiss franc began to strengthen. When the
a program. Indeed, sterling remained vulnerable to down­ rate reached its effective ceiling of $0.2317^ in early
ward pressures throughout the month of August and, as May, the Swiss National Bank entered the market as a
yields on dollar-denominated investments rose rapidly, buyer of dollars for the first time since the beginning of the
exerting a strong pull on funds from London, the spot year. The franc remained at the ceiling in subsequent weeks
sterling rate declined to $2.7880 while forward sterling as the Swiss banking community began to repatriate funds
discounts narrowed very sharply to under 1 per cent. to meet midyear liquidity needs and as foreigners who had
Nevertheless, there is already evidence that the British Gov­ previously borrowed Swiss francs switched to less costly
ernment’s new program has begun to take hold at the same Euro-currencies, paying off their Swiss franc borrowings
time that the measures introduced in the April budget with outright purchases of francs. At the same time,
are also taking effect. Even before the full effect of these mounting pressures on sterling added further to the de­
corrective measures is felt, the technical position of ster­ mand for Swiss francs. Consequently, during May and
ling, which has been grossly oversold in recent months, June the Swiss National Bank took in $200 million
should bring about a strong recovery of the sterling rate. through outright purchases, and an additional $82 million
In the meanwhile, with the reinforcement of the Bank in short-term swaps with Swiss commercial banks to help
of England’s credit lines that has now taken place with the provide for their temporary midyear requirements.
Federal Reserve and other central banks, the Bank clearly
By July, uncertainties generated by the pressures on
has ample resources to deal with any temporary specula­ sterling again dominated the foreign exchange markets,
tive flurries that might otherwise impede the progress of and the usual reflux of funds from Switzerland following
the midyear window-dressing date was sharply reduced.
recovery.
Moreover, as some additional funds gravitated to the coun­
try, the franc remained at or close to its ceiling. Accord­
S W ISS FRANC
ingly, in July the Federal Reserve reactivated its swap
The Swiss franc declined steadily during the first quar­ facilities with the Swiss National Bank and with the BIS,
ter of 1966 as a result of seasonal influences, sizable out­ drawing $75 million of francs from each bank to absorb
flows of capital induced by easy monetary conditions in uncovered dollars from the Swiss central bank. In addition,
the Swiss market, rising Euro-dollar rates, and attrac­ the Swiss authorities purchased $20 million of gold from
tive yields on offshore United States corporate issues. In the United States Treasury. Thereafter, however, pressures




195

FEDERAL RESERVE BANK OF NEW YORK

on sterling subsided somewhat, and with yields on dollar
investments moving higher during late July and August,
funds once more began to flow out of Switzerland, and
the franc eased well below its ceiling.
GERM AN MARK

The deficit that had emerged in the German balance
of payments during 1965 continued at a reduced rate in
early 1966. In the first five months of this year official
German reserves declined $310 million (exclusive of a
payment on its increased IMF quota), reflecting short­
term outflows of funds attracted by higher Euro-dollar
rates, and rising net overseas expenditures for services.
Consequently, during this period the mark was generally
on offer at rates somewhat below the parity of $0.2500.
The ready availability of German marks enabled United
States monetary authorities to continue purchasing marks
— as they had since June 1965— in order to repay
medium-term mark-denominated United States Treasury
indebtedness to the German Federal Bank. By March 1,
1966 some $175 million equivalent of such obligations had
been repaid (see this Review, March 1966). In the next
four months a total of $117 million equivalent of marks
was purchased for Treasury account, mostly in the New
York market. The Treasury used these marks, together
with balances on hand, to redeem at their respective
maturities on April 1, June 1, and July 1 an additional
$150 million equivalent of mark-denominated securities
held by the German Federal Bank. Thus in the course of
twelve months ended in mid-1966 the Treasury had re­
duced its mark-denominated indebtedness by $326 million
to $350 million equivalent.
The German Federal Bank had been pursuing a gen­
erally more restrictive monetary policy throughout 1966,
and on May 26, in line with this policy, it announced an
increase in its discount rate to 5 per cent from 4 per cent.
With large tax payments also falling due in June, the
German money market tightened toward midyear. This
factor, together with increasing pressures on sterling,
the usual midyear window-dressing operations, and the
beginnings of a recovery in the German trade position
following a sharp deterioration in 1965, contributed to re­
newed demand for marks. By late June the spot mark had
risen to parity. The further worsening in the sterling situ­
ation and the continued improvement in Germany’s trade
account imparted additional strength to the mark in July,
and by the end of that month official German reserves
were $391 million higher than at the end of May. More
balanced conditions emerged in the exchanges in August,
however, and mark quotations steadied at about $0.2506.




IT A L IA N LIR A

Italy continued to register a substantial balance-ofpayments surplus during the first eight months of 1966.
The surplus was smaller than a year earlier, however,
partly because of a wider trade deficit but mainly because
of a sizable outflow of long-term capital attracted by
the high yields available in the international bond market.
In addition, Italian commercial banks once again began
supplying fairly important amounts of short-term funds
to the Euro-dollar market in the early months of the year.
These short-term outflows offset the overall surplus and
Italian official reserves actually changed little during the
first half-year.
At the beginning of 1966, the Federal Reserve had out­
standing a drawing of $100 million under its swap ar­
rangement with the Bank of Italy. In February, this draw­
ing was liquidated using $50 million equivalent of lire
purchased in a special transaction with a foreign central
bank and $50 million acquired through a sterling-lira swap
with the BIS. In March and May, there were occasionally
small offerings of lire in the New York market and the
Federal Reserve purchased a total of $10 million equiva­
lent. These lire were used on May 25 to reduce the thirdcurrency swap with the BIS from $50 million to $40
million equivalent.
In June, demand for lire began to rise as Italy’s tourist
season moved into full swing. By this time, moreover,
most Italian banks had already eliminated any net
liability position vis-a-vis foreigners, and in these circum­
stances the Bank of Italy was no longer prepared to shift
dollars abroad through short-term swaps with those com­
mercial banks at preferential rates. As a result, the Italian
payments surplus was increasingly reflected in the growth
of official reserves, which rose rapidly during the summer
months. Accordingly, the Federal Reserve reactivated its
$450 million swap facility with the Bank of Italy in July
and early August, absorbing a total of $225 million from
the Italian authorities. These drawings under the swap
arrangement were liquidated through a United States
drawing of $250 million equivalent of lire from the IMF
on August 22. The lire drawn from the Fund were sold
by the United States Treasury to the Federal Reserve,
which in turn used $225 million equivalent to repay in
full its swap commitment to the Bank of Italy. The re­
maining $25 million equivalent, plus $1 million of existing
lira balances, was used to reduce to $14 million the
sterling-lira swap with the BIS. Federal Reserve and Trea­
sury technical forward commitments in Italian lire, under­
taken in 1965, remained unchanged during the period
covered by this report.

196

MONTHLY REVIEW, SEPTEMBER 1966
B E LG IA N FR A N C

The Belgian franc traded below its ceiling during the
first half of 1966, as the sizable current account surplus of
the previous year gave way to a small deficit. In the
late spring, however, as credit policy in Belgium tightened
and the money market firmed, the spot franc rate began
to strengthen. The National Bank of Belgium moved to
reinforce its existing measures of restraint by raising its
discount rate by V2 percentage point to 5V4 per cent on
June 2. Nevertheless, official reserve gains remained small
until July and August, when funds were repatriated as a
result both of the domestic liquidity squeeze and the
speculative pressure on sterling. The spot franc rate moved
to its ceiling in late July, and the National Bank began
purchasing fairly sizable amounts of dollars.
In order to absorb some of the rapid increase in Bel­
gium’s holdings of dollars, the Federal Reserve in August
reactivated the $50 million standby portion of its $100
million swap facility with the National Bank of Belgium
and purchased a total of $30 million from the Belgian
authorities. Later in August, however, the Belgian money
market eased and funds once again began flowing abroad
in response to higher dollar investment rates. The National
Bank then began supplying foreign exchange to the mar­
ket and covering these losses by purchasing dollars from
the Federal Reserve. Thus, by the end of the month the
System was able to reduce its short position in Belgian
francs to $20 million equivalent.

further in early August, and the Federal Reserve reactivated
its $100 million swap facility with the Netherlands Bank,
drawing a total of $65 million of guilders and using them,
together with $2.5 million of guilder balances, to absorb
an equivalent amount of dollars. By mid-August, however,
the Dutch money market had eased and, as increasingly
attractive interest rates on dollar investments were exert­
ing a pull on Dutch funds, there was no further need for
System operations in guilders.
A U S T R IA N S C H ILLIN G

Austria’s international reserves decreased in late 1965
and early 1966, as a consequence of a weakening in the
Austrian balance of payments. In order to meet this de­
velopment, the Austrian National Bank in April sold to the
United States Treasury $25 million of Austrian schillings
and the Treasury used these schillings to repay at maturity
an Austrian schilling-denominated Treasury bond. Aus­
tria’s overall payments position then improved, and through
the early summer months the Austrian National Bank was
able to add somewhat to its reserves. In late August, how­
ever, there was again an outflow of funds from Austria, and
official reserves declined. Once again, this provided an
opportunity for the Treasury to acquire Austrian schillings,
and on September 6 the Treasury paid off another $25
million equivalent Austrian schilling-denominated bond,
thereby reducing its total schilling-denominated indebted­
ness to $50 million equivalent.

D U TCH G U ILD E R

C A N A D IA N DOLLAR

The Dutch guilder was generally on offer during the
first four months of the year, as both seasonal weakness
and some special factors contributed to a widening in the
Netherlands trade deficit. Occasionally, tight money mar­
ket conditions in Amsterdam induced inflows of short­
term funds which temporarily offset the downward pres­
sure on the guilder rate, but on balance quotations eased
noticeably. As early as January, the guilder was quoted
below par, and by late April it had reached the lowest
level since the revaluation of March 1961.
Effective May 2, the Netherlands Bank raised its dis­
count rate to 5 per cent from AV2 per cent in order to curb
the growth of domestic bank credit and stem the deteriora­
tion of the Dutch balance of payments. The guilder im­
mediately rallied and then continued to rise, reaching par
by early June. After midyear, increasingly tight money
market conditions in Amsterdam and growing tensions in
the sterling market led to a sizable inflow of funds. As a re­
sult, Dutch reserves increased $94 million in July and rose

Movements in the Canadian dollar rate during the early
months of the year were significantly influenced by fluc­
tuations in the volume of new Canadian securities offer­
ings in New York. At the same time, seasonal weakness
in the trade account and Canadian government purchases
of about $110 million of United States-held Canadian gov­
ernment debt resulted in a decline of $323 million in
Canada’s official gold and dollar reserves during the first
half of the year (after payment of $47 million to the
IMF in connection with its quota increase). About midJune, however, the return of seasonal strength in Canada’s
external accounts, announcements of some fairly sizable
new securities sales in New York, and conversions of
sterling by Canadian exporters as the pound came under
increased pressure, led to a firming of the Canadian dollar
rate. Moreover, the announcement on June 20 of a new
Canadian-Russian wheat agreement, providing for ship­
ments to Russia of $740 million of wheat over three years,
helped sustain market demand. Official reserves never­




FEDERAL RESERVE BANK OF NEW YORK

theless declined once again because of additional official
purchases on July 2 of $31 million of United States-held
Canadian Treasury securities.
Canadian dollars also were actively sought in the for­
ward market during much of the period as a result of
covered conversions by Canadian banks of domestic time
deposits into United States dollar investments. In early
summer, this demand was reinforced by intermittent buy­
ing by grain interests and by exporters hedging future
sterling receipts. The latter activity subsided later in Au­
gust, however, when an easier tone also reappeared in
the spot market, with quotations fluctuating narrowly just
below $0.9300. There were no Federal Reserve or Trea­
sury operations in Canadian dollars during the period
except for those relating to IMF transactions described
below.
OTHER C UR R E N CIE S

There have been no official United States transactions
in French francs, Japanese yen, or Swedish kronor this
year.
IN T E R N A T IO N A L M O N E T A R Y F U ND

During the period under review, the United States made
two separate types of drawings on the IMF. The first,
designated “technical”, extended the practice initiated in
February 1964 of obtaining currencies from the IMF for
sale to other countries making repayments to the Fund
(see this Review, October 1965, page 208, for a detailed
explanation of this type of operation). The United States
Treasury, between March and August, arranged for draw­
ings totaling $300 million equivalent of Canadian dol­
lars. Whereas earlier the facilities were drawn on in their
entirety at their inception, under the current arrangements
drawings are made periodically as needed.
The second type of drawing was of the more conven­
tional type in which member countries obtain currencies
for use directly in the financing of their international pay­
ments deficits. The United States first had recourse to the
Fund in this manner in July 1965, when it made a multicurrency drawing equivalent to $300 million and used
most of the drawing to fund earlier short-term credits.
On August 22, 1966, the Treasury again went to the
Fund for this purpose, drawing $250 million equivalent
of Italian lire and subsequently selling the lire to the
Federal Reserve for liquidation of its $225 million equiv­
alent swap commitment to the Bank of Italy and a partial
repayment of a sterling-lira swap with the BIS. The Fund,
whose lira balances were at a low level, borrowed the




197

required lire from the Italian government under an agree­
ment lying outside the $6 billion General Arrangements
to Borrow (G.A.B.). This was the first occasion on which
the IMF had employed its authority under the articles of
agreement to borrow needed currency from a member
country other than under the G.A.B., and it marked an­
other significant step in the evolution of the Fund credit
machinery.
United States drawings from the Fund between Febru­
ary 1964 and August 1966 have totaled $1,532 million.
At the same time, other countries have drawn dollars
from the Fund, thereby reducing the Fund’s holdings of
dollars in excess of 75 per cent of the United States quota
and thus reducing this country’s repayment obligation to
the Fund. Consequently, at the end of August 1966 net
United States indebtedness to the Fund was only $893
million.
The vital role that the IMF plays in the international
financial mechanism was greatly reinforced last February
when a general Fund quota increase of 25 per cent or
more, adopted in 1964 by the Governors of the Fund,
became effective for 58 members who had accepted the
proposal and whose combined quotas as of February 23,
1965 constituted the requisite two-thirds majority for ap­
proval. By August 31, an additional 32 members had sub­
mitted their ratification, and Fund resources had been
increased from $16 billion to $20.6 billion, or close to the
ultimate $21 billion target for the Fund’s entire 104
nation membership. The quota increases must be paid
to the Fund partly in a member’s own currency and partly
in gold. Such gold payments, however, have entailed
gold losses for the two key currency countries, the United
States and the United Kingdom, as other members have
converted dollars and sterling into gold for payment of
their gold subscription. In order to compensate for these
losses, the quota increase arrangement provides that the
Fund will deposit a total of up to $350 million of gold
with the Federal Reserve Bank of New York and the
Bank of England. Insofar as the United States is con­
cerned, these compensating operations began in Septem­
ber 1965 and as of August 31 the Federal Reserve Bank
of New York held for United States Treasury account
$202.7 million of gold so deposited by the IMF. The gold
is reflected in the Federal Reserve’s statement of condition
under “other assets” and the deposit liability under “other
deposits”.
GOLD M ARKET DEVELOPM ENTS

The price of gold in the London market has ranged
between $35.11 and $35.1940 during the first eight

198

MONTHLY REVIEW, SEPTEMBER 1966
Table III

U N IT E D STATES N E T M ONETARY GOLD TRANSACTIONS
W ITH FO REIG N COUNTRIES A N D INTER N A TIO N A L INSTITUTIONS*
January-June 1966
In m illions o f dollars at $35 per fine troy ounce;
U nited States net sales (—), net purchases (+ )
Country

Canada ..............................................................

+ 100.0

Colombia .........................................................

+

Second
quarter

First
quarter

+

50.0

7.0

France ..............................................................

-

102.8

Lebanon

_

10.8

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

— 220.7

Switzerland .....................................................

+

7.0

+

United Kingdom ..........................................

-

19.0

-

7.2

A ll other .........................................................

-

15.6

-

0.4

N et sales .................................................

-

34.0

- 167.3

11.0

Note: Because of rounding, figures do not necessarily add to totals.
* N ot reflected in this table are United States monetary gold transactions with
foreign countries mitigated through special deposits by the IMF.

months of this year, with upward pressures on the price
predominating during much of the period. The underlying
supply-demand relationship in the market has been quite




different this year, however, from the same period a year
ago when similar price pressures prevailed. Private de­
mand for gold this year has remained well below last
year’s levels, no doubt reflecting in part the much more
attractive interest yields this year as a result of tightening
credit conditions in many countries. On the other hand,
the supply of gold coming on the market has also been
considerably reduced from last year, primarily because
of the shift in South Africa’s balance-of-payments posi­
tion. Whereas during the first seven months of 1965
South African gold reserves declined by $213 million,
adding roughly that much to the supplies available from
new production for sale in London, during the same pe­
riod this year South African gold reserves have increased
by $250 million, with consequent reduction of the amount
of new production available for sale. As a result of
this swing in South Africa’s payments position and re­
serves, therefore, there has been a temporary decline of
about $500 million in gold coming on the London mar­
ket from this source. Moreover, there have been no
Russian sales of gold during the first eight months of this
year. Over coming months there is a reasonable likelihood
that the flow of gold to the London market will return to
more normal levels.

FEDERAL RESERVE BANK OF NEW YORK

199

The B usiness Situation
Recent economic developments have underscored the
basic strength and momentum of the business expansion.
At the same time, however, it is becoming increasingly clear
that inflationary pressures are continuing to intensify. In
view of the critical importance of price stability in achieving
long-term economic growth and the urgent need to maintain
and improve our international competitive position, it is
evident that inflation has again become one of the nation’s
most pressing economic problems.
Industrial output climbed strongly in July, and the large
and rising backlog of orders in manufacturing provides a
basis for further growth of production in the months ahead.
The strength of consumer demand was clearly demonstrated
by a further advance in retail sales in July, following the
sharp June recovery, and by a recent survey of consumer
buying intentions indicating that overall plans to purchase
major durable goods remain well above the high year-ago
level. Business spending on productive facilities continues
at the rapid pace forecast earlier in the year, and a recent
survey by the National Industrial Conference Board shows
that appropriations for capital expansion by large manufac­
turing firms moved up sharply in the second quarter. Out­
lays for inventories by manufacturing firms also continue to
increase strongly. While Federal defense spending remains
one of the most uncertain elements in the outlook for ag­
gregate demand, the buildup of military forces already in
process is likely to result in a continued sharp uptrend in
defense spending well into 1967.
Residential construction continues to be the only major
sector of the economy exhibiting significant weakness. Hous­
ing starts have declined steadily since the beginning of the
year. Other types of construction remain strong, however,
especially industrial and public building. Thus, while em­
ployment in residential construction has eased in certain
regions, some of the resources released by the decline in
residential construction are being absorbed into other
types of building activity. Moreover, residential building
should be stimulated by the implementation of pending
legislation designed to increase the mortgage purchase and
lending authority of the Federal National Mortgage Asso­
ciation by as much as $4.7 billion.
In the face of tight labor markets and high-level utiliza­




tion of production facilities, the price level continues to
reflect demand pressures. Consumer prices again rose
sharply in July, while at the wholesale level prices of farm
products and processed foods moved upward substantially,
following several months of declines. Industrial wholesale
prices also increased further, although at a pace slower
than in the first half of the year. Furthermore, the recent
rise in consumer prices— notably the prices of food and
services— has added to the wage demands now being
pressed in collective bargaining. Management may find it
hard to resist these demands in view of the high level of
profits and substantial backlogs of orders. Indeed, the settle­
ment recently concluded in the airline strike, apparently
calling for annual increases in wages and fringe benefits
more than half again as large as the Administration’s 3.2
per cent guideline for noninflationary wage increases,
underscores the developing dangers of cost inflation.
PR O D U C T IO N , O RDERS, A N D B A C K L O G S

The Federal Reserve Board’s seasonally adjusted index
of industrial production advanced by a substantial 1.3 per­
centage points in July to 157.5 per cent of its 1957-59
average, despite a 10 per cent decline in the output of
automobiles. Excluding the automotive component of the
index, industrial production climbed 1.8 percentage points
for the largest monthly advance since February.
The July gain in total production included a substantial
further expansion in the output of defense materials and
business equipment, reflecting the continuing military
buildup and the persistent growth of business capital
spending. Increases in output were also widespread among
producers of both durable and nondurable industrial ma­
terials. Output of iron and steel turned up after a twomonth decline, and new orders booked by steel mills for
September and October show increases among a wide
range of users, including automobile manufacturers.
Among the other major market groupings in the indus­
trial production index, the output of finished consumer
goods remained roughly unchanged as declines in automo­
biles and some other major durable goods were offset by
increases in the production of consumer nondurables. The

200

MONTHLY REVIEW, SEPTEMBER 1966

recent slowdown in the output of consumer durables may
well have been a delayed reaction to the spring decline in
retail sales of these items, and it should be noted that retail
sales have since rebounded strongly.
The July advance in manufacturing production was at a
seasonally adjusted annual rate of 10 per cent, somewhat
above the average rate of expansion of manufacturing
capacity indicated for 1966 as a whole by the spring
McGraw-Hill survey. The average capacity utilization rate
is already at 93 per cent for manufacturing firms, and a
continued gain in production on the order of July’s per­
formance would be likely to place considerable further
strain on the nation’s productive facilities.
Recent data on new orders suggest continued strong
advances in industrial production. New orders received by
manufacturers of durable goods in the second quarter rose
to a record seasonally adjusted quarterly average of well
over $24 billion (see Chart I). New orders in July were
down slightly from this level, as decreases in automobile
and aircraft orders more than offset advances in other in­
dustry groups. However, the volume of new bookings re­
mained well above the July rate of shipments, and back­
logs of unfilled orders piled up further among a wide range
of durables industry groups. The total order backlog has
risen sharply and steadily since early 1964, following a
period of more moderate growth earlier in the expansion.
The ratio of unfilled orders to shipments of durables (also
shown on the chart) is now at its highest level since No­
vember 1959, with the present backlog equivalent to more
than three months of shipments at the current rate.
The figures on total unfilled orders and total shipments
of durables manufacturers have been subdivided into
fourteen industry groups and an “all other” category.
These industry data are useful in assessing the extent to
which order backlogs are concentrated within or diffused
throughout the durables manufacturing sector. The bot­
tom panel of Chart I depicts the proportion of the fifteen
industry groups that in any given month had unfilledorders-to-shipments ratios above those six months earlier.
This chart shows that the recent advance has been very
widespread indeed. Whereas the proportion of industries
experiencing increases in their unfilled-orders-to-shipments
ratios fluctuated widely during 1962 and 1963, the pro­
portion passed the 50 per cent mark at the beginning of
1964 and trended upward thereafter. July data indicate
that the ratio of backlog to shipments in thirteen of the
fifteen component categories is higher than it was six
months earlier.
Thus, in contrast to earlier years of the current expansion
when the existence of relatively low order backlogs and a
sizable margin of unutilized capacity enabled durable goods




Chart I

INDICATORS OF DURABLES MANUFACTURERS’ ACTIVITY
Billions of doiiars

80

Billions of dollars

80

NEW AND UNFILLED ORDERS OF
DURABLES MANUFACTURERS *

RATIO OF UNFILLED ORDERS TO SHIPMENTS
OF DURABLES MANUFACTURERS *
3.0

2.8
2.6
2.4
Per cent

100
80
60
40
DIFFUSION INDEX: SIX-MONTH SPAN
_ 20
UNFILLED ORDERS TO SHIPMENTS-15 INDUSTRIES t
i 11 11111 111 U. 1111111111111.11 11 i 11.11I I 1111111111111 M 1» 11 i l
.
1962
1963
1964
1965
1966
*

Quarterly averages of seasonally adjusted monthly data.

+

This index expresses the percentage of the fifteen component industries that have highei
ratios of unfilled orders to shipments than they did six months earlier.

Source: United States Department of Commerce, Bureau of the Census.

producers to accommodate increases in orders without sub­
stantial increases in delivery times, over the past two and a
half years the proportion of firms operating at or near pre­
ferred capacity rates has risen markedly and order back­
logs have grown substantially. This situation threatens to
lead to greater price pressures, production bottlenecks, and
shifting of orders to foreign producers than has been the
case in the past.
CONSUMER DEMAND

Preliminary data indicate that retail sales (seasonally
adjusted) rose 0.6 per cent in July, reaching an annual rate
of $306 billion, only $300 million below the record set in
March (see Chart II). This advance followed a sharp re­

201

FEDERAL RESERVE BANK OF NEW YORK

covery in June which, on the basis of upward revised data,
came to 3.6 per cent. Much of the pickup in June was
attributable to increased purchases of automobiles follow­
ing the April and May slump, while slightly more of the
July advance was accounted for by other consumer du­
rables. Although a part of the recent increase in retail sales
reflects higher prices on many items, especially food, it
nonetheless appears that real demand has increased also.
Much of the adjustment of consumer spending to earlier in­
creases in social security taxes and higher withholding rates
has probably already been accomplished, and consumer
buying is now moving more closely in line with the rising
trend in personal incomes. Total personal income rose
strongly in July as Federal pay increases went into effect.
The advance in wages and salaries was the largest since
February, and would have been even greater but for the
earlier than usual shutdown for model changeovers in the
automobile industry and the machinist strike at some airlines.

Per cent

Per cent

Note: Buying plans are expressed as the ratio of the number of families who indicate

Chart li

DISPOSABLE PERSONAL INCOME AND RETAIL SALES

they intend to buy to the total number of families in the survey.
Source: United States Department of Commerce, Bureau of the Census.

S e a so n ally adjusted a n n u a l ra te
B illions of d o llars

C h art 1 1
1

CONSUMER INTENTIONS TO BUY NEW AUTOMOBILES
AND HOUSEHOLD DURABLES WITHIN SIX MONTHS

Billions of do llars

The prospect for automobile sales remains the foremost
uncertainty in the outlook for consumer spending. While
dealer sales of new cars averaged 8.3 million units in June
and July, up sharply from the low May level of 7.3 million,
it is not clear how much of this improvement has resulted
from the intensive efforts of dealers to reduce their large
stocks of 1966 models. Nonetheless, the automobile indus­
try itself is expecting some further gains in sales during the
remainder of this year. The most recent survey of consumer
buying intentions, taken in mid-July, indicates that the pro­
portion of families planning to purchase a new car within
six months was roughly the same as last year’s reading (see
Chart III). The proportion of families intending to buy one
or more of the seven household durables included in the
survey was substantially higher than a year ago, indicating
that the consumer durables sector could make a further
sizable contribution to expanding demand in the months
ahead.
E M P L O Y M E N T , W A G E S , A N D PR IC E S
Note: Disposable personal income data are quarterly; retail sales data are monthly.
Source: United States Department of Commerce, Bureau of the Census.




The overall unemployment rate in August remained at
the July level of 3.9 per cent of the civilian labor force, with

202

MONTHLY REVIEW, SEPTEMBER 1966

a slight increase in the rate of unemployment among
adult women, a further decline among teen-agers, and no
change for married men. The August figures reflect
a gain in total employment roughly equal to the moderate
advance in the civilian labor force. Even with the August
increase, however, the growth of the civilian labor force
this year has been sluggish. In the first eight months of
1966, the labor force has expanded by only three fourths
the rate in the comparable period of 1965. It had been ex­
pected that labor force growth this year would be quite
substantial, reflecting both demographic factors and the
usual tendency for high-level economic activity to induce
many persons into the labor force who otherwise would
not enter the job market. Nevertheless, this expected
strength in the civilian labor force did not develop due to
such factors as the buildup in the armed forces, a larger
than usual number of students remaining in school, in­
clement weather conditions that reduced employment in
agriculture, and strikes in the construction and airline in­
dustries. The relatively slow growth of the labor force has
been one of the factors tending to maintain the heavy pres­
sures on the available labor supply.
A recent Labor Department report indicates that
annual wage increases (excluding fringe benefits) in
agreements involving 1,000 or more employees concluded
in the first half of 1966 will average 3.7 per cent over the
life of the contracts. Comparable negotiated wage increases
averaged 3.3 per cent in 1965, 3.0 per cent in 1964, and
2.5 per cent in 1963. Moreover, the higher gains cited for
the first half of this year exclude settlements in the construc­
tion industry, where increases have been especially large—
averaging about 6 per cent a year during the first half of
1966. The prospect for still higher wage demands and settle­
ments in coming months may have been influenced by the
well-publicized settlement in the airline industry which in­
volves, in addition to a large pay increase, a provision for
cost-of-living adjustments. Furthermore, many important
wage contracts are coming up for negotiation over the
next twelve months.
The price picture remains highly disturbing. The con­
sumer price index rose once again in July, although the
advance in the food component was less than seasonal.
Prices also mounted further at the wholesale level.
The prices of farm products, which had leveled off in the
early summer, jumped 3.4 percentage points in July for
the largest monthly increase since March 1960. Part of the




advance may be reversed as some commodities— such as
eggs and livestock—resume their normal flow to market
after being held up somewhat during the hot weather ex­
perienced in June and July in some regions of the nation.
A large part of the price rise is likely to be sustained, how­
ever, as the spring drought and the prolonged heat wave
have cut yield prospects for many types of grain crops and
pasture feeds, especially in the south central and Atlantic
seaboard states. Industrial wholesale prices also moved
upward in July at a seasonally adjusted annual rate of 2.3
per cent, somewhat below the average monthly advance
for the first half of the year. Against the background of
rising demand and the possibility of large increases in
future wage settlements, price pressures are likely to re­
main a problem in the months ahead.

K E E PIN G O U R M O N E Y H E A L T H Y
AND
M O NEY: M ASTER OR SERVANT?

The Federal Reserve Bank of New York has re­
vised two booklets which will be available free of
charge at the end of September.
Keeping Our Money Healthy, a 16-page booklet,
is an illustrated primer on how the Federal Reserve
System works to promote price stability, high em­
ployment, and economic growth in our economy. It
discusses in a simplified fashion recession, inflation,
the value of money, and the stabilizing influence of
the Federal Reserve System.
Money: Master or Servant?, a 48-page booklet,
explains the role of money and banking in our econ­
omy. It includes a description of our monetary
system, tells how money is created, and relates
how the Federal Reserve System influences the cost,
supply, and availability of credit as it seeks to en­
courage sustainable economic growth at high levels
of employment with a reasonably stable price level.
Requests for copies should be addressed to the
Publications Section, Federal Reserve Bank of New
York, New York, N. Y. 10045.

FEDERAL RESERVE BANK OF NEW YORK

203

The M oney and Bond M ark ets in A ugust
A sharp and persistent rise in interest rates amid an
atmosphere of considerable uncertainty was the dominant
feature of the money and securities markets through most
of August. Technical rallies appeared on occasion, but
they tended to fade rather quickly under the weight of a
steady stream of economic and financial news that under­
scored both the continued heavy demand for credit and
the limited availability of funds. As the month progressed,
the view became widespread that monetary policy might
tighten further, possibly increasing pressures on the
market in September when commercial banks would be
facing substantial seasonal loan demands and heavy ma­
turities of certificates of deposit. However, the atmosphere
in the securities markets improved somewhat at the close
of the month in response to renewed talk of a possible tax
increase. On September 1, after the close of the period
covered in this article, the Federal Reserve System issued
a policy statement which is reprinted on page 211.
Among the specific factors affecting the securities
markets in August was the increase in the prime lending
rate of commercial banks, from 53 per cent to 6 per
A
cent, that was announced on August 16 and 17. The
boost was the fourth in less than nine months and raised
the banks’ minimum lending rate to the highest level
in over thirty years. Then, on August 17, the Board of
Governors of the Federal Reserve System announced a
further increase from 5 per cent to the statutory ceiling of
6 per cent in reserve requirements against certain time de­
posits of member banks. The new 6 per cent reserve re­
quirement will apply to each member bank’s time deposits
—other than passbook savings accounts— in excess of $5
million. (Passbook savings deposits and the first $5 mil­
lion of other time deposit accounts will continue to be sub­
ject to a 4 per cent reserve requirement.) The increase,
which follows a midyear rise from 4 per cent to 5 per cent
in such requirements, will go into effect at reserve city
banks in the reserve computation period beginning Sep­
tember 8, and will first apply to other member banks dur­
ing the reserve computation period beginning September
15. In announcing this increase in reserve requirements,
the Board of Governors explained: “Like [the] earlier




measure, [this] action is designed to exert a tempering in­
fluence on bank issuance of time certificates of deposit,
and to apply some additional restraint upon the expansion
of bank credit to businesses and other borrowers. Mone­
tary actions already taken have resulted in some modera­
tion of the rate of bank credit growth thus far this year.
However, in view of increasing pressures on prices stem­
ming from recent developments in the economy, [this lat­
est] action is being taken to reinforce the anti-inflationary
effects of overall monetary restraint.”
Contributing to the upward pressure on interest rates
during the month were the steady addition of prospective
issues to an already sizable calendar of future corporate
bond offerings, heavy commercial bank selling of taxexempt securities, an increase in the supply of Treasury
bills with the sale of $3 billion of March and April tax
anticipation bills, and expectations that the Federal Na­
tional Mortgage Association (FN M A )) would sell a large
issue of participation certificates in September. Further­
more, dealer financing costs were persistently high during
the month, making dealers hesitant to add securities to
their inventories.
Under the various pressures, yields on Treasury notes
and bonds rose by as much as 77 basis points in August
to their highest levels since the 1920’s. Yields on cor­
porate bonds reached thirty-year highs, and even at these
levels investors proved to be only cautious buyers. In the
tax-exempt bond market, yields also rose sharply over the
month in a generally weak atmosphere. Treasury bill
rates climbed to record levels, with average issuing rates
on three- and six-month bills set at 5.09 per cent and
5.57 per cent, respectively, in the auction of August 29.
The money market generally remained quite firm in Au­
gust. Federal funds traded mainly in a 5Vi to 5% per cent
range, with the effective rate first reaching a record 5% per
cent level on August 5. Commercial paper dealers raised
their rates on two occasions during the month, bringing
their offering rate on prime four- to six-month paper to
5% per cent. Rates on bankers’ acceptances also rose dur­
ing the period, reaching 5% per cent (bid) for 31- to
90-day unendorsed acceptances. Rates posted by the

204

MONTHLY REVIEW, SEPTEMBER 1966
Table I

Table II

FACTORS T EN D IN G TO INCREASE OR D ECREASE
MEM BER BANK RESERVES, A U G U ST 1966

RESERVE POSITIONS OF MAJOR RESERVE CITY BANK S
A U G U ST 1966

In millions of dollars; ( 4 ) denotes increase,
(—) decrease in excess reserves

In m illions of dollars
Daily averages—week ended
Factors affecting
basic reserve positions

Changes in daily averages—
week ended

Aug.
3

Aug.
10

Aug.
24

Aug.
17

Aug.
31

Federal Reserve f lo a t..........
Treasury operations-* . . . . . .
)
Gold and foreign ac co u n t..
Currency outside banks*. . .
Other Federal Reserve
accounts ( n e t ) $ ....................
Total "m arket” fa c to rs..
Direct Federal Reserve credit
transactions
Open market instrum ents
Outright holdings:
Government securities . . .
Bankers' acceptances . . .
Repurchase agreements:
Government securities . . .
Bankers’ acceptances . . .
Member bank borrow ings___
Other loans, discounts, and
advances ....................................

August
10

August
17

August
24

40

4 . 221

+

91

4 236

— 219

— 613
— 336
— 29
— 249
— 83

— 234
— 115
4- 203
4-181
— 405

4 - 338
4 -i 200

4- 50
4- 17

4 - 29

+ 13
— 15
4 - 144

628
766
18

4 . 94

—
—
—
—
4-

199

—1,087
—1,000
4- 19S
— 142
— 51

4 - 82

— 99

+

8

— 108

4

23

— 573

— 13

4-429

4 - 286

— 847 j

Reserve excess or
deficiency ( —) t ......................
Less borrowings from
Reserve Banks .........................
Less net interbank Federal
funds purchases or sales(—)..
Gross purchases ................
Gross sales ..........................
Equals net basic reserve
surplus or deficit( —) ............
N et loans to Government
securities dealers .....................

4

_

8

35

120

39

482
1,245
763

339
1,114
775

531
1,228
697

-4 6 4

— 452

— 535

5

178

-2 5 4

230

185

171

70

281

187

18

46

21

— 94

+

7

+ 414
— 15

—
—

— 422
— 2

+

1

+ 158
—
98

4- 194
—
+
4

— 158
—■
— 52

— 194
—
— 11

—

2

+

56

+

4

—

3

4
—

—

66

4- 784
+

2

4- 369

4 724
— 16

_
—
— 28
+

1

—
4-

11

—

4- 653

4- 145

— 638

— 201

4- 759 |

+718

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

4 - 80

4 - 132

— 209

4- 85

— 88 1

~

Reserve excess or
deficiency ( —) f .......................
Less borrowings from
Reserve Banks .........................
Less net interbank Federal
funds purchases or sales(—)..
Gross purchases ................
Gross sales ...........................
Equals net basic reserve
surplus or deficit ( —) ............
N et loans to Government
securities dealers .....................

32

— 11 - 132
920
913
931 1,045

242
1,084
842

1

32

28

16

20

19

223

139

193

100

61

143

681
1,556
875

796
1,681
885

738
1,651
913

724
1,670
946

570
1,686
1,117

702
1,649
947

-9 0 4

-9 0 2

— 903

105

4

58

— 808 - 6 1 1
-

7

- 826

214

75

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

Daily average levels

Table III
A V ERAGE ISSU IN G RATES*
AT R E G U LA R T R EA SU R Y BILL AUCTIONS

Member bank:
Total reserves, including
vault c a s h * ................................ 22,987
Required reserves* .................. 22,638
349
Excess reserves* .......... ...........
B o rro w in g s........ .......................
778
— 429
Free reserves* .............. ..
Nonborrowed reserves*
.......... 22,209

1

Thirty-eight banks outside N ew York City

— 718

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

22,898
22,417
481
782
— 301
22,116

22,598
22,326
272
730
— 458
21,868

22,447
22,090
357
719
— 362
21,728

22,578
22,309
269
691
— 422
21,887

In per cent

22,7025
22,356§
346§
740§
— 394§
21,9628

Weekly auction dates— August 1966
Maturities
August
1

August
August
8
|
1
5

Three-month

4.834

4.826

Six-month ....

Changes in Wednesday levels

4.969

5.050

System Account holdings
of Government securities
maturing in:

August
22

August
29

5.048

5.020

5.087

5.315

5.410

5.566

Monthly auction dates— June-August 1966

Less than one y e a r ..................
More th a n one y e a r ................

4 662

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

4 - 662

— 197

— 197

— 732
— 83

4 -3 8

— 815

4 38

4-847

4 - 618

— 83

Note: Because of rounding, figures do not necessarily add to totals.
* These figures are estimated.
t Includes changes in Treasury currency and cash.
t Includes assets denominated in foreign currencies.
§ Average for five weeks ended August 31.




August
31*

Eight banks in N ew York City

“ Market" factors
Member bank required
reserves* .......................... .
Operating transactions

August
3

Net
changes

Factors

Average of
five weeks
ended
August 31*

4 - 847

June
23

4 - 535

One-year

July
26

August
25

4.697

4.964

5.844

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

FEDERAL RESERVE BANK OF NEW YORK

major New York City banks on call loans to Govern­
ment securities dealers were in a 6V4 to 6 % per cent range
until late in the month, when rates as low as 5 V2 per cent
were quoted. Leading commercial banks continued to pay
the ceiling rate of 5 V2 per cent for negotiable time certifi­
cates of deposit maturing in thirty days or more.

205

refunding. Approximately $10.1 billion of the $14.9 bil­
lion outstanding August and November issues eligible for
exchange was converted into the new offerings. Subscrip­
tions totaled approximately $5.9 billion for the new 5lA
per cent certificates of 1967 and almost $4.3 billion for the
new 5V4 per cent notes of 1971. Public holders of the elig­
ible maturing securities exchanged about $2.5 billion— or
78.5 per cent— of their $3.2 billion holdings of August 15
TH E G O V E R N M E N T SE C U R ITIES M A R K E T
maturities, and $1.6 billion— or 33.5 per cent— of their
Prices of Treasury notes and bonds declined sharply $4.9 billion holdings of November 15 maturities. The
through most of August but recovered somewhat in the clos­ amount of August maturities exchanged was approxi­
ing days of the month. As the month opened, the Treasury’s mately in line with market expectations, while the amount
August refunding operation, then in progress, held the mar­ of November maturities refunded somewhat exceeded
ket spotlight.1 Immediately following the Treasury’s July 27 earlier market estimates, leaving only routine refinancing
refunding announcement, prices of many outstanding cou­ on the Treasury calendar for November.
pon issues moved down by as much as half a point,
The refunding results had little effect upon price quota­
partly in adjustment to the additional supplies of five-year tions in the coupon sector, where attention was increasingly
maturities which would arise out of the refunding. In addi­ focusing upon other considerations. The tone of the market
tion, the market anticipated a considerable amount of deteriorated considerably in the wake of an August 9 fea­
switching out of outstanding coupon issues into the new ture article in the financial press which predicted that heavy
refunding offerings—particularly into the new 5V4 per cent loan demands might soon trigger another increase (subse­
notes of 1971. Some such switching did indeed occur, par­ quently confirmed) in the prime lending rate of commercial
ticularly out of the 5 per cent notes of 1970 into the refund­ banks. The coupon sector was also adversely affected
ing issues. On balance, however, investor interest in the by the heavy atmosphere evident elsewhere in the capital
new 5Va per cent certificates and notes—trading in the markets where new corporate and agency issues floated at
secondary market on a “when issued” basis—was rather record yields were encountering investor apathy. Dealer
limited. Against this background, prices of outstanding cou­ offerings continued to expand, some commercial bank
pon issues and the new refunding issues fluctuated nar­ sales took place, and prices of the new refunding issues
rowly in dull trading during the August 1-3 subscription and of outstanding securities steadily gave ground. The
period.
price decline gathered momentum around midmonth
After the refunding subscription books closed on August and, for some time afterward, daily price losses of up to
3, prices of outstanding intermediate- and long-term issues V2 point on individual issues became commonplace. The
drifted lower in light trading as the market awaited the August 16-17 rise in the prime lending rate of commercial
results of the refinancing operation. Dealers became pro­ banks further depressed the securities market and reinforced
gressively more anxious to make sales— even at lower apprehension that monetary policy would become more re­
prices— as they reacted to reports that the calendar of strictive. In this atmosphere, the increase in reserve require­
scheduled corporate and Government agency financing ments against certain time deposits, announced by the Board
was growing rapidly, and to predictions that credit de­ of Governors on August 17, triggered another sharp down­
mands would be exceptionally large in the autumn. At ward adjustment in prices of coupon issues. (The rightthe same time, investor offerings expanded when some hand panel of the chart on page 208 illustrates the rise in
switching from outstanding long-term Treasury issues yields which accompanied this decline in prices.)
As the month progressed, market participants also be­
into higher yielding corporate bonds developed. During
this period, market participants also assessed the poten­ came increasingly concerned over the ability of commercial
tial impact of the increase in steel prices upon the gen­ banks to replace the heavy volume of certificates of deposit
eral level of prices and interest rates.
soon to mature, since rates on several competing money
On August 5, the Treasury announced the results of the market instruments had risen above the 5 V2 per cent ceiling
rate on time certificates. The feeling was widespread among
market participants that, should commercial banks en­
counter difficulty in rolling over their maturing certificates,
bank sales of Government securities and/or tax-exempt
1 For details of the offering, see this Review (August 1966),
issues would accelerate. In addition, dealers became ap­
page 177.




206

MONTHLY REVIEW, SEPTEMBER 1966

SELECTED INTEREST RATES*
Percent

M O N E Y MARKET RATES

June

July

June-August 1966

August

BOND MARKET YIELDS

June

July

Percent

August

Note: D ata are shown for business days only.
M O N E Y MARKET RATES QUOTED: D aily range of rates posted by m ajor N ew York City banks
on new call loans (in Federal funds) secured by United States Governm ent securities (a point
indicates the absence of any range); offering rates for directly placed finance com pany paper;
the effective rate on Federal funds (the rate most representative of the transactions executed);
closing bid rates (quoted in terms of rate of discount) on newest outstanding three- and six-month
Treasury bills.

same issue im m ediately afte r it has been released from syndicate restrictions); d a ily

o r more) and of Governm ent securities due in three to five years, computed on the basis of
closing bid prices; Thursday averages of yields on twenty seasoned twenty-ye a r ta x-exem pt

bonds (carrying M oody’s ratings o fA a a ,A a , A , and Baa).

BOND MARKET YIELDS QUOTED: Yields on new A a a - and A a-rated public utility bonds are plotted
around a line showing daily averag e yields on seasoned A aa -ra te d corporate bonds (arrows

prehensive about the availability of funds to finance their
positions. New York City bank rates on dealer loans were
quoted as high as 6% per cent, and only a limited amount
of funds was available from out-of-town sources. A some­
what improved market tone developed at the end of the
month when participants responded favorably to renewed
discussion of a possible anti-inflationary tax increase.
Demand for coupon issues expanded and prices rebounded,
erasing a portion of their earlier losses.
A very cautious atmosphere was also evident in the
Treasury bill market through most of August. The rapid
general rise in interest rates— including the increase in the
prime lending rate of commercial banks— compounded the
uneasiness of bill market participants as they weighed the
rate outlook in their own sector. In the opening days of




point from underwriting syndicate reoffering yield on a given issue to m arket yield on the
averages of yields on long-term Government securities (bonds due or callab le in ten years

Sources: Federal Reserve Bank of N ew York, Board of Governors of the Federal Reserve System,
Moody's Investors Service, and The W e e k ly Bond Buyer.

August, investment demand favored the short-dated bills,
which were in scarce supply in the market, and rates re­
ceded slightly in the under-three-month maturity area. At
the same time, however, little investor interest was evident
in longer bills, which continued to edge higher in rate.
Market sentiment was dampened considerably when the
magnitude of reinvestment demand for bills of various
maturities from sellers of “rights” to the Treasury’s August
refinancing of coupon issues fell short of earlier market
expectations.
From August 8 onward, the upward rate movement
spread into the shorter bill maturity area as well (see the
left-hand panel of the chart). Offerings of these issues in­
creased and demand for them tapered off. On August 11,
the Treasury announced that it would auction $2 billion

FEDERAL RESERVE BANK OF NEW YORK

of March 1967 tax anticipation bills and $1 billion of
April 1967 tax bills on August 18. In the wake of the
announcement, which came at a time when market uncer­
tainty over the interest rate outlook was growing, rates on
outstanding bills moved sharply higher, largely as a result
of aggressive dealer offerings. At the regular weekly bill
auction on August 15, where bidding was quite restrained,
average issuing rates climbed to 5.048 per cent for the
new three-month bill and 5.315 per cent for the sixmonth issue (see Table III). Another marked increase
in bill rates took place in reaction to the rise in the
prime rate announced by most commercial banks on August
16 and 17. At the August 18 auction of the tax antici­
pation bills, effective bidding was confined to commercial
banks, which were permitted to make full payment through
credits to Treasury Tax and Loan Accounts— a privilege
estimated by the market to be worth about 30 to 35 basis
points to the banks. Nevertheless, banks anticipated some
difficulty in distributing the tax bills in the secondary
market and therefore bid very cautiously. Average issu­
ing rates were set at 5.338 per cent for the March bills
and 5.433 per cent for the April bills, historic highs for
such securities.
For a brief period following the tax bill auction, the bill
market rallied when demand expanded somewhat. Rates
for outstanding bills edged lower with the sharpest declines
recorded by short bill maturities. Subsequently, however,
the bill sector weakened again. At the regular monthly auc­
tion of one-year bills on August 25, an average issuing rate
of 5.844 per cent was set, almost 90 basis points higher
than the average rate at the preceding monthly auction.
(When measured on a bond yield equivalent basis, the yield
on this issue was 6.20 per cent.) The bill market rallied late
in the month, when demand expanded somewhat and rates
turned downward. Nevertheless, at the end of the month,
the newest outstanding three- and six-month Treasury bills
were bid at rates of 5.06 per cent and 5.58 per cent, respec­
tively, 29 and 62 basis points above the rates quoted on
comparable issues a month earlier.
In the market for United States Government agency obli­
gations, participants displayed considerable concern over
the general outlook for interest rates and the expanding
calendar of scheduled agency flotations. Consequently,
prices in this market fell back steadily through most of the
month. Several new agency issues, which were floated at or
close to record high yields, were accorded mixed investor
receptions. Early in the period, the FNMA publicly offered
$300 million of new two-year debentures priced to yield
5.91 per cent, and sold an additional $50 million of the
issue to Treasury trust accounts. The publicly offered de­
bentures encountered investor resistance and their yield




207

rose in subsequent secondary market trading. Around mid­
month, a public offering by the Federal Home Loan Banks
of $500 million of one-year bonds, priced to yield a new
record high for agency financing of approximately 6 per
cent, also encountered investor apathy. Later in the month,
the market was further restrained by discussion of the pos­
sibility that a sizable offering of participation certificates
might be made in September. However, some improvement
in the atmosphere of the agency market occurred at the end
of August following press reports that no firm decision had
yet been made with respect to this offering.
O TH ER SE C U R IT IE S M A R K E T S

In the markets for corporate and tax-exempt bonds,
prices generally fell back sharply until late in August as
participants became increasingly concerned over the
mounting demands for credit converging upon their mar­
kets. A better atmosphere emerged in both sectors at the
end of the month, however, when participants reacted to re­
newed discussion of a possible tax increase. Historically,
a lull in new issue activity has generally developed in the
capital markets during August, but such was not the case
this year. New publicly offered corporate bonds totaled
$1.2 billion in August, the largest volume ever recorded in
a single month. Early in the month, market attention fo­
cused upon the American Telephone and Telegraph Com­
pany $250 million flotation of Aaa-rated 55 per cent
A
debentures maturing in 1995 which were sold at the highest
net interest cost to the company in over forty years. These
securities, which carried five-year call protection, were ag­
gressively bid for by underwriters. When first reoffered to
yield 5.58 per cent, the debentures attracted good interest
from small investors. Subsequently, however, distribution
of the issue slowed considerably, syndicate price restric­
tions were removed, and the debentures initially jumped 6
basis points in yield when they began to trade freely. By the
end of the month, the telephone issue was trading to yield as
much as 5.82 per cent. Other new corporate issues were
generally accorded mixed receptions during the month.
Only issues that carried extended protection against early
call, had delayed delivery provisions, and were reoffered at
considerably reduced prices drew any investor interest.
Prices of recent corporate offerings and seasoned issues also
fell sharply during the month (see the comparable rise in
yields illustrated in the right-hand panel of the chart),
although a steadier tone emerged at the end of the period.
In the tax-exempt sector, prices of new offerings and sea­
soned issues dropped sharply through most of the month
in an uncertain atmosphere and yields rose to their highest
levels in more than thirty years. Commercial banks con­

208

MONTHLY REVIEW, SEPTEMBER 1966

tinued to reduce their holdings of tax-exempt securities on
a fairly large scale, while dealers were able to make sales
from their inventories only after progressive price conces­
sions. New tax-exempt bond flotations totaled about $735
million in August, as against $630 million (revised) the
month before and about $720 million in August 1965.
Several new tax-exempt issues which had been scheduled
for sale during the month failed to reach the market either
as a result of postponements or because prevailing market
yields exceeded certain local statutory interest rate limita­
tions. The largest new tax-exempt bond offering of the
month consisted of $100 million of Aa-rated state bonds.
The bonds were reoffered just after midmonth to yield from
4 per cent in 1967 to 4.20 per cent in 1987, and were fairly
well received due in part to their relatively attractive yield.
Over the month as a whole, the average yield on Moody’s
seasoned Aaa-rated corporate bonds rose by 21 basis points
to 5.44 per cent, while The Weekly Bond Buyer's series for
twenty seasoned tax-exempt issues (carrying ratings rang­
ing from Aaa to Baa) climbed by 28 basis points to 4.24
per cent (see the right-hand panel of the chart). These
indexes are, however, based on only a limited number of
seasoned issues and do not necessarily reflect market move­
ments fully, particularly in the case of new and recent issues.

the five-week August period, as against $739 million dur­
ing the four weeks ended July 27.
The distribution of reserve pressures shifted somewhat in
August from the pattern that had prevailed during most
of July. The reserve positions of banks outside the major
money centers came under increased pressure, and these
banks turned more frequently to the Federal Reserve “dis­
count window” to fill their residual reserve needs. At the
same time, the reserve positions of money market banks—particularly those located in New York City— were under
somewhat reduced pressure (see Table II). The improve­
ment in the reserve positions of banks in the central money
market largely reflected a decline in their lending to Govern­
ment securities dealers who, faced by call loan rates of
6V4 per cent to 65 per cent at New York banks, kept
/s
their inventories low and increasingly sought out less ex­
pensive sources of funds to fill their limited financing needs.
Rates on a variety of short-term money market instru­
ments continued to move upward during the month. By the
end of August, offering rates on commercial paper placed
by dealers were Va of a per cent higher than a month earlier,
and rates on bankers’ acceptances were generally Vs of a
per cent higher. The major New York City banks con­
tinued to pay the 5 V2 per cent ceiling rate on all maturities
of new negotiable time certificates of deposit. Rates on
prime certificates trading in the secondary market edged
THE M O NEY M ARKET AND BANK RESERVES
steadily higher, reaching a 5% to 6 per cent range on
The money market was quite firm during most of Au­ three-month maturities and a 5.8 to 6Va per cent range
gust, although a slightly easier tone emerged toward the on six-month maturities by the end of the month. Over
end of the month. Nationwide net borrowed reserves aver­ $3.7 billion of outstanding negotiable certificates of de­
aged $394 million during the five weeks ended August 31, posit matured at large commercial banks in August, and
little changed from the revised level of the month before an additional $6.7 billion is scheduled to come due over
(see Table I). Reflecting the persisting pressures on com­ the September-October period. With interest rates on most
mercial bank reserve positions, Federal funds were competing money market instruments above the 5 V2 per
strongly bid through most of the month. The effective rate cent ceiling rate applicable to new time certificates, com­
on such funds generally ranged from 5Vi per cent to a mercial banks were faced with the prospect of mounting
record 5Vs per cent and, for the first time, some trad­ difficulties in replacing maturing certificates. In August,
ing occurred at 6 per cent— l Vi per cent above the Fed­ negotiable time certificates outstanding at weekly report­
eral Reserve discount rate. Member bank borrowings from ing member banks in New York City declined by $263
the Federal Reserve Banks averaged $740 million during million.




FEDERAL RESERVE BANK OF NEW YORK

Federal R eserve System Policy Statem ent
On September 1, 1966, the Federal Reserve System
issued the following statement:
It is the view of the Federal Reserve System that
orderly bank credit expansion is appropriate in to­
day’s economy. However, that expansion should be
moderate enough to help insure that spending— and
particularly that financed by bank credit— does not
exceed the bounds that can be accommodated by the
Nation’s growing physical resources. An excessive
expansion of bank credits would aggravate inflation­
ary pressures that are already visible.
While the growth of total bank credit and total
bank lending has moderated somewhat as compared
with last year, total bank loans plus investments have
grown at an annual rate of over 8 per cent during
the first eight months of this year, and total bank
loans at a rate of over 12 per cent. Meanwhile, bank
lending to business has increased at an annual rate
of about 20 per cent.
It is recognized that business demands for bank
credit have been particularly intense. While such
credit requests often appear justifiable when looked
at individually, the aggregate total of credit-financed
business spending has tended towards unsustainable
levels and has added appreciably to current inflation­
ary pressures. Furthermore, such exceedingly rapid
business loan expansion is being financed in part by
liquidation of other banking assets and by curtail­
ment of other lending in ways that could contribute
to disorderly conditions in other credit markets.
The System believes that the national economic
interest would be better served by a slower rate of
expansion of bank loans to business within the con­
text of moderate overall money and credit growth.
Further substantial adjustments through bank liquida­
tion of municipal securities or other investments
would add to pressures on financial markets. Hence,
the System believes that a greater share of member




bank adjustments should take the form of modera­
tion in the rate of expansion of loans, and particu­
larly business loans.
Accordingly, this objective will be kept in mind
by the Federal Reserve Banks in their extensions of
credit to member banks through the discount win­
dow. Member banks will be expected to cooperate
in the System’s efforts to hold down the rate of
business loan expansion— apart from normal season­
al needs— and to use the discount facilities of the
Reserve Banks in a manner consistent with these
efforts. It is recognized that banks adjusting their
positions through loan curtailment may at times need
a longer period of discount accommodation than
would be required for the disposition of securities.
This program is in conformity with the provision
in section 201.0, paragraph (e), of the Board’s Reg­
ulation A governing lending to member banks: “In
considering a request for credit accommodation, each
Federal Reserve Bank gives due regard to the pur­
pose of the credit and to its probable effects upon
the maintenance of sound credit conditions, both as
to the individual institution and the economy gen­
erally___ ”
Federal Reserve credit assistance to member
banks to meet appropriate seasonal or emergency
needs, including those resulting from shrinkages of
deposits or of other sources of funds, will continue
to be available as in the past.
A slower rate of business loan expansion is in the
interest of the entire banking system and of the
economy as a whole. All banks should be aware of
this consideration, whether or not they need to bor­
row from the Federal Reserve. Management of
bank resources in accordance with the principles out­
lined above can make a constructive contribution to
sustained economic prosperity, and the Federal Re­
serve System is confident that the banks will give
their wholehearted support to this effort.

209