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159 FEDERAL RESERVE BANK OF NEW YORK Treasury and Federal Reserve Foreign Exchange Operations* By Charles During the first four months of 1967, sterling staged a strong recovery while international financial markets gen erally moved into better balance as inflationary pressures receded and credit conditions eased. Toward the end of May, unfortunately, the sudden eruption of the Middle East crisis jolted confidence in both the gold and foreign exchange markets. Money immediately flowed in heavy volume to the traditional haven of Switzerland, thereby imposing further strain on the Euro-dollar market from which funds were already being withdrawn in anticipation of midyear liquidity requirements. Sterling also came under pressure, reflecting concern that Britain might prove par ticularly vulnerable to adverse developments in the Middle East. In the gold market, fears that the Middle East hos tilities might develop into a broader conflict briefly, but strongly, intensified speculative buying, already influenced by public discussions of United States gold policy, the Treasury’s suspension of silver sales, alternating reports of imminent success or failure of negotiations to increase international liquidity, and tensions in the Far East. These severe pressures in the gold and exchange mar kets in early June brought an immediate central bank response. To relieve the stringency in the Euro-dollar market, the Bank for International Settlements (BIS) drew $143 million on its swap line with the System and placed these funds in the market. This BIS operation, which was reversed in July, helped to settle the market and ease the pressures on sterling resulting from the pull of higher A. C oom bs Euro-dollar rates. At the same time, the United States authorities, in cooperation with the Bank of England, acted to absorb sterling from the market by purchasing spot against forward resale a total of $112.8 million equiv alent of sterling. In addition, the Bank of England strength ened its own resources by reactivating its swap line with the Federal Reserve through a drawing of $225 mil lion in June. The Federal Reserve made even heavier draw ings on its Swiss franc swap lines to absorb the flow of Table I FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS August 31, 1967 Institution Austrian National Bank ..................... 100 National Bank of Belgium ................. 150 Bank of Canada ................................... 500 National Bank of Denmark ............... 100 Bank of England ................................... 1,350 Bank of France .................................... 100 German Federal Bank ......................... 400 Bank of Italy ......................................... 600 Bank of Japan ....................................... 450 Bank of Mexico ..................................... 130 Netherlands Bank ................................. 150 Bank of Norway ................................... 100 Bank of Sweden ................................... 100 Swiss National Bank ........................... 250 * This report, covering the period March to September 1967, Bank for International Settlements is the eleventh in a series of reports by the Vice President in Swiss francs/dollars ......................... charge of the Foreign function o f the Federal Reserve Bank of Other European currencies/dollars New York and Special Manager, System Open Market Account. The Bank acts as agent for both the Treasury and the Federal Re Total ............................................. serve System in the conduct o f foreign exchange operations. Amount of facility (in millions of dollars) 250 300 5,030 MONTHLY REVIEW, SEPTEMBER 1967 160 Table U DRAWINGS AND REPAYMENTS BY FEDERAL RESERVE SYSTEM UNDER RECIPROCAL CURRENCY ARRANGEMENTS M arch 1962-August 1967 In millions of dollars 1962 Institution First half 1963 Second half Austrian N ational Bank Drawings ................................................ Repaym ents............................................. 50.0 National Bank of Belgium Drawings ................................................ Repaym ents............................................ 30.5 15.5 First half 50.0 Bank of France Drawings ................................................ Repaym ents............................................. 50.0 50.0 10.0 25.0 150.0 Bank of Italy Drawings ................................................ R epaym ents............................................ Netherlands Bank Drawings ................................................ Repaym ents............................................. 25.0 25.0 50.0 German Federal Bank Drawings ................................................ R epaym ents............................................ 50.0 10.0 50.0 50.0 Second half First half 15.0 15.0 Second half First half Second half First half JulyAugust Total 145.0 100.0 65.0 50.0 85.0 110.0 35.0 30.0 30.0 37.5 10.0 92.5 510.5 390.5 20.0 20.0 10.0 10.0 85.0 85.0 21.5 12.5 9.0 136.0 226.0 55.0 115.0 Drawings outstanding on August 31, 1967 50.0 100.0 15.0 65.0 140.0 250.0 82.0 100.0 168.0 100.0 140.0 546.0 546.0 325.0 310.0 15.0 725.0 725.0 50.0 10.0 100.0 70.0 80.0 100.0 25.0 25.0 65.0 30.0 35.0 50.0 80.0 5.0 25.0 100.0 150.0 90.0 60.0 75.0 60.0 60.0 40.0 480.0 447.0 210.0 403.0 80.0 25.0 55.0 150.0 5.0 145.0 310.5 190.5 235.0 265.0 532.5 348.5 80.0 464.0 dollars to Switzerland, while the Gold Pool kept the Lon don gold market price under firm control. Although the immediate disturbances in the gold and exchange markets associated with the Middle East crisis were thus quickly dealt with, international financial mar kets remained uneasy during succeeding months while short-term funds continued to move across the exchanges in response to differentials in interest rates and credit con ditions. Recurrent pressures on sterling, for example, seemed to reflect interest rate differentials marginally un favorable to London, as well as hedging. At the close of August, the successful conclusion of the Group of Ten discussions on international liquidity brought about some covering of short positions in sterling while also relieving speculative buying pressure on the London gold market. As in the past, dollar rates in the exchange markets 120.0 71.5 71.5 50.0 Bank for International Settlements Drawings ................................................ Repaym ents............................................. First half 1967 20.0 20.0 50.0 110.0 Second half 1966 50.0 50.0 Swiss National Bank Drawings ................................................ Repaym ents............................................. All banks Drawings ................................................ Repaym ents............................................ 1965 50.0 Bank of Canada Drawings ................................................ R epaym ents............................................ Bank of England Drawings ................................................ Repaym ents............................................ 1964 100.0 395.0 100.0 135.0 20.0 420.0 400.0 20.0 185.0 43.0 33.0 17.0 598.0 425.0 173.0 75.0 185.0 75.0 15.0 605.0 405.0 200.0 710.0 430.0 407.5 318.0 160.5 3.631.0 17.0 3.118.0 513.0 were influenced both by the United States balance-ofpayments deficit and the backwash from large shifts of funds among third countries. The Federal Reserve swap lines, after having reverted fully to a standby basis last February, were once again activated in May when the Sys tem began a series of drawings on its swap line with the Belgian National Bank in order to absorb a continuing influx of dollars into Belgium. Such drawings of Belgian francs rose to $120 million equivalent by the end of August, while drawings of $20 million equivalent of Dutch guilders were also required to absorb dollar acquisitions by the Netherlands Bank. By far the largest operation, how ever, was undertaken in Swiss francs in order to absorb $390 million that poured into the Swiss National Bank during May and June. There were only very limited op portunities to reverse these operations during the sum- 161 FEDERAL RESERVE BANK OF NEW YORK sues, partly offset by redemption at maturity of Belgian franc-denominated bonds totaling $30.2 million, brought to $1,015.5 million total outstanding issues of United States Treasury foreign currency obligations (see Table III). Table III OUTSTANDING UNITED STATES TREASURY SECURITIES FOREIG N CURRENCY SERIES In millions of dollars equivalent Issued to Austrian National Bank.... National Bank of Belgium ... 1967 Amount Issues or redemptions (—) Amount outstand outstand Net ing on ing on changes January 1, 1966 July- August 31, 1967 1966 August II 1 50.3 100.7 — 50.3 30.2 -3 0 .2 477.0 German Federal Bank.......... 602.1 -251.5 Bank of Italy.......................... 124.8 124.8 257.3 — 46.2 210.8 Swiss National Bank............. Bank for International Settlements*........................... Total............................... 92.6 1,207.8 —348.0 125.5 152.7 60.2 30.0 125.5 1,015.5 Note: Discrepancies in amounts are due to valuation adjustments, refundings, and rounding. * Denominated in Swiss francs. mer months, and at the end of August System swap drawings outstanding totaled $513 million (see Table II). Subsequently, in early September the Federal Reserve drew an additional $5 million under its arrangement with the National Bank of Belgium and $10 million from the Neth erlands Bank. During the period under review, the Federal Reserve swap network was expanded and further strengthened. In May, new swap facilities were negotiated with the cen tral banks of Denmark and Norway in the amount of $100 million each and with the Bank of Mexico for $130 million. Then in July, against the background of the Middle East problem, the System negotiated in creases in: (1) its Swiss franc swap lines with the Swiss National Bank and the BIS (each facility being increased by $50 million to $250 million), and (2) its swap line with the BIS providing for swaps of dollars against other European currencies (this facility rising from $200 mil lion to $300 million). Thus, the Federal Reserve swap network now comprises bilateral agreements with fourteen central banks plus the BIS which provide mutual credit facilities totaling $5,030 million. In April and May, the United States Treasury issued to the BIS certificates of indebtedness denominated in Swiss francs, the proceeds of which ($60.2 million equiva lent) were used to reduce third-currency swaps negotiated with the BIS last February to liquidate previous Swiss franc drawings by the System. In July the Treasury issued the first of four scheduled AVi-year $125 million notes, denominated in German marks. These latest security is STERLING During the first quarter of 1967, funds that had fled from sterling during the summer of 1966 began moving back at an accelerated pace. By early March, these in flows had enabled the Bank of England to liquidate com pletely the swap drawings from the Federal Reserve and to repay fully other sizable special credits from the Federal Reserve and the United States Treasury. (At their peak in August of last year, credits from the United States had reached $750 million. By the end of September they had been reduced to $575 million through substitution of other credit facilities.) Announcement of these repay ments confirmed to the market the degree of recovery that had already taken place and triggered a spurt of buying that gained momentum as the month progressed. Other developments during March contributed to a surge of covering of short positions. These included an nouncements of (1) renewal of the credit lines from nine central banks and the BIS, (2) unexpectedly good fourthquarter balance-of-payments figures, (3) a cut in bank rate from 6 V2 per cent to 6 per cent, which was taken as a sign of confidence, and (4) the Government’s decision to con tinue strict control over price and wage increases through July 1968. In addition to having repaid early in March its swap with the Federal Reserve, the Bank of England later in the month used most of its record reserve gains to repay other short-term central bank debts. Thus, within a sixmonth period, the Bank of England had repaid $575 mil lion to the United States authorities and $720 million to other parties. Remaining central bank credits linked spe cifically to changes in overseas sterling balances were liquidated early in the second quarter. The influx of short-term capital continued in April and early May, though at a diminishing rate. The British authorities were able to announce a reserve increase of $145 million in April, as foreign short-term interest rates continued to fall and the United Kingdom budget message met with a generally favorable reception. As early as April, however, some market concern was beginning to be ex pressed about the trend in the trade figures, and by early May covered interest rate comparisons that had tended to favor London earlier in the year started to turn ad verse. Shortly after the announcement on May 4 of the third cut in bank rate this year, from 6 per cent to 5 V2 per cent, Euro-dollar rates began to firm, despite subse 162 MONTHLY REVIEW, SEPTEMBER 1967 quent steps toward further monetary ease by several Con tinental countries. Moreover, announcement on May 11 that the British trade deficit had jumped from $36 million in March to $115 million in April was followed a few days later by President deGaulle’s sharply negative comments at a press conference on Britain’s application to join the Common Market. By mid-May the combination of these adverse factors had led to the first net selling of sterling this year. Nevertheless, the British authorities proceeded with their plans to prepay $405 million on May 25 to the Inter national Monetary Fund (IM F )— more than half of the amount due this December under the 1964 drawing— together with the whole amount ($80 million) borrowed in 1964 from Switzerland, thus further reestablishing avail able credit facilities. On June 1, market expectations of an imminent out break of hostilities in the Middle East sparked a burst of selling of sterling. Such apprehension of war affected sterling not only directly but also indirectly through the Euro-dollar market, where precautionary withdrawals of funds combined with the usual pressures associated with midyear window dressing to create a sudden squeeze and a sharp hike in rates. These dual pressures were immediately met by a coordinated central bank response in both the exchange and Euro-currency markets. On June 1 the United States authorities, in consultation with the Bank of England, purchased a total of $92.9 million of sterling in the New York market on a swap basis, buying spot against forward sales. That same day the BIS began placing in the Euro-dollar market new dollar funds drawn under its swap arrangement with the Federal Reserve. By June 7, when a cease-fire resolution by the United Nations served to reduce tensions somewhat, the BIS had drawn a total of $143 million from the System and had placed these dollars, together with funds received from other central banks, in the Euro-dollar market. Meanwhile, the United States authorities had temporarily taken another $20 million of sterling out of private hands through additional swap pur chases in New York. With the cessation of actual hostili ties, covering by the market of short positions in sterling boosted the spot rate from a low of $2.7900 on June 6 to $2.7932 on June 7 while permitting the Bank of England to recoup much of the exchange that had been used during the preceding few days. As the month progressed, however, rumors that Arab countries might withdraw sterling balances revived market anxieties while the announcement at midmonth of disap pointing trade figures for May had a further disturbing effect. Finally, the pull of foreign interest rates, particu larly during a brief squeeze in the Euro-dollar market at the end of June, exerted further pressure. To cushion the reserve impact of these adverse developments, the Bank of England drew $225 million during June under its $1,350 million swap arrangement with the Federal Re serve. SWISS FRANC During the first half of 1967, Swiss interest rates de clined less rapidly than rates outside Switzerland. Indeed, during much of this period, the Swiss credit market re mained relatively tight, and there was on the whole more incentive for foreigners to pay off previous Swiss franc borrowings than there was for Swiss residents to place new funds abroad. Even in the early months of the year, the reflux to foreign markets of funds repatriated by Swiss residents at the year-end was less than might have been expected on the usual seasonal pattern. As a result, the Federal Reserve was unable to acquire through the market sufficient francs to pay down completely earlier drawings under its swap lines with the Swiss National Bank and the BIS. To liquidate the residual balance of $75 million in Swiss francs due to the BIS, the United States authorities in February used $75 million equivalent of sterling bal ances to acquire Swiss francs from the BIS on a temporary swap basis. Subsequently, when the Swiss National Bank released to the Swiss commercial banks part of their de posits that had been blocked since 1961 the banks bought BIS Swiss franc promissory notes in the amount of $60.2 million equivalent. The BIS placed these francs at the dis posal of the United States Treasury, which in exchange issued certificates of indebtedness denominated in Swiss francs. The Swiss franc proceeds of these issues were used to reduce the commitment under the sterling/Swiss franc swap to $14.3 million equivalent. In order to forestall a rapid rise in the Swiss franc rate during March when Swiss banks repatriated funds for liquidity requirements, the Swiss National Bank announced early in the month that it would provide Swiss francs against dollars for end-of-quarter needs through short term swaps with the Swiss commercial banks. This was the first time that the Swiss authorities had offered this facility other than at midyear and at the year-end. During the final weeks of March, the central bank took in $221 mil lion on this basis and immediately reinvested the money in the Euro-dollar market to assist in moderating pres sures in that market. Following the end of the quarter, interest rates on ster ling and dollar investments continued to decline, while the unwinding of the Swiss National Bank swaps with its com mercial banks tended to tighten the Swiss market once again. Foreigners, particularly Italians, began to bid for 163 FEDERAL RESERVE BANK OF NEW YORK Table IV DRAW INGS AND REPAYMENTS BY FOREIG N CENTRAL BANKS U NDER RECIPROCAL CURRENCY ARRANGEMENTS March 1962-June 1967 In millions of dollars 1962 Institution First half Second half National Bank of Belgium Bank of Canada Drawings .............................................................. Repaym ents.................................................... ..... 250.0 1964 1963 First half Second half 35.0 25.0 10.0 20.0 First half 1965 Second half First half Second half First half 25.0 Bank of Italy Drawings .............................................................. R epaym ents....................................................... ... 25.0 50.0 Bank of Japan D raw in g s.............................................................. R epaym ents.......................................................... 15.0 1.355.0 1.215.0 1.170.0 1.055.0 550.0 435.0 175.0 475.0 50.0 250.0 250.0 60.0 25.0 60.0 45.0 First half 17.6 17.6 267.6 267.6 450.0 275.0 225.0 4.010.0 350.0 3.785.0 Drawings outstanding on June 30, 1967 225.0 150.0 150.0 100.0 150.0 80.0 80.0 30.0 80.0 Bank for International Settlements* D raw in g s................................................ ............. R epaym ents......................................................... All banks D raw in g s.............................................................. R epaym ents.......................................................... Second half Total 45.0 45.0 250.0 Bank of England Drawings .............................................................. Repaym ents.......................................................... 1967 1966 165.0 1.385.0 1.215.0 150.0 1.250.0 1.055.0 550.0 435.0 175.0 475.0 285.0 85.0 225.0 282.0 510.0 367.0 143.0 752.6 377.6 450.0 5.062.6 632.0 4.694.6 368.0 * Includes, in addition to drawings in connection with Euro-dollar operations, BIS drawings of dollars against European currencies other than Swiss francs to meet temporary cash requirements. During the first six months of 1967, such drawings totaled $82 million. Swiss francs to repay indebtedness previously incurred and started shifting their borrowings to currencies that were being lent more cheaply, notably German marks, while in addition there may have been some net repatriation of funds by Swiss banks. As a result, the spot rate moved up from $0.2307Vi at the beginning of April to the effective ceiling of $0.23 VJV2 by April 26, at which point the Swiss National Bank became a buyer of dollars for the first time in 1967. With credit conditions remaining tight and some nervousness developing about sterling and the prospects of a Middle East clash, the rate held at or close to the ef fective ceiling through most of May, and the Swiss Na tional Bank added some $180 million to its reserves. The prepayment by the Bank of England in May of the $80 million credit extended to it in December 1964 resulted in equivalent dollar acquisitions by the Swiss National Bank. During the first days of June the rumor, and then actual outbreak, of hostilities in the Middle East precipitated a heavy flow of funds to Switzerland. The dollar holdings of the Swiss National Bank, already swollen by the in flows in May, jumped by $212 million in the first week of June. In order to absorb these dollar flows, the Federal Reserve on June 2 and June 8 drew a total of $370 million equivalent of Swiss francs in equal amounts under its swap arrangements with the Swiss National Bank and the BIS; in addition, the Swiss National Bank pur chased $30 million of gold from the United States Trea sury. Although only a part of the shift of funds to Switzer land during this period represented transfers directly out of sterling, the Swiss authorities were prepared to cooper ate with the Bank of England in countering the effects of such shifts. One by-product of this cooperation was the acquisition by the Federal Reserve of $28 million equiva lent of Swiss francs which were used on June 16 to repay an equivalent amount of its drawings on the Swiss Na tional Bank. Following the cease fire in the Middle East, the demand for francs abated, only to pick up again on a moderate scale just before midyear. Once again, the Federal Reserve drew on its swap arrangements to absorb these inflows; it added $33 million to its drawings on the Swiss central bank and $15 million to its drawings on the BIS, bringing the total of Swiss franc drawings outstanding on July 3 to the equivalent of $390 million, out of credit lines then to taling $400 million. The drawing on the Swiss National 164 MONTHLY REVIEW, SEPTEMBER 1967 Bank was reduced on July 28 to $180 million, when the Swiss National Bank purchased $10 million from the Sys tem against Swiss francs to meet Swiss official require ments. In view of continuing uncertainties in financial markets and unsettled conditions in the Middle East during the summer, it was agreed in mid-July that the Federal Re serve swap lines in Swiss francs with the Swiss National Bank and the BIS should be expanded by $50 million each to a new combined total of $500 million. (At the same time, the $200 million swap facility with the BIS in Eu ropean currencies other than Swiss francs was increased by $100 million equivalent to $300 million.) The capital inflows in May and especially in June led to increased liquidity in Switzerland and eliminated the need for any special measures, such as short-term swaps, to meet midyear needs. Indeed, there was some easing in Swiss interest rates. In order to reinforce this trend, the Swiss central bank on July 10 reduced its discount rate from 3V2 per cent to 3 per cent, explaining that the move was “likely to facilitate the reestablishment of interest rate differences existing normally between Switzerland and foreign countries and thus also the reflux abroad of the excess liquidity registered in the past two months”. Follow ing this move, and as Euro-dollar rates became relatively more attractive, some movement of funds out of Switzer land began to develop, and by late August the franc had eased considerably. When the rate reached $0.2304V&, the Swiss National Bank began selling dollars to the mar ket. The Bank subsequently purchased $7 million from the System which used the Swiss franc counterpart to reduce its outstanding drawings in Swiss francs. Such Federal Re serve drawings thus amounted to $373 million as of the end of August. Following the usual seasonal pattern, there was a sub stantial reflow of funds from Germany just after the yearend, and the Federal Reserve was able to acquire in the market and through special transactions sufficient marks to liquidate by mid-February the $140 million drawn on the swap line with the German Federal Bank in December 1966. During March and April, the spot rate generally held close to its upper limit but the central bank did not add significantly to its reserves. By mid-May, however, the mark began to ease as the cumulative influence of easy money policy induced heavy outflows of commercial bank funds. At the same time, German firms that had taken up sizable amounts of funds abroad began making repayments as credit became more readily available in Germany. The easing trend in spot marks became more pro nounced toward the end of June, when the German Fed eral Bank announced the fourth reduction in reserve requirements this year. To encourage retention in Ger many of this newly released bank liquidity, the German Federal Bank at the same time altered its pattern of ex change market activity. For several months, the central bank had been concerned that its policy of active ease had been more successful in stimulating outflows of funds than in reducing domestic interest rates. By widening its announced buying and selling rates and permitting a rapid fall in the spot rate, the central bank sought to increase the degree of uncertainty about future rate movements, particularly for those who were investing abroad at very short term on an uncovered basis. As the spot rate dropped sharply in early July to just below par, investors immediately began to purchase forward cover to avoid the risk of a future rise in the rate and the cost of such cover back into marks jumped from about 3A per cent for threemonth maturity, for example, to over 1% per cent and GERMAN MARK remained close to IV2 per cent through August. The German economy has been operating at less than During the period under review, there were discussions capacity this year, and the slack in domestic activity has between Germany and the United States, together with been reflected in a substantial drop in imports and buoy the United Kingdom, concerning military forces in NATO ant exports. As a result, the German trade surplus nearly and the balance-of-payments consequences of United quadrupled from $555 million in the first half of 1966 States and United Kingdom troop deployments in Ger to $2.2 billion in the first half of this year. Had it not been many. In early May, the United States authorities released for the very large outflows of short-term funds stimulated an exchange of letters growing out of these discussions by the significant easing in German monetary policy, this between the President of the German Federal Bank, Karl trade surplus could have created severe strains in interna Blessing, and the Chairman of the Federal Reserve Board, tional credit markets and the foreign exchange market. William McChesney Martin, Jr., in which the former indi Thus, the series of reductions in the discount rate and in cated that the Federal Bank intended to continue its prac reserve requirements during the first eight months of this tice of not converting dollars into gold as part of a policy year, while designed primarily to stimulate the flagging of international monetary cooperation. This statement domestic economy, were very helpful from an international was made with the agreement of the German Federal standpoint as well. Government, which at the same time took note of the FEDERAL RESERVE BANK OF NEW YORK Federal Bank’s intention to purchase $500 million of United States Government medium-term securities in four equal quarterly instalments beginning in July. The first $125 million equivalent German mark security was issued on July 3. DUTCH GUILDER During the early part of 1967, the guilder came on offer as the Dutch trade balance moved into deficit, pri marily due to slackening demand by some of its major trading partners. At the same time, the recovery of sterling attracted additional outflows of guilder funds. Under the circumstances, the Netherlands Bank released dollars to the market and further reduced its dollar reserves by con verting into dollars the guilder tranche of a multicurrency drawing from the IMF by Spain. The Netherlands Bank then replenished its dollar reserves by buying $35 million from the Federal Reserve against guilders. The Federal Reserve used the guilders to repay by the end of January the remaining commitment under a $65 million swap draw ing made during the summer of 1966. The Dutch economy continued to ease, and in midMarch the Netherlands Bank reduced its discount rate from 5 per cent to 4 Vz per cent. (The rate had been raised to 5 per cent in May 1966 in order to damp down the then overheated economy.) The move also brought in terest rates in the Netherlands more nearly into line with those in other centers. At the same time, the Netherlands Bank removed the penalty deposit requirement for banks exceeding credit ceilings. Despite these moves, money market conditions in the Netherlands remained tighter than abroad and Dutch banks withdrew funds from other markets. Under the circumstances, the Dutch authorities began to rely increasingly on swap transactions in the ex change market—that is the purchase of dollars spot against forward delivery— as a regular method of relieving money market pressures. Dollars taken in by the central bank on a swap basis reached fairly substantial levels be ginning in May and rose to a peak of $150 million in early June. In the early summer, the backwash of the hostilities in the Middle East and renewed pressures on sterling domi nated the foreign exchange markets. As additional funds moved into Amsterdam, the guilder rose sharply and the Netherlands Bank took in dollars both outright and on a swap basis. Accordingly, at the end of July the Federal Reserve drew $20 million of guilders under its $150 mil lion swap line with the Netherlands Bank and used the proceeds to absorb an equivalent amount of dollars on the books of the Dutch central bank. Following a further flow 165 of funds into the Netherlands, in early September the Federal Reserve made an additional drawing of $10 mil lion equivalent. CANADIAN DOLLAR During the early part of 1967, movements in the Cana dian dollar rate were influenced by fluctuations in the volume of new Canadian bond flotations in the New York market and by short-term capital flows. A flurry of new issues in January, together with the take-down of proceeds of previous issues and the repatriation of funds from the United States, more than offset adverse seasonal factors and the Canadian dollar moved above par ($0.9250) where it held through mid-February. At the end of Feb ruary, as the rate of new external issues abated and ad verse seasonal factors asserted themselves, the rate moved below par and remained there during the rest of winter and early spring. The Canadian dollar began moving into a period of sea sonal strength late in the spring as grain shipments started up again. Then in June an increase in the level of bond issues lent further strength to the Canadian dollar, push ing it above par. An additional— although quite temporary —boost was given to the spot rate when unfounded rumors of an increase in the Canadian-Russian wheat agreement were prompted by the arrival in Canada of a Russian trade delegation. During the summer, tourist re ceipts were unusually large as the success of EXPO 67 drew an exceptional number of visitors to Canada. Con sequently, the Canadian dollar remained quite strong dur ing July and August, fluctuating in a narrow range around $0.9300. Official gold and foreign exchange reserves nevertheless declined moderately during the first seven months of the year (by $53.3 million), with the decline in large part ($31.8 million) the result of purchases by the Canadian authorities of Canadian Government debt held by United States residents. BELGIAN FRANC The Belgian franc moved above par in January as lightly slackening activity in the Belgian economy con tributed to a more than seasonal drop in imports, and the current account shifted from deficit to surplus during the winter. There was no real pressure in the exchange mar ket, however, and official holdings of gold and foreign ex change were little changed through the first quarter. In April the franc began to strengthen further as the current account continued in surplus and from May on ward the franc held at or near its upper intervention point. 166 MONTHLY REVIEW, SEPTEMBER 1967 In part, this strength reflected an inflow of short-term capital despite steps by the central bank to ease monetary policy somewhat, including three discount rate cuts dur ing the first half of the year. During the rest of the period, the National Bank of Belgium was compelled to take in substantial amounts of dollars. Inflows in late April and early May led the Federal Reserve to absorb $30 million that had been acquired by the National Bank by utilizing its $150 million swap line with that Bank. In an unrelated transaction, the United States Treasury during May re paid two maturing Belgian franc denominated bonds to taling $30.2 million originally issued in 1963 using francs it had acquired in late 1966 when the dollar was in de mand in Belgium. The Federal Reserve used an additional $7.5 million of the swap line in June but shortly thereafter repaid $10 million by selling dollars to the National Bank to meet Belgian Government needs. In July and August demand for francs was intensified as commercial banks increased their inflow of short-term capital. (The scope for the banks to employ in Belgium the proceeds of foreign borrowings increased with the removal in late June of the credit ceil ings that had been previously applied on a voluntary basis.) The renewed pressures on sterling also contributed to the substantial inflow as commercial interests and banks re duced their holdings of sterling. In order to absorb dollars purchased by the National Bank during this period, the Federal Reserve used a further $92.5 million under the swap arrangement plus $3 million of Belgian franc balances. Thus at the end of August, total swap drawings by the Federal Reserve stood at $120 million. Following a fur ther flow of funds into Belgium, in early September the Federal Reserve made an additional drawing of $5 mil lion equivalent. ITALIAN LIRA The deficit that had emerged in late 1966 in Italy’s bal ance of payments continued during the first two months of 1967, reflecting seasonal factors and intensified im port demand associated with an expanding economy. In addition, there were sizable exports of capital, partly in anticipation of changes in the Italian tax laws. Under the circumstances, United States monetary authorities were able to acquire sufficient lire to repay short-term lira commitments totaling $114 million, of which the final $15 million portion was liquidated at the begin ning of 1967. In March, Italy’s balance of payments began to strengthen, although the reemerging surplus was consid erably less than during the comparable period a year earlier as import demand expanded further and capital ex ports continued. As economic expansion generated mount ing financial requirements on the part of Italian residents for both foreign exchange and local currency, Italian banks reduced their net claims on foreigners by nearly $275 mil lion during the first six months of the year. During the same period, Italian official reserves, including Italy’s position in the IMF, increased by $55 million. About midyear the Italian payments position moved into the period of seasonal strength and the demand for lire intensified. The Italian authorities began to acquire sub stantial amounts of dollars, though on a lesser scale than the previous year. The Federal Reserve did not draw upon its $600 million swap line with the Bank of Italy during the period, but outstanding Federal Reserve and Treasury technical commitments in forward lire were rolled over periodically during 1967. OTHER CURRENCIES During the period under review, there were no Sys tem transactions in Austrian schillings, French francs, Japanese yen, Danish kroner, Norwegian kroner, Swedish kronor or Mexican pesos. Nor were there any drawings by the United States Treasury on the IMF. As of the end of August, net United States indebtedness to the Fund was $922.2 million. EURO-DOLLAR MARKET The Euro-dollar market eased considerably during the first four months of 1967, after having been subjected to considerable strain last year. Excessive reliance on mone tary policy in a number of countries had pushed domestic interest rates to historically high levels which affected the international money market as well. United States banks in particular turned to the Euro-dollar market in an effort to recoup deposits being lost as certificate of deposit rates reached ceiling levels under Regulation Q and became uncompetitive with commercial paper. Thus, between late June and the peak in mid-December, United States banks added some $2.4 billion to their borrowings through foreign branches. Later, year-end liquidity re quirements placed additional demands on the market. In the final weeks of 1966, concerted action was taken by the BIS and a number of central banks to counter these year-end pressures, and the constellation of Euro-dollar rates began to ease. (For a description of these operations, see this Review, March 1967, pages 43-51.) The decline in rates was even more pronounced after the turn of the year. By late April, three-month deposits FEDERAL RESERVE BANK OF NEW YORK YIELD COMPARISONS BETWEEN THREE-MONTH EURO-DOUARS UNITED KINGDOM IOCAL AUTHORITY DEPOSITS AND CERTIFICATES OF DEPOSIT OF UNITED STATES BANKS Per c«nt Per cent 1964 1967 were quoted at 41% 6 per cent, lower than at any time in 1966 and 2 Vi percentage points below their peak of late November (see chart). This sharp decline in rates re flected, in addition to the usual seasonal pattern, decidedly easier monetary conditions in the United States and Ger many and to a lesser extent in other countries as well. By the end of the first quarter, United States banks had reduced their liabilities to foreign branches mainly in London by some $1.25 billion from the mid-December peak, while German and Swiss institutions added sub stantially to their net foreign currency assets abroad. A large part of the foreign funds shifted to London dur ing the early months of the year were converted into 167 sterling, reflecting both the relative attractiveness of sterling-denominated short-term assets and the return of confidence in that currency. As indicated on the accom panying chart, British local authority deposits commanded a modest edge over Euro-dollars early in the year and again in April, even allowing for exchange cover. On an un covered basis, of course, there had been a substantial interest margin in favor of sterling assets right along, but this incentive became of practical significance in terms of shifts of funds only with the return of confidence. The trend in interest rate relationships shifted during the second quarter as conditions in the Euro-dollar mar ket began to tighten, partly reflecting a similar movement in United States short-term rates. Banks in some countries began to withdraw funds from the Euro-dollar market while those in other countries accelerated the pace of their previous borrowing. At the same time, placement of Ger man funds tapered off and United States banks on balance were no longer repaying previous borrowings. Rates in the Euro-dollar market began to rise in May, and with the outbreak of hostilities in the Middle East in June, precau tionary withdrawals of funds combined with preparations for mid-year to cause a sharp jump in rates. The increased interest incentive to shift funds from sterling to the Euro dollar market added a further element of pressure on sterling. Accordingly, as indicated in the section on sterling, the BIS immediately began to place sizable amounts of dollars in the Euro-dollar market, financing $143 million of such placements by drawing on the swap line with the Federal Reserve. These operations quickly calmed the market, and, with the cessation of fighting, the rapid rise in rates came to a halt. Apart from a brief period of stringency at midyear and in early July, Euro-dollar rates have generally tended downward in recent weeks despite renewed borrowings by United States banks through their branches that have brought these liabilities back to a level approaching last December’s peak. Some new funds have come into the market as a result of the United States payments deficit as well as from short-term outflows from Germany and Swit zerland. In addition, there has been a shift of funds out of sterling, partly because the covered incentive between sterling and Euro-dollar investments has favored the latter for several months now. 168 MONTHLY REVIEW, SEPTEMBER 1967 Some Current Banking and Economic Problems* By W i l l ia m F. T r e ib e r First Vice President, Federal Reserve Bank of New York It is a great pleasure to be with you today. You, as state bank supervisors, and we in the Federal Reserve System have many common interests. Both are interested in pro moting a sound banking system that will continue to de velop and to serve effectively the nation and its people. You have the responsibility of chartering and supervising banks organized under state law. We in the Federal Re serve have a secondary responsibility of supervising some of those banks. We are also concerned with the preserva tion of the value of our nation’s money, for we have been delegated responsibilities in this respect by the Congress which under the United States Constitution has the power to coin money and regulate the value thereof. Today I propose to discuss with you, as we see them, some recent developments and current problems in promoting an effi cient and sound banking system, in preserving the value of the dollar, and in promoting our other national economic goals. Most of these problems involve Federal legislation in one way or another. REGULATION OF INTEREST RATES PAID BY FINANCIAL INSTITUTIONS Public Law 89-597, which was enacted September 21, 1966, broadened and placed on a discretionary basis the authority of the Federal Reserve Board and the Fed eral Deposit Insurance Corporation (FDIC) to limit in terest rates paid by banks on time and savings deposits. It granted similar authority to the Federal Home Loan Bank Board to limit interest rates paid by savings and loan associations, and required prior consultation among all three agencies before any one agency could prescribe new rate limits.1 The law is temporary. On September 21, 1967, the prior provisions of law will be restored unless the Congress enacts new legislation. On July 17, 1967, the Senate voted to extend for two years the provisions of Public Law 89-597. The Senate bill is now before the Committee on Banking and Currency of the House of Representatives. I would like to comment on two aspects of this tempo rary legislation: (1) the discretionary nature of the au thority to limit the rate of interest paid by commercial banks, and (2) the authority to limit interest rates paid by mutual savings banks and savings and loan associa tions. I think that these provisions, as well as other pro visions upon which I will not take the time to comment, should be made permanent. c o m m e r c i a l b a n k s . Prior to the enactment of the tem porary legislation last year, the Federal Reserve Board was required by law to establish maximum rates on time and savings deposits in member banks, and the FDIC was required to establish maximum rates on similar de posits in insured nonmember banks.2 The objective of the requirement, enacted more than three decades ago, was to help assure sound banking. Improved bank examination and supervision in recent decades make continuous regula 1 The law also expanded the range within which the Federal Reserve Board may vary reserve requirements on time and sav ings deposits, and it authorized the Federal Reserve Banks to conduct open market operations in United States Government agency obligations. * An address at the sixty-sixth annual convention of the N a 2 Since 1938, insured nonmember mutual savings banks had been tional Association of Supervisors of State Banks, Louisville, expressly exempted by the FDIC from the maximum rates estab Kentucky, August 16, 1967. lished by it for insured nonmember banks. FEDERAL RESERVE BANK OF NEW YORK tion of interest rates unnecessary as a means of preventing destructive competition and the resultant acquisition of unsound assets. In general, the public interest is best served when the forces of supply and demand are permitted to reflect them selves in prices, including interest rates. The relationship between buyers and sellers, or borrowers and lenders, is likely to be more equitable, and the allocation of resources is likely to be more satisfactory, when prices and interest rates are free to reflect market forces. Yet there may be times, and 1966 was such a time, when the establishment of maximum interest rates is necessary either to prevent in stitutional practices in the payment of interest that would be inconsistent with the safety and liquidity of a significant number of institutions or to supplement other govern mental policies to promote our national economic goals. These factors counsel continuation of the authority on a discretionary basis. The exercise of such discretionary authority, it seems to me, should be limited to such special situations. MUTUAL SAVINGS BANKS AND SAVINGS AND LOAN ASSOCIA Although prior to 1966 the Federal Reserve and the FDIC were required to establish maximum interest rates for banks, no Federal supervisory authority was directed or even authorized to fix maximum rates of interest pay able by savings and loan associations. The absence of a maximum interest rate for thrift in stitutions gave them, at times in the past, a competitive edge over commercial banks in attracting funds. However, as interest rates rose rapidly in 1966, the thrift institutions were faced with very strong competition on the part of not only banks but also marketable securities including those of the United States Government. Because most of the investments of thrift institutions had been made for long terms when interest rates were lower, their earnings did not rise as rapidly as did current interest rates. The temporary legislation specifically authorized the FDIC to limit the rate of interest paid by insured mutual savings banks, and it authorized the Federal Home Loan Bank Board to limit the rate paid by insured savings and loan associations. The authority was granted to restrain some thrift institutions from trying to match or to better competitive rates available to savers. Although the rates paid by insured commercial banks were already subject to Federal Reserve or FDIC control, it was not feasible to restrict further the rates paid by commercial banks while the rates paid by competing thrift institutions were subject to no supervisory control. The experience of 1966 dem onstrated the desirability of vesting in the FDIC and the Federal Home Loan Bank Board, on a permanent basis, TIONS. 169 discretionary authority to limit the rates of interest paid by insured thrift institutions. DISCOUNT WINDOW ADMINISTRATION Another problem on which I would like to comment is the administration of the Federal Reserve “discount win dow”. In recent years the Federal Reserve has sponsored legislation that would eliminate the outmoded technical requirements regarding the “eligibility” of customers’ paper presented at the discount window to secure advances by the Reserve Banks to member banks. The System has also been engaged in a basic reappraisal of the functioning of the discount window in the light of the changes in the banking system and the financial markets over the past decade. e l ig ib il it y l e g i s l a t i o n . In April 1967, the Senate passed S.966, streamlining discount window operations. The bill is now before the House Committee on Banking and Currency. Enactment of the bill would not cause a dramatic or abrupt change in the type of collateral offered by member banks to secure their borrowings at the Federal Reserve Banks. It would still be more convenient most of the time for member banks to pledge U.S. Government obligations and simple notes of customers as collateral for their borrowings. But this is important legislation for mem ber banks that have limited holdings of unpledged Govern ment obligations or that have small amounts of “eligible paper” in their loan portfolios. For these banks, access to the discount window under the circumstances specified in the Reserve Board’s Regulation A would be facilitated. The legislation should also prove helpful to any member bank encountering an emergency or any other situation requiring substantial assistance from a Federal Reserve Bank. The Federal Reserve System is already engaged in forward planning to process the wide variety of collateral that may be tendered at the discount window to support borrowings. The System has organized and has commenced to operate a school to train Federal Reserve discount per sonnel in collateral appraisal. As we in the Federal Re serve prepare for enactment of this legislation, member banks, too, would be well advised to consider how they may take advantage of the new possibilities when they materialize. s t u d y o f d i s c o u n t m e c h a n i s m . It is too early to report the conclusions of the fundamental study of the discount mechanism. It is not unlikely, however, that there will be recommendations leading to a greater use of the discount 170 MONTHLY REVIEW, SEPTEMBER 1967 window to the advantage of both member banks and the Federal Reserve. a bank and for determining appropriate ways to meet such needs. We expect to share the results of the study with you, and we trust that they will be helpful. STUDY OF BANK LIQUIDITY AND CAPITAL The Federal Reserve System is also engaged in another study which is even more closely associated with your in terests and responsibilities as bank supervisors. The events of 1966 highlighted the importance of reexamining our approach to member bank liquidity and capital. b a n k l i q u i d i t y . Traditionally, a bank’s need for liquid ity has been thought of in terms of a possible drop in de posits. The events of last year brought into sharp focus the necessity of considering also a bank’s ability to meet potential credit demands, especially unexpected demands representing legitimate needs in the community. Many banks found it difficult to shift assets to meet such needs in a period of rapidly rising interest rates. Liquidity analy sis should take into account not only potential deposit losses but also potential credit demands. Changing banking practices have highlighted the im portance of liability management. Banks have found that sometimes an increase in liabilities may be a more feasible way to obtain loanable funds than a sale or other disposi tion of assets. Banks and bank supervisors need to know more about the potential impact on a bank of an increase in various types of liabilities. b a n k c a p i t a l . During the past decade, bank assets and deposits have grown more rapidly than retained earnings. The growth in time and savings deposits, coupled with the steady rise in interest rates paid on such deposits, has brought a sharp increase in total bank expenses in relation to total assets. In addition, the shift in the composition of bank assets from securities to loans, while yielding greater income to offset higher costs, has increased the relative amount of risk assets. Consequently, for most banks the ratio of capital funds to total resources has declined, while the ratio of risk assets to total resources has risen. A number of banks have increased their capital by sell ing securities. Many more need to do so. All bank super visors are interested in the continued soundness of the banks they supervise, including the maintenance of a capi tal position adequate to enable the banks to serve their communities and remain strong and competitive. s t u d y o b j e c t i v e s . The study being undertaken by the Federal Reserve has two objectives: (1) developing im proved standards for measuring a bank’s liquidity, and (2) formulating a guide for measuring the capital needs of PROTECTION OF PUBLIC DEPOSITS The laws of many states require that banks receiving deposits of the state or its political subdivisions secure those deposits by the pledge of U.S. Government obliga tions or other specified types of securities. Similarly, banks must pledge collateral to secure United States Treasury Tax and Loan Accounts and other U.S. Government de posits. A decade or more ago, when most banks held large quantities of eligible securities, there was not much of a problem in making the pledge; but in recent years as loan demands have been heavy and banks have reduced their securities holdings, many banks have experienced some difficulty in meeting the pledge requirements and at the same time maintaining desirable flexibility with respect to their investment portfolios. It has been estimated that over $45 billion of collateral are tied up in such pledges. Most state laws that require the pledge of assets to se cure public deposits exempt the FDIC-insured portion of such deposits from the pledging requirements. There is a similar exemption with respect to U.S. Government depos its. Last year an advisory committee of banking experts appointed by the New York Superintendent of Banks to assist him in a comprehensive reappraisal of banking laws and regulations recommended to the Superintendent that appropriate statutes be amended to provide for full FDIC insurance of public deposits as a substitute for the pledging of assets.3 Presumably upon the enactment of Federal leg 3 1Second R eport of the A dvisory Com m ittee on Commercial Bank Supervision submitted to the Superintendent of Banks of the State of N ew York, September 19, 1966. In summarizing its recommendations, the Committee said on page 9: Security for Public D eposits. In order to provide security for the repayment of public deposits and at the same time to eliminate the onerous restrictions on the management of bank assets and the costs associated with the pledging of assets as security for such deposits, this Committee recommends that appropriate statutes be amended to provide for full FDIC insurance of public deposits as a substitute for the pledging of assets. In a study prepared in 1967 for the Trustees of the Banking Research Fund of the Association of Reserve City Bankers, en titled The Pledging of Bank Assets, A Study of the Problem of Security for Public Deposits, Charles F. Haywood, Dean and Pro fessor of Economics of the College of Business and Economics, University of Kentucky, said (page 8 ): The final conclusion of this study is that the answer to the pledged-assets problem should be sought within the context of Federal deposit insurance and that an early effort in this direc tion would be most timely. FEDERAL RESERVE BANK OF NEW YORK islation providing for such FDIC insurance, the legislatures of those states that do not exempt insured deposits from pledging requirements would adopt legislation eliminating the pledge requirements. I think the proposal provides a constructive solution of the problem. The proposal would protect public funds and simplify the operations of public officers responsible for the funds. The proposal would benefit practically every bank. It would give the bank greater flexibility in the management of its investment portfolio; it would increase the bank’s effective liquidity because securities now immobilized as collateral for public deposits would become available for sale or for pledge as collateral for borrowing at the Re serve Bank; it would simplify a bank’s internal operations in handling public deposits; and it would simplify operat ing relationships between the bank and the Federal Re serve Bank in its custodial, discount, and fiscal agency functions. RESERVE REQUIREMENTS AND DISCOUNTING PRIVILEGES Another important problem involves the role of com mercial bank reserves. On March 15, 1967, Senator Sparkman, Chairman of the Senate Committee on Bank ing and Currency, introduced S. 1298 at the request of the Federal Reserve Board. The bill has three principal provisions: (1) it would make reserve requirements applicable to all insured commercial banks; (2) it would eliminate the present classification of all member banks as reserve city banks or as “coun try” banks, and establish a system of graduated reserve requirements under which the reserves required on a bank’s demand deposits would de pend primarily upon the amount of its deposits rather than its location; and (3) it would afford all insured commercial banks ac cess to Federal Reserve discount facilities. u n i v e r s a l r e s e r v e r e q u i r e m e n t s . Historically, bank reserves were that part of the assets of a bank specially kept in cash, or in assets readily convertible into cash, as a reasonable provision for meeting demands upon the bank. The basic purpose of bank reserves is now quite different from what it used to be. Today the primary pur pose of bank reserves is to serve as a fulcrum for the implementation of monetary policy. The monetary policy of the Federal Reserve is directed to the promotion of our national economic goals of maximum sustainable economic 171 growth, reasonable price stability, maximum practicable employment, and equilibrium in international payments. The Federal Reserve promotes these goals by influencing the availability and cost of credit. Additions to bank credit generally bring additions to bank deposits, and the banks then need additional reserves to support the additional deposits. Under the Federal Reserve Act, the deposits of a mem ber bank may not exceed a given multiple of its reserves, and its reserves must consist of currency and coin or deposits in the Reserve Banks. The basic source of such reserves is the Federal Reserve Banks which, through open market and discount operations, create reserves. By making reserves readily available, or by making them less readily available, the Federal Reserve System influ ences the ability and willingness of member banks to make loans and investments. This activity of the Federal Re serve involves the performance of a national function delegated to the Federal Reserve by the Congress. It is a function similar to that performed by central banks in other countries throughout the world. Deposits in nonmember banks are no less a part of the money supply of the country than those in member banks. Yet reserve requirements applicable to nonmember banks do not play a direct role in the implementation of mone tary policy, and in general they are less onerous than those applicable to members of the Federal Reserve Sys tem. In one state there are no reserve requirements for nonmember banks. In many states, the form in which reserves may be held is more favorable to nonmember banks. For instance, in a number of states, reserves may be held partly in the form of securities. Furthermore, correspondent balances, which nonmembers would main tain in some amount even in the absence of reserve re quirements, and from which they derive benefits, serve to satisfy part or all of state reserve requirements. The difference in reserve treatment of member banks and nonmember banks tends to confer a competitive advantage on nonmember banks. It is generally recognized that an effective national monetary policy is essential to a sound banking system and the economic well-being of the country. Nonmember banks enjoy the general benefits of such policy as well as the specific benefit of Federal deposit insurance, but they avoid the cost of the reserve requirements established to effectuate national monetary policy. Monetary policy can not have its maximum impact when it fails to have a direct effect upon a substantial number of banks. In my view, the proposal for universal reserve require ments would contribute to the more effective implementa tion of national monetary policy, and would not adversely 172 MONTHLY REVIEW, SEPTEMBER 1967 affect the dual banking system. There would be no impairment of the right of a state to charter a bank, to determine the extent to which it should be permitted to have branches, to determine its lending and investment powers, and to regulate, examine, and supervise it. But in an area of national concern, in promoting our nation’s economic goals, the proposal would put all banks on an equal footing. any other basic change in reserve requirements will require substantial adjustments. Federal Reserve open market operations are customarily used to facilitate the adjust ment of the banking system to any change in reserve requirements. No doubt, every banker would prefer that there be no increase in the required reserves of his bank. It is obvious that, if there were no increase in the required reserves of any bank, and if the requirements of thousands of banks were reduced in varying amounts, there would be a large reduction in the general level of required re serves in the banking system; large excess reserves would be created overnight. Whether such a result would be justified and whether open market operations could ade quately provide the necessary adjustment would depend on economic and credit conditions at the time of the adoption of the new reserve requirements, and such condi tions cannot be predicted now. If, at such time, economic conditions called for monetary ease, the creation of the additional bank reserves would not create as great a prob lem as if economic conditions then called for restraint. Today, it seems to me that it would be fruitless to discuss further the details of any possible change and the problem of adjustment in the light of future economic conditions about which we know nothing. With graduated re serve requirements, the reserves required of a bank in respect of its demand deposits would depend on the size of its deposits rather than its location. A smoothly gradu ated system would permit each bank to maintain a rela tively low reserve against the first few million dollars of its demand deposits, a higher reserve against its demand deposits above this minimum and up to a substantial fig ure, and a still higher reserve against its demand deposits, if any, above the latter amount. As you know, smaller banks find it necessary, in order to obtain certain services from their city correspondents, to hold a substantial portion of their assets in the form of noninterest-bearing balances at other banks. In addi tion, the smaller banks are less able than the larger banks to take advantage of the economies of scale. Thus, many bankers and students of banking have concluded that, as a ACCESS TO FEDERAL RESERVE DISCOUNT W INDOW . At the matter of equity, the smaller banks should have a lower same time that S.1298 would establish universal reserve level of reserve requirements in order to offset to some requirements, it would grant all nonmember insured com extent the disadvantages of smallness. mercial banks access to Federal Reserve advances. With graduated reserve requirements, all banks of the Through its power to create reserves, the Federal Reserve same size in terms of demand deposits would carry equal is the ultimate source of funds to the banking system as a reserves. As a bank grew in size and passed into a higher whole. Any insured commercial bank would have the same reserve bracket, its overall reserve requirement percentage privilege that member banks now have of borrowing from would rise smoothly and gradually, because the higher the Reserve Bank. Every insured commercial bank would requirement would apply only to its additional deposits. know it could go directly to the Federal Reserve in case There would, no doubt, be less change in total required of need. reserves resulting from shifts in deposits among banks in different cities, and there would be no need to struggle ECONOMIC OUTLOOK AND FISCAL MEASURES with the elusive problem of determining whether or not a particular city is to be classified as a reserve city. A few minutes ago I referred to our national economic Many people consider it desirable to work toward a goals and the responsibility of the Federal Reserve to pro goal of uniform reserve requirements under which, for mote these goals. What is the present economic situation? example, the same percentage requirement would apply What is the economic outlook? to all demand deposits in large and small banks wherever Business activity has continued to gain momentum. As located. The proposal in S. 1298 would provide flexibility. the President reported in his message to the Congress on Graduated reserve requirements would be facilitated but ^ August 3, Federal Government expenditures, particularly would not be required. By permitting the Federal Reserve for defense, have continued to rise at a fast rate— much to move first to graduated reserve requirements, the pro faster than indicated in the January budgetary estimates. posal would make possible a transition to greater uniform At the same time, private spending is once more rising ity, or to full uniformity, should that prove desirable. across a broad range. The rise in consumer prices has ac The inauguration of graduated reserve requirements or celerated. Many wage settlements this year have provided graduated r e s e r v e r e q u ir e m e n t s . 173 FEDERAL RESERVE BANK OF NEW YORK increases much greater than the increase in general pro ductivity, and wage demands in current bargaining ses sions are large. Thus, pressures of increased demand on an economy with little slack, coupled with upward cost pressures, threaten an even more rapid increase in prices. Corporations and state and local governments have bor rowed record amounts in the capital markets so far this year, and in recent weeks yields on some types of long term obligations have exceeded last summer’s peaks. The prospect of large United States Treasury borrowing in the second half of 1967 and a growing belief that the rate of economic advance will accelerate sharply have weighed more and more heavily on the markets. The United States continues to be plagued by a critical international balance-of-payments problem. Inflation at home would reduce our ability to compete in international markets; it would be detrimental to our exports and would, no doubt, increase our imports. At the same time, inflation would diminish the faith of foreign holders of dollars in the value of our currency. It would weaken the position of the dollar internationally at the very time our world wide efforts require that confidence be sustained and strengthened. These developments make imperative prompt action to reduce the Federal budget deficit significantly. Expendi tures should be rigidly controlled and reduced as much as possible, but it is not realistic to expect large cutbacks in spending. The President has recommended a compre hensive program to increase Government revenues; the key recommendation is a temporary surcharge of 10 per cent on individual and corporate income taxes. Prompt and decisive fiscal action by the Congress would go far to help assure that the renewed growth in the economy is held to a sustainable pace with a reduction in the pressure on prices and in the tensions in the money and capital markets. It would, of course, lessen the need for monetary policy to carry an excessive share of the overall antiinflationary effort, as was the case in 1966. * * * In closing, I am sure that all of us—not only bank supervisors but also all our fellow citizens— want a sound banking system and a sound dollar. The studies and pro posals I have discussed today are aimed at strengthening our financial institutions and the procedures through which our economic goals are promoted. Monetary policy and fiscal policy have a coordinated responsibility in promot ing those goals. To assure a sound dollar, we need a more effective monetary machine and wise monetary and fis cal policies. 174 MONTHLY REVIEW, SEPTEMBER 1967 The Business Situation The business expansion gained increasing strength dur ing the summer months. Housing starts rose strongly in July, industrial production advanced for the first time this year, and the backlog of unfilled orders in durables manu facturing reached a new record high. At the same time, personal income increased substantially, and preliminary data indicate that retail sales turned in another strong ad vance. In August the unemployment rate dropped for the second month in a row as employment—notably in manu facturing—recorded a large rise. Along with the quick ening pace of business activity, price increases on both the wholesale and retail levels are accelerating and again pose a threat to the orderly growth of the economy. Al though it is difficult to assess at this time the impact on the economy of the automobile strike, which began as this Review went to press, it seems likely that the strike will only temporarily moderate the business expansion. PRODUCTION, INVENTORIES, AND ORDERS Industrial activity increased in July, following six months of virtually uninterrupted declines. The Federal Reserve Board’s seasonally adjusted production index rose by a full percentage point—to 156.3 per cent of the 1957-59 average—recouping one fourth of the overall decline in the index from its December peak of 159.0 per cent. While the July upturn reflected improvement in the gen eral pace of industrial activity, a good part of the in crease was due to the settlement of strikes in the rubber and electrical machinery industries and the surge in domes tic crude oil output following the curtailment of supplies from the Middle East. In terms of broad market groupings, production of materials, equipment, and consumer goods all rose from the June levels. In the consumer sector, output of automotive products increased once again in July, continuing the advance from the low mark reached in February. On a seasonally ad justed basis, the production of new cars rose by about W i per cent to an annual rate of just over 8 million units. While output slipped a bit in August, preliminary sched ules for September had indicated an unusually large rise in automobile assemblies. However, the strike against the Ford Motor Company— which manufactures about 25 per cent of the nation’s cars—-will hold production below scheduled levels. Output of consumer goods other than automobiles was about unchanged in July from the May-June pace. De clines in the apparel and furniture indexes were offset by gains stemming from the settlement of a strike against a major television set producer, as well as by increases in output of other appliances. As a result of the JanuaryMay sluggishness in retail demand and of the sizable inventories that existed earlier in the year, production of nonautomotive consumer goods has shown little buoyancy in the past few months. However, the recent pickup in retail sales, coupled with an improved inventory situation, points to a likely strengthening of activity in industries producing for the consumer market. In the equipment category, defense-related production increased once again in a continuation of the rapid growth that began two years ago. The rise in the output of defense equipment over the first seven months of 1967 was at an annual rate of 18 Vi per cent, only moderately below the 22 Vi per cent increase registered over the full course of last year. At the same time, July saw this year’s first increase in the production of business equipment. The slowdown in capital spending in the first half of 1967 had been reflected in a steady decline, dating from last Decem ber, in the pace of activity in the business equipment industries. The July rise in output of business equipment was not unexpected. Surveys of capital spending plans taken throughout this year, including the most recent one taken in August, have all pointed to increased outlays for plant and equipment in the second half. The July rise in industrial production, while due in part to special factors, also provided some evidence that the inventory adjustment is nearing an end (see Chart I). This adjustment has, of course, been the major factor dampening industrial activity this year. Following the fourth quarter of 1966, when inventory additions averaged FEDERAL RESERVE BANK OF NEW YORK Chart! MANUFACTURERS’ INVENTORY ACCUMULATION Seasonally adjusted M illio n s of d o llars M illio n s of d o llars 600 600 M a te ria ls a n d su p p lie s 400 200 TTf - 200 ___I___I__ I___1___1__ I___1___I___I__ I___I J F M A M J J A S O N 1966 D I J I l I I I I F M A M J 1 I 1— 200 J A S 1967 Source: United States Department of Commerce: about $lVi billion a month, the rate of business inventory accumulation declined sharply.1 In June, manufacturers actually reduced their inventories, the first decumulation in three years. In the following month, however, such stocks rose once again. The July accumulation was cen tered in inventories of work in process, and finished goods. Inventories of raw materials and supplies were cut back further. Although the overhang of excessive inventories at the beginning of the year was most noticeable in the manu facturing sector, trade inventories early in 1967 were also 1 Revised figures for second-quarter gross national product (G N P ) show a cutback in inventory accumulation larger than that previously estimated. However, upward revisions in other com ponents— notably consumer spending— offset the reduced figure for inventory accumulation, and total GNP was therefore virtually unchanged from the preliminary estimate discussed in this Review, August 1967, pages 139-41. 175 high relative to sales. As a result of rising sales and of in ventory reductions during the first half, however, inventorysales ratios in the trade sector by midyear had moved back down to levels prevailing before the inventory surge in the later months of 1966. Indeed, the trade sector accounted for almost half the December-June cutback in total inven tory accumulation. The June inventory-sales ratio for re tail trade was the lowest in many years. The continued rise in the backlog of orders on the books of durables manufacturers is another element of strength in the outlook for production and employment. Though new orders for durables declined in July from the high June level, largely as a result of a sharp drop in the volatile defense component, the backlog of unfilled orders expanded once again. The July increase put the backlog at a new record, surpassing the previous high set last December. At the same time, shipments by durables manufacturers rose for the third month in a row. Residential construction activity is apparently continu ing its vigorous recovery from the depressed 1966 pace. In July, housing starts rose strongly to an annual rate of 1.35 million units, closely approaching the average level that prevailed before last year’s slump. Although the num ber of units authorized by building permits eased off slightly in July, prospects for further improvement in residential construction continue to be favorable. Statistics on vacancy rates and sales of new homes indicate strong demand. At the same time, mortgage credit availability currently appears adequate for additional expansion in new home and apartment construction. EMPLOYMENT, INCOME, AND CONSUMER DEMAND Payroll employment rose sharply further in August. Most significant among the widespread gains was the upturn in manufacturing employment which resulted pri marily from a large rise in the number of production workers employed. At the same time, the average week worked by manufacturing production workers increased again. The civilian labor force expanded further in August for the third consecutive rise. In most of the earlier months of this year the labor force had declined on a seasonally adjusted basis, and the recent turnaround suggests that the quickening pace of economic activity has encouraged more individuals to enter the labor force. Reflecting the strength of demand in the labor markets, the growth of employment in both July and August exceeded the rise in the labor force, with the result that unemployment edged off to 3.9 per cent in July and 3.8 per cent in August. MONTHLY REVIEW, SEPTEMBER 1967 176 Increases in personal income through most of the first half of 1967, though quite sizable, were nevertheless damp ened by the sluggish behavior of employment during the period, and particularly by the reduction in the number of workers and the length of the workweek in manufac turing. In June and July, however, the expansion of per sonal income showed renewed strength as employment gains gave rise to rapid growth in wage and salary pay ments. The stepped-up rate of income growth has undoubtedly been a factor in the recent strengthening of consumer demand. But, at the same time, consumers also seem to be showing a willingness to spend a larger share of their incomes. Indeed, recent revisions in the GNP accounts for the second quarter indicate that the advance in con sumer spending was stronger than had been shown in the preliminary estimates. The revised figures put the secondquarter savings ratio at an estimated 6.7 per cent, down appreciably from the unusually high rate of 7.3 per cent in the first quarter. The second-quarter savings figure was nevertheless relatively high by historical standards, and it is altogether possible that future consumer spending may benefit from still further decreases in the savings ratio as well as from income gains. In any case, the available data do indicate rising con sumer demand. According to preliminary estimates, retail sales volume recorded a sizable increase in July, follow ing a strong rise in the preceding month. During the first five months of the year, sales at retail stores had followed a generally upward course but at a very modest pace. Thus, in the five-month period ended with May, retail sales rose only 2 per cent; the June-July expansion, in contrast, amounted to fully 3 per cent. In July, the increase was centered entirely at durables outlets, where gains were reported both for the automotive group and for other hard goods lines. Sales of new automobiles in July were at a seasonally adjusted annual rate of almost 8 V2 million units, well above the low point of 7 million reached last Febru ary. In August, however, automobile sales dropped off, reportedly because of a short supply of cars in the popular lines. At the month end, the inventory of 1967 models was more than 25 per cent below carry-over in 1966 of prioryear models (the timing of the changeover to the new models was the same in both years). totaling 4.6 per cent a year, compared with increases of 4.1 per cent for all of 1966 and 3.3 per cent for 1965. The rapid advance in labor compensation this year has been ac companied by a leveling off in productivity growth. The combination of rising labor costs and virtual stability in output per man-hour resulted in a sharp increase in labor costs per unit of output. To be sure, the index of unit labor costs in manufacturing fell a bit in July, as the result of a jump in productivity associated with the upturn in output. Nevertheless, the July level of the index represented an ad vance over the first seven months of this year at a seasonally adjusted annual rate of about 5 V2 per cent, compared with a rate of 3 Vi per cent for all of 1966. While productivity can reasonably be expected to move upward once again as the economy expands more vigorously, it is unlikely that the growth in output per man-hour will be adequate to offset mounting labor costs. In conjunction with the strengthening of demand, the rising trend in unit labor costs has been a major Chart II CONSUMER AND WHOLESALE PRICES WAGES, PRODUCTIVITY* AND PRICES Wage costs continue to mount and the rate of increase has accelerated. According to the Bureau of Labor Statis tics, collective bargaining settlements concluded in the first half of 1967 involved wage and fringe benefit increases Note: Consumer prices are plotted through Ju ly; w holesale prices are plotted through August(prelim inary). Source: United States Bureau of Labor Statistics. FEDERAL RESERVE BANK OF NEW YORK source of upward pressure on prices. The midsummer was marked by a rash of announced price increases for a broad range of commodities, including trucks, rubber goods, household appliances, textiles, construction materials, aluminum and steel for can-making, a variety of other steels, and goods containing silver. Moreover, railroad freight rates— which affect costs throughout the economy —were also raised. Some of these increases have already had an effect on the broad index of industrial wholesale prices. Preliminary figures indicate that this index rose sharply in August after five months of stability (see Chart II). Wholesale prices of 177 agricultural commodities, however, dropped in August after a steep three-month run-up, and this decline more than outweighed the increase in industrial commodities. As a result, the total wholesale index moved lower. In the consumer area, prices rose by a sharp 0.4 per cent in July as costs of food and services increased again. Prices of nonfood commodities also rose substantially. The overall advance was the largest in nine months and followed four months of sizable gains. From February to July, the total consumer price index advanced at an annual rate of 3.6 per cent, compared with 1.5 per cent in the preceding five-month period. The Money and Bond Markets in August Money market conditions remained comfortable during August. Federal funds generally traded in a narrow band around the 4 per cent discount rate, while nationwide net reserve availability continued to fluctuate within the range of recent variation. As the month progressed, there was a significant improvement in the basic reserve positions of major banks in the money centers, reflecting in part a sub stantial contraction in business loans and increased acquisi tions of Euro-dollars. Major banks also acquired a large volume of funds through sales of negotiable certificates of deposit (C /D ’s) during the month. As was the case in July, even with the comfortable tone in the money market, yields on short-term and capital market instruments rose further in August. The Presi dent’s request on August 3 for a 10 per cent surcharge on individual and corporate income taxes was welcomed by market participants, but the optimistic reaction was soon dampened by consideration of the accompanying projec tions of a large budget deficit and Treasury financing needs in fiscal 1968. Two Treasury cash offerings during the month— one to refund the August maturities and the other to raise new money— attracted only routine interest on the part of investors and trading activity in the Treasury market was generally light. Meanwhile, large current and antici pated corporate borrowing and the fair to poor receptions accorded several new corporate issues— in spite of mount ing yields— contributed to a hesitant atmosphere through out the capital markets. By the end of the month, yields on intermediate-term Treasury issues had risen by about 24 basis points, while long-term yields were up about 6 basis points. The yield on a new Aa-rated utility bond issue with five years’ special call protection reached 6.20 per cent at the end of the month, 15 basis points more than the highest yielding comparable offering in July. The tax-exempt mar ket was under somewhat less pressure than the corporate market, against a background of a comparatively light cal endar and talk of an added relative yield advantage for tax-exempt securities in the event of a tax increase. The cautious mood of the capital markets during August also pervaded the market for Treasury bills. Although there was a significant investment demand for bills at times during the month, rates on outstanding issues rose almost steadily until late in the month, when they receded slightly. The market yields on three- and six-month maturities rose by 26 and 23 basis points, respectively, to 4.38 per cent and 4.83 per cent at the close of the month. BANK RESERVES AND THE MONEY MARKET The money market remained comfortable throughout August. The effective rate for Federal funds generally was close to the 4 per cent discount rate, with some trading at 4Vs per cent in the first half of the month and generally in a 3 to 4 per cent range later on. Free reserves averaged MONTHLY REVIEW, SEPTEMBER 1967 178 Table I Table n FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, AUGUST 1967 RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS AUGUST 1967 In millions of dollars; (+ ) denotes increase, (—) decrease in excess reserves In millions of dollars Daily averages—week ended on Factors affecting basic reserve positions Changes in daily averages— week ended on Factors Aug. 2 Aug. 9 Aug. 16 Aug. 23 Aug. 30 Member bank required 4- 82 -|-214 - f 63 -j- 94 4-371 Operating transactions Federal Reserve flo a t............. Gold and foreign account---Currency outside banks*........ Other Federal Reserve Total “ market” factors---- — 68 — 342 4-179 — 70 — 43 — 235 — 193 — 178 — 14 - f 29 — 107 — 54 + 477 — 50 — 510 — 8 — 18 — 79 4- 2 + 71 + 330 + 247 — 7 — 6 4- 125 -f- 122 + 31 — 25 + 14 — 30 + 73 4-210 -j-206 4-393 4- 46 4-' 303 — 317 — 48 — 324 — 34 — 2 4- 242 Direct Federal Reserve credit transactions Open market instruments Outright holdings: Government securities........ — 29 — — 200 — — 100 — 6 — 255 — 7 — 466 — 12 — — — - f 62 - f 127 + 49 — 17 — 49 + 2 + 38 — 110 — — 2 — 82 — — — — 1 — — — — 8 + 3 + 184 — — — — — + 120 — 226 — 301 — 263 — 486 — 133 4- 95 — 20 4- 92 — 217 — 183 4- 118 + Repurchase agreements: Government securities........ Bankers* acceptances ........ Federal agency obligations. Member bank borrowings.......... Other loans, discounts, and 1 — 25 3 Aug. 23 Aug. 16 Aug. 30* Eight banks in New York City “ Market” factors — 82 Aug. 9 Aug. 2 Net changes Averages of five weeks ended on August 30* Reserve excess or deficiency(—)t ....................... Less borrowings from Reserve B a n k s....................... Less net interbank Federal funds purchases or sales(—). Gross purchases ............... Gross sales ......................... Equals net basic reserve surplus or deficit(—) ............. Net loans to Government securities d ealers................... 19 12 10 14 25 26 ___ 6 ___ « _ 392 1,255 862 486 1,186 700 508 1,198 690 — 399 963 474 — 505 — 1,048 943 16 6 169 - 19 1,120 991 951 1,010 307 1,150 843 — 155 44 — 298 928 907 958 Thirty-eight banks outside New York City Reserve excess or deficiency(—)t ....................... 28 30 24 6 18 Less borrowings from — — Reserve B a n k s....................... 13 17 28 Less net interbank Federal 835 633 funds purchases or sales(—).. 370 813 1,038 Gross purchases ............... 1,845 1,936 1,901 1,698 1,666 Gross sales ......................... 1,032 898 1,066 1,065 1,296 Equals net basic reserve surplus or deficit(—) ............. — 823 -1,029 - 8 1 8 - 6 0 9 — 364 Net loans to Government securities d ealers................... 571 560 337 505 669 21 12 738 1,809 1,071 -7 2 9 568 Note: Because of rounding, figures do not necessarily add to totals. * Estimated reserve figures have not been adjusted for so-called “ as of” debits and credits. These items are taken into account in final data, t Reserves held after all adjustments applicable to the reporting period less re quired reserves and carry-over reserve deficiencies. T a b le in AVERAGE ISSUING RATES* AT REGULAR TREASURY BILL AUCTIONS Daily average levels In per cent Member bank: Total reserves, including Required reserves* ..................... Excess reserves* ........................ Nonborrowed reserves* ............. 23,967 23,676 291 116 175 23,851 23,980 23,594 386 91 295 23,889 23,746 23,380 366 129 237 23,617 23,775 23,317 458 47 411 23,728 23,464 23,223 241 46 195 23,418 23,786 § 23,438§ 3485 86§ 262§ 23,700§ Weekly auction dates—August 1967 maturities August 7 August 14 August 21 August 28 Three-month.................................. 4.174 4.193 4.336 4.490 Six-month....................................... 4.757 4.791 4.922 4.995 Changes in Wednesday levels Monthly auction dates—June-August 1967 System Account holdings of Government securities maturing in: Less than one year ................... — 50 — — —1,424 - f 1,224 — 100 — —335 —1,909 4-1,224 Total .................................... — 50 — — 200 — 100 —335 — 685 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. 8 Average for five weeks ended on August 30. One-year......................................... June 27 July 25 4.723 5.164 5.098 4.732 5.150 5.100 August 24 * Interest rates on bills are quoted in terms of a 360-day year, with the discounts from par as the return on the face amount of the bills payable at maturity. Bond yield equivalents, related to the amount actually invested, would be slightly higher. FEDERAL RESERVE BANK OF NEW YORK about the same as in July, with continued fairly wide fluctu ations from week to week in line with varying demands for excess reserves (see Table I). Nationwide borrowings from the Federal Reserve Banks also averaged about the same as in July but declined sharply in the last two statement weeks of August. In the week ended on August 23, the banking system benefited substantially from large declines in required reserves and currency outside banks. In that week, the major reserve city banks were entirely free of Reserve Bank indebtedness, and borrowings of other re serve city and “country” banks fell to negligible levels (see Table II). In the final week, only country banks borrowed at the Reserve Banks. Throughout the month, banks in New York City having branches abroad continued to bor row substantial amounts of Euro-dollars, as they had in July. The sharply increased use of Euro-dollars since June has resulted from a considerable narrowing of the differen tial between Euro-dollar rates and domestic C /D rates. The attractiveness of Euro-dollars as a source of funds for banks is enhanced by the fact that such borrowings are not subject to reserve requirements or deposit insurance assess ments. The financing needs of Government securities dealers increased during August but were satisfied without dif ficulty by borrowing from either the New York City banks or out-of-town institutions or through repur chase agreements with corporations. Borrowing was par ticularly heavy at the start of the period when the dealers made payment for their awards of the new nine- and twelve-month Treasury bills sold in the regular monthly auction. Rates posted by the large New York City banks on new call loans to Government securities dealers were generally quoted within a 4Vs to 4% per cent range dur ing most of August, but declined rather sharply toward the month end. Most other short-term money rates were little changed on balance during August. The New York City money market banks continued to attract time deposits in volume during August through the issuance of negotiable C /D ’s; over the five statement weeks ended on August 30, the net increase in C /D liabili ties amounted to $298 million. Large commercial banks outside New York City also benefited from a rapid inflow of funds from this source, and their aggregate C /D liabili ties expanded by $643 million over the same five weeks. The most often posted offering rate on new C /D ’s of the large New York City banks at the end of August was 4.125 per cent for the shortest maturities, down from 4.50 per cent earlier in the month. On the other hand, the city banks seemed to be having difficulty in selling longer term C /D ’s, though the generally posted rate re mained at 5 lA per cent. 179 THE GOVERNMENT SECURITIES MARKET An atmosphere of renewed caution appeared in the Treasury coupon market in August, following a temporary improvement in the market tone during July. Prices moved irregularly lower to register declines for the month as a whole of as much as 1 point in the intermediate area and almost IV 2 points in longer maturities. Exceptionally large Treasury financing needs in the second half of this calendar year, together with the prospect of a sustained heavy corporate demand for funds, were again the major market influence during August. The President’s request for a 10 per cent surcharge on corporate and individual income taxes buoyed the market briefly at the beginning of the month, but participants quickly came to the realiza tion that the deficit would be very large even after allow ance for the additional revenues this tax measure would produce. Moreover, it was felt in the market that the tim ing and magnitude of the tax surcharge or, indeed, its very adoption by the Congress were far from certain. Two Treasury financing operations executed in Au gust dominated trading during the month. After the close of the market on August 2, the Treasury an nounced the results of its refunding of three issues matur ing on August 15, for which subscription books had been open on July 3 1.1 Awards of the new fifteen-month 5Va per cent notes offered for cash or in exchange for the ma turing securities amounted to $9.9 billion against total subscriptions of $15.6 billion. Larger public subscriptions were subject to a 35 per cent allotment. This allotment percentage was somewhat higher than initially estimated by most market participants. After the close of the market on August 17, the Trea sury announced the terms of a $2.5 billion of new cash borrowing. Investors were offered a new 5% per cent note due February 15, 1971, priced at 99.92 to yield 5.40 per cent. Subscription books were open on August 22, and payment was made on August 30. Commercial banks were permitted to make payment for the issue by credits to Treasury Tax and Loan Accounts. Many market partici pants had hoped that the Treasury would offer a some what longer note, perhaps in the five- to seven-year area, as a means of extending the average maturity of its out standing debt. The Treasury’s choice of a 3 V i -year matu rity was widely interpreted as an attempt to avoid a higher coupon rate which might have had adverse effects on the thrift institutions and on other securities markets. Sub- 1 For details, see this Review , August 1967, page 143. MONTHLY REVIEW, SEPTEMBER 1967 180 SELECTED INTEREST RATES June-August 1967 MONEY MARKET RATES Per cent june July August BOND MARKET YIELDS July August Note: D ata a re shown for busine ss d a y s only. * M O N EY MARKET RATES Q UO TED: D a ily ra n ge of rates posted b y m ajor New York C ity banks point from underw riting syn d icate reo fferin g yield on a given issue to m arket yield on the on new call loans (in ^ d e r a l funds) secured by United States G overnm ent securities (a point sam e issue im m ediately after it has been rele ased from syn d icate restrictions); d a ily in d ica te s the ab sen ce of an y ran ge); offering rates for directly p la ce d finance co m p an y pap er; the effective rate on Fed eral funds (the rate most representative of the transaction s executed); a v e ra g e s of yield s on lon g -term G overnm ent securities (bonds due or c a lla b le in ten years or more) and of G overnm en t securities due in three to five ye a rs, computed on the b asis of clo sing bid rates (quoted in terms of rate of discount) on newest outstanding three- and six-month clo sin g bid prices; T hursday a v e ra g e s of yields on twenty seaso n ed twenty-ye ar tax-exem pt Trea sury b ills . bonds (carrying M oody’s ratings of A a a , A a , A , and Baa). BO N D MARKET YIELD S Q U O TED: Y ie ld s on new A a a - and A a-rated p ub lic utility bonds are plotted around a line show ing d a ily a v e ra g e y ie ld s on seasoned A aa-ra ted co rp o rate bonds (arrows scriptions totaled $6 billion and late on August 24, the Treasury announced that larger ones would be subject to a 38 per cent allotment. This allotment percentage was above initial estimates by most market participants, but generally in line with the consensus that emerged after the books had closed. Price fluctuations on Treasury coupon issues were fairly wide early in August, but considerably narrower over the remainder of the month. In the first three days of the period, prices of intermediate issues declined in reac tion to speculation that the response of investors to the offering of the new 5V4 per cent note in the August re funding would prove less favorable than had originally been thought. Prices rebounded immediately thereafter in a highly favorable market reaction to the President’s re Sources: Fe d e ra l Reserve Bank of N ew Yo rk, Board of G o v ern o rs of the Federal Reserve System, M o ody’s Investors Service, and The W eekly Bond Buyer. quest for a tax surcharge, since the suggested 10 per cent was higher than most market participants had expected. Once the new Federal budget statistics were fully di gested, however, prices began an irregular downward drift which continued through the month end. The pessi mism prevalent in the market was reinforced by the rising yield trend in the corporate and tax-exempt bond markets. The reports of a light volume of subscriptions for the new 5% per cent notes had little effect on the market. Market activity during the month was mainly confined to professional liquidation of holdings of intermediate is sues, investment switching into the new 5lA per cent notes, and outright sales of long-term issues by investors moving into corporate securities. The Treasury bill market was moderately firm over the FEDERAL RESERVE BANK OF NEW YORK first part of August, and rates for short-term bills continued to decline from the high levels attained in July after the Treasury announced that it would increase the size of each of the regular weekly and monthly bill auctions by $100 million. The early strength of the market resulted partly from the favorable yield on longer term bills relative to that offered on the closely competitive new 5X A per cent Trea sury notes of November 1968. Moreover, a fairly good in vestment demand from public funds and commercial banks was in evidence. After midmonth, the declining rate trend was reversed as the bill market was affected by the caution apparent in the coupon sector. With investor demand con tracting and the possibility of some selling of bills around the mid-September dividend and tax dates, dealers were cautious in bidding for bills in the final auctions held dur ing the month, and bill rates rose somewhat. In the monthly auction of nine- and twelve-month bills held on August 24, average issuing rates were set at 5.098 per cent and 5.100 per cent, respectively, slightly lower than in the July monthly auction. Average issuing rates established on the regular three- and six-month Treasury bills moved pro gressively higher over the month, and in the last weekly auction these rates reached 4.490 per cent and 4.995 per cent, respectively (see Table III), compared with 4.182 per cent and 4.638 per cent in the last July auction. In the wake of the auction, an active demand for bills by investors and dealers developed, and rates declined over the final three days of the month. OTHER SECURITIES MARKETS Developments in the markets for corporate and taxexempt securities closely paralleled those in the Govern ment securities market during August. The President’s pro posal of an income tax surcharge injected some temporary optimism into the market at the beginning of the month and, in fact, aided underwriters in completing a lagging distribution of the month’s largest single corporate bond offering. Subsequently, however, market sentiment deterio rated with the growing concern over the huge demands likely to be made on the capital markets by the Treasury and corporate borrowers in coming months. The taxexempt sector was slower than the corporate area to succumb to the general weakening tendencies, however, because of the somewhat lighter calendar of new offerings than in other recent weeks and perhaps also because of 181 the yield advantage tax-exempt securities will gain by any income tax increase. Nevertheless, The Weekly Bond Buyer's average yield series for twenty seasoned taxexempt bonds, carrying ratings ranging from Aaa to Baa, rose to 4.06 per cent at the month end from 3.98 per cent at the close of July (see chart). The average yield on Moody’s Aaa-rated seasoned corporate bonds rose to 5.69 per cent from 5.60 per cent a month earlier. In the corporate sector, a total of $1.8 billion of securi ties was publicly offered during August, the same amount as in July. The largest single offering was a $250 million Aaa-rated issue of 6 per cent 3 3-year debentures of the American Telephone and Telegraph Company, reoffered to yield 5.95 per cent and nonredeemable for five years. The issue was awarded to underwriters at a net interest cost of 6.006 per cent, a record for this borrower and considerably higher than the net interest cost of 5.46 per cent on a similar flotation by the same company in January of this year. The offering drew only a modest investor response prior to the President’s tax message, but subsequently sold out quickly. In the heavier market atmosphere that developed later in the month, only negoti ated industrial issues sold well, while public utility offer ings awarded in competitive bidding were received un enthusiastically by investors. One $200 million offering by an oil company of Aaa-rated 53A per cent sinking fund debentures, carrying ten-year call protection, sold well at a reoffering yield of 5.85 per cent, 10 basis points higher than the yield on a comparable offering only three weeks earlier. During the month there were a number of syndicate terminations resulting in upward yield adjust ments of about 10 basis points. Total new publicly-offered tax-exempt securities amounted to $0.7 billion in August, down from $0.8 bil lion in July. In contrast to the corporate market, the municipal market retained a firm tone through mid month, enabling dealers to reduce their inventories to the lowest level in seven months. Encouraged by the improved technical position of the market and rather light volume of offerings, dealers bid aggressively for new issues around midmonth. Investors showed consid erable resistance to the lower yield levels, however, and reoffering yields tended to rise subsequently. Even at the higher yields available over the latter part of the month, there was a marked lack of enthusiasm for new issues being marketed, and most offerings moved very slowly. MONTHLY REVIEW, SEPTEMBER 1967 Publications of the Federal Reserve Bank of New York The following is a selected list of publications available from the Public Information Department, Federal Reserve Bank of New York, 33 Liberty Street, New York, N. Y. 10045. Copies of charge pub lications are available at half price to educational institutions, unless otherwise noted. 1. c e n t r a l b a n k c o o p e r a t i o n : 1924-31 (1967) by Stephen V. O. Clarke. 234 pages. Dis cusses the efforts of American, British, French, and German central bankers to reestablish and maintain international financial stability between 1924 and 1931. $2 per copy. 2. e s s a y s i n m o n e y a n d c r e d i t (1964) 76 pages. Contains articles on select subjects in bank ing and the money market. 40 cents per copy. 3. k e e p i n g o u r m o n e y h e a l t h y (1966) 16 pages. An illustrated primer on how the Federal Re serve works to promote price stability, full employment, and economic growth. Designed mainly for sec ondary schools, but useful as an elementary introduction to the Federal Reserve. ($7 per 100 for copies in excess of 100.*) 4. m o n e y a n d e c o n o m i c b a l a n c e (1967) 27 pages. A teacher’s supplement to Keeping Our Money Healthy. Written for secondary school teachers and students of economics and banking. ($8 per 100 for copies in excess of 100.*) 5. m o n e y , b a n k i n g , a n d c r e d i t i n e a s t e r n e u r o p e (1966) by George Garvy. 167 pages. Reviews recent changes in the monetary systems of the seven communist countries in Eastern Europe and the steps taken toward greater reliance on financial incentives. $1.25 per copy (65 cents per copy to edu cational institutions). 6. m o n e y : m a s t e r o r s e r v a n t ? (1966) by Thomas O. Waage. 48 pages. Explains the role of money and the Federal Reserve in the economy. Intended for students of economics and banking. ($15 per 100 for copies in excess of 100.* ) 7. o p e n m a r k e t o p e r a t i o n s (1963) by Paul Meek. 43 pages. Describes and explains the Sys tem’s use of open market purchases and sales of Government securities to influence the cost and avail ability of bank credit. ($17 per 100 for copies in excess of 100.*) 8. t h e n e w y o r k f o r e i g n e x c h a n g e m a r k e t (1965) by Alan R. Holmes and Francis H. Schott. 64 pages. Describes the organization and instruments of the foreign exchange market, the techniques of exchange trading, and the relationship between spot and forward rates. 50 cents per copy. 9. t h e s t o r y o f c h e c k s (1966) 20 pages. An illustrated description of the origin and develop ment of checks and the growth and automation of check collection. Primarily for secondary schools, but useful as a primer on check collection. ($4 per 100 for copies in excess of 100.*) * Unlimited number of copies available to educational institutions without charge. Subscriptions to the m o n t h l y r e v i e w are available to the public without charge. Additional copies of any issue may be obtained from the Public Information Department, Federal Reserve Bank of New York, 33 Liberty Street, New York, N. Y. 10045.
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