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FEDERAL RESERVE BANK OF NEW YORK 195 T reasu ry and Federal R e se rve Foreign E xchange Operations* By C h a rles A. C o o m bs Although most of the major industrial countries were heavy reserve losses in January and February by draw beset by inflation and domestic financial strains during ing $800 million on the Federal Reserve swap line, but the period under review, the foreign exchange markets this debt has subsequently been fully repaid, partially by were generally characterized by quiet and orderly trad substituting medium-term financing through the Euro ing, interrupted only briefly by the Canadian recourse to dollar market. As of the end of August, no credits by the a floating rate early in June. Indeed, the very prevalence Federal Reserve to foreign central banks under the swap of inflationary trends, both here and abroad, left the ex network were outstanding (see Table I). change markets in something of a quandary as to which Meanwhile, the Federal Reserve found it necessary to currencies might eventually fare better or worse. make repeated drawings on its swap lines with the Swiss So far in 1970 the United States balance of payments National Bank, the National Bank of Belgium, and the on official account has shifted from surplus to deficit. Vari Netherlands Bank (see Table II). Federal Reserve draw ous policy actions taken by the Federal Reserve to relieve ings of $145 million of Swiss francs that were outstanding the stringency of credit conditions in the United States re at the beginning of 1970 could not be reversed through sulted in a heavy return flow of funds to the Euro-dollar market transactions, as the usual seasonal weakening of the market which, in turn, facilitated the recovery of official Swiss franc during the early months of the year failed to reserves in France, Germany, Italy, and the United King materialize. Accordingly, the Swiss National Bank agreed dom where money remained tight. These shifts in the in to sell, in a direct transaction with the Federal Reserve, ternational flow of funds, in response to differential credit the Swiss francs required to clean up the balance, and the conditions, were reflected in a corresponding shift of swap line reverted to a standby basis. Later in the spring, creditor-debtor relationships in the Federal Reserve swap new flows of dollars to Switzerland required the reactiva network and related credit arrangements. More than $1 tion of the swap line, in May, in the form of a $200 billion of Bank of England debts to the Federal Reserve million drawing of Swiss francs by the Federal Reserve. and the United States Treasury outstanding at the begin Through market transactions the Federal Reserve sub ning of the year were almost fully repaid by the end of sequently repaid $30 million of this debt, another $50 June, and since then the Bank of England has had no million was cleared away through a United States Treasury further recourse to United States credit facilities. The sale of gold to the Swiss National Bank, and the remain Bank of France debt of $200 million to the United States ing $120 million was liquidated in August by another Treasury was also fully repaid. The Bank of Italy financed direct sale of Swiss francs to the Federal Reserve by the Swiss National Bank. In the case of the Belgian franc, the Federal Reserve late in 1969 reactivated its swap line with the National Bank of Belgium by drawing $55 million of Belgian *This report, covering the period March to September 1970, is francs, and further drawings in 1970 increased such the seventeenth in a series of reports by the Senior Vice President in charge of the Foreign function of the Federal Reserve Bank of debt to $130 million by early May. Since the swap line New York and Special Manager, System Open Market Account. The Bank acts as agent for both the Treasury and Federal Reserve had by then been in continuous use for almost six System in the conduct of foreign exchange operations. months, the United States Treasury undertook to assist MONTHLY REVIEW, SEPTEMBER 1970 196 Table I DRAWINGS AND REPAYMENTS BY FOREIGN CENTRAL BANKS AND THE BANK FOR INTERNATIONAL SETTLEMENTS UNDER RECIPROCAL CURRENCY ARRANGEMENTS In millions of dollars Drawings (+ ) or repayments (—) Banks drawing on Federal Reserve System Drawings on Federal Reserve System outstanding on January 1,1970 1970 1 Bank of England ...................................................................................................... 650.0 Bank of France ........................................................................................................ Bank of Italy .............................................................................................................. Bank for International Settlements (against German marks) ......................... II July 1— August 31 - 650.0 f+ I- 100.0 100.0 + 800.0 R 200.0 1-600.0 -40 0 .0 f+ I- 136.0 136.0 B - 77.0 1 - 77.0 H- 22.0 } - 22.0 C+l,036.0 I— 886.0 f+277.0 (—677.0 f-f 22.0 (—422.0 Drawings on Federal Reserve System outstanding on August 31,1970 -O- Total ........................................................................................................................... 650.0 the Federal Reserve in fully liquidating its Belgian franc debt by drawing Belgian francs from the International Monetary Fund (IMF) and by selling a small amount of special drawing rights (SDR’s) to the National Bank of Belgium. The swap line then reverted to a standby basis but, as the flow of funds to Belgium continued, new draw ings were made by the Federal Reserve during the summer months for a total currently outstanding of $95 million. Similarly, a Federal Reserve drawing of $130 million in guilders on the Netherlands Bank that was outstanding as of the end of 1969 could not be reversed through market transactions. Accordingly, it was agreed in May 1970 to clean up the debt through several special trans actions, including a United States Treasury drawing of guilders from the IMF together with a small sale of SDR’s to the Netherlands Bank. Here again, the flow of dollars to the Netherlands persisted through the summer months, and by September 10 had necessitated new guil der drawings by the Federal Reserve amounting to $220 million. There were no operations in Austrian schillings, Canadian dollars, Japanese yen, Mexican pesos, or the Scandinavian currencies. Among other developments during the period under review, the Federal Reserve swap network was further enlarged to an $11,230 million total on March 12 as a result of an increase in the swap line with the Bank of Italy from $1 billion to $1,250 million (see Table III). In April, the United States Treasury redeemed at ma turity a six-month Swiss franc-denominated certificate of indebtedness equivalent to $54.7 million held by the Bank for International Settlements (BIS) while other foreign-currency-denominated securities were rolled over at maturity, leaving a total of $1.4 billion equivalent currently outstanding (see Table IV). No operations in forward markets were undertaken by either the Federal Reserve or the Treasury. C A N A D IA N DO LLAR The Canadian dollar rose to its effective ceiling of $0.9324 in late December 1969 and, except for a brief easing in February, remained at or very near that level through May (see Chart I). The strength of the Canadian dollar reflected developments in both the current and capital accounts of the Canadian balance of payments. The trade surplus widened substantially, as there was a broad-based increase in exports. In the capital sector, funds were repatriated from the New York stock market, while during the first quarter Canadian borrowing abroad remained heavy. Moreover, relatively high interest rates resulting from the vigorous anti-inflationary policies pur sued by the Canadian authorities attracted short-term inflows, including some repatriation of funds previously placed in the Euro-dollar market. As the exchange markets became increasingly aware of the strength of the Canadian payments position, to- FEDERAL RESERVE BANK OF NEW YORK ward the end of April rumors began to circulate that the Bank of Canada would raise its upper intervention point to the full 1 percent above par allowed by the IMF, or even that the Canadian dollar would be revalued. Con sequently, demand for Canadian dollars surged and the Bank of Canada began to purchase United States dollars on a mounting scale. These heavy purchases of foreign exchange were financed by the drawing-down of government deposits with the chartered banks. As the inflow intensified, how ever, such deposits began to be depleted, and on May 11 the Canadian authorities announced that they would sell a special issue of bills totaling Can.$250 million. At the same time, the Bank of Canada raised the chartered banks’ minimum secondary reserve requirement from 8 percent to 9 percent of deposits. This move immo bilized approximately the amount to be raised by the bill issue. In addition, in an attempt to reduce the inflow of short-term funds, the Bank of Canada announced a Vz percentage point decrease in its discount rate from 8 per cent to IVi percent. The Canadian dollar eased very briefly but then again moved to the ceiling as a rise in the forward premium continued to provide a hedged incentive for short-term funds to flow into Canada. Toward the end of May, how ever, when the Bank of Canada entered the forward market both on a swap and on an outright basis, the forward premium backed down and the spot rate declined. Under these circumstances, the market was taken by surprise on Sunday, May 31, when Finance Minister Ben son announced that, for the time being, the upper limit for the Canadian dollar would not be defended. Mr. Benson cited the rapid and accelerating accumulation of reserves and the threat of large-scale speculative inflows as reasons for the decision “to permit some appreciation of the market rate of exchange”. (Reserves had risen $1.2 billion since the beginning of the year, of which some $622 million—including forward purchases—had occurred in May alone.) Mr. Benson stated, however, that the authorities would intervene to prevent an excessive appreciation, as well as to maintain orderly conditions in the exchange market, and that “the IMF has also been informed of the Canadian government’s intention . . . to resume the fulfilment of its obligations under the Articles of Agreement of the IMF as soon as circumstances permit”. In order to prevent a rise in the Canadian dollar from being excessively deflationary, the Bank of Canada simultaneously cut its discount rate by a further V2 percentage point, to 7 per cent, while the government decided not to proceed with 197 198 MONTHLY REVIEW, SEPTEMBER 1970 certain consumer credit restraints it had planned to introduce. The market opened on Monday, June 1, in an atmo sphere of considerable nervousness, reflecting the prevalent uncertainty as to how high and for how long the Canadian dollar would float. In hectic trading early that morning in London, the rate rose nearly to parity with the United States dollar but then fell back to the $0.97-$0.98 range. A substantial demand for Canadian dollars appeared when the markets opened in North America, primarily from banks covering short positions, but the Bank of Canada intervened to prevent a further run-up in the rate. By late afternoon demand had begun to ebb, and the rate de clined to as low as $0.9655 on June 2. Activity then diminished to abnormally low levels over the remainder of the week. In subsequent weeks, the rate continued to fluctuate widely—reaching as high as $0.9710 and as low as $0.9554 (see Chart II). In accordance with the an nounced policy, the Bank of Canada intervened to dampen the swings, in particular acting to prevent an excessive rise in the rate. By the end of June the Canadian dollar had settled around $0.9660, as the market began to feel that this might be close to the level at which a new parity would eventu ally be established. The rate held fairly steady around that level through mid-July, the daily fluctuations becom ing narrower and less erratic. At that point, however, a new wave of demand built Chart II CANADIAN DOLLAR UNITED STATES CENTS PER C A N A D IA N DOLLAR * M A Y TO SEPTEMBER 1 9 7 0 100 100 It It 96 I • High A v e r a g e n o on rates Low A t effective c eilin g th ro u g h o u t th e w e ek ■ 93 -------------------------------- 9 2 .5 L. ]__ 1..1. 1... 1 J J ...1 .J...L i , 1. 1 1 . 1 .1..1 J .J . 92 2 .5 92 M ay June July A ugust S e p te m b e r * N e w Y o rk o ffe re d ra te s . Table II FEDERAL RESERVE SYSTEM DRAWINGS AND REPAYMENTS UNDER RECIPROCAL CURRENCY ARRANGEMENTS In millions of dollars equivalent Drawings ( -f ) or repayments (—) Transactions with System swap drawings outstanding on January 1,1970 1970 1 II July 1September 10 + 50.0 45.0 1-130.0 4- 75.0 95.0 —130.0 4-220.0 220.0 National Bank of Belgium .................................................................................... 55.0 Netherlands Bank ...................................................................................................... 130.0 Swiss National Bank .................................................. ........................................ 145.0 -1 4 5 .0 -j-200.0 —200.0 Total .................................. ............... ......................................................................... 330.0 B - 50.0 1—145.0 f+245.0 }—260.0 f+295.0 1-200.0 System swap drawings outstanding on September 10,1970 315.0 FEDERAL RESERVE BANK OF NEW YORK up and in just over a month the Canadian dollar reached $0.9850. The advance mainly reflected the onset of seasonal demand, a pickup in long-term borrowings abroad, and an inflow of short-term funds resulting from a sharp squeeze for balances in Canada. Moreover, the rise in the rate tended to be self-reinforcing in that it encouraged an increasing tendency to cover Canadian dollar commit ments. Another factor in the market, starting toward the end of July, was the appearance of professional traders, mainly in European banks, who would move in and out of the Canadian dollar within a single day to take advan tage of the wide fluctuations in the rate, their actions clearly aggravating those fluctuations. Finally, in mid-August there was a burst of demand for Canadian dollars, as grain dealers reacted to reports that a substantial portion of the United States corn crop was threatened by blight. Later in the month, as the market calmed again, the rate moved lower. On August 31 the Bank of Canada announced that in view of both external and domestic economic develop ments it was cutting its discount rate by Vz percentage point to 6 V2 percent. Table III FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS September 10,1970 In millions of dollars Institution Amount of facility Austrian National Bank ...................................... 200 National Bank of Belgium .................................. 500 Bank of Canada ...................................................... 1,000 National Bank of Denmark ................................ 200 Bank of England .................................................... 2,000 Bank of France ...................................................... 1,000 German Federal Bank .......................................... 1,000 Bank of Ita ly ............................................................. 1,250 Bank of Japan ........................................................... 1,000 Bank of Mexico ....................................................... 130 Netherlands Bank ................................................... 300 Bank of Norway ....................................................... 200 Bank of Sweden ....................................................... 250 Swiss National Bank ............................................... 600 Bank for International Settlements: Swiss francs-dollars ........................................... 600 Other authorized European currencies-doliars 1,000 Total ........................................................................... 11,230 199 GERMAN MARK The German authorities’ decision on September 29, 1969 to suspend temporarily their intervention at the mark’s ceiling and the subsequent revaluation of the mark on October 26 triggered a massive outpouring of funds from Germany; by the end of the year, the German Fed eral Bank had sold more than $6V2 billion in spot market operations. In December, a significant factor in the out flow was the repatriation of funds by United States and European corporations to meet balance-of-payments tar gets or year-end needs. After this year-end positioning was completed and as Euro-dollar rates declined sharply, the outflow from Germany came to an abrupt halt. The mark then firmed and generally traded above its $0.2710 floor in January, although it eased back close to the floor by the end of February. The Federal Reserve built up its mark balances in February by purchasing $97.6 million equivalent of marks from a foreign central bank. In the meantime, credit conditions had tightened con siderably in Germany, as the monetary authorities had allowed the outflow of late 1969 to constrict domestic liquidity. In the absence of strong action on the fiscal front, however, this liquidity squeeze proved insufficient to check the inflationary forces under way in Germany and the market began to anticipate a further tightening of monetary policy. Accordingly, traders bid more actively for marks in early March, lifting the spot rate slightly above its floor in the process. Nevertheless, the market was surprised by the severity of the measures announced by the Federal Bank Council on March 6: the central bank’s discount rate was raised by IV2 percentage points; to IV 2 percent, its “Lombard” rate on advances against securities by V2 percentage point to 916, percent, and., to discourage banks from borrowing too heavily abroad,, an additional reserve requirement of 30 percent was, imposed, effective April 1, on increases in the banks'" nonresident liabilities. The spot mark rate immediately rose sharply in re sponse to this pronounced tightening of monetary policy. Even though the Federal Bank repeatedly raised its day-today intervention points, on April 6 it began absorbing dollars from the market for the first time since last fall After easing temporarily at the month end, the mark began to climb again in May. Borrowing abroad by German banks continued, but on a more limited scale, while borrowings by commercial firms reached major proportions. With this demand for marks reinforced by fears of additional measures of monetary restraint and by rumors that the Federal Bank might raise its official upper intervention point to the full 1 percent above par allowed by the IMF, MONTHLY REVIEW, SEPTEMBER 1970 200 Table IV UNITED STATES TREASURY SECURITIES FOREIGN CURRENCY SERIES In millions of dollars equivalent Issues (+ ) or redemptions (—) Issued to Amount outstanding on January 1,1970 1 German Federal Bank ............................................................................. .............. 1,081.6* German banks ............................................................................................................ 135.5* Bank of Italy ............................................................................................................ 125.4 Swiss National Bank ............................................................................................... 540.6 Bank for International Settlementsf .... .................... ........................................... 204.4 Total ........................................................................................................................... 2,087.6 Amount outstanding on September 10,1970 1970 11 July 1— September 10 -54 2 .0 539.6 135.5 -1 2 5 .4 - 0- 541.0 - 5 4 .7 —667.4 -5 4 .7 150.0 -0- 1,366.1 Note: Discrepancies in totals result from minor valuation adjustments and from rounding. ♦Includes valuation adjustments subsequent to the revaluation of the German mark, t Denominated in Swiss francs. the spot rate reached its ceiling of $0.2754% on May 13 and the Federal Bank had to purchase a large amount of dollars. A brief easing occurred again in the second half of May, but the rate was rising once more by the month end. The floating of the Canadian dollar on June 1 added a new speculative element to the continuing inflow of short-term funds stemming from interest arbitrage. Thus, even though Germany’s current account was undergoing a substantial deterioration, particularly on services, the mark remained extremely strong in June. A characteristic pattern soon emerged, with a bunching of purchases on Wednesdays when value-date considerations favor the mark, followed by an ebbing of demand in subsequent days. The Federal Bank began taking in dollars on Wed nesday, June 3. During the following week the market was quite nervous and revaluation rumors, along with the approaching mid-June tax period, led to a large-scale conversion of foreign borrowings by German corporations and triggered the movement into marks of other funds as well. In the most hectic day since the fall of 1969, on June 10, the Federal Bank purchased $640 million at the ceiling, while the rate moved even higher that afternoon in New York after the close of business in Frankfurt. Even though the immediate demand for marks spent itself in this flare-up and activity was again normal during the following days, the market remained unsettled and fearful about the future. In a move aimed at calming these fears, the Fed eral Bank began offering to sell outright forward marks, and this action helped improve market atmosphere. Never theless, the underlying demand for marks remained strong and was further intensified toward the end of June by German commercial banks’ positioning to meet increased reserve requirements (effective July 1, these were raised by 15 percent). At the same time, relatively high Ger man interest rates were again pulling in funds from the Euro-dollar market—where rates were declining in re sponse to the partial lifting of Regulation Q ceilings in the United States—and, on July 1, the Federal Bank once more purchased a large amount of dollars. The heavy inflows of interest-sensitive funds made it clear that Germany could not fight inflation with monetary policy alone in an environment of declining interest rates abroad. Early in July, therefore, the German cabinet decided to tighten fiscal policy, thereby allowing some easing of monetary restraint. Included among the measures taken then were a temporary suspension of accelerated depreciation allowances for industry and the imposition of a refundable 10 percent surcharge on personal and corporate income taxes. Subsequently, effective July 16, the Federal Bank reduced its discount and “Lombard” rates by Vi percentage point to the still very high levels of 7 and 9 percent, respectively. German money market rates remained firm, nevertheless, ranging above 9 percent, so that, against a background of easing Euro-dollar quota tions, a considerable interest-arbitrage incentive in favor of Germany persisted. As a consequence, demand for 201 FEDERAL RESERVE BANK OF NEW YORK marks dipped but briefly, and the central bank again made large gains in the latter part of July. Eventually, however, the German money market began to respond to the influx of liquidity from abroad. With domestic interest rates easing as a consequence, demand for marks lessened and the central bank’s dollar pur chases tapered off by early August. By then, however, the expansion of domestic liquidity had become excessive and threatened to thwart the anti-inflationary efforts of the German authorities. Consequently, on August 12 the Federal Bank Council announced new measures of mone tary restraint: effective September 1, increases in bank liabilities above the second-quarter average were subjected to heavy new reserve requirements, and accordingly the additional 30 percent requirement imposed in March on increases in the banks’ nonresident liabilities was abolished. With tighter domestic credit conditions in prospect, demand for marks strengthened somewhat and the Federal Bank again had to absorb dollars from the market. The amounts were relatively modest, however, and the general market atmosphere at the close of the period was much calmer than in earlier months. ST E R L IN G Sterling recovered strongly throughout the fall of 1969, as the British trade position shifted into surplus and a reversal of earlier speculative outflows gathered momen tum. Concurrently, monetary policy tightened sharply, and by the year-end spot sterling had reached parity while for ward sterling discounts had narrowed substantially. The Bank of England was thereby enabled to make sizable reserve gains during the fall months, and by the year-end its outstanding drawings on the Federal Reserve had been reduced to $650 million from the May 1969 peak of $1,415 million. Even stronger demand for sterling emerged during the first four months of 1970. Britain’s basic payments posi tion continued to run in heavy surplus, and there were further favorable shifts in commercial leads and lags. Moreover, London began to attract very heavy inflows of short-term investment funds, as Euro-dollar rates fell sharply while tight money market conditions continued to prevail in the United Kingdom. The three-month Euro dollar rate, for example, had reached WVi percent in midDecember but thereafter declined sharply during the first quarter of 1970 and into April, reaching a low of about 8 percent in mid-April. Deposit rates in the United King dom, on the other hand, remained firm early in the year and then moved up in February and early March in re sponse to the mid-March tax squeeze. Inflows during this period were reflected, in part, in a large rise in the sterling balances of the overseas sterling area as well as in some rebuilding of the balances of nonsterling-area countries. In addition, British-based firms with international subsidiaries apparently were bringing funds home to bolster their liquid ity positions. As funds flowed into Britain the spot sterling rate moved well above par and the Bank of England made very sizable reserve gains, which as before were largely devoted to the liquidation of official indebtedness. Drawings on the Fed eral Reserve swap line were cleaned up through repayments of $300 million in January and $350 million in February, thus restoring the $2 billion swap line to a fully available standby basis for the first time since July 1968. Over the same period and continuing into March, very substantial repayments were made to other creditors, including the United States Treasury (see Table V ). The exceptionally strong performance of sterling during the winter months, and the emergence of a significant interest differential in favor of sterling, had led the Bank of England to reduce its discount rate by V2 percentage point to IV 2 percent on March 5. Nevertheless, inflows to London continued as Euro-dollar rates declined further, and the bank rate was cut again to 7 percent in mid-April at the time of the announcement of the United Kingdom budget. The budget was generally well received by the market and, despite the further reduction in British interest rates, sterling continued in good demand, enabling the Table V BRITISH SHORT-TERM INDEBTEDNESS TO THE UNITED STATES TREASURY AND FEDERAL RESERVE SYSTEM Amounts outstanding in millions of dollars Date Federal Reserve swap line June 1966 sterling balances Treasury arrangement credit line of (SystemNovember 1967 Treasury) Total 1969 1,415 310 350 1,025 310 350 1,685 September 30 .... 1,100 310 350 1,760 December 3 1 ..... 650 271 350 1,271 379 May 1 3 ............... 2,075 1970 March 31 ........... -0- 154 225 June 3 0 ............... -0- 115 -0- 115 August 3 1 ........... -0- 115 -0- 115 Note: Certain special credits from the United States Treasury also were liquidated by March 31. 202 MONTHLY REVIEW, SEPTEMBER 1970 Bank of England to take in more dollars. While some of these gains were added to reserves, most were used to pay off debt, including the final $225 million due under the credit line of $350 million extended by the United States Treasury in November 1967. Demand for sterling remained strong through early May, when it was announced that the British trade posi tion had slipped into small deficit in April. Buying then tapered off, and the subsequent call on May 18 for a gen eral election to be held on June 18 brought sterling under some pressure. In succeeding days, the spot rate declined fairly sharply from about $2.4050 to just above par. Ster ling firmed at the month end, however, and for May as a whole the reserve position showed a small gain. The floating of the Canadian dollar on June 1 intro duced a new element of uncertainty into the market and, as the British elections drew closer, sterling slipped below par. The decline in the rate was not precipitous, however, and little official support was required. The announcement on June 15 that there had been a second successive trade deficit in May, coupled with growing concern over wage and price developments in Britain, put still further pressure on sterling, and the rate dropped to about $2.3960. Fol lowing the June 18 election, however, there was an increase in demand that briefly carried sterling above par and re sulted in substantial reserve gains by the British authorities. Consequently, the Bank of England was able in June to make a further advance repayment of credits extended under the June 1966 sterling balances arrangement. Of this repayment, the Federal Reserve and United States Treasury share was $39 million, bringing the total of such repayments to the United States since late 1969 to $195 million. For the first half of 1970 as a whole, United King dom reserves rose $264 million, while net repayments on short-term credit facilities totaled $2,619 million and $269 million was repaid to the IMF. The improvement in the British reserve position in May and June was accomplished despite rising Euro-dollar rates resulting from heavy borrowing from some Continental centers and firm demand on the part of United States banks. Although Euro-dollar rates leveled off by mid-June, the interest comparison remained adverse to the United Kingdom into early July, and for a few days at the begin ning of the month there was heavy switching out of sterling, which pushed the spot rate down to nearly $2.39 and brought the Bank of England into the market in support. Euro-dollar rates then moved lower as a change in Regu lation Q by the Federal Reserve Board, in response to pres sures in United States financial markets in late June, led to a sharp decline in the Euro-dollar borrowings of United States banks. Consequently, the pressure on sterling eased and the spot rate held above $2.39, despite the threat of a nation wide dock strike. The July 14 announcement of a substan tial trade deficit for June, followed the next day by the dock workers’ vote to strike, resulted in a further decline in the sterling rate to about $2.3885, but no official support was required. Although the market remained nervous during the period of the strike, there was no significant liquidation of sterling balances and no further slide in the rate. Indeed, the settlement of the strike in late July brought renewed demand for sterling. The market then entered a period of summer doldrums in August, and through midmonth sterling fluctuated on either side of $2.39 in quiet trading. Late in the month, however, against the background of an adverse seasonal swing, concern about the domestic labor situation brought on some selling of sterling, and the spot rate declined to about $2.3830 by month end. IT A L IA N L IR A The Italian lira had been subjected to considerable pressure in September 1969 as a result of speculative outflows to Germany, and the Bank of Italy had drawn $300 million on its swap facility with the Federal Reserve. When the German mark was allowed to “float” at the end of September, Italian residents started to unwind their mark positions and, by mid-November, the lira had moved up to par. With this reversal in the flow of funds, the Bank of Italy was able to acquire dollars in the market and liquidate completely its swap drawing from the Fed eral Reserve. Late in November, unfortunately, the situation took an abrupt turn for the worse. A rash of labor strikes crippled industrial production, thereby choking off ex ports while simultaneously pulling in additional imports. This worsening of the current account was accompanied by increased capital outflows. As a consequence, the lira came under heavy selling pressure that persisted until midMarch, and the Bank of Italy had to extend sizable market support even though it had allowed the spot rate to fall to its floor by early January. To cover market losses the Bank of Italy reactivated its swap line with the Federal Reserve, drawing $200 million in late January and an additional $600 million during the course of February, when pres sures intensified following the resignation of the Italian government. In the meantime, however, the Italian authorities had started to take a series of measures to curb the capital outflow, and these were to bring a significant improvement in the situation. In mid-February, the Bank of Italy curtailed the potential for large shifts in commercial leads 203 FEDERAL RESERVE BANK OF NEW YORK and lags by limiting prepayments of imports to no more than 30 days and requiring the repatriation of export earn ings within 120 days of shipment. The Bank also dis couraged the outflow of Italian bank notes by substantially tightening procedures for handling such notes when presented for conversion. At the same time, the Italian authorities began encouraging official entities to meet their capital needs by borrowing abroad. Early in March, the Bank of Italy acted to bring Italian interest rates into bet ter alignment with those abroad by raising both its discount rate and its rate on advances against securities by IVi per centage points, to 5Vi percent, while maintaining the addi tional penalties of IV2 percentage points on the borrow ings of banks making large or frequent use of central bank credit. Domestic liquidity conditions then tightened, and Italian interest rates moved up to more competitive levels. Furthermore, to bolster the Italian authorities’ defenses, on March 12 the Federal Reserve’s swap ar rangement with the Bank of Italy was increased by $250 million to $1,250 million and the United States Treasury extended to the Bank of Italy a special swap facility of $250 million. There was a clear improvement in the market during the second half of March, reflecting the formation of a new coalition government, tourist travel to Italy over the Easter holidays, and a tapering-off of capital outflows. This stronger tone of the lira persisted until mid-May (even though intermittent strikes helped keep the trade deficit large), and the Bank of Italy was able to purchase a moder ate amount of dollars in the market. Furthermore, the Italian electricity authority—ENEL—raised a total of $425 million in the Euro-dollar market in May, and the foreign currency proceeds of the borrowings were added to official reserves. With the help of these funds, the Bank of Italy repaid in May swap drawings of $600 million, thereby reducing its indebtedness to the Federal Reserve to $200 million. Starting around mid-May, however, the lira again came under some pressure as a result of new strikes and un certainty about the outcome of the regional and local elections of June 7 and 8. Against this background, there were renewed fears of a devaluation of the lira, and the Bank of Italy had to provide sizable support to the mar ket. Such fears were also evident in the forward market, where the discount on the three-month lira widened from around 1 percent per annum at the end of May to 13 per cent early in July. Then, on July 6, the Italian government resigned after less than four months in office, and the political crisis temporarily intensified the pressure on the lira. To help cover its market losses of late spring and early summer, the Bank of Italy drew an additional $200 million on the Federal Reserve facility in June, thereby raising such swap debt to $400 million. These drawings were fully liquidated by July 10, as the Italian author ities decided to mobilize resources available from the IMF. A $250 million special claim on the IMF was con verted into dollars by transferring the claim to Japan and $463 million more, representing Italy’s super gold tranche position plus lending under the General Arrangements to Borrow, was drawn directly from the Fund. In a related precautionary operation, the Bank of Italy activated for the first time its special $250 million swap facility with the United States Treasury, drawing $100 million on July 14 and repaying the entire amount on July 17. In early August the lira again needed support, but a bet ter tone emerged following the formation of a new govern ment led by former Finance Minister Emilio Colombo on August 6. Indications of the programs to be proposed by the new government brought a strengthening of mar ket confidence in the lira, and there was some covering of short positions. Late in the month the government an nounced its new fiscal program, including a hike in gasoline prices, higher excise taxes, and several measures to increase productivity. By the end of August the spot rate had risen well above par and the Italian authorities had begun to accumulate dollars from the market. FRENCH FRANC In the year that has elapsed since the franc’s devalua tion in August 1969, the French authorities have been able to liquidate completely $1.5 billion in short-term international indebtedness, to repay in full the for eign exchange deposits that French commercial banks had been required to hold at the Bank of France, and to add $952 million to official reserves, while allowing the franc rate to move from close to its floor to near its ceil ing. This impressive achievement, although partly based on drawings on the IMF totaling $985 million, reflects primarily the dramatic improvement in France’s balanceof-payments position since mid-October 1969—a turn about from massive deficit to substantial surplus. The rapid recovery of the franc was largely attrib utable to an effective combination of French monetary and fiscal policy in support of the devaluation as well as to developments abroad. Beginning in the fall of 1969 the authorities undertook a vigorous anti-inflationary program —cutting back public spending, curbing consumer credit, encouraging savings, and, more broadly, moving to a firmly restrictive monetary policy. This stringent program was maintained with only minor relaxations, even after the 204 MONTHLY REVIEW, SEPTEMBER 1970 external situation had turned around. Second, the specula tive flows prior to the devaluation were followed after that event by opposite movements which contributed to the franc’s strength: leads and lags and other short-term flows were reversed, while consumption and imports, which had risen sharply in anticipation of a devaluation, receded markedly in the latter part of 1969. Third, the subsequent revaluation of the German mark reinforced the new parity of the French franc, initially by triggering a reflow of funds out of Germany. Finally, the severe price and wage infla tion experienced by virtually all industrialized countries helped mitigate the balance-of-payments effects of France’s own inflation and of the additional pressures exerted on domestic prices as a result of the devaluation. Against this background, the French franc strengthened significantly and in January moved above par as Euro dollar rates began to decline steeply while French mone tary conditions remained taut. Moreover, the French trade position was steadily improving and reached approxi mate balance by spring. In April, demand for francs increased markedly as confidence steadily improved, and the Bank of France added considerably to its reserves. The franc maintained its strength in May and June, and the Bank of France again made large dollar purchases, particularly at the month end. To offset the domestic monetary effects of these inflows, the Bank of France in early June raised commercial bank reserve requirements by 1 percentage point. In view of the strengthening of the franc, travel allowances and some other limitations on the use of foreign currencies were relaxed in the spring and in midyear, but the main body of the exchange controls introduced in the autumn of 1968 remains in effect. The swing into external surplus enabled the authorities to move in mid-1970 toward a somewhat less stringent policy domestically; some quantitative credit controls were relaxed, tax and credit restrictions on the purchase of a number of durable goods were eased, and some budgetary funds that had been frozen earlier were released. In order to limit the expansionary effects of these measures, however, the authorities once again raised re serve requirements by 1 percentage point in early July to 7.5 percent for sight deposits and to 2.5 percent for time deposits of up to three years’ maturity. There was a further strengthening of demand for the French franc at the end of July, mainly reflecting a bunching of conversions of export receipts prior to the August vacation period, and the spot rate reached a new post-devaluation high. In August, the rate eased marginally in an inactive market until late in the month when the Bank of France cut its discount rate by V2 percentage point to IV 2 percent. This further evidence of official confidence in the recovery of the franc helped bring about a firming in the spot rate during the closing days of August. During 1970 the Bank of France used its reserve gains to reduce further its international indebtedness. By the end of April it had fully liquidated its short-term credits from foreign central banks. At the same time, the Bank of France also cleared away its debt to the United States Treasury under the November 1968 facility, repay ing the total of $200 million by April 24: $70 million in February, $55 million in March, and $75 million in April. Then, as a result of the increase in official reserves, France was required to make a repayment of its outstand ing indebtedness to the IMF; this payment, amounting to $246 million, was made on September 2. S W IS S FR AN C In late 1969 and early 1970, the Swiss authorities took a number of steps to combat the inflationary pressures generated in part by an export boom. Late in December the government decided to complete its Kennedy-round tariff cuts during the spring of 1970 rather than in 1971 and 1972 as originally scheduled. Then in January the National Bank and the commercial banks agreed, under the existing restrictions on credit expansion, to reduce further the permissible rate of growth in bank credit dur ing the first half of 1970. Meanwhile, bank liquidity had been progressively tightening, and this squeeze became evident in January when the usual seasonal weakening of the Swiss franc caused by the reversal of year-end flows failed to materialize. Consequently, the Federal Reserve was unable to acquire through the market the Swiss francs needed to liquidate the System’s swap debt of $145 million to the Swiss National Bank. In February, with relative calm prevailing in the mar kets, the Federal Reserve and the Swiss National Bank agreed that the time had come to clear up the System’s Swiss franc swap debt, which had been outstanding since October. Consequently, during the month the National Bank sold $140.7 million of francs directly to the System against dollars. The Federal Reserve used these francs and some from balances to repay the $145 million swap debt, thereby restoring the swap arrangement to a fully available standby basis. Toward the end of February, monetary conditions again tightened in Switzerland and, when the franc rose to its ceiling, the Swiss National Bank had to absorb some dollars from the market. Following this injection of liquid ity into the domestic market, the franc eased but, in March, Swiss commercial banks began to repatriate FEDERAL RESERVE BANK OF NEW YORK 205 funds from abroad to meet heavy quarter-end require francs lessened and a somewhat easier tone prevailed ments. The National Bank decided to accommodate this through August. quarter-end demand through swaps with the banks (buy With a view toward repaying the $200 million swap ing dollars spot against sale for delivery in early April), drawing made in mid-May, the Federal Reserve had in order to prevent the spot rate from running up to the begun to accumulate modest amounts of Swiss francs, ceiling. By entering into $418 million of swaps, the Na occasionally in the market and also directly from the Swiss tional Bank forestalled large uncovered spot purchases National Bank against Italian lire held in balances. (The of dollars. After the end of the quarter, there was no National Bank has a recurrent need for lire, arising from easing in the market as credit remained tight. At remittances made by Italian workers in Switzerland.) this point the Swiss and United States authorities agreed Using such franc balances, on July 6 the System prepaid that the Treasury should redeem at maturity a six-month $15 million of swap debt to the Swiss National Bank. Addi Swiss franc-denominated certificate of indebtedness equiva tional franc balances were accumulated in July and early lent to $54.7 million held by the BIS. The National Bank August. The Federal Reserve and the National Bank at consequently sold the necessary francs to the Treasury that point decided to clear the swap line once again through against dollars. direct measures. Accordingly, $50 million equivalent of Underlying credit conditions in Switzerland remained the swap debt was repaid through a United States Trea very tight throughout April and into early May. In view sury sale of gold to the Swiss National Bank. Then, on of the pressures on the Swiss capital market, the three August 25, the System purchased $120 million equivalent large Swiss banks decided at the end of April to suspend of francs from the National Bank and used those francs temporarily the placement of new issues for foreign plus $15 million from balances to restore the swap arrange borrowers. In mid-May, a large repatriation of funds ment to a fully standby basis. finally eased the domestic liquidity situation. This inflow of dollars, however, considerably increased the Swiss Na D U TCH G U ILD E R tional Bank’s dollar holdings at a time when they were already large. To provide cover for some of the most recent Beginning in late September 1969 there were heavy dollar accruals, on May 15 the Federal Reserve reactivated speculative inflows into the Netherlands as the market its swap facility with the Swiss National Bank, drawing assessed the risk that the guilder might follow a revalua $200 million equivalent. tion of the German mark. After the German Federal For the rest of May, Swiss monetary conditions were Bank, on September 29, suspended its intervention at relatively easy, and pressure also lessened somewhat in the mark ceiling, the buying of guilders intensified and the capital market as a result of the temporary suspension became increasingly heavy through October. By the time of new foreign issues. The Swiss franc rate consequently the mark was formally revalued on October 26 the remained well away from the National Bank’s intervention Netherlands Bank had been forced to absorb $785 point. million from the market. Part of these reserve gains was The floating of the Canadian dollar on June 1 re used by the Netherlands Bank to repay $109.7 million awakened latent market fears that the Swiss franc would be in Dutch drawings then outstanding on the swap line revalued or allowed to float. Against this background, there with the Federal Reserve. To provide cover for some of were several bursts of demand for francs early in June, the Netherlands Bank’s additional dollar intake, the and on such days the franc rate rose sharply in hectic Federal Reserve in turn reactivated the swap facility, trading. A full-scale speculative rush did not materialize, drawing the full $300 million equivalent. In addition, however, and the passage in mid-June of a bill—to be the United States Treasury made a special one-week effective in September—requiring Swiss exporters to make swap of $200 million with the Netherlands Bank. noninterest-bearing deposits helped ease pressures. When Immediately following the revaluation of the mark once again, in late June, the Swiss National Bank assisted in late October, the Dutch authorities made known the commercial banks with their midyear liquidity needs their decision not to revalue the guilder and the spot rate by entering into $479 million in swaps, the market calmed quickly moved away from the ceiling as speculative posi further. Domestic liquidity conditions nevertheless re tions began to be unwound. By November 5 the Nether mained relatively tight in July, and the Swiss franc began lands Bank had sold slightly more than one third of the edging higher. Near the month end the spot rate was bid dollars it had purchased in October. Consequently, the up to the ceiling and the National Bank had to absorb United States Treasury had no difficulty in repaying its dollars from the market. Thereafter, demand for Swiss $200 million swap, and the Federal Reserve re 206 MONTHLY REVIEW, SEPTEMBER 1970 paid $70 million equivalent of its indebtedness on No vember 6, thereby reducing its outstanding swap debt in guilders to $230 million. Further repayments were made in November and December, reducing the System’s out standing debt in guilders to $130 million by the year-end. The guilder remained soft during the first quarter of 1970, as the Dutch current account turned seasonally weak and domestic credit conditions eased somewhat, but there was no significant selling pressure and no oppor tunity for further reductions in the Federal Reserve swap drawing. By late April the guilder was showing signs of renewed strength and the outlook for further reversal of the swap drawing was not promising. Since the remaining swap debt had been outstanding for six months, the System sought alternate means of repay ment. On April 29, the Federal Reserve sold German mark balances directly to the Netherlands Bank to acquire $60 million of guilders. The guilders were used to reduce swap drawings to $70 million. Then, on May 15 the United States Treasury drew $60 million of guilders from the IMF and sold them to the System. At the same time the Treasury sold 10 million SDR’s to the Netherlands Bank which in turn sold $6.8 million of guilders to the Federal Reserve. These guilders, plus a small amount from balances, were used to repay the outstanding $70 million drawing, thereby restoring the swap line to a fully available standby basis. The guilder market entered a new phase with the float ing of the Canadian dollar, which briefly rekindled some of last autumn’s fears and nervousness in the exchange markets. The market’s initial agitation and hectic trading died down by mid-June, but the underlying atmosphere remained tense with the guilder once again being regarded as a candidate for revaluation. Against this background, considerable foreign interest developed in new guilder bond issues being floated in the Dutch capital market. Moreover, a favorable shift of leads and lags developed, and there was a significant capital inflow in connection with an industrial take-over. Early in July, the spot guilder rate moved up through par and the Netherlands Bank soon began to purchase considerable amounts of dollars from the market. To deal with this dollar inflow, the United States Treasury sold $20 million of gold to the Netherlands Bank and the Federal Reserve reactivated its swap line on July 24, drawing a total of $75 million equivalent of guilders in July. The capital inflow intensified in August, and the Federal Reserve drew an additional $145 million, bringing System swap drawings in Dutch guilders to $220 million equivalent. In late August, monetary conditions eased in the Netherlands and the guilder market turned quieter. B E LG IA N FR A N C During the turbulent period preceding the revaluation of the German mark in October 1969, there were heavy speculative flows of funds to Belgium as the market also considered the Belgian franc a candidate for revaluation. Although the speculative outburst was quelled in late October by a firm government statement rejecting revalua tion, the underlying demand for francs remained very strong. With the spot rate holding close to its ceiling, the National Bank absorbed dollars from the market through out the rest of 1969. To provide cover for some of these dollar gains, the Federal Reserve reactivated its swap line with the National Bank, drawing a total of $55 million equivalent of Belgian francs in November and December. Buying pressure on the Belgian franc persisted after the turn of the year, reflecting tight credit conditions do mestically and a large surplus on current account. As a consequence, the spot rate held at or near its ceiling and the National Bank continued to absorb dollars from the market. The Federal Reserve provided cover for these inflows by further drawings on the swap line equivalent to $30 million in February, $20 million in March, $10 mil lion in April, and $15 million in early May. Federal Reserve indebtedness under the swap facility was thus raised to $130 million by May 5. A need for dollars by the Belgian government made possible a partial repayment of these drawings when the Belgian National Bank purchased $30 million from the Federal Reserve against Belgian francs on May 12. At that point it seemed unlikely, however, that further significant reduction in the remaining in debtedness of $100 million could be effected through similar operations or through a reversal of market flows. Since the swap line by then had been in continuous use by the Federal Reserve for some six months, it was agreed that alternate financing should be arranged, in keeping with the principle that use of central bank credit should not be unduly prolonged. Accordingly, on May 15 the United States Treasury drew $90 million of Belgian francs from the IMF and sold the francs to the Federal Reserve. At the same time the Treasury sold 10 million SDR’s to the Belgian National Bank, which in turn sold $8.8 million of Belgian francs to the Federal Reserve. The System used the francs so acquired, plus a small amount from balances, to repay completely the remaining $100 million swap debt. As had been anticipated, the Belgian franc remained quite firm through the spring and summer months, re flecting a strong current-account position. In July exag gerated reports of the Group of Ten discussions on ex change rate flexibility led to further speculation over a FEDERAL RESERVE BANK OF NEW YORK possible revaluation of the Belgian franc. Consequently, the National Bank had to absorb dollars from the market periodically during the summer. To cover the bulk of these reserve gains, the System reactivated its swap line, drawing $20 million equivalent at the end of June, $55 million in July, and $20 million in August, for a total of $95 million currently outstanding. 207 C h a rtlll SELECTED INTEREST RATES IN THE UNITED STATES THE UNITED KINGDOM, WEST GERMANY AND THE EURO-DOLLAR MARKET THREE-MONTH MATURITIES EXCEPT WHERE OTHERWISE NOTED Percent W e e k ly a v e rag es of d a ily rates Percent 12 E U R O -D O L L A R M A R K E T Tensions in the Euro-dollar market lessened consider ably during the period under review. Late in 1969, interest rates began an across-the-board retreat. The threemonth rate, for example, moved from IIV 2 percent in mid-December to 8 percent by mid-April (see Chart III). During the next two months, rates moved up, reaching levels well above 9 percent for most maturities, but over the summer months receded once again. Initially, the drop in Euro-dollar rates from their near record levels reflected the reversal of year-end pressures. The continued downtrend in rates, however, which oc curred despite very heavy switching of funds into sterling investments, was mainly attributable to the progressive re duction of Euro-dollar borrowings of United States banks through their own foreign branches (see Chart IV). United States banks’ takings declined steadily from midJanuary through the first quarter, as alternate domestic sources of funds were being tapped. At first, United States banks obtained a steadily rising amount of funds through the issuance of commercial paper by affiliated holding companies or subsidiaries. Then, as United States monetary policy moved toward a stance of less stringent restraint, and yields on United States Treasury securities fell below the recently increased rate ceilings on CD’s of similar maturities in February and March, commercial banks were able to increase sharply their sales of CD’s to a broad spectrum of investors. Consequently, outstanding Euro dollar borrowings fell by $2.3 billion to $12.0 billion between mid-January and April 1. Indeed, if United States banks had not been reluctant to run their Euro-dollar takings below reserve-free base levels established under an amendment to Regulation M, the decline in borrowings and in Euro-dollar rates might have been more precipitous. Starting in mid-April, however, the decline in Euro dollar rates was reversed, and by the middle of June most quotations had risen to well over 9 percent. This tighten ing of the market reflected in part the liquidity squeeze in Germany and France, which drew funds into those countries, and the takedown of two large Euro-dollar issues by the Italian electricity authority. More generally, there was a pronounced change in market expecta- 10 8 C e rtific a te s o f d ep o sit o f U n ite d S tates banks Primary market C e rtific a te s o f d ep o sit o f U n ited S tates banks ] Prim ary m a rk e t 6 0 -8 9 d ays. 90-179 days I j C hart IV . UNITED STATES BANKS’ LIABILITIES TO FOREIGN BRANCHES Billions of dollars W e d n e s d a y d a ta Billions of d o llars 14 12 10 8 S O N 1969 D J F M A M J J A S 1970 tions, stemming in part from growing fears regard ing the liquidity situation in the United States. During this period, United States banks’ liabilities to their own foreign branches rose modestly, averaging around $12 Vi billion in the second half of May and through June. Effective June 24, in a move aimed at facilitating the refinancing by the banking system of maturing corporate commercial paper borrowings following the failure of the Penn Central Transportation Company, the Board of Governors of the Federal Reserve System suspended Regulation Q interest rate ceilings on time deposits of $100,000 or more with maturities of thirty to eighty-nine days. Euro-dollar rates immediately receded as the Sys tem’s action helped ease money market strains and allayed some of the fears regarding a potential liquidity 208 MONTHLY REVIEW, SEPTEMBER 1970 crisis in the United States. With the surge in United States banks’ sales of large CD’s that followed the partial suspension of Regulation Q ceilings, the banks were able to curtail sharply their Euro-dollar borrowings through their own overseas branches; such liabilities fell below $11 billion by late July, more than $4 billion under the November 1969 peak. Meanwhile, money market conditions also had relaxed appreciably in Germany, following the large inflow of funds to that country and the reduction in the German Federal Bank’s discount rate on July 15. Consequently, Euro-dollar rates declined fairly steadily over the summer months, with the three-month rate falling as low as 73A percent in early September. 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. FEDERAL RESERVE BANK OF NEW YORK 209 T he Business Situation After having moved essentially sideways in late spring, the domestic economy seems to have begun the second half of 1970 on a somewhat stronger note. Housing starts recorded a substantial gain in July, while industrial pro duction edged upward. In addition, personal income grew modestly after having shown little change in recent months apart from the effects of the recent Federal pay increase and the rise in social security benefit payments. Revised gross national product (GNP) data for the second quarter show that both prices and real output increased by fractionally greater amounts in the April-June period than was previ ously indicated.1 In August, however, employment weak ened and the unemployment rate edged up to 5.1 percent. On balance, the decline in business activity appears to have bottomed out, and prospects for a near-term eco nomic expansion are brighter than a month ago. However, the strength of such an upturn is hard to assess. The pos sibility of an automobile strike remains an important ele ment of uncertainty in the economic outlook. Meanwhile, recent price movements have given rise to the hope that the pace of inflation may at last be slowing. The seasonally adjusted consumer price index rose less rapidly during June and July than earlier in the year. At the same time, the rise in industrial wholesale prices has slowed in recent months, also suggesting an improvement in the price picture. As yet, however, there is no evidence indicating a significant moderation of wage pressures. 1 The second-quarter revisions have GNP in current dollars at a seasonally adjusted annual rate of $971.1 billion, up $1 billion from the preliminary estimates. GNP adjusted for price changes increased by 0.6 percent, up slightly from the earlier figure of 0.3 percent despite a small upward revision in the GNP deflator. A major portion of the higher GNP levels revealed in the final data comes from the $0.5 billion upward adjustment in business inventories. P R O D U C T IO N , O R D E R S , S H I P M E N T S , A N D IN V E N T O R IE S Industrial production, as measured by the Federal Re serve Board’s index, registered a slight increase of 0.2 per cent in July, but remained 3 percent below its high of 174.6 reached twelve months earlier. The small gain re corded this July reflected increases in output of con sumer goods and materials, which more than offset further declines in the production of defense and business equip ment. Defense equipment production fell 1.5 percent in July, bringing the decline over the past year to 21 per cent. This drop has resulted in some severe unemployment rises in localities where defense industries are major employers. Output of business equipment has also been on a fairly long slide, peaking last October and falling in every subsequent month except the two months immediately following settlement of the General Elec tric strike last winter. At current levels, output of busi ness equipment is 7 percent below the October high. The weakness in business equipment production has ac companied a progressive trimming of capital spending plans, as reported in each of this year’s Department of Commerce-Securities and Exchange Commission surveys. Against the backdrop of an 11.5 percent increase in plant and equipment expenditures in 1969, the Commerce-SEC survey early this year pointed to a rise of almost 10 per cent. This figure was cut back to slightly less than 8 per cent with the spring survey, and the latest forecast, based on July-August data, now places the 1970 growth of plant and equipment spending at 6.6 percent. This survey indi cates that spending will continue to grow at a modest rate in the second half of 1970, with virtually all the increase concentrated in the public utilities sector. After taking price changes into account, the physical volume of plant and equipment investment in 1970 will probably remain close to last year’s level. In the consumer sector the production of automobiles and home goods rose somewhat in July. Allowing for 210 MONTHLY REVIEW. SEPTEMBER 1970 normal seasonal factors, which at this time of year in clude the model changeover period, unit auto assemblies were at an annual rate of approximately 8 V2 million in July and August. Production schedules for September indicate that output will continue at about this pace. The volume of automobile production in subsequent months will, of course, be greatly affected by the scope and duration of a strike, if one takes place. New orders for durable goods, which had posted gains in both May and June, rose 3.3 percent in July to a season ally adjusted level of $30.7 billion. However, all the gain can be traced to a substantial growth in new orders for de fense goods. Excluding the defense sector, new orders fell nearly 1 percent in contrast to the moderate upward trend over the previous two months. While defense orders cer tainly have implications for employment, prices, and output, they are not necessarily indicative of future trends in overall business activity. Moreover, on a month-tomonth basis, the defense orders series has been particularly volatile, and the July increase may reflect an orders bulge at the start of the fiscal year which is not accounted for by the seasonal adjustment process. In the important producers’ capital goods sector, new orders rose for the fourth straight month. Despite the rise in new orders for manufacturers’ durables in July, ship ments again exceeded new orders, and the backlog of unfilled orders declined for the seventh successive month. Preliminary data indicate that total inventories in man ufacturing rose by a substantial $0.8 billion in July, to a seasonally adjusted annual rate of $98.5 billion. All this increase occurred in the durable goods sector, where declines had taken place in the two preceding months. However, the rise in inventories was matched by the in crease in manufacturers’ sales of durables, so that the inventory-sales ratio was virtually unchanged from the fairly high June figure. mutual savings banks, which specialize in home financing, has strengthened notably in recent months, and net mort gage acquisitions by these institutions have begun to rise. All of July’s rise in private housing starts was concentrated in multifamily dwellings, with single family starts practically unchanged at an 827,000 unit annual rate. Since the num ber of single family starts was particularly depressed earlier in the year, the average for the first half of 1970 was held down to approximately the 700,000 mark. In contrast, total single family private starts numbered slightly less than 820.000 during 1969. The recent strengthening of housing starts was fore shadowed, as is often the case, by an earlier gain in res idential building permits (see Chart I). Permits jumped very sharply in April and edged up slightly in May to a 1.321.000 unit seasonally adjusted annual rate. Sub sequently, there has been some backing-off from the May pace, but the 1,265,000 unit rate for July is still markedly above the levels registered in the first three months of the year. In contrast to the housing starts improvement, pre liminary estimates of the current-dollar value of total new construction activity fell 1 percent in July on a seasonally adjusted basis, continuing the rather steady decline of recent months. Public construction and private commercial C h a rt I TOTAL PRIVATE HOUSING STARTS AND PERMITS S easo n ally adjusted AAill ions of units C O N S T R U C T IO N The housing industry is showing some signs of coming out of its recent slump. After a rather weak April, housing starts strengthened in May and June and aver aged a 1,280,000 unit annual rate in the second quarter, up slightly from 1,252,000 in the first quarter. In July, seasonally adjusted starts jumped a sharp 15 percent from the June level to a 1,585,000 unit annual rate. The starts series, to be sure, is highly volatile (see Chart I), and this latest jump may exaggerate the extent of the under lying improvement. Nevertheless, there have been some basic gains in the financing situation for home construction. The flow of funds to savings and loan associations and Source: U n ite d States D e p a rtm e n t o f C o m m erce , B u rea u o f th e Census. In d ex 211 FEDERAL RESERVE BANK OF NEW YORK buildings contributed to the decrease, while private resi dential and industrial buildings were both above the pre vious month’s figures. After excluding the effects of rapidly rising prices, the volume of total construction activity is off almost 9 percent from a year earlier. Chart II EMPLOYMENT AND LENGTH OF WORKWEEK Seasonally adjusted M illio n s of persons M illio n s of persons E M P L O Y M E N T , P E R S O N A L IN CO M E , A N D R E T A IL S A L E S Despite recent indications of a somewhat stronger general business performance, labor markets have con tinued to show slack. The seasonally adjusted unemploy ment rate edged up to 5.1 percent in August from July’s 5.0 percent. While the labor force shrank in August, a somewhat greater fall in employment pushed the jobless rate up. The small increase in the unemployment rate was concentrated among teen-agers, with the rate for adult males remaining unchanged and that for adult women declining. Long-term unemployment, i.e., the percentage of the work force out of a job for fifteen weeks or more, remained virtually unchanged in August at 0.9 percent. Although this rate has increased during 1970, it is generally considered to be a “lagging indicator”. Joblessness among workers covered by state unemployment compensation programs, which usually extend insurance coverage only to experienced members of the labor force, moved back up to the June rate of 3.7 percent after dipping in July. The August monthly payroll survey indicated that the number of employees on nonagricultural payrolls slipped after the small July increase shown by the revised data (see Chart II). In recent months, employment has fallen off in the construction, manufacturing, trade, and finance sectors, with the decline being longest and most severe in manufacturing. Since employers tend to adjust the hours worked by their employees before varying the total number of workers on their payrolls, the length of the manufacturing work week is often viewed as a leading indicator of business conditions. The index has, however, behaved erratically in recent months (see Chart II). During August, the seasonally adjusted workweek in manufacturing fell 0.2 hours, partially reversing the 0.3 hour rise in July. Nevertheless, the 39.9 hour workweek for August was still above the levels for May and June of this year. Personal income rose by $3.6 billion in July. Excluding the Federal pay raise and the improvement in social se curity payments, personal income had grown by an aver age of only $1.3 billion per month in the second quarter. Thus, the July increase, while still smaller than the roughly $5 billion per month average growth experienced in the first half of 1969 prior to the economic slowdown, never- Source: United States Department of Labor, Bureau of Labor Statistics. theless represents an improvement over the weak perform ance registered in the second quarter of 1970. However, Federal actions did supply massive injections of income during the April-June interval. As a consequence, the actual climb in personal income, including the Federal payments, averaged $3.5 billion per month in the period. Consumer spending responded with a large 2.5 percent quarterly increase in retail sales, and during July—per haps bolstered by the final elimination of the surtax— retail sales rose a further $0.2 billion from June, or 0.7 percent over the second-quarter average. Better new car sales have been an important element in the pickup of consumer buying, with the seasonally adjusted annual rate of sales of domestically produced automobiles rising from about 7.4 million in the first quarter to 7.9 million in the second quarter. Over July and August, auto sales aver aged approximately 8V2 million units. PR O D U C T IV IT Y , C O ST S, A N D PR IC E S During the second quarter of 1970, the combined im pact of higher average output per man-hour and a slower average rate of increase in hourly compensation led to a slowdown in the average rate of increase in labor costs per unit of output. As measured by the change in output 212 MONTHLY REVIEW, SEPTEMBER 1970 per man-hour, productivity in the private nonfarm econ omy rose at a 3.3 percent seasonally adjusted annual rate during the second quarter, after having fallen at a 2.9 percent rate in the first three months of 1970 and a 0.2 percent rate over the four quarters of 1969. The second-quarter rise in productivity reflected the combina tion of an essentially unchanged aggregate output and a substantial 3.3 percent drop (annual rate) in man-hours. Clearly, employers were less inclined to hoard labor in the second quarter than they had been earlier in the eco nomic contraction and thus began to release workers made redundant by the lower output rates. Average compensation per man-hour in the private nonfarm economy, including both wage and benefit pay ments, slowed to a 5.6 percent annual rate of increase in the second quarter, down from 6.6 percent in the preced ing three months and from 6.6 percent in the four quarters of 1969. The slower rate of gain in the April-June period this year reflected a cutback in expensive overtime hours and the economic contraction that has tended to be con centrated in industries with relatively high rates of com pensation. Thus, a reduction in these industries’ share of total output has helped to pull down the overall average rate of compensation. However, wages and salary benefits negotiated in recent major labor contract settlements have suggested, if anything, an acceleration rather than a slow down in the rate of increase. The second-quarter combination of productivity gains and smaller average rates of increase in compensation brought about a slowdown in the average rate of increase of labor costs per unit of output. During the second quarter, unit labor costs in the private nonfarm economy rose at a 2.2 percent seasonally adjusted annual rate, down sharply from the 9.8 percent gain during the first three months of the year and the 6.8 percent rise aver aged over the four quarters of 1969. A slower rate of growth in consumer prices during June and July has raised hopes that the pace of inflation may at last have begun to ease. The consumer price index rose at a 4.2 percent seasonally adjusted annual rate in June and at a 3.4 percent rate in July. Both months rep resented an improvement over the 6.3 percent rate of growth registered in the first five months of 1970 and the 6.1 percent rate recorded in 1969. Retail prices of food, other goods, and services have all risen less rapidly lately, but the most clear-cut movement in the desired direction has been in food prices. On a seasonally adjusted basis, the food component of the index actually declined in June and was little changed in July. These favorable developments had been foreshadowed somewhat earlier by a generally downward trend in wholesale farm prices, which began around April and has been extended through August. Farm prices, however, are heavily influenced by agricultural supply factors and are not necessarily good indicators of price conditions elsewhere in the economy. Moreover, the recently reported appearance of a corn blight has apparently dampened prospects for further de clines in wholesale food prices over the coming months. The most recent slowdown in the overall consumer price index is certainly encouraging. Unfortunately, how ever, it is necessary to keep in mind that other similar intervals of improvement were quickly reversed. For ex ample, a decline in the rate of price increases during July and August 1969 was followed by an acceleration in the rate of increase. The cooling effects of the economic slowdown are a major reason for hoping that the current easing will prove more lasting. The balance between supply and demand is now markedly less favorable to rapid price increases. Weaker demand has apparently been a factor in the recent easing in prices for some nonferrous metals, thus contributing to the somewhat slower growth of industrial wholesale prices in the June-August period. FEDERAL RESERVE BANK OF NEW YORK 213 The M on ey and Bond M ark ets in A ugu st Pressures on the nation’s financial markets continued to moderate during August, as the tense atmosphere that had developed in late spring and early summer receded fur ther. In the Government securities market, the month began on an optimistic note when the Treasury’s $6.5 billion refunding encountered an enthusiastic reception. Despite this increase in the volume of new securities available, rates on intermediate-term Government obliga tions declined almost uninterruptedly throughout the month. Prices of long-term debt, however, temporarily declined in early August, as the calendar of forthcoming corporate and Federal agency issues continued to mount and a backlog of previous financings overhung this market. Thus, rates on most long-term securities rose over the first half of the month, reversing in part the improvement in June and July (see Chart I). Yields began to decline again later in August when underwriters and investors, leaning to the view that monetary policy was moving to a less restrictive stance, again became encouraged about the outlook for interest rates. The tax-exempt bond market turned in a particularly strong performance in August and, by the month end, yields on some high-grade state and local government securities were at their lowest level in a year. To some extent, pressures evident early in the month were concentrated in the corporate market and reflected liquidity rebuilding by many borrowers. Corporations ap pear to have been refunding short-term bank and com mercial paper debt through the sale of long-term securities, and this development has given further impetus to the growing stability apparent in the commercial paper market. Money market conditions gradually became more com fortable in August, and most short-term interest rates declined. The improving atmosphere in the commercial paper market during the month mitigated pressures on the banking system, and member banks reduced their borrowings at Federal Reserve Banks from the unusually high levels posted in July. Commercial banks also received a sizable inflow of time deposits for the second successive month, while the outstanding volume of bank-related com mercial paper declined somewhat. Amendments to Regu lation D on reserve requirements, adopted by the Board of Governors of the Federal Reserve System on August 17, will change the relative cost to banks of alternative sources of funds. The Board is reducing member bank reserve requirements on time deposits in excess of $5 million from 6 percent to 5 percent and imposing an equivalent 5 per cent reserve requirement on all funds raised by member banks through the sale of bank-related commercial paper with a maturity of thirty days or longer. Regulation D reserve requirements on demand deposits are to be im posed on funds raised by banks from sales of commercial paper of less than thirty days’ maturity. This dual action will take effect in the reserve-computation period beginning on October 1 and places most bank-related commercial paper outstanding after September 17 on substantially the same basis with respect to reserve requirements as nego tiable time CD’s. The combined effect of the amendments will reduce required reserves by about $350 million for the banking system. The effective date of the change was timed to coincide with the fall period of seasonal reserve needs. B A NK RESERVES A N D THE M O NEY M ARKET Conditions in the money market became gradually more comfortable in August. Reserves provided through open market operations more than offset reserve drains during the month. Average borrowings from the Federal Reserve Banks fell to $881 million in August, (see Table I), down from the high level of $1,317 million in July. The basic reserve deficit of the forty-six major reserve city banks deepened considerably, however, from an average of $5.3 billion in July to $6.3 billion in August, (see Table II), as these banks helped finance increased dealer inventories of Government securities and, on bal ance, lost private demand deposits. Heavy dealer and bank participation in the Treasury financing, combined with some operating difficulties caused by a fire in the New York financial district, contributed to a sharp rise in the deficit during the second week of August (see Chart II). However, the major reserve city banks experienced no particular difficulty in adjusting to this marked deteri MONTHLY REVIEW, SEPTEMBER 1970 214 C hart I SELECTED INTEREST RATES J u n e -A u g u s t 197 0 P ercen t M O N E Y M ARKET RATES B O N D M ARKET YIELDS P ercen t Note: D ata are shown for business days only. M O N EY MARKET RATES QUOTED: Bid rates for three-month Euro-dollars in London; offering rates for directly placed finance company paper; the effective rate on Federal funds (the rate most representative of the transactions executed); closing bid rates (quoted in terms of rate of discount) on newest outstanding three-month and one-year Treasury bills. BO ND MARKET YIELDS QUOTED: Yields on n e w A a a - and A a -ra te d public utility bonds (arrows point from underwriting syndicate reoffering yield on a given issue to market yield on the same issue im m ediately afler it hcs b e e n released from syndicate restrictions); oration of their basic reserve position. The average effec tive rate on Federal funds declined from 7.21 percent in July to 6.62 percent in August. There was a slight moderation in commercial bank loan expansion during the month, compared with July, and banks were able to continue rebuilding liquidity by increasing the size of their investment portfolios. The nation’s banking system experienced sustained time de posit inflows during August, although the pace of expan sion slowed somewhat from the extremely rapid growth that followed the partial suspension of Regulation Q ceilings in late June. These developments were evident in the behavior of the adjusted bank credit proxy. On the basis of prelimi nary data, this measure of the sources of funds used to dai!y averages of yields on seasoned A a a -ra te d corporate bonds; daily averages of yields on long-term Government securities (bonds due or callab le in ten years or more) and on G overnm ent securities due in three to five years, computed on the basis of closing bid prices; Thursday averages of yields on twenty seasoned tw enty-year tax-exem p? bonds (carrying M oody's ratings of A a a , A a , A, and Baa). Sources: Federal Reserve Bank of N ew York, Board of Governors of the Federal Reserve System, Moody's Investors Service, and The W e e k ly Bond Buyer. finance credit by the banking system increased at a sea sonally adjusted annual rate of about 24 percent in Au gust. The adjusted proxy1 expanded at approximately a 17 percent rate in the June-August period. In part, the growth of bank credit apparently took the place of financ ing in the commercial paper market, although the latter market showed signs of stabilizing following the difficulties that had developed in the aftermath of the Penn-Central insolvency. 1 The adjusted bank credit proxy consists of total member bank deposits subject to reserve requirements plus nondeposit liabilities, including Euro-dollar borrowings and commercial pa per issued by bank holding companies or other affiliates. FEDERAL RESERVE BANK OF NEW YORK 215 Table I Table II FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, AUGUST 1970 RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS AUGUST 1970 In millions of dollars; (+ ) denotes increase (—) decrease in excess reserves In millions of dollars Daily averages— week ended on Changes in daily averages— week ended on Factors affecting basic reserve positions August 5 Net changes Factors August August August August 12 5 19 26 “ M arke t” factors -f- 76 — 449 — 166 + 9 — 17 — 125 — 151 — 94 4- 125 + 79 — 41 Total “ market” factors ...................... — 373 — 547 — 311 4- 636 — 595 — 139 — 172 4- 249 — 161 — 8 — 377 4-411 4- 225 — 177 - f 120 — 8 - f 211 August 19 E igh t banks in N e w Y ork City Member bank required reserves ............... Operating transactions (subtotal) ............. Federal Reserve flo a t.............................. Treasury operations* .............................. Gold and foreign acco u n t...................... Currency outside banks .......................... Other Federal Reserve liabilities and capital .............................................. — 354 — 193 — 13 4- 73 4- 19 — 177 August 12 Averages of four weeks ended on August August 26 26 — 6 — 589 107 + 41 — 14 — 468 Reserve excess or deficiency (—)*........ Less borrowings from Reserve Banks... Less net interbank Federal funds purchases or sales (—) .......................... Gross purchases .................................. Gross sales ............................................. Equals net basic reserve surplus or deficit (—) ......................................... Net loans to Government securities dealers .................................... Net carry-over, excess or deficit (—) t . . — 58 114 24 — 382 28 12 21 56 2,146 2,757 611 1,544 2,357 812 2,130 2,874 744 —1,960 —3,398 —2,195 —1,588 —2,285 1,788 2,742 954 3,040 3,641 600 934 937 30 641 39 8 — 12 143 1,158 7 918 21 T hirty-eight banks ou tside N e w Y ork City Direct Federal Reserve credit transactions Open market operations (subtotal) Outright holdings: Government securities .......................... Bankers’ acceptances .......................... Repurchase agreements: Government securities ........................ Bankers' acceptances .......................... Federal agency obligations ................. Member bank borrowings ............................ Other Federal Reserve assetst ................... 4- 583 + 427 4- 724 — 322 4-1,412 4- 293 — 4 - 266 — 1 - f 644 4- i 4- 209 — 4-1,412 — - f 247 4 - 10 4- 33 — 222 4- 47 4- 196 — 6 — 28 4- 164 4- 48 4- 9 4- 25 4- 45 — 493 — 118 — 452 — 29 — 50 — 20 — 219 — — — 571 — 272 Total ...................................................... 4- 408 4- 639 4- 113 — 593 4- 567 Excess reserves ........................................ 4- 35 4- 92 — 198 4- 43 — 28 2 62 — 362 362 1 — 11 12 243 144 278 3,875 5,747 1,873 3,652 5,586 1,934 3,785 5,673 —3,797 i—4,480 —4,119 —3,807 —4,051 3.497 5,172 1,676 4,116 6,185 2,069 849 26 — 563 60 711 28 1,888 741 34 842 21 Note: Because of rounding, figures do not necessarily add to totals. * Reserves held after all adjustments applicable to the reporting period less required reserves, t Not reflected in data above. Monthly averages Daily average levels Table m AVERAGE ISSUING RATES* AT REGULAR TREASURY BILL AUCTIONS Member bank: 28,142 27,954 188 Borrowings .................................................... Free, or net borrowed (—), reserves......... Nonborrowed reserves ................................ Net carry-over, excess or deficit (—) § .... 1,010 — 822 27,132 141 28,588 28,308 280 1,174 — 894 27,414 138 28,529 28,447 82 680 — 598 27,84** 160 28,161 28,03* 125 660 — 535 27,501 82 Changes in Wednesday levels System A ccount holdings securities m aturin g in : Reserve excess or deficiency (—)*......... Less borrowings from Reserve B an 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 dealers ..................................... Net carry-over, excess or deficit (—)t>- of Weekly auction dates-—August 1970 August 3 Three-month .................................... August 10 August 17 August 24 August 31 6.413 6.512 6.527 6.198 6.342 6.496 6.682 6.587 6.338 6.508 Monthly auction dates—June-August 1970 -fl,252 — 347 4-509 4- 4-1,252 21 4-530 Note: Because of rounding, figures do not necessarily add to totals. * Includes changes in Treasury currency and cash, f Includes assets denominated in foreign currencies. t Average for four weeks ended on August 26. § Not reflected in data above. Net changes Government Less than one year ................................ More than one year .............................. In percent 28,355$ 28,186$ 169$ 881$ — 712$ 27,474$ 130$ -155 4-1,259 4- 21 4-1,280 June 23 July 23 August 25 7.069 6.467 6.510 7.079 6.379 6.396 t Interest rates on bills are quoted in terms of a 3G0-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. 216 MONTHLY REVIEW, SEPTEMBER 1970 Commercial bank reliance on nondeposit sources of remainder of the month along with other short-term rates. funds was reduced slightly in August. Euro-dollar bor Trading activity in the early part of August centered on rowings rose somewhat, following a sharp decline in July. the Treasury’s refunding operation. Holders of $6.5 billion Bank-related commercial paper sales declined, however, of maturing issues could exchange their securities between and banks began to repay maturing obligations in the August 3 and 5 for new 3 Vi-year 13A percent notes priced wake of the Board of Governors’ application of reserve at par and/or seven-year 73A percent notes, priced to yield requirements to such obligations. Although the rate on about 7.80 percent. Prices of the new securities on a bank-related commercial paper was higher than that on “when-issued” basis moved immediately to a large premium, 30- to 59-day large CD’s in August, the cost of funds to and dealers purchased substantial quantities of maturing banks from the two sources was about equivalent, since issues or rights which were used to subscribe to the new reserves were not yet required against funds raised through issues w7hile order books were open. The Treasury’s cash offering on August 5 of an eighteen-month IV 2 percent sales of commercial paper. The reduction in bank dependence on nondeposit sources note, priced to yield 7.54 percent, encountered an excellent of funds was accompanied by heavy deposit inflows. Pre reception. On August 18, the Treasury announced the re liminary data indicate that seasonally adjusted daily aver sults of its financing operation and disclosed that it had age time deposits at all commercial banks grew at about raised a net $2.3 billion of cash, reflecting low attrition a 28 percent annual rate in August. Demand deposits also on exchangeable securities and strong demand for the new increased, and the narrowly defined money supply appears eighteen-month note.2 to have risen at a seasonally adjusted annual rate of about The August 17 announcement of a reduction in reserve 11 percent after increasing at a 4 percent rate in July. The requirements on time deposits and the simultaneous im seasonally adjusted daily average money supply appears to position of requirements on bank-related commercial have risen at an annual rate of about 11 percent after in paper, which will on balance release some funds in the creasing at a 4 percent rate in July. It should be stressed banking system, led dealers to anticipate increased pur that short-run movements in economic time series, such as chases of securities by commercial banks in the near the money supply, are difficult to gauge because it is hard future, and this development had a favorable impact on to distinguish between underlying trends and temporary long-term securities markets. Earlier in the month, the phenomena whose influence may not be significant in the demand for long-term Governments had been adversely long run. The daily average money supply grew at approx affected by the growing congestion in the corporate bond imately a 4 Vi percent seasonally adjusted annual rate in market. Steadily increasing yields on a large supply of new the June-August period. highly rated corporate issues had led investors to switch out of Governments and into private securities. Prices of long-term Government notes and bonds moved up strongly TH E G O V E R N M E N T SE C U R IT IE S M A R K E T in the last half of the month, however, as conditions in the The excellent reception encountered by the new issues corporate sector improved. offered at the beginning of August in connection with the The Treasury bill market was subject to moderate pres Treasury’s cash and exchange operation underscored the sure in early August, while banks sold TAB’s acquired at notable improvement in the market for intermediate-term two auctions in July. As the month progressed, bank selling Government securities that had taken root over the sum gradually subsided and, given the steady easing of money mer. Yields on outstanding intermediate-term Treasury market rates and the cost of financing inventories, dealers securities declined over the month despite the expanded were not particularly anxious even though their inventories supply of new notes. This contrasted sharply with marked rate increases experienced last May at the time of the previous refinancing. A rally in the long-term sector faded somewhat in early August, and yields rose as investors 2 Of the approximately $5.6 billion of maturing issues in the sold Governments and purchased higher yielding corporate hands of the public, about $4.8 billion was exchanged into the two new issues: the 7 3A percent notes due in February 1974, and securities. However, price declines eroded only a part of the 7 3A percent notes due in August 1977. The 14.8 percent the gains achieved in June and July, and prices were rising attrition rate on this exchange was less than one half the rate of previous refunding in May. In the cash offering of IV 2 per strongly toward the end of August. Bill rates fluctuated the cent Treasury notes due in February 1972, subscriptions totaled narrowly within a higher range over the first two weeks $ 18.6 billion from the public of which $3.2 billion was accepted, a 9.5 percent allotment on large subscriptions. This con of the period as banks sold tax anticipation bills (TAB’s) providing trasts sharply with the 100 percent allotment on a similar offering acquired the previous month, but they declined over the in May. FEDERAL RESERVE BANK OF NEW YORK had increased sizably in late July and early August. Over the month as a whole, rates on bills due within three months were generally 5 to 15 basis points lower and rates on longer term bills ranged from 3 basis points higher to 14 basis points lower. O TH ER SE C U R IT IES M A R K E T S A relatively heavy supply of new securities issues and a rapidly growing calendar of forthcoming debt flotations tended to depress corporate bond prices during the first half of August. This increase in yields on long-term debt contrasted with developments in other financial markets, as most short- and intermediate-term interest rates de clined. A rally in the taxable sector in June and July had most likely encouraged corporate borrowers to re finance existing short-term debt through the sale of long term obligations. The rally petered out toward the end of July when dealers and investors became convinced that bond yields would come under upward pressure until there C h a r t II BASIC RESERVE POSITION OF MAJOR MONEY MARKET BANKS S illions o f d o lla r s N o te : B illio n s o f d o lla r s C a lc u la tio n o f the basic re serve p o sitio n is illu strated in T a b le II. 217 was some reduction in the visible supply of new securities. The poor reception encountered by a large competitive of fering in the first week of August reinforced this growing pessimism about the course of long-term interest rates in the near future. The issue, marketed on August 5, consisted of $100 million of Aa~rated thirty-year first mortgage bonds issued by the Duke Power Company. The 8% per cent bonds were priced to yield 8.65 percent, 10 basis points below a similarly rated issue offered in the last week of July and the lowest offered during the summer on a high-grade electric utility issue. Underwriters were re portedly able to market only about one third of the securi ties before they were freed from price restrictions on August 17. Shortly thereafter the price of the bonds fell until they were yielding about 8.90 percent. Many other new financings in the first half of the month failed to receive good receptions, and a number of underwriting syndicates were disbanded during the second week of August. The rise in corporate bond yields was temporary, however, and conditions in this sector began to show no table improvement in the latter part of August. The action of the Federal National Mortgage Association in post poning a $200 million offering of twenty-year mortgagebacked bonds, and some tapering-off of the visible supply of other new offerings, encouraged market participants. More importantly, however, the easing of money market rates and the Board’s move on reserve requirements prompted discussion of a possible cut in the prime rate and reinforced optimism that monetary policy was becom ing less restrictive. Although the tax-exempt sector was faced with supply problems similar to those in the corporate sector, new issue activity was temporarily reduced early in the month, and this contributed to an easing of congestion at that time. A July ruling by the Internal Revenue Service led to in creased purchases of state and local government securities by commercial banks in late July and early August. This movement gained impetus later in August when the Federal Reserve Board announced the amendments to Regulation D. Many banks will have funds released when the lower reserve requirement on time deposits becomes effective. Debt flotations are subscribed to about one month before they are paid for, and commercial bank orders for new taxexempt securities began to pick up shortly after the Board’s action was announced. By the end of August, yields on some high-grade state and local government securities had fallen to their lowest levels in over a year. The Weekly Bond Buyer's index of yields on twenty municipal bonds fell by 33 basis points to 6.07 in the four weeks ended on August 26. MONTHLY REVIEW, SEPTEMBER 1970 Publications of the Federal R eserve Bank of N e w Y o rk The following is a selected list of this Bank’s publications, available from our Public Information De partment. Except for periodicals, mailing lists are not maintained for these publications. Delivery takes two to four weeks. Orders must be prepaid if charges apply; the first 100 copies of our “general” pub lications are free. Additional copies for classroom use or training are free to schools, including their bookstores, and commercial banks in the United States. (Classroom and training copies will be sent only to school and commercial bank addresses.) Others are charged for copies in excess of 100. Single copies of our “special” publications are free to teachers, commercial bankers, and libraries (public, school, and other nonprofit institutions) in the United States and to domestic and foreign government officials, central bankers, and newsmen. Additional copies for classroom use or training are available to these groups (including school bookstores) at our educational price. (Free and educational-price copies will be sent only to school, business, or government addresses.) Others are charged the full price for each copy. G E N E R A L P U B LIC A T IO N S 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. A comprehensive discussion of the roles of money, commercial banks, and the Federal Reserve in our economy. Explains what money is and how it works in a dynamic economy. (13 cents each in excess of 100 copies) o p e n m a r k e t o p e r a t i o n s (1969) by Paul Meek. 48 pages. A basic explanation of how the Federal Reserve uses purchases and sales of Government securities to influence the cost and availability of money and credit. Recent monetary actions are discussed. (10 cents each in excess of 100 copies) p e r s p e c t i v e . Published each January. 9 pages. A brief, nontechnical review of the economy’s per formance and the economic outlook. Sent to all Monthly Review subscribers. (6 cents each in excess of 100 copies) SP E C IA L P U B LIC A T IO N S 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. A detailed description of 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; educational price: 25 cents) e s s a y s i n d o m e s t i c a n d i n t e r n a t i o n a l f i n a n c e (1969) 86 pages. A collection of nine articles dealing with a few important past episodes in United States central banking, several facets of the relationship between financial variables and business activity, and various aspects of domestic and international finan cial markets. (70 cents per copy; educational price: 35 cents) essay s in in m oney and c r e d it (1964) 76 pages. A c o ll e c t io n o f e le v e n a r ti c l e s o n s e l e c te d s u b j e c t s b a n k i n g , t h e m o n e y m a r k e t , a n d t e c h n i c a l p r o b l e m s a f f e c tin g m o n e t a r y p o l ic y . (40 c e n ts p e r c o p y ; e d u c a tio n a l p r ic e : 2 0 c e n ts ) t h e v e l o c i t y o f m o n e y (1969) by George Garvy and Martin R. Blyn. 116 pages. A thorough dis cussion of the demand for money and the measurement of, influences on, and the implications of changes in the velocity of money. ($1.50 per copy; educational price: 75 cents) 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. A documented discussion of the efforts of American, British, French, and German central bankers to reestablish and main tain international financial stability between 1924 and 1931. 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. A re view of the characteristics, operations, and recent changes in the monetary systems of seven communist countries of Eastern Europe and the steps taken toward greater reliance on financial incentives.
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