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FEDERAL RESERVE BANK OF NEW YORK
215
Treasury and Federal Reserve Foreign Exchange Operations*
By
C harles A . C oom bs
After consultation with the major trading partners of the
United States, Treasury Secretary Shultz announced on
the evening of February 12, 1973 that the dollar would
be devalued by 10 percent. Almost all of the developed
nations maintaining par or central values left them un
changed, thus bringing about a uniform realignment of
their exchange rates reflecting the full devaluation of the
dollar. In the case of Japan, the yen was allowed to float
temporarily to permit an additional appreciation vis-a-vis
the dollar. Sterling and the Swiss franc remained on the
floating basis initiated in earlier months and were joined
by the Italian lira.
While there was some initial profit-taking, new flows of
funds into marks and other foreign currencies soon resumed.
Despite the major adjustment in exchange rates resulting
from the dollar devaluation, there continued to be wide
spread discussion of the possibility of a joint float of the
European Community (EC) currencies in the event of
renewed dollar inflows. Market worries were further
exacerbated by the speculative buoyancy of the floating
Swiss franc, which had appreciated significantly more than
other European currencies.
In short, the markets remained entirely unconvinced
that the crisis was over, and by February 23 the dollar
had fallen to its new floor against the mark, French franc,
guilder, and Belgian franc. Then on Thursday, March 1,
in a sudden new flight from the dollar, more than $3.6
billion was dumped on the European central banks. That
* This report, covering the period March through July 1973,
is the twenty-third in a series of reports by the Senior Vice
President in charge of the Foreign function of the Federal Reserve
Bank of New York and Special Manager, System Open Market
Account. The Bank acts as agent for both the Treasury and Federal
Reserve System in the conduct of foreign exchange operations.
night the European authorities closed their exchange mar
kets until further notice.
Emergency meetings of the EC and Group of Ten
(G-10) Finance Ministers quickly got under way and
yielded two major policy decisions. On March 11, five mem
bers of the EC— Germany, France, Belgium, the Nether
lands, and Denmark— agreed to maintain fixed exchange
rate relationships among themselves within a 2^4 percent
band, which would be permitted to float as a bloc against
the dollar. Norway and Sweden subsequently joined this
bloc. In conjunction with this EC decision to establish
a flxed-rate bloc, the German authorities revalued the
mark by 3 percent. As further protection against new
speculative inflows of funds, most countries participating
in the EC bloc tightened and extended their existing ex
change controls. The Japanese yen, Swiss franc, sterling,
and the Italian lira each continued to float independently.
The EC decision to engage in a joint float against the
dollar left open a major question whether such a float
would be “clean” or subject to intervention by the Federal
Reserve and the EC central banks at their discretion. This
policy issue was taken up by the Paris meeting of the
G-10 Finance Ministers, including Secretary Shultz, who
issued on March 16 a communique reiterating their deter
mination to ensure jointly an orderly exchange rate sys
tem. They agreed in principle that official intervention
in the exchange markets might be useful at appropriate
times to facilitate the maintenance of orderly conditions.
Each nation represented stated that it would be prepared
to intervene at its initiative in its own market in close
consultation with the countries whose currencies were being
traded. To ensure adequate resources for such official
exchange operations, it was envisaged that some of the
existing swap facilities would be enlarged.
With these new rules of the game, the markets were
officially reopened on March 19 and over the next six
MONTHLY REVIEW, SEPTEMBER 1973
216
Chart 1
THE D O L L A R - M A R K RATE
D M /S
2.9
D M /$
2.9
2.8 -
\
\
2.7
2.6 -
-
2.5 -
A
-
2.8
-
2.7
2.6
-
2.5
-
2.4
2.3 -
-
2.3
2.2 -
-
2.2
/
2.4 -
2.1
2.1
M ay
June
July
August
1973
reached a climax on July 6 (see Chart I), the German
mark had been bid up by some 30 percent above the
central rate established in February, the French franc and
other currencies in the EC bloc by 18 to 21 percent,
while the London gold price had shot back up to $127.
Meanwhile, trading conditions in the exchange markets
had become increasingly disorderly, and by Friday, July 6,
a number of New York banks were refusing to quote rates
on certain European currencies. Exchange trading was
grinding to a standstill.
Such excessive depreciation of the dollar was simul
taneously generating further hectic speculation in the in
ternational commodity markets and otherwise seriously
intensifying inflationary pressures in the United States.
Those countries whose currency rates were moving down
with the dollar suffered the same inflationary impact while,
conversely, those countries whose currencies were ap
preciating excessively visualized a major and unjustifiable
threat to their competitive position in world markets. This
was a dangerous situation from almost every point of
view and was recognized as such by press commentary
around the world.
Table I
weeks the dollar improved hesitantly as earlier adverse
leads and lags were partially unwound. Despite an improv
ing trend in the United States balance of payments and the
frequently voiced view that the dollar was now under
valued, there was no large sustained covering of short
dollar positions or reflow of funds. Indeed, the market
became increasingly concerned over the worsening United
States inflation, forecasts of vastly higher energy imports,
and the possible ramifications of the Watergate affair.
While the dollar remained strong against the currencies
of this country’s two major trading partners— Japan and
Canada— a tendency to shift out of dollars in favor of
European currencies resumed in early May. By midmonth
a new speculative attack had broken out in which soaring
gold prices, sliding Wall Street stock prices, and a weaken
ing dollar fed upon each other. Pressure on the dollar
in Europe was further intensified by the progressive
tightening of German monetary and fiscal policies, as the
consequent sharp rise of the German mark began to pull
up the other EC currency rates against the dollar. In June
and early July, the dollar was driven down in recurrent
bursts of heavy selling to levels unjustified and undesir
able on any reasonable assessment of the outlook for the
United States payments position. As these pressures
FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS
In millions of dollars
Institution
Increase on
July 10, 1973
Amount of farility
July 10, 1973
Austrian National Bank ........................
50
250
National Bank of Belgium ....................
400
1,000
Bank of Canada.......................................
1,000
2,000
National Bank of Denmark....................
50
250
Bank of England .....................................
-0 -
2,000
Bank of France .......................................
1,000
2,000
German Federal Bank ............................
1,000
2,000
Bank of Italy ............................................
750
2,000
2,000
Bank of Japan ..........................................
1,000
Bank of Mexico .......................................
50
180
Netherlands Bank ....................................
200
500
Bank of Norway ......................................
50
250
Bank of Sweden........................................
50
300
Swiss National Bank ..............................
400
1,400
Bank for International Settlements:
Swiss francs-dollars..............................
-0 -
600
Other authorized European
currencies-dollars ................................
250
1,250
T otal............................................................
6,250
17,980
FEDERAL RESERVE BANK OF NEW YORK
217
Table II
FEDERAL RESERVE SYSTEM DRAWINGS AND REPAYMENTS
UNDER RECIPROCAL CURRENCY ARRANGEMENTS
In millions of dollars equivalent
Drawings ( + ) or repayments (— )
Transactions with
System swap
commitments,
January 1, 1973
1
National Bank of Belgium
Bank of France
................................................
..................................................................................
415.0
-0 -
Swiss National Bank
........................................................................
570.0
Bank for International Settlements (Swiss francs) ......................
600.0
T otal
.........................................................................
II
- 25.0
1,585.0
July
6.0
396.0
+ 47.0
47.0
+220.5
220.5
+
-0 -
German Federal Bank ........................................................................
System swap
commitments,
July 31, 1973
1973
(+104.6
1-104.6
565.0
— 5.0
600.0
(+104.6
{—134.6
-0 -
+273.4
1,828.4
Note: Discrepancies in totals are due to rounding.
At a meeting of the Bank for International Settlements
group of central banks on the following weekend, Federal
Reserve representatives wound up earlier negotiations
providing for major increases in the Federal Reserve
swap lines as well as for new arrangements covering ex
change risks on floating rates. On Sunday night, July 8,
the governors of the BIS central banks issued a statement
noting that the necessary technical arrangements were now
in place to implement the Paris agreement of March 16
regarding exchange market intervention to maintain or
derly markets. On the following Monday afternoon, in
agreement with the United States Treasury, a telephone
conference of the Federal Open Market Committee ap
proved a resumption of exchange operations, to be financed
if necessary by drawings on the swap lines.
The exchange markets were meanwhile anticipating such
action and by the following Tuesday afternoon, when the
Federal Reserve announced an increase in the swap net
work from $11.7 billion to nearly $18 billion (see
Table I), a strong recovery of the dollar against most of
the European currencies already had occurred. Against
the mark, for example, the dollar had rocketed up by 7
percent from the all-time low reached on the preceding
Friday. In large part, the steep rise of dollar rates seemed
to reflect market hedging against the possibility of sudden,
massive intervention by the Federal Reserve. When inter
vention on such a scale did not immediately materialize,
dollar rates began to slip back and were further seriously
depressed during the rest of July by a progressive tighten
ing of the German money markets. On July 26, the call
money rate in Frankfurt rose to 38 percent.
Market intervention by the Federal Reserve was in
fact initiated on July 10 and continued through the end
of the month. Rather than the massive action envisaged
by some traders, the Federal Reserve pursued the less
dramatic path of trying to assist the market in finding
a solid footing from which a strong recovery might then
develop once the German credit crunch was relieved, and
prospectively good trade figures for the United States for
June were released. In this stabilizing effort, the Federal
Reserve through frequent intervention in the New York
market sold $220 million of German marks, $47 million
of French francs, and $6 million of Belgian francs—
an intervention total of $273 million— all financed by
drawings on the swap lines with the foreign central banks
concerned. These drawings increased the System’s swap
debt from $1,555 million to $1,828 million by the end
of July (see Table II). Federal Reserve operations in
New York were strongly reinforced by coordinated
Bundesbank purchases of dollars in Frankfurt totaling
somewhat more than $300 million.
In late July, the market stabilized well above the lows
reached earlier in the month. Then, as the Bundesbank
took action to relieve the German credit squeeze, the New
218
MONTHLY REVIEW, SEPTEMBER 1973
York money market tightened, and the June trade figures
for the United States showed considerable improvement,
the dollar recovered strongly through the first two weeks
of August. Since then, the exchange markets have been
functioning in more orderly fashion in a much calmer
atmosphere. Bid and offer spreads are moving back toward
normal, and daily swings in market rates are somewhat
less volatile. In early September, dollar rates against the
mark and French franc, for example, were some 10
percent and l l 5/s percent above their July 6 lows. After
the shocks to confidence in recent years, however, the
healing process is bound to take some time, and much
will depend on emerging trends in the United States bal
ance of payments and on the degree of success in holding
inflation in check in this country. Meanwhile, the market is
aware of the joint statement made on July 18 by Chairman
Burns and Secretary Shultz that active intervention will
take place in the future at whatever times and in whatever
amounts are appropriate for maintaining orderly market
conditions.
GERM AN MARK
By early 1973, Germany’s economic expansion had
accelerated and the rate of inflation had reached the high
est level in more than two decades. In attempting to curb
this inflation, the German authorities were relying heavily
on monetary policy instruments and, consequently, were
concerned over simultaneously attracting renewed flows
into marks from abroad. Therefore, the German govern
ment had erected various barriers to ward off capital
inflows and to protect the economy from the expansionary
impact of such inflows as did occur. These controls could
not be airtight, however, and in January and early Febru
ary of this year, a combination of developments in Europe
and the United States had touched off a rush into marks
which thereafter broadened into a full-scale attack on the
United States dollar.
In conjunction with the February 12 devaluation of the
dollar, the German authorities immediately set a new
central rate of $0.3448 for the mark, corresponding in full
to the change in the special drawing right (SDR) value
of the dollar. When regular exchange trading resumed
after a two-day closure of the markets, the mark-dollar
market was subjected to strong crosscurrents. On the one
hand, many dollar holders decided that they were no longer
prepared to hold dollar assets. Some foreigners simply
sold dollars to return to their own currencies, but many
others, including some central banks, shifted from dollars
into German marks and other European currencies. This
process added substantially to the demand for marks, not
only in February but also, in varying volume, virtually
throughout the spring and early summer. On the other
hand, there remained the massive positions, short of dollars
and long of marks, on which profits had yet to be taken.
Therefore, after the Bundesbank acted to neutralize the
monetary impact of the buildup of mark balances by impos
ing a 100 percent reserve requirement on excess balances
of nonresidents, and the German banks responded by
selectively imposing negative interest charges on nonresident
balances, reflows out of marks developed. The spot mark
eased and, by February 19, the mark reached its new floor
against the dollar. Over the next few days the Bundesbank
was able to release to the market some $1 billion of its
previous dollar intake and as part of this operation sold
the Federal Reserve marks sufficient to repay the full $105
Table III
DRAWINGS AND REPAYMENTS BY FOREIGN CENTRAL BANKS
AND THE BANK FOR INTERNATIONAL SETTLEMENTS
UNDER RECIPROCAL CURRENCY ARRANGEMENTS
In millions of dollars
Drawings ( + ) or repayments (— )
Drawings on
Federal Reserve
System outstanding
July 31,1973
1973
1
II
July
Bank for International Settlements (against German marks) ...
-0 -
f+11.0
1-11.0
J+23.0
1-23.0
{±1:8
-0 -
Total
-0 -
1+11.0
{-1 1 .0
{+23.0
i —23.0
i t
*0*0
Banks drawing on
Federal Reserve System
Drawings on
Federal Reserve
System outstanding
January 1, 1973
-0 -
.........................................................................
FEDERAL RESERVE BANK OF NEW YORK
million of Federal Reserve swap drawings incurred before
the February devaluation of the dollar.
These reflows out of marks quickly dried up, however,
and the balance of forces in the market swung sharply
the other way. With the dollar weakening across the
board at a time when European officials were openly
discussing the possibility of a joint float against the dol
lar, few traders were willing to take up the heavy volume
of dollars being offered in the exchanges. In the two days
February 22-23, the mark rose from its floor to its new
upper limit and traded near that level through the end
of the month. The continuing discussion on both sides of
the Atlantic of the exchange rate question— whether the
dollar’s devaluation had been enough or whether there
might be a joint float of the European currencies— kept
the market anxious. Pressures came to a head on March 1,
when massive amounts of dollars were dumped on the
exchanges and the Bundesbank alone took in a record $2.6
billion. The German and other European exchange markets
were then closed and official international discussions to
resolve the crisis began.
As the market awaited the outcome of these nego
tiations, the mark fluctuated erratically before drifting
back somewhat in very thin trading. On March 11,
Common Market officials announced that Germany and
four of its EC partners would keep their exchange
rate relationships fixed against each other within a 2%
percent band while suspending the intervention limits
against the dollar. As part of this agreement the German
authorities revalued the mark vis-a-vis the SDR and
other participating currencies by about 3 percent. On
March 16, in Paris, the United States authorities joined
in a broader agreement incorporating these moves and
recognizing that official intervention in the exchange mar
kets may be useful at appropriate times to facilitate the
maintenance of orderly market conditions.
When the markets were formally reopened on March 19,
traders remained in a state of shock over the events
of the previous two months. Moreover, the vast uncer
tainties over how well the market would function under
the new arrangements— a mixture of fixed and floating
exchange rates plus a spate of new capital controls—
initially had a paralyzing effect. As a result, the market
was quiet, trading was thin, turnover was small, and
day-to-day movements in the mark rate continued to
be abnormally wide. Over the previous two months,
most market participants had satisfied their normal
demand for marks for some time to come, leaving an
absence of routine demand for marks once the markets
reopened. In addition, some of the long positions in marks
were being cut out, as the interest costs of maintaining
219
Chart II
GERMANY
MOVEMENTS IN EXCHANGE RATE *
Percent
45
40
-
35
-
30
Percent
45
40
\
-
35
-
-
30
25
-
-
25
20
—
—
20
-
15
ff
—
10
1[\1
-
5
J/ 1r "
1
/
15
A
-
/
!
—
10
5+
Smith
sonian
central
rate
t
-5
1
0
—
1
-1 0
J
1 1
1
A
S
O
I
1
N
D
J
1972
l 1 l
F
M
A
i l l
M
J
J
1
A
-5
-1 0
S
1973
In this and the following currency charts, movements in exchange rates are
measured as percentage deviations of weekly averages of New York noon
offered rates from the middle or central rates established under the
Smithsonian agreement of December 18, 1971.
Upper and lower intervention limits established in December 1971.
^ Upper and lower intervention limits around new central rate established on
February 13, 1973 following proposed devaluation of United Sates dollar.
Limits suspended on March 1, 1973.
those positions mounted. Consequently, the mark settled
just below its effective central rate of $0.3551 against
the dollar and slipped to the bottom of the EC band,
where it required support against those currencies at the
top of the joint float. Except for a brief reversal in midApril on a temporary tightening of monetary conditions
in Germany, the mark continued to drift lower against the
dollar and to exert a drag on other EC currencies through
early May.
In May, a new series of events broke the surface calm
of the exchange markets and set off a progressive rise of
the mark that continued virtually uninterrupted through
early July. The precipitous rise in the mark reflected
developments in Germany and the United States as well
as the dynamics of the exchange market itself. In Ger
many, the Bundesbank had been striving to maintain its
firm grip on domestic liquidity through higher reserve
requirements, cuts in discount quotas, hikes in discount
and Lombard rates, and limits on access to the Lombard
facility. These measures, and expectations in the market
that further tightening would be forthcoming, tended to
reinforce the demand for marks in the exchanges at a
220
MONTHLY REVIEW, SEPTEMBER 1973
time when the German government also was developing
a program of anti-inflationary fiscal measures. At first
there were rumors that this program would be accom
panied by a further revaluation of the mark, which led
to renewed speculative demand for marks. When the fiscal
program was announced, however, there was no revalua
tion and speculation subsided for the time being.
Meanwhile, the United States was suffering from a
daily diet of bad news about escalating prices and the
Watergate affair. Coupled with successive sharp jumps
in the gold price and repeated declines in prices on Wall
Street throughout May, these factors brought frequent
sharp declines in the dollar.
Against this background, the announcement of a small
United States trade surplus for April gave the dollar only
a brief lift in late May, and a renewed scramble for marks
began following the Bundesbank’s announcement of a
further 1 percentage point increase in the discount and
Lombard rates and the subsequent suspension of the Lom
bard facility on May 30. By June 5, the spot mark had
climbed to $0.3864— nearly 9 percent above its central
rate— and had moved up from the bottom of the Euro
pean “snake”, where it had traded since mid-March, almost
to the top.
Shortly thereafter, reports of an impending new United
States anti-inflation program and, later, the Bundesbank’s
move to moderate the impact of its May measures by re
opening a special discount facility against commercial bills
helped turn the mark rate down briefly. But the sixty-day
price freeze announced for the United States disappointed
the market. Then, on June 26 traders were further dis
turbed by the United States trade figures for May, which
showed a moderate deficit rather than the sizable surplus
many had been expecting, and by the Bundesbank’s an
nouncement of another move to tighten domestic liquidity—
a 25 percent cut in the reserve base for foreign deposits.
That day, heavy demand for marks drove the spot rate up
almost 2l/i percent in a matter of four hours, to a level
HV 2 percent above the March central rate.
The mark was now spearheading the rise of the Com
munity currencies against the dollar, and substantial inter
vention in marks by EC central banks was required
on June 27 to keep the bloc together. On June 28, the
mark was driven up another 3 percent against the dollar
and the central banks participating in the fixed-rate bloc
had to supply very large amounts of marks against EC
currencies, bringing the twelve-day total to $1.5 billion
equivalent. On June 29, the German government an
nounced a further revaluation of the mark by 5Vi percent
in SDR terms.
This move relieved the immediate tensions within the
snake but gave little pause to the slide of the dollar vis-a-vis
the mark. In the first week of July, the mark rose each day
to record levels, which market professionals agreed were
absurdly high. Nevertheless, efforts of traders to sell dollars
against marks and other European currencies intensified,
soon reaching panic proportions. By July 6, the markets had
fallen into such disarray that spreads between bid and offer
Table IV
UNITED STATES TREASURY SECURITIES
FOREIGN CURRENCY SERIES
In millions of dollars equivalent
Issues ( + ) or redemptions (— )
Issued to
Amount
outstanding
January 1, 1973
Amount
outstanding
July 31, 1973
1973
1
II
July
German Federal Bank .....................................................................
306.0
Swiss National Bank ..........................................................................
1,232.9
1,384.1
Bank for International Settlements* ................................................
170.9
189.5
Total
.................................................................................
1,709.8
Note: Increases in amounts outstanding as compared with January 1 reflect valuation
changes on April 30 and upon renewals of maturing securities.
* Denominated in Swiss francs
-153.0
-153.0
172.4
-0-
-0 -
1,746.0
221
FEDERAL RESERVE BANK OF NEW YORK
rates widened almost to 1 percent and several New York
banks refused to deal in marks at all. At its high of
$0.4525 that day, the mark had gained more than 9V2 per
cent since June 29 and stood some 30 percent above
its February central rate, 4534 percent above the previous
Smithsonian central rate, and fully 65Vi percent above its
parity before May 1971.
Following the regular monthly meeting of central banks
in Basle that weekend, reports circulated that an increase
in the Federal Reserve swap lines was in the offing, and
as the market developed exaggerated expectations of
massive intervention to be launched in support of the
dollar, the mark dropped off sharply. By the time the
swap-line increases were confirmed on July 10, the spot
rate had fallen by about 7 percent. On that day, the
Federal Reserve began intervention in the New York
market, using marks drawn under the swap line with the
Bundesbank, and following up with simultaneous interven
tion in French francs and Belgian francs, which also were
at or near the top of the EC band. The intervention was
less dramatic than the market had expected, however, being
intended primarily to help the markets regain some sense
of balance and stability. Thus, although trading did become
more orderly as the Federal Reserve continued to intervene
and the Bundesbank began to intervene by buying dollars
openly in Frankfurt, the earlier recovery of the dollar was
not fully sustained.
After midmonth, German money market conditions
came to dominate the exchange market; as banks found
themselves short of liquidity, their efforts to meet their
reserve requirements touched off renewed heavy bidding
for marks. This liquidity squeeze persisted over several
days, even though the Bundesbank provided a substantial
amount of assistance to the domestic market and inter
vened in the exchange market to avoid a sharp decline in
the dollar rate. The Federal Reserve intervened in New
York while, at the same time, other central banks were
obliged to intervene to maintain the margins of the snake.
On July 26 the squeeze came to a head, and a combined
amount of $350 million equivalent of marks was provided
through central bank intervention in limiting the rise of
the mark, which nevertheless reached $0.4390, some 17
percent above its central rate. The liquidity squeeze then
passed and German money rates fell off at the same time
that United States interest rates were rising and improved
trade figures were released. As the spot mark eased, the
Federal Reserve applied gradual pressure, selling marks
to keep the rate moving. By the end of July, Federal
Reserve intervention in marks amounted to $220.5 million
equivalent, while the Bundesbank had bought some $300
million for its own account in support of the dollar.
FRENCH FRANC
Following the announcement on February 12 that the
dollar would be devalued, the French authorities reaffirmed
the gold parity of the French franc, thereby establishing a
par value against the dollar which fully reflected the
dollar’s devaluation. As the dollar soon came under re
newed attack in the exchange markets, the franc rose with
most other currencies, touching its new ceiling on Febru
ary 23. In the general selling of dollars that developed
in early March, the Bank of France was obliged to take in
some $500 million at the upper limit before the Paris ex
change market was officially closed on March 2.
In subsequent days, with all the major European cur
rencies effectively floating during negotiations to resolve
the exchange crisis, the franc rate rose more than 2 percent
above its new ceiling in exceedingly thin trading. Dur
ing the negotiations, the French authorities agreed to par
ticipate in a collective EC float against the dollar while, at
the same time, announcing a barrage of new regulations
designed to ward off speculative inflows. These included a
ban on interest for nonresident deposits, a 100 percent
marginal reserve requirement on those deposits, prohibi
tion on the use of financial francs for nonresident pur
chases of short-term financial assets, and limitations on
certain forward currency transactions by French banks.
When the Paris exchange market was officially reopened
on March 19, trading was light as market participants
tried to assess how these new controls would affect their
individual operations. For their part, French banks soon
responded to the 100 percent marginal reserve require
ment by selectively imposing a charge similar to a negative
interest rate on nonresident balances. By and large, the
controls had their desired effect, as no new rush into francs
developed and, indeed, the franc soon began to ease in
response to the downward pull of the German mark.
Among the EC currencies, however, the franc remained
fairly buoyant. By early spring, the French trade balance
was strong, thanks to both the competitive edge France
had gained through earlier exchange rate realignments
and to steady improvements in industrial productivity
within France. Thus, as the dollar generally strengthened
in late March and through much of April, the commercial
franc declined more slowly than its partner EC currencies.
The French franc was, therefore, at the top of a fully
stretched European snake, with modest sales of francs
required to maintain the limits.
As the dollar came under renewed pressure in Europe
just before mid-May, the commercial franc joined the
other Continental currencies, in setting new highs against
the dollar almost every day. Speculative demand focused
222
MONTHLY REVIEW, SEPTEMBER 1973
Chart III
FRANCE
MOVEMENTS IN EXCHANGE RATE*
Percent
Percent
1972
1973
*S ee footnote on Chart I.
Upper and lower intervention limits established in December 1971.
flip p e r and lower intervention limits around new par value established
on February 14,1973. Limits suspended on March 2,1973.
more heavily on the German mark, however, and although
the franc rose steadily, by June it was superseded by the
mark as the leader of the snake.
At this point, monetary conditions remained more com
fortable in France than in several EC countries where
monetary policies had been drastically tightened. In addi
tion, French government officials spoke out repeatedly
and in strong terms against further appreciation of the
franc. Nevertheless, the franc was pulled up further in the
wake of other currencies in the common EC float and, as
speculation on the mark accelerated in June, the spot
rate shot up against the dollar to 113A percent above its
par value. By this time, heavy demand for marks had put
intense pressure on the snake and market professionals,
who were coming to question the viability of the fixed-rate
band and the commitment of the European banks to sup
port the arrangement, were switching funds from France
and other EC countries into Germany. On June 27 and
28, the French franc required heavy intervention to stay
within its EC lower limit against the German mark.
The June 29 revaluation of the mark relieved the im
mediate pressure on the EC band but did nothing to stem
the growing pressure on the dollar. Early in July the
French government introduced a broad range of credit
measures designed both to counter domestic inflation and
to bring French money market conditions more in line with
those elsewhere in the EC. These measures bolstered
the franc against other European currencies as well as
against the dollar in an exchange market that was becom
ing increasingly disorderly day by day. On July 6, as the
crisis came to a head, the franc was bid upward against
the dollar to a high of $0.2626, almost 21 percent above
its par value. On that day, the commercial franc moved
exceptionally widely and spreads between bid and offer
quotations widened to more than 1 percent. French gov
ernment spokesmen expressed strong concern about both
the level to which the franc had been pushed and the de
moralization of the markets.
Following the July 8 communique from the BIS meet
ing in Basle, the market turned around abruptly on rumors
of imminent official intervention on behalf of the dollar.
Over the next two days, the franc dropped back more than
IV 2 percent, in part on reports— confirmed on July 10—
of substantial increases in the Federal Reserve swap lines.
The Federal Reserve in fact resumed intervention the same
day, and through July 19 this Bank had sold $47.0 million
of French francs in the New York market in conjunction
with operations in German marks and Belgian francs.
These sales were covered by corresponding drawings on
the swap line with the Bank of France. By late July, capital
outflows were depressing the financial rate and, as it fell,
it dragged the commercial rate along with it. Conse
quently, the commercial rate sank to the bottom of the
EC snake where it required modest support to remain
within the band.
S W ISS FRANC
Late in January, the Swiss authorities had decided to
permit the Swiss franc to float so as to prevent their restric
tive monetary policy from being compromised by renewed
speculative inflows from abroad. By the time the proposed
devaluation of the dollar was announced on February 12,
the floating Swiss franc had been pushed up in heavy
demand to nearly 8 percent above its Smithsonian central
rate. Unlike Switzerland’s major trading partners, the
Swiss government did not set a new central rate and
intervention limits based on the United States devaluation
but decided to allow the franc to continue on a floating
basis until the markets settled down again. As trading
resumed after announcement of the dollar’s devaluation,
the Swiss market continued to await anxiously indications
of the Swiss National Bank’s intervention policy. The next
week, when the Swiss authorities reiterated their deci
sion not to fix new bench marks for the franc, the market
vigorously bid the franc up to almost 15 percent above
its Smithsonian central rate in a speculative rush that soon
spilled over into other European markets. Although the
Swiss National Bank intervened in the spot and forward
markets to the extent of $700 million, the speculative
FEDERAL RESERVE BANK OF NEW YORK
onslaught continued. On March 1 the franc was driven
up still further to $0.3247, almost 25 percent above
the Smithsonian central rate. At this level, the Swiss
franc had appreciated some 7 percent against the German
mark.
Following the Paris accord of March 16, the Swiss
authorities reconfirmed their intention to maintain the
independent float of the Swiss franc rather than affiliate
themselves with the joint float of the EC countries. Never
theless, as the National Bank provided some of the
Swiss banks’ quarter-end liquidity needs by way of $500
million of swaps and additional money market assistance,
normal quarter-end exchange market pressures were blunted
and the Swiss franc began to ease as the currencies in the
EC bloc moved lower. By early April the Swiss franc had
come down to $0.3060, still H V i percent above the Smith
sonian rate.
Throughout the rest of the early spring the franc
market remained in rough balance, as Swiss banks found
themselves more liquid than at any time since the intro
duction of Switzerland’s restrictive monetary policy of
late 1972. The banks were feeling the impact of quanti
tative limits on the growth of bank credit imposed the
previous winter; with their ability to lend heavily con
stricted, they cut deposit rates by X
A to V2 percent and
reduced their dependence on the exchange market for ad
ditional funds. Although the authorities provided some
liquidity to the domestic market during April, the National
Bank was not called upon to provide month-end swaps
or other direct month-end assistance to the banks for
the first time since November 1972.
Around the middle of May, a convergence of trouble
some events disrupted the earlier steadiness in the Swiss
franc market. The renewed surge of inflation in the
United States, concern about the Watergate investigations,
and the soaring gold price touched off vigorous bidding
for the Swiss franc, along with other European currencies.
By late May the franc had advanced to $0.3245, moving
up along with the EC joint float.
At that point, the market began to question whether
the rise in the franc relative to other European currencies,
particularly the German mark, had not been overdone.
As market attention shifted to the severe tightening of the
German money market during June, the rise in the franc
lagged behind that of the mark. With the strong rise in
the mark exerting a mounting strain on the EC band,
speculative money was switched out of Swiss francs into
marks at an increasing pace to take advantage of any pos
sible breakdown in the European common float.
The expected revaluation of the mark on June 29
failed to quiet the speculative turmoil. Trading condi
223
tions in the exchanges deteriorated alarmingly in the first
week of July, as the market lost all confidence in its
ability to assess the near-term prospects for dollar rates.
Moreover, those who had taken advantage of the rela
tively low Swiss interest rates in recent years urgently
bid for francs to cover their short franc positions, and
the spot franc surged to new highs e^ch day in increas
ingly volatile and disorderly trading. By July 6, the franc
was quoted at $0.3774, 45 percent above its Smithsonian
central rate. Swiss National Bank Director-General Leutwiler in a public statement that day described the foreign
exchange market as being “completely out of control”.
After the July 7-8 central bank meeting at the BIS,
talk of imminent United States intervention appeared
in the Zurich market and soon spread to other financial
centers. With the market now hopeful that the dollar
would be supported in the exchanges, the franc came on
offer both in Switzerland and in New York. By the time
the Federal Reserve announced the increase in the swap
network on July 10, the Swiss franc had dropped almost
IV 2 percent from its high on July 6.
The initial burst of enthusiasm prompted by hopes of
massive official intervention wore off quickly, however,
and although exchange market conditions generally im
proved the Swiss franc began to rise again along with other
European currencies. A severe stringency then developed
in the German money market, prompting unprecedented
224
MONTHLY REVIEW, SEPTEMBER 1973
increases in German interest rates and a renewed strong
rise of the mark which pulled other European currency
rates, including the Swiss franc, along in its wake. After
German monetary conditions eased in late July, the spot
franc followed the mark down against the dollar. By the
end of July the franc stood 341/4 percent above its Smith
sonian central rate.
STE R LIN G
During the period under review, the pound sterling was
caught up both in the shifting tides of the United King
dom’s domestic and international position and in the
speculative storms which swept through the world mone
tary system. At home, inflation continued to be a major
concern and, increasingly, the decline of the sterling rate
last year was seen as intensifying the upward pressure on
prices. The substantial competitive advantage gained for
the British economy vis-a-vis other industrial countries
through depreciation of the floating pound since June 1972
had not as yet been translated into an improvement in the
trade balance, while the worsening terms of trade and
boom in commodity prices had escalated import costs.
Moreover, the market remained pessimistic over the pros
pects for Britain’s price and wage policies. Abroad, events
strongly and unpredictably influenced the sterling rate
from time to time, as the market struggled to interpret the
implications for sterling of the dollar’s weakness and recur
rent strains within the EC band. Thus, depending on how
these factors interacted, sterling would on some occasions
tend to move in parallel with the dollar, and on others to
reflect more closely the movements of EC currencies.
Following the February 12 announcement of the deval
uation of the dollar, the British government indicated that
sterling would continue to float for the time being. Soon
after the London exchange market reopened on Febru
ary 13, the pound was quoted at $2.47%, up almost 5
percent from early-February levels. Although this rise was
less than that for those European currencies with new
fixed rates against the dollar, sterling was soon pulled
along with the general advance of the continental Euro
pean currencies against the dollar late in February. By
March 1, the pound had climbed to $2.51% as a re
newed flight from the dollar reached its climax.
The following day, in line with actions taken by their
EC partners, the British authorities formally closed the
London foreign exchange market while permitting normal
trading to continue. That weekend, Chancellor of the
Exchequer Barber met with his counterparts from other
EC countries in an effort to forge a European solution
to the continuing currency crisis. Agreement was reached
on some issues but not on the terms and conditions
under which sterling might cease to float against the
other EC currencies. As reports of this impasse reached
the market early on March 6, the pound was marked
down to $2.46V4. Later that day, however, the mar
ket turned around in response to the Chancellor’s an
nual budget message. Although strongly stimulative, the
new budget was less expansionary than the market had
feared and also contained provisions to encourage publicsector borrowing in international markets— a measure de
signed to relieve pressure on Britain’s capital market and
to bolster Britain’s official reserves. This proved reassur
ing to the market, and there was no adverse reaction to
the British government’s confirmation that sterling would
continue to float independently.
With the formal reopening of the European exchange
markets on March 19, sterling, unlike the Continental
currencies, was relatively free of exchange controls against
inflows of funds from abroad. High rates on short-term
sterling assets became increasingly attractive to those who
had been holding Continental currencies in forms which
were becoming either increasingly expensive or difficult to
maintain. In addition, several favorable developments on
the labor front lightened some of the market’s pessimism
over the prospects for success of Phase Two of the gov
ernment’s incomes policy. By April, sterling was also
benefiting from growing expectations that the United King
dom government was prepared to support the exchange
rate in order to protect the British economy from a further
deterioration of the country’s terms of trade. Thus, the $1
billion Euro-bond issue by the Electricity Council and
the sizable amounts of additional borrowings abroad by
United Kingdom local authorities, all of which would be
converted into sterling at the Bank of England under the
exchange cover provision outlined in the March budget,
were seen as bolstering reserves to permit a defense of
the exchange rate despite an expected worsening of the
trade accounts.
Consequently, the inflow of funds into London that
began in mid-March accelerated even as money market
rates in Britain backed off their peak levels. Recipients of
sterling payments became more inclined to hold on to
these balances while traders were increasingly willing to
take on positions in sterling. Even release of figures show
ing a sharp worsening in the United Kingdom trade deficit
in March failed to arrest sterling’s progressive strengthen
ing, and the spot rate advanced to the %2 A W i level by
mid-April and to $2.50Vi by early May. In mid-May, the
intensifying speculative pressures against the dollar pro
pelled the pound almost to $2.58 and, as sterling moved
to the highest level since June 1972, the Bank of England
FEDERAL RESERVE BANK OF NEW YORK
entered the market to moderate the pace of its advance.
The pound briefly turned lower in response to another set
of disappointing British trade figures and subsequent an
nouncement of a substantial United States trade surplus
for April. But, as the dollar weakened still further in late
May and early June, the spot rate was bid up above the
$2.58 level.
Meanwhile, however, the steady decline of London
money market rates, contrasted with rising rates elsewhere,
had eliminated most of the interest incentive for moving
into sterling. Moreover, in view of the widely held expecta
tion that the strong upswing in economic activity in Britain
would lead to a further deterioration in the external pay
ments position, the market was beginning to question
whether current rates for sterling could be maintained.
Consequently, the rise in sterling against the dollar in
late May had already been less pronounced than the
sharp increase in continental European rates, thereby
producing a further substantial depreciation of sterling
against the EC currencies. During June, the outlook for
sterling became increasingly uncertain, especially as it
seemed more likely that the government would face stiff
union resistance to plans for Phase Three of its incomes
policy. Also, London interest rates were continuing to
fall, to levels that created strong interest incentives to move
out of sterling. As increasingly chaotic trading conditions
developed in exchange markets everywhere during the first
week of July, sterling was hit by speculative selling. Even
as the dollar dropped sharply vis-a-vis continental Euro
pean currencies, sterling declined still further and, when
225
the dollar began to rally, the pound lagged behind.
Then, later in the month sterling again began to
slide in a sell-off which soon led to a drop in the rate
to below $2.50 on July 26. As market sentiment turned
against the pound, the British authorities took strong
and decisive action to deal with the buildup of specu
lative pressures and outflows of funds prompted by a
credit squeeze in Germany. To arrest an easing in the
banks’ reserve positions and to bring British interest rates
more into line with those elsewhere, on July 19 the Bank
of England called for additional special deposits for the
first time since December 1972, requesting British banks
to place on deposit 1 percent of the banks’ total liabilities.
This measure was followed by increases in the Bank of
England’s minimum lending rate from IV 2 percent to
9 percent on July 20 and then to IIV 2 percent only one
week later. Meanwhile, the Bank of England was strongly
supporting sterling by intervening in dollars. On Friday,
July 27, Chancellor of the Exchequer Barber asserted that
sterling had become undervalued and that “I would not
hesitate to use our ample reserves to protect our econ
omy”. As the British authorities thus made clear their
intent to avoid a further severe decline of sterling and the
Bundesbank relieved the money market stringency in Ger
many, the market pressures eased, and by the end of July
sterling was trading above $2.50.
B E LG IA N F R A N C
For Belgium, the exchange market upheaval of late
January-early February, leading to the devaluation of the
dollar on February 12, occurred at a time of growing con
cern over domestic inflation. Consequently, from a mone
tary policy point of view, the heavy inflows of funds at that
time were far from welcome. Following the announcement
of the United States devaluation, the Belgian government
established a new central rate corresponding to $0.024793
for the franc, allowing it to appreciate by the full 11.1
percent change in the dollar parity. Shortly thereafter, the
authorities introduced an anti-inflationary package featur
ing limits on credit expansion. As a result, the franc was
already firming when the renewed run on the dollar
developed in late February and by early March, the Na
tional Bank was obliged to intervene at the new ceiling,
taking in an additional $125 million.
After the official closing of the Belgian market on
March 2, trading remained nervous, as the authorities
began to devise new regulations to prevent a further ac
cumulation of nonresident commercial balances with Bel
gian banks. By the time the market was officially reopened,
the authorities had established a negative interest charge
MONTHLY REVIEW, SEPTEMBER 1973
226
of X
A percent per week on any excess of nonresident
balances above normal levels. Holders of francs unloaded
some balances subject to this charge— thereby pushing
down the spot rate— while maintaining their long posi
tion in francs by purchasing forward francs— thereby
widening the forward premium. Once this adjustment had
been completed, the spot franc moved more or less in
line with the other EC currencies in late March and early
April. Since liquidity conditions were somewhat tighter
in Brussels than in Amsterdam, the franc tended to hold
firmer than the guilder so that, while the two currencies
eased progressively against the dollar through early May,
there was occasional moderate intervention to maintain
the 1Vi percent Benelux band.
Early in May, the National Bank hiked its discount
rate by Vi percentage point to 5 V2 percent, and so the
franc had already begun to firm when the new rush out
of the dollar began in mid-month. By early June, the
franc was some 9 percent above its central rate, but
already trailing behind the German mark which had
become the focus of speculation. By June 27, as the
demand for marks intensified, the franc joined the other
currencies requiring substantial support at the bottom of
the EC band, while rising to more than 12 percent above
its central rate.
The June 29 mark revaluation resolved temporarily the
strains on the snake, but in the week that followed there
were enormous new pressures on the dollar in all Con
tinental markets. Thus, by July 5, traders were finding it
Chart VI
BELGIUM
MOVEMENTS IN EXCHANGE RATE *
Percent____________________________________________________________ Percent
30
25
—
20
-
15
_
10
—
5
Smith
sonian
central
rate
-5
y \
-
r
/\
/
-
I
t-
J
f i
J
i T i
A
S O
1972
t i l l
i
N
D
J
F
M
A
lit
M
1973
J
J
I
A
}|(
See footnote on Chart I.
1" Upper and lower intervention limits established in December 1971.
^
Upper and lower intervention limits around new central rate established
on February 14, 1973. Limits suspended March 1, 1973.
S
nearly impossible to get quotations or to do normal busi
ness. In just one week of extremely heavy demand, the
franc had been pushed up some 6 percent to reach
$0.029200 in New York, almost 18 percent above its
central rate.
The market in Brussels turned dramatically around
early the next week, as it did in other financial centers,
following the meeting of central bank governors in Basle
over the weekend of July 7-8. By the time the Federal
Reserve’s swap-line increases were formally announced
on July 10, the Belgian franc had dropped 53A percent
from its July 6 highs. In conjunction with intervention
in German marks and French francs, this Bank began
to sell Belgian francs, at first to consolidate the earlier
gains and then to provide resistance to sharp reversals
in the dollar rate. Over several days the Federal Reserve
sold $6.0 million equivalent of francs, which were obtained
by drawings under the swap line with the National
Bank. These sales were on a much smaller scale than
those of other currencies, reflecting the relatively small
volume of trading in Belgian francs in the New York
market. When the franc moved away from its upper range
of the European band, the Federal Reserve suspended its
intervention in francs.
N E T H E R L A N D S G U IL D E R
In the aftermath of the February dollar devaluation, the
Dutch authorities set a new central rate of $0.3424, and
the guilder quickly moved up to trade near this level.
The market remained badly shaken by the dollar’s second
devaluation, however, and when another rush out of dollars
developed at the end of February, bids for guilders again
flooded the market as traders took advantage of the rela
tively free access to the Amsterdam market at a time
when other centers were being closed off by progressively
tighter restrictions. The Netherlands Bank, once again
obliged to absorb dollars, took in more than $750 million
by the time the authorities officially closed the market on
March 1.
Then, as negotiations to devise a European solution to
the exchange crisis proceeded, the guilder market turned
extremely thin. With traders hesitant to deal in the face of
uncertainty over the outcome of these discussions and
over possible new exchange controls in the Netherlands,
even very small trades provoked wide rate fluctuations.
Against this background, the guilder spurted up on the
news of another mark revaluation in connection with
establishment of a collective EC float against the dollar.
Traders soon became convinced, however, of the Dutch
government’s resolve, in view of the persistently high
FEDERAL RESERVE BANK OF NEW YORK
Chart VII
NETHERLANDS
MOVEMENTS IN EXCHANGE RATE
Percent
30
25
Percent
30
-
Aa
20 -
J
15 -
V A
- 25
^
-
15
/
4 /
10
10
1
5 _
Smith. t
sonian
central t
rate
-5
20
_
\\
5
0
i
J
l
A
l
S
1
O
1
N
1972
1
D
J
1
F
1
M
1
A
M
1
I
J
J
1
1
-5
A S
1973
*
See footnote on Chart I.
t
Upper and lower intervention limits established in December 1971.
+
Upper and lower intervention limits around new central rate established
on February 14, 1973. Limits suspended March 1,1973.
domestic unemployment, not to revalue the guilder. More
over, the Dutch authorities, to curb potential speculative
inflows, announced that a V* percent per week commis
sion would be imposed on further increases in nonresi
dent guilder deposits. As a result, the guilder was already
falling back when the market was officially reopened on
March 19. Nonresidents, moving to avoid the special
commission but reluctant to unwind their positions, sought
to switch out of spot and into forward guilders. Conse
quently, the spot rate soon fell to 1 percent below its new
central rate while the forward premium widened sharply.
Even when the bulk of this repositioning had been
completed, the guilder maintained its easier tone. By early
spring the expansionary effect of the huge first-quarter
inflows had brought short-term money rates down to vir
tually nil in Amsterdam and less than 2 percent in the
Euro-guilder market. The Dutch authorities took succes
sive steps to neutralize part of the monetary impact of
the earlier inflows by raising the cash reserve ratio to
7 percent and by open market transactions. Nevertheless,
they proceeded carefully so as not to hamper a reflow of
funds. Therefore, as the immediate strains of the FebruaryMarch currency crisis receded, funds were increasingly
pulled out of Amsterdam by more attractive yields in other
European financial centers. In addition, some earlier leads
and lags in favor of the guilder were being unwound. These
short-term capital outflows more than offset the continuing
strength of the underlying payments position and the
227
guilder slid to the bottom of both the EC snake and the
narrower Benelux band by early April, requiring support
under both arrangements. As nonresident balances sub
sequently declined to pre-February levels, the Netherlands
Bank lifted the special commission.
In May and early June the guilder strengthened against
the dollar, although it remained weak relative to other cur
rencies in the EC joint float and continued to require sup
port. With the mark at the top of the EC band, pressure
on the guilder intensified. Therefore, even though Dutch in
terest rates were now noticeably firming following a V2 per
centage point increase in the Netherlands Bank’s discount
rate, the guilder required increasing support to maintain the
EC margins as the snake rose rapidly against the dollar. By
late June, intervention against marks swelled to major
proportions. In the four days prior to the June 29 mark
revaluation, the Netherlands Bank was obliged to sell some
$400 million equivalent of marks to stay within the band.
Meanwhile, the guilder had been pulled up to $0.3831,
almost 12 percent above its February central rate.
Following the mark revaluation, the guilder market
settled down only briefly, and in the first week in July
the guilder was again caught up in the speculative on
slaught against the dollar. By July 5, trading had become
tumultuous, as the market was flooded with rumors of
another mark revaluation, a guilder revaluation, and a
third dollar devaluation. As traders rushed from dollars
into the European currencies, the guilder was pushed up
above $0.4000 on July 6. In the chaotic market condi
tions prevailing that day, many New York banks refused to
trade guilders and quotations were little better than indica
tions, with bid-offer spreads exceeding V2 percent at times.
Release of the Basle communique that weekend and
subsequent reports of expanded Federal Reserve swap
lines helped reassure the market. The guilder dropped
back to $0.3765 on hopes of large-scale United States
intervention and traded quietly around this level for
several days. This relative calm was then interrupted
as the German liquidity crunch built up. As the mark
moved 2 lA percent above the guilder, the Netherlands
Bank again provided support against the German currency.
By the time the German money squeeze abated just
before the end of July, the cumulative outflows from the
Netherlands had worked to tighten domestic liquidity and
thereby to encourage a firming of Dutch interest rates,
which the Netherlands Bank validated by progressively
raising its discount rate to 6 V2 percent. As monetary
conditions firmed and short-term capital outflows subsided,
the strength of the Dutch current account reemerged and
the guilder, while easing nearly 2 percent against the dollar,
began to move toward the top of the 2Va percent EC band.
MONTHLY REVIEW, SEPTEMBER 1973
228
IT A L IA N LIR A
Coming into 1973 the Italian economy was beset by
sluggish growth and high unemployment coupled with
rising inflation. This economic situation, against a back
ground of political uncertainties and social unrest, pro
voked leads and lags against the lira and outright capital
flight. After a long series of speculative attacks on the
lira, on January 22 the Italian authorities had intro
duced a two-tier market for the lira, split between a
commercial market in which the authorities would con
tinue to intervene in support of the Smithsonian limits and
a financial market where the lira would float freely. In the
ensuing upheavals in the exchanges in late January and
early February, the commercial lira remained under sell
ing pressure, while the financial lira moved to a substan
tial discount.
The Italian authorities responded to the February 12
announcement of the proposed devaluation of the dollar
by allowing the commercial lira to float, thereby with
drawing for the time being from the joint EC snake
arrangement. When trading resumed on February 14, the
commercial rate— at $0.001765— was some 2% percent
above its abandoned Smithsonian central rate; at this level
it had appreciated far less than the currencies of Italy’s
major European trading partners, which had moved up
by 10 percent or more. At the same time the discount on
the financial lira narrowed somewhat.
When the dollar fell under attack again in late February,
the outlook for the lira was still beclouded by concern
over the domestic labor situation. But as the rush out of
dollars reached a climax on March 1, the lira also came
into demand, and the commercial rate briefly rose as far as
9 percent above its Smithsonian central rate. This advance
was not sustained, however, when in the subsequent nego
tiations it became apparent that Italy would not join the
common European float against the dollar but would
continue to float independently. Consequently, by midMarch the lira had slipped back to some 2 lA percent above
the Smithsonian level for a further net depreciation against
most European currencies.
Except for a temporary boost late in March, the lira
remained vulnerable to renewed selling pressure and it
weakened late in April on release of figures showing a
further widening in the trade deficit in January and
February. With concern over the Italian economic and
political situation continuing to overhang the market, the
lira did not participate in the sharp upsurge of European
rates against the dollar in early May. Indeed, the Bank
of Italy continued to operate intermittently to keep the
commercial rate from depreciating further against the
currencies of its EC partners.
Toward the end of May and the first week of June
the atmosphere in Italy’s exchange market had turned
even more sour. The long-simmering government crisis
came to a head almost simultaneously with release of
April balance-of-payments figures showing a sharp and
contraseasonal deterioration in the overall current account.
The Bank of Italy intervened only occasionally in the
market, and in seven trading days the commercial rate
tumbled about 7 percent while the financial lira fell even
more sharply as capital outflows from Italy swelled.
On June 18, the caretaker government announced a
package of credit measures designed to restore confidence
in the lira and reduce the Italian inflation rate to levels
prevailing in the rest of Europe without choking off Italy’s
incipient industrial recovery. These measures included a
steep increase in the penalty charge for repeated use of
the Bank of Italy’s discount facility. Moreover, to re
direct longer term investment into the securities markets,
the Italian commercial banks were instructed to invest no
less than 6 percent of end-of-1972 deposits in designated
public and private bonds during 1973.
While making these announcements, the government
noted the size of net official reserves and possible credits
available under the EC and Federal Reserve swap networks.
In addition, it announced supplementary central bank
facilities and indicated that there would be further borrow
ing by state enterprises in the international markets. As a
result, the market became persuaded that the Bank of
Italy, its resources now bolstered by the additional credit
FEDERAL RESERVE BANK OF NEW YORK
facilities, would shortly resume intervention in support of
the lira, and the spot rate strengthened along with other
European currencies into early July. Meanwhile, the polit
ical situation had stabilized with the formation of a new
coalition government under Premier Mariano Rumor. In
addition, the Italian Foreign Exchange Office decided to
unwind dollar swaps with the commercial banking system
instead of renewing them as had been expected, a move
which both underscored the magnitude of the exchange
resources available and tightened domestic liquidity. Never
theless, the Bank of Italy continued to intervene heavily
in the market to keep the lira in line with other European
currencies.
In late July, the Rumor government announced details
of its new anti-inflation program, including a three-month
freeze on selected food and industrial prices, and ceilings on
the growth of bank loans for certain categories of clients.
Also featured in the package was a massive $2 billion
long-term Euro-dollar borrowing by several Italian public
institutions that was designed to bolster official reserves.
New exchange controls were also introduced to discourage
destabilizing speculation in the exchange. The controls
required that Italian residents put up to 50 percent of any
foreign investment in a noninterest-bearing account with
the authorities, that prepayment for imports be financed
in foreign exchange, and that commercial banks maintain
not only a balanced foreign exchange position overall, but
separate balanced positions in United States dollars, EC
currencies, and other currencies. The market reacted favor
ably to these announcements, and the lira soon began to
improve in the exchanges.
C A N A D IA N D O LLA R
In February, heavy demand for Canadian dollars
erupted at the time of the devaluation of the United
States dollar but, once that episode passed, the market
relationship between the two North American currencies
remained largely free of the speculative influences that
afflicted other exchange markets. In fact, during the period
under review, the spot Canadian dollar moved roughly in
line with the United States dollar vis-a-vis European cur
rencies. In general, the underlying forces affecting Can
ada’s payments position were in rough balance, as a
rise in imports stemming from more rapid expansion of
the domestic economy was largely offset by a surge of
exports, mainly commodities and raw materials. As a re
sult, movements of the exchange rate over the spring and
early summer mainly reflected shifting interest rate differ
entials in the nexus of Canadian and United States financial
markets and the Euro-currency markets. Consequently,
229
Chart IX
CANADA
MOVEMENTS IN EXCHANGE RATE*
Percent
Percent
^Measured as percentage deviations from the $0.92/2 official parity established
in May 1962. The Canadian dollar has been floating since June 1,1970.
the Canadian dollar traded generally around $1.00 through
early July. Then, following the particularly sharp run-up
of interest rates in the United States in late July and early
August, which was not matched in Canada, the spot rate
eased to around the $ 0 .9 9 ^ level.
JA PA N ESE YEN
When the dollar was devalued on February 12, the
Japanese authorities announced that they would permit
the yen to float temporarily. The authorities nevertheless
remained prepared to moderate rate movements in the
Tokyo exchange market. Soon after trading resumed on
February 14, the yen was in heavy demand and the spot
rate was driven up to a level more than 17 percent above
the Smithsonian central rate. Activity then subsided, and
the yen edged lower through the end of February. When
heavy pressure against the dollar reemerged in Europe,
the Japanese authorities, acting in concert with the Euro
peans, decided to close the Tokyo market on March 2.
With the markets closed during the first half of March,
there were no interbank transactions in Tokyo either in
spot or forward dealings. Following the March 16 Paris
communique of the Group of Ten Finance Ministers,
normal trading in yen was resumed and a strong reversal
of earlier speculation in favor of the yen started to emerge.
By late March the dollar had strengthened in Tokyo in
response to a variety of factors. The rapid expansion of
the Japanese economy and the 1971 revaluation of the
yen had already stimulated import demand, particularly
for raw materials and industrial commodities, and the
boom in world commodity prices produced a further esca
MONTHLY REVIEW, SEPTEMBER 1973
230
lation in the cost of Japanese imports. At the same time,
various official limits on export growth instituted last year
were beginning to have a restrictive effect. Moreover, the
leads and lags built up in the months prior to the floating
of the yen were now being unwound, a sign that the mar
ket did not expect a further sharp rise of the yen rate in
the near future. Furthermore, long-term capital outflows
swelled, as Japanese interests stepped up their participa
tion in international financial markets, nonresidents liqui
dated a sizable amount of their investments, and Japanese
firms also increased their direct investment abroad. All
of these factors combined to generate a persistent demand
for dollars in Tokyo, and the Bank of Japan, intervening
at some 16 percent above the Smithsonian central rate,
sold about $4 billion of reserves between mid-March and
the end of June.
These shifts in the Japanese payments position so dom
inated developments in the Tokyo market that there was
little response to a series of discount rate increases by the
Bank of Japan, which brought the rate to 6 percent from
AlA percent by early summer. Furthermore, there was
only a slight reaction to the buildup of pressures on the
dollar in Europe in May. Dealers expressed concern over
the implications for the yen of the June 29 revaluation
of the mark, but the Japanese authorities quickly re
sponded by emphasizing that the German action, designed
to correct an isolated problem within Europe, should have
no impact on the yen.
When the dollar came under pressure early in July,
however, the yen market became fearful of the threat
posed by deteriorating market conditions elsewhere and
Chart X
JA P A N
MOVEMENTS IN EXCHANGE RATE *
Percent
Percent
1972
1973
See footnote on Chart I.
"t" Upper and lower intervention limits established in December 1971.
Intervention limits suspended on February 14, 1973.
the spot yen was bid up as much as 5 percent. Trading
then settled down following the BIS communique and sub
sequent enlargement of the Federal Reserve swap network.
The yen then backed off to earlier levels and, over the
remainder of July, the Bank of Japan resumed its dollar
sales in the exchange market.
E U R O -D O LLA R
The deepening crisis in the exchanges early this year,
not unlike monetary disturbances in the past, left a dis
tinct mark on supply and demand patterns as well as on
rates in the Euro-dollar market. As traders and investors
in many parts of the world increasingly covered their dol
lar exposure by means of forward sales, banks in Europe
and elsewhere that had purchased those forward dollars
from their customers sought to even out their positions
by borrowing Euro-dollars and selling the spot proceeds in
the exchanges. Speculative borrowing of dollars for conver
sion into stronger currencies was also an important market
factor early this year. In addition, some Euro-dollar in
vestors, notably in less developed countries without wellfunctioning forward markets for their own currencies,
decided to reduce their stake in the market by sizable
amounts.
These changes in the pattern of supply and demand,
together with rising United States money market rates,
drove Euro-dollar rates steadily higher. By the end of
February, the one-month Euro-dollar rate was above 9Vi
percent, up from about 6 percent at the beginning of the
year. The currency crisis, in turn, induced a massive move
ment of funds from the United States into the market, as
foreign banks withdrew balances previously placed and
borrowed heavily on outstanding credit lines with United
States banks or from their agencies, branches, and other
affiliated institutions in this country. At the same time, these
foreign subsidiary institutions in the United States and,
to a lesser extent, United States banks repaid large
amounts of maturing dollar borrowings that they had pre
viously drawn from the market. Supplies in the market
were also enlarged by additional deposits, particularly
from governments and central banks in several developing
countries.
In the wake of the February crisis and the dollar’s
devaluation, the authorities of several continental Euro
pean countries introduced a variety of regulations in de
fensive moves to deter further speculative inflows into
their countries. Some of them imposed stiffer reserve
requirements and even negative interest charges on incre
ments to nonresidents’ deposits at domestic banks. Several
governments, moreover, imposed additional restrictions
FEDERAL RESERVE BANK OF NEW YORK
Chart XI
INTEREST RATE S IN THE UNITED STATES A N D
THE E U R O - D O L L A R M A R K E T
Percent
12
Certificates of deposit
of New York banks
Primary market 60-89 days*
__
t
J ___I___ I___ I___I___ L
Chart XII
SELECTED INTEREST R A TES IN THE UNITED K I N G D O M ,
WEST G E R M A N Y , A N D C A N A D A
THREE-MONTH MATURITIES
^ W e e k ly averages of daily rates.
'•’ W ednesday data.
on corporate borrowings from the Euro-dollar market
and in some cases prohibited such borrowings alto
gether, forcing banks operating in the market aggressively
to seek new customers in other overseas loan markets.
In the process, they not only relaxed already low credit
standards, but also permitted interest rate margins to
narrow further.
Substantial demands for Euro-dollar loan facilities con
tinued to originate among traditional users, large amounts
being employed for the financing of trade with eastern
Europe and for British direct and portfolio investment
abroad. In the spring and summer these borrowings were
augmented when both the British and Italian governments,
to cushion balance-of-payments pressures, encouraged pub
lic bodies in their countries to draw very large amounts from
the market. In the United Kingdom, the Chancellor of the
Exchequer announced in his budget statement of early
231
March that certain public bodies would again be allowed
official exchange cover facilities for foreign currency borrow
ings. As a result, local authorities and public corporations
began to enter into very heavy borrowing commitments,
the Electricity Council alone contracting for a $1 billion
ten-year loan. Similarly, several Italian state institutions
raised very large loans in the medium-term Euro-dollar
market. These borrowings served to replenish monetary
reserve holdings in the two countries.
In the United States, the Board of Governors of the
Federal Reserve System made several regulatory changes
that are now beginning to affect the demand of banks in
the United States for Euro-dollar balances. In mid-May,
the Board amended Regulations D and M to reduce from
20 percent to 8 percent the reserve requirements appli
cable to certain foreign borrowings of United States banks
to the extent that they exceed the applicable reserve-free
base of each bank. In addition, the reserve-free bases would
be phased out. On June 1, the Board requested the agencies,
branches, and nonmember bank subsidiaries of foreign
banks to maintain voluntarily reserves of 8 percent against
any increases above the May level in net funds obtained
from banks abroad, including their head offices and other
directly related institutions. The revision in the rules
for United States banks and the reemergence of a market
incentive for United States banks to acquire Euro-dollars
in lieu of purchasing Federal funds contributed to a stepup in their borrowings from their foreign branches.
Euro-dollar rates, which had been surprisingly stable
during the period of exchange rate disturbances in the
spring and early summer, began to escalate again late in
July as exceptionally high money market rates in Ger
many exerted a strong pull on rate levels in other money
markets. Moreover, money market rates in this country
were also rising to very high levels. Throughout August,
rates for three-month Euro-dollars remained in the 11%
to 11 Vat percent range.
The international monetary uncertainties, together with
soaring interest rates in the short end of the Euro-currency
market, resulted in a severe contraction of the Euro-bond
market, most notably its dollar-denominated segment. In
deed, during the periods of greatest currency unrest it
became extremely difficult, if not impossible, to offer suc
cessfully to the public even mark-denominated issues. On
balance, however, the pressure on the dollar seemed to have
encouraged a further expansion of the role of other cur
rencies in this market. Moreover, many of the needs of
traditional Euro-bond borrowers are now being met by
the medium-term Euro-currency market.
232
MONTHLY REVIEW, SEPTEMBER 1973
The Business Situation
The latest information on business developments indi
cates that economic activity is continuing at a high level,
although the pace of advance has evidently slowed some
what in recent months.* It still is not clear, however, to
what extent this moderation reflects a diminution of de
mand as distinct from the slowing effects of capacity limi
tations and supply bottlenecks. After rising rather mod
estly in recent months, industrial production exhibited a
sizable increase during July. Inventory spending in
creased substantially in June, probably to a considerable
extent the result of higher prices rather than an expan
sion of physical stocks. Retail sales rose sharply in July
but were still only slightly above the previous peak
reached in March. Despite the one-month rise in housing
starts during July, other indicators more clearly point to
a substantial slowing in residential construction activity.
The most recent changes in the Economic Stabili
zation Program dominated the behavior of consumer
prices during July and have made it more difficult to gauge
the underlying intensity of inflationary pressures. Nonfood
consumer prices rose quite slowly during the month, but
food costs registered a surprisingly large increase, given
the fact that the food price data were gathered primarily
during the period of the freeze. Prices for certain impor
tant commodities in the agricultural spot and futures mar
kets soared even further around midsummer, but there
were some tentative signs of declines during the latter half
of August. While the impact of these movements on retail
food prices is uncertain, Secretary of the Treasury Shultz
has indicated that further substantial consumer price in
creases are expected in the next few months.
IN D U ST R IA L P R O D U C T IO N , O R D E R S ,
A N D IN V E N T O R IE S
According to preliminary data, the Federal Reserve
Board’s index of industrial production, which measures
the physical volume of output of the nation’s factories,
mines, and utilities, rose at an 8.6 percent seasonally ad
justed annual rate in July. In comparison, the growth in
output had slowed to slightly less than a 5 percent pace
during the preceding four months, after increasing by
more than 12 percent over the year ended this past
February. These rates of increase are based on recent
revisions of the industrial production index, instituted
partly to take account of new seasonal factors.
Gains in July production were widespread among mar
ket groupings. The output of industrial materials advanced
at a 9.3 percent annual rate, with particularly rapid gains
in durable goods materials. Production of textiles, paper,
and chemical materials also increased sizably. On the other
hand, iron and steel output showed no advance, as pro
duction has been close to capacity for several months.
Output of business equipment advanced at a modest 3.9
percent annual rate in July. The slower growth of busi
ness equipment output probably resulted in part from
capacity limitations on products such as trucks and buses.
The production of defense and space equipment, which
tends to show considerable month-to-month fluctuation,
advanced rapidly in July.
Consumer goods output increased at a 6.4 percent sea
*
The estimate of second-quarter current-dollar gross national
product (G N P) growth has been revised upward slightly from
sonally adjusted annual rate in July, with production of
$28.5 billion to $29.5 billion. Inventory investment was lowered,
appliances, television sets, and some household goods
while the estimate of final sales was raised. In real terms, GNP is
continuing to show rapid gains. Automobile production
now estimated to have grown at the even slower rate of 2.4 per
cent, compared with the initial estimate of 2.6 percent. The GNP
also advanced. Passenger car output reached 10.3 million
price deflator increased at a 7.3 percent annual rate during the
units in July, a bit above the high production pace sus
quarter, up from the preliminary estimate of 6.8 percent. Corpo
rate profits before taxes (adjusted for changes in the inventory
tained
during previous months of this year. July sales of
valuation adjustment) advanced $4.7 billion to a $109 billion sea
domestic-type
autos, at a 10 million unit seasonally ad
sonally adjusted annual rate.
FEDERAL RESERVE BANK OF NEW YORK
justed annual rate, indicate that sufficient demand for
such high production levels is being maintained. The cur
rent strong demand for autos may be, however, partly a
result of consumer attempts to escape higher prices ex
pected for 1974 models because of additional mandatory
antipollution and safety features. There are signs, more
over, that the composition of recent automobile produc
tion has not fully matched that of consumer demand.
Specifically, the demand for smaller vehicles with lower
gasoline consumption has been relatively stronger than
the call for larger autos. As a result, inventories toward
the end of the model year contain a high proportion of
large cars. Seasonally adjusted inventories at the end of
July amounted to 1.7 million units, up from 1.6 million
the month before and 1.5 million averaged over the first
five months of this year.
Seasonally adjusted new orders placed with manufac
turers of durable goods dropped by $0.3 billion during
Chart 1
O R D E R S A N D SHIPMENTS OF M A N U F A C T U R E D
DURABLE G O O D S
Seasonally adjusted
Billions of dollars
Billions of dollars
Source: United States Department of Commerce, Bureau of the Census.
233
July (see Chart I), following the June increase of $0.6
billion. Excluding bookings for defense products which
exhibit substantial month-to-month volatility, durables
orders rose by $0.8 billion in July, compared with an
increase of $0.2 billion in June. Nevertheless, there is
some evidence that producers may be hesitant to accept
new orders in areas where capacity is severely strained.
While orders with primary metals producers were off
$0.3 billion in July, bookings for machinery continued
to expand at a robust pace.
Even including the July decline, the rise in new orders
for durables has been at a substantial 20 percent annual
rate over the first seven months of this year. Some, but
certainly not all, of this climb represents the impact of
higher prices, insofar as the seasonally adjusted price
index for durable manufactured goods rose at an 8 percent
annual rate over the same period. During 1972, how
ever, the rise in “real” bookings was probably considerably
stronger, since new orders climbed by 23 percent in dollar
terms while the durable goods price index rose by only
3 percent.
Although the backlog of unfilled orders increased again
in July, shipments advanced more strongly so that the
ratio of unfilled orders to sales declined for the first time
since January. At 2.43, the ratio is still considerably above
the levels reached in 1972, providing further evidence of
the existence of reported supply bottlenecks. Moreover,
a new index of capacity utilization for basic materials
industries compiled by the Federal Reserve Board climbed
to 94.4 percent during the second quarter of 1973,
its seventh consecutive quarterly advance. The secondquarter rate is the highest ever recorded for the twelve
industries included in the index since the beginning of the
series in 1948.
According to a Conference Board survey, net new capi
tal appropriations of the 1,000 largest manufacturing
firms rose by 11.6 percent (seasonally adjusted) during
the second quarter, following a 17.2 percent first-quarter
rise. Excluding the rather volatile petroleum and coal
category, net new appropriations moderated to a 4.3
percent rate of increase during the second quarter, com
pared with the extraordinary 22.3 percent first-quarter
gain. The backlog of appropriated but unspent funds has
increased strongly since the start of 1972, after falling
steadily throughout 1970 and 1971. By the second quarter
of this year, the backlog had climbed more than 40 per
cent above the year-earlier level and could serve to propel
capital spending even if the growth of new appropriations
slows substantially in coming quarters.
Total business inventories continued their rapid ex
pansion on a book value basis in June and increased by
234
MONTHLY REVIEW, SEPTEMBER 1973
C h art II
B U S IN E S S IN V E N T O R Y -S A L E S RATIO
S e a s o n a lly a d ju s te d
M onths o f s a le s
M onths o f s a le s
Source: United States Department of Commerce, Bureau of Economic Analysis.
a large $2.6 billion, seasonally adjusted, following a $2.1
billion advance in May. These additions reflected sub
stantial gains in inventories at the manufacturing, whole
sale, and retail trade levels. Recent reports suggest that
at least some inventory building has served to support
rising production; moreover, firms are probably anxious
to increase inventories as a hedge against anticipated
shortages and future price increases. Nevertheless, much
of the recent expansion in the book value of business in
ventories has probably resulted from continuing price
inflation rather than from the accumulation of physical
stocks.
The underlying inventory situation is placed in perspec
tive when the ratio of inventories to sales is considered.
The stock-sales ratio for all business has remained under
1.45 over the past six months (see Chart II). In com
parison, the ratio remained below this level for a longer
period only during one other episode— the Korean war
year of 1950. In June, the inventory-sales ratio edged
up to 1.44, as total business sales dropped off. It is too
early to determine, however, whether this increase signals
a turnabout in the downward trend of the inventory-sales
ratio which has prevailed since late 1970.
According to preliminary data, the book value of manu
facturers’ inventories advanced by a strong $0.9 billion,
seasonally adjusted, in July. This increase was below the
very sizable June inventory buildup, but was somewhat
above gains averaged over the first five months of 1973.
July accumulation of nondurable goods was well above
the monthly average for the first half of the year, while
durables accumulation was slightly under its monthly
average for the same period. Manufacturers’ shipments
moved ahead strongly in July, particularly in the durables
sector, leading to a further decline in the already low
inventory-sales ratio in manufacturing.
P E R S O N A L IN C O M E , C O N S U M E R D E M A N D ,
A N D R E SID E N T IA L C O N STR U C TIO N
Personal income rose $7.3 billion in July, about the
same increase as that experienced on average during the
first half of the year. Since the beginning of 1973, per
sonal income, seasonally adjusted, has grown at an 8.8
percent annual rate, somewhat slower than the 10.2 per
cent expansion during 1972. Of the $1.2 billion step-up
in transfer payments in July, about one half was attribut
able to the extension of Medicare coverage to social
security beneficiaries under 65 years of age.
Retail sales, seasonally adjusted, spurted by $1.4 billion
in July to $42.6 billion. The July increase in sales more
FEDERAL RESERVE BANK OF NEW YORK
than reversed the $0.5 billion decline registered the pre
vious month and brought the level of retail sales 1.5 per
cent above the previous peak established this past March.
The July resurgence appears to have resulted in part from
the pickup in sales of new domestic-type autos. Sales of
imported cars remained at an annual rate of 1.8 million
units in July, down from the 1.9 million to 2.0 million
unit pace of the first five months of 1973. July retail
sales of other consumer durables remained below March
levels; however, sales of nondurable goods posted an
unusually robust increase. No doubt part of this gain re
flects recent stockpiling of beef and other foodstuffs. More
over, if the sales totals are adjusted for price increases,
it appears that retail sales volume has risen much more
slowly in 1973 than it did during 1972. Indeed, adjusted
for price rises, the July volume of retail sales was below
the level of March. Since March, the all-commodities
consumer price index has climbed at an annual rate of
7.6 percent while current-dollar retail sales have risen at
a 4.6 percent rate.
Consumer credit outstanding expanded substantially
over the first six months of the year, with the seasonally
adjusted June gain of $2.1 billion about equaling earlier
Chart III
C H A N G E S IN C O N S U M E R PRICE S
Seasonally adjusted annual rates
Percent
118
FOOD
235
monthly average increases. Automobile credit grew mod
erately in June, but noninstalment credit, which includes
retail charge accounts and service station credit cards,
swelled by $0.5 billion, the largest increase in six months.
Part of this expansion certainly stems from price rises.
Recent evidence suggests that residential construction
activity has moderated from the hectic pace of 1972 and
early 1973. Housing starts rose in July to a seasonally
adjusted annual rate of 2.18 million units. However,
taking a somewhat longer perspective, the July pace was
slightly slower than the 2.21 million unit annual rate
averaged during the second quarter and considerably
below the 2.40 million first-quarter rate. Housing starts
were at a 2.37 million unit rate in 1972. Newly issued
building permits declined in July to a level substantially
below that averaged during the first half of the year.
Mobile home deliveries slipped in June for the third con
secutive month to a seasonally adjusted annual rate of
616,000 units. Similarly, inventories of unsold new onefamily homes continued to mount, while the number of
homes sold dropped to a seasonally adjusted annual rate
of 652,000 units, the slowest sales volume in two years.
These movements led to a substantial increase in the
inventory-sales ratio; at the end of July, inventories of
unsold single-family homes equaled a record 8.3 months
of sales, substantially above the 6.2 months of a year
earlier. These data suggest that a considerable amount of
overbuilding may have occurred.
An additional perspective on the weakening of the
demand for housing is evident in the increased amount of
time it takes for a new one-family home to be sold from
the start of construction. During the second quarter, it
took a median of 4.7 months (seasonally adjusted) from
groundbreaking to sale. This represents a considerable
lengthening from the 3.9 months required during the first
quarter and the 3.1 months averaged in 1972. The longest
monthly sales span was recorded in 1966 when the “for
sale” time reached 6.1 months. Housing activity is not
expected to rebound in the near future in light of the
decreased availability and increased cost of mortgage funds.
R E C E N T P R IC E D E V E L O P M E N T S
12 mo.
-e n d e d July 1973—
6 mo.
-4----------- ended
3 mo.
Source: United States Department of Labor, Bureau of Labor Statistics.
1 mo.
July 1973-------------►
Recent consumer price movements have been domi
nated— and their interpretation complicated—by the lat
est changes in the Economic Stabilization Program. On
June 13 the President announced a freeze on virtually all
prices, with the major exception of rents and unprocessed
agricultural products at the farm level. Wages and interest
rates were, however, allowed to change as long as in
creases were in keeping with the Phase Three guidelines.
236
MONTHLY REVIEW, SEPTEMBER 1973
For most nonfood items, the freeze ended and Phase Four
started on August 12, with prices for these items per
mitted to rise no faster than the dollar increase in costs,
subject to profit margin requirements and notification by
large producers.
Changes in food price controls have been somewhat
different. Price ceilings had been imposed on beef, lamb,
and pork at the end of March and were continued when
other food prices were frozen in mid-June. On July 18,
food prices, with the exception of beef, were allowed to
rise to reflect increases in raw agricultural prices. Beef
ceilings remain in effect until September 12, at which time
prices of all food items will be allowed to rise by as much
as the dollar increases of all costs, subject to profit margin
requirements and notification by large producers.
During July, the consumer price index rose at a
2.7 percent annual rate after adjustment for normal sea
sonal variation. However, since the freeze and subsequent
modifications to the controls program have undoubtedly
affected the usual seasonal pattern of price changes, it is
best to examine both the adjusted and the unadjusted data.
At an annual rate, prices of nonfood commodities fell 1.9
percent before seasonal adjustment but rose 1 percent
after adjustment, bringing the rise over the past twelve
months to 3.4 percent (see Chart III). Prices of services,
which are not adjusted for seasonal variation, increased
at an annual rate of 2.6 percent in July and 3.7 percent
over the past year. Increased rents and home-mortgage
interest rates, which are items exempt from controls, con
tributed to the rise in services prices during the month.
Although food price data were gathered largely during
the period when the freeze was in effect, such prices rose
at a 6 percent annual rate on a seasonally adjusted basis
and even more rapidly on an unadjusted basis in July.
Over the past six months, food prices have soared at a
17.1 percent seasonally adjusted annual rate. An un
determined portion of the July increase in the price of
food may have resulted from technical factors associated
with the timing of data collection and the definition of
ceiling prices used for the freeze. Nonetheless, the magni
tude of the July rise is somewhat surprising.
Food price data collected for the August consumer price
index will largely, but not entirely, reflect the first stage
of the food price rules that went into effect on July 18.
While there have been wide fluctuations in the prices of
some food items since that time, it seems likely that
further increases in food prices will occur in the months
ahead as a result of sustained demand pressures.
FEDERAL RESERVE BANK OF NEW YORK
237
The Money and Bond Markets in August
Interest rates on short-term instruments continued to
climb during much of August in response to the momen
tum of an expanding economy and expectations that mone
tary policy would exert prolonged restraint. The Federal
Reserve provided nonborrowed reserves sparingly, and
commercial banks competed aggressively for funds. Fed
eral funds traded at IOV2 percent or above over much of
the month, and banks raised offering rates on largedenomination certificates of deposit (CDs). The Federal
Reserve discount rate was increased by V2 percentage
point to a record 7 V2 percent about midmonth, while
member bank borrowings remained heavy throughout the
period. Commercial banks boosted the prime lending rate
charged to large business borrowers in four V4 percentage
point steps over the month, with the rate reaching 9%
percent by the month end. Rates on most maturities of
commercial paper increased by V2 to 1 percentage point
during the period.
The market for Treasury securities experienced wide
fluctuations during the month. Treasury bill rates increased
considerably during the first half of August but reversed
course later in the month. Prices of Treasury coupon
securities rose sharply, although unevenly, over much
of the period, recovering from the precipitous decline of
late July. The Treasury’s August 24 auction of $2 billion
of 8% percent 25-month notes attracted substantial inter
est and resulted in an average issuing yield of 7.94 per
cent. Prices of Federal agency securities also improved
in August despite a continued heavy calendar of new
issues. New issue activity in the corporate and municipal
bond markets was generally light, while yields on older
outstanding issues declined slightly on balance.
The growth of
— defined as demand deposits adjusted
plus currency outside banks— slowed considerably during
August. However, M2, which also includes time and sav
ings deposits other than large CDs, expanded more
rapidly in August than it had in July. Growth of consumer
time and savings deposits at commercial banks was strong
in August, perhaps as a result of the July increase in
interest rates payable on such deposits. The gain in other
time deposits together with the sustained growth of largedenomination CDs contributed to the rapid expansion
of the adjusted bank credit proxy in August, bringing its
estimated rate of growth above those recorded in the
previous four months.
BANK RESERVES AND THE MONEY MARKET
The money market remained firm throughout August,
as the Federal Reserve maintained pressure on bank
reserve positions. The effective rate on Federal funds
averaged 10.79 percent in the statement week ended
August 29, 22 basis points above the average of the
August 1 statement week. A sizable decrease in Treasury
balances at the Reserve Banks led to some temporary
easing in the Federal funds rate around midmonth; indeed,
on August 15 the Treasury borrowed $350 million from
the Federal Reserve to avoid an overdraft. In an effort to
slow the growth of the money and credit aggregates, the
monetary authorities restrained the growth of nonbor
rowed reserves during the month. However, faced with
the restrictive stance of monetary policy, commercial
banks continued their massive borrowing from the Federal
Reserve. Borrowings from the discount window averaged
$2.14 billion in August (see Table I), compared with
$1.97 billion of borrowed reserves in July and a monthly
average of $ 1.66 billion over the first six months of this year.
Effective August 14, the Board of Governors of the
Federal Reserve System approved a V2 percentage point
increase in the discount rate at ten Reserve Banks. Similar
increases in the discount rate at the two remaining Reserve
Banks were approved shortly thereafter. This move, the
seventh increase in the discount rate this year, brought the
rate to IV 2 percent, the highest in the history of the
Federal Reserve System. Persistent rises in short-term
market rates of interest and ongoing concern with inflation
and with the excessive growth of the monetary aggregates
led to the successive increases from the AV2 percent rate
238
MONTHLY REVIEW, SEPTEMBER 1973
Table I
FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, AUGUST 1973
In millions of dollars; (+ ) denotes increase
(—) decrease in excess reserves
Changes in daily averages—
week ended
Net
changes
Factors
Aug.
Aug.
1
Aug.
15
Aug.
22
Aug.
29
— 129
— 48
— 115
+
— 662
— 613
—717
+ 382
— 1,254
+ 62
+ 604
+
+
8
“ M a rke t” factors
Member bank required
+
171
499 +
(subtotal) ...........................................
Federal Reserve float ................ —1,030 +
Treasury operations* ................. + 246 +
2 +
Gold and foreign account ........ —
492
4-1,358
— 307
412
+
178
—201
149 + 1,350
132 — 39
147 — 329
+ 491
— 34
reserves ............................................... +
Operating transactions
Currency outside banks ............
Other Federal Reserve
liabilities and capital ..............
+
241
449
-
161
_
54
+
663
258
Total “ m arket” factors ..........
+
— 436
120
+ 1,519
119
141
— 145
198
— 128
—
+ 1,229
— 355
-777
— 931
+ 394
+ 487
— 977
+ 190
— 4
+ 417
_ 328
+
3
—
4
— 50
—
+
502
Direct Federal Reserve credit
transactions
Open market operations
(subtotal) ........................................... • 674 —1,019
Outright holdings:
Treasury securities ....................... + 528
486
1
Bankers' acceptances ................ +
Special certificates .......................
24 —
Federal agency obligations........ +
3
Repurchase agreements:
Treasury securities ....................... + 126
440
Bankers' acceptances ................ +
27 —
46
Federal agency obligations........ — 32 — 44
Member bank borrowings ............ +
14 — 89
Seasonal borrowings! ................ +
13 +
17
Other Federal Reserve assetst . . . +
34 +
20
Total§
............................................. +
Excess reserves $
............................... +
—
+
4
50
395
—
—
-
7
+
14
_
+ 230
+ 19
+
12
_
+
+
+
+
—
13
49
423
22
23
+
-
72
13
—
4
+
9
+ 219
+ 15
— 510
-
18
477
57
475
723 —1,088
—1,017
+ 10-3
+ 8S8
-
391
465
+
— 252
+ 111
+
111
-
425
—
—
90
—
10
+
212
+
+
Monthly
averages
Daily average levels
Member bank:
Total reserves, including
vault casht .......................................
34,051
33,455
33,796
33,592
33,818
33,742||
Required reserves ...........................
33,552
33,381
33,510
33,673
33,535 j|
.............................
499
74
286
33,558
34
145
2071!
Total borrowings .............................
2,095
2,006
1,916
2,135
2,558
2,1421!
Seasonal borrowings'}- ................
Nonborrowed reserves .....................
141
31,956
158
31,449
148
31,880
163
31,457
185
159!!
31,260
31,600!!
32
385
72
109
49
129!!
Excess reserves§
Net carry-over, excess or
deficit ( —)# .....................................
N ote: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash.
t Included in total member bank borrowings.
t Includes assets denominated in foreign currencies.
§ Adjusted to include $112 million of certain reserve deficiencies on which penalties can
be waived for a transition period in connection with bank adaptation to Regulation J
as amended effective November 9, 1972. The adjustment amounted to $450 million
from November 9 through December 27, 1972, $279 million from December 28, 1972
through March 28, 1973, and $172 million from March 29 through June 27, 1973.
II Average for five weeks ended August 29.
# Not reflected in data above.
prevailing at the beginning of this year.
Other short-term interest rates advanced further in
August (see Chart I). With continued expansion in eco
nomic activity, the demand for credit remained strong, and
major commercial banks sought additional funds through
the sale of large CDs. Competitive bidding for these depos
its raised rates to new highs. With the cost of funds rising
sharply and demand for loans still strong, banks increased
their prime lending rate for large business borrowers by
1 percentage point over the month in four Va -point steps.
These hikes brought the prime rate to 9% percent, a
historic high. During the 1969-70 period of high interest
rates, the prime rate peaked in June 1969 at 8 V2 percent
and remained at that plateau for nearly ten months. Com
mercial paper rates continued their upward spiral in
August. The rate on 90- to 119-day paper advanced %
percentage point over the month and closed at IOV2 per
cent. Thus, despite the steady advance in the prime rate,
bank loans remained less costly than borrowing in the
commercial paper market, although the difference is prob
ably not so large as the divergence in rates suggests be
cause of compensating balance requirements and other
costs imposed by commercial banks. In addition, many
bank loans are presently being made on a variable rate
basis, so that over the term of the loan the cost of funds
will fluctuate with changes in the prime rate. Rates on
bankers’ acceptances increased in concert with other mar
ket rates by V2 percentage point over the month.
Preliminary estimates indicate that the advance of
slowed considerably during August. With this moderation,
the growth of Mt over the three months ended in August
comes to a bit below 6 percent at a seasonally adjusted
annual rate (see Chart II). Over the past twelve months,
Mx has expanded by 6 V4 percent. On the other hand,
the growth of M2 accelerated in August in the wake of
the July changes in interest rate ceilings on consumer time
and savings deposits and the abandonment of ceiling restric
tions on deposits of maturities of four years or more. Time
deposits other than large CDs grew significantly in August.
The growth of these time and savings deposits had been
on a declining trend over the past year. Over the three
months ended in August, M2 increased at an annual rate
of about IV 2 percent.
The adjusted bank credit proxy—which consists of daily
average member bank deposits subject to reserve require
ments and certain nondeposit liabilities— advanced sub
stantially in August, bringing the growth over the past
three months to approximately a 12Vi percent annual rate.
Much of the growth in the proxy can be attributed to the
rise in time deposits. Large CD growth remained strong, in
creasing at about the same rate as in July. This gain, cou-
FEDERAL RESERVE BANK OF NEW YORK
239
Chart I
S E L EC T E D IN T E R ES T R A T E S
Percent
June - A ugust 1973
M O N E Y MARKET RATES
July
August
July
1973
1973
N o te:
B O N D MARKET YIELDS
A ugust
D ata a re shown for business days only.
M O N E Y MARKET RATES QUOTED: Bid rates for three-m onth Euro-dollars in London; offering
rates (quoted in terms of rate of discount) on 90- to 119-day prim e com m ercial p a p er
quoted by three of the five d ealers that report their rates, or the m idpoint of the range
standard A a a
bond of at least twenty y ears' m aturity; d a ily averag es of yields
on seasoned A a a -ra te d co rporate bon d s; d a ily a v e ra g e s of yields on lon g
term Governm ent securities (bonds due or c a lla b le in ten years or more) and
quoted if no consensus is a v a ila b le ; the effective rate on Federal funds (the rate most
on G overnm ent securities due in three to five yea rs , computed on the basis of
rep resen tative of the transactions executed); closing bid rates (quoted in terms of rate of
closing bid prices; Thursday averages of yields on twenty seasoned tw enty -y ea r
discount) on newest outstanding three-month Treasury bills.
tax-exem p t bonds (carrying M oody's_ratings of A a a , A a, A, and Baa).
B O N D MARKET YIELDS QUOTED: Yields on new A a a -ra te d public utility bonds are based
on prices asked by u nderw riting syndicates, adjusted to m ake them eq u iv a le n t to a
pled with the expansion of other time deposits and some
increase in interbank deposits, resulted in the rapid
expansion of the credit proxy. The rate of growth of re
serves available to support private nonbank deposits
(RPD) diminished considerably in August.
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
Treasury bill rates continued to advance over the first
half of August, as expectations were widespread that
monetary policy would foster an extended period of re
straint. The final phase of the August refunding was con
ducted in this atmosphere, and the $2 billion of 35-day
Sources: Federal Reserve Bank of New York, Board of G overnors of the Federal
Reserve System, M oody's Investors Service, Inc., and The Bond Buyer.
tax anticipation bills was auctioned on August 8 at a
record average yield of 9.802 percent.* An announcement
by the Federal Home Loan Bank (FHLB) Board that
it would market a large block of short-term securities
contributed to the upward pressure on bill rates through
the first two weeks of the month. In the weekly auction
on August 13, the average issuing rates for the three-month
and six-month bills climbed 49 and 29 basis points, re
*
For details of the August refunding announcement, see this
Review (August 1973), pages 200-201.
MONTHLY REVIEW, SEPTEMBER 1973
240
spectively, above the rates set at the previous auction.
The bill market rallied shortly after midmonth and siz
able rate declines ensued, particularly on issues maturing
beyond four months. Improved investor demand sustained
the declines over much of the remainder of the month.
Rates on the three- and six-month bills were below their
mid-August levels in the August 31 auction (see Table II)
but were 46 basis points and 26 basis points, respectively,
above the rates set in the final auction in July. The volume
of noncompetitive tenders awarded at the weekly bill
auctions in August averaged about 13.5 percent of the
total accepted. In comparison, noncompetitive tenders
accounted for less than half of this percentage on average
in the auctions held during the first three months of the
year. The yield on 52-week bills in the monthly auction
held August 22 was 8.39 percent, about unchanged from
the rate established at the previous month’s auction. These
rates have surpassed the peaks established in 1969-70 by
a wide margin. In that period, for example, the highest
C h art II
C H A N G E S IN M O N E T A R Y A N D CREDIT A G G R E G A T E S
S easo n ally ad ju sted a n n u a l rates
Percent
15
Ml
Percent
15
f
10 -
/\
V
/
From 3
|
m onths e a r lie r
\
J
/
\
10
____
5
5
! /
1/
1 1 1 i
0
1 1 1 1 i
1 1
r\
l l
From 12
months e a r lie r
V
i 1 i I 1 i i 1 11 M
i
0
1 1 11
20
20
M2
/
Froi T1 12
m onth: » e a rlie r
\
15
/
10
/
1
_________
/
1
15 -
10
j
From 3
5 ■
1 1
0
20
1
1 1
1 I
1
I
1 1
1 l 1 I I
1 1 1 I
1 1
0
l 1 1 1 1 1 1 1
20
A DJUSTED BANK CREDIT PROXY
From 3
m onths e a r lie r
15
A
15
/ \
10
10
—
From 12
months e a rlie r
5 -
0
5
m onths e a r iier
-
1 1 1 1 1 1 1 1 1 1 1
1 1 1 1 1 1 1 1 1 1 1
1 1 1 1 1 1 1 1
1971
1972
1 973
Note: Data for August 1973 are preliminary.
M l = Currency plus adjusted demand deposits held by thi; public.
M2 = M l plus commercial bank savings and time deposits held by the public,
less negotiable certificates of deposit issued in denominations of $100,000
or more.
Adjusted bank credit proxy = Total member bank deposits subject to reserve
requirements plus nondeposit sources of funds, such as Euro-dollar
borrowings and the proceeds of commercial paper issued by bank holding
companies or other affiliates.
Sources: Board of Governor s of the Federal Reserve System and the
Federal Reserve Bank of New York.
5
0
yield set in a monthly auction of 52-week bills was the
7.592 percent recorded in November 1969.
Prices of Treasury coupon securities fluctuated widely
during August but rose on balance from the post
financing lows recorded early in the month. Remarks made
by Federal Reserve Board Chairman Burns suggesting
that monetary policy might become more restrictive if the
growth of the monetary aggregates failed to recede led
to some initial erosion in prices of intermediate-term issues.
However, prices of longer term securities benefited from
the limited amount of the Treasury’s new IV i percent
twenty-year bonds awarded to the public in the August
refunding, and the ensuing rally spread to intermediateterm issues before midmonth. While the initial price im
provement stemmed largely from the favorable technical
position of the market, the rally was extended as partici
pants took encouragement from the stability exhibited by
the Federal funds rate during the middle of the month and
from news of improvement in the United States balance of
payments in the second quarter. Over the month, yields on
most three- to five-year issues declined by an average of
64 basis points, while yields on longer term issues gener
ally fell by about 25 basis points. Although short-term
rates have risen well above their peaks of 1969-70, yields
on Treasury coupon securities have remained considerably
below their 1970 highs.
On August 20, the Treasury announced that it would
auction $2 billion of 25-month notes on August 24. This
new offering was intended to raise funds to cover a low
period in the Treasury’s cash balance in early September
and to replace, in part, some redemptions of special nonmarketable securities held by foreign monetary authorities.
The Treasury deferred setting a coupon rate for the note
until August 22 in view of the sharp gyrations that had
been experienced in the bond market. In the event, the
Treasury placed an 8% percent coupon on the note, and
bidding for the issue proved to be quite aggressive. The
new note was issued at an average rate of 7.94 percent.
Prices of Federal agency securities rose during August.
New issue activity remained substantial, but the mar
ket benefited to some extent from the good overall
technical position of the capital markets. Most new issues
were afforded favorable receptions by investors. Early in the
month, the FHLB system offered a package of short-term
securities consisting of $700 million of six-month 93A
percent notes, $800 million of one-year 95/s percent bonds,
and $300 million of thirty-month 8% percent bonds. This
offering sold well as a considerable amount of investor
interest developed. Around midmonth, the Export-Import
Bank offered $300 million of five-year securities priced to
yield 8.35 percent. This issue sold out quickly. Shortly
FEDERAL RESERVE BANK OF NEW YORK
Table II
AVERAGE ISSUING RATES*
AT REGULAR TREASURY BILL AUCTIONS
In percent
Weekly auction dates— August 1973
Maturities
Aug.
13
Aug.
6
20
Aug.
27
Aug.
31
8.486
8.650
8.976
8.943
8.910
8.856
8.577
8.778
8.735
Aug.
Three-month
Six-month ..
Monthly auction dates— June-August 1973
June
26
July
24
Aug.
22
Fifty-two weeks
* Interest rates on bills are quoted in terms of a 360-day year, with the discounts from
par as the return on the face amount of the bills payable at maturity. Bond yield
equivalents, related to the amount actually invested, would be slightly higher.
thereafter, $660.5 million of the Federal Intermediate
Credit Banks’ nine-month bonds encountered good demand
when priced to yield 9.75 percent. Subsequently, the issue
was trading well above par. On August 29, the Federal
National Mortgage Association encountered excellent
interest for its $1 billion issue. The offering consisted
of $300 million of 27-month 814 percent debentures,
$400 million of four-year bonds, and $300 million of
69-month debentures, with both longer term securities
yielding 7.85 percent.
O TH ER SE C U R IT IE S M A R K E T S
Prices of corporate and municipal bonds also experi
enced sharp price fluctuations in August. In the corporate
sector, dealer positions were minimal and the supply of
new issues was modest. However, continuing concern over
inflation and the persistent rise in short-term interest rates
241
combined to limit investor demand. As a result, prices of
corporate securities fluctuated rather widely in response
to largely professional trading. Prices of outstanding cor
porate bonds rose before midmonth in concert with the
rally in the market for United States Government securi
ties. However, some of these gains were dissipated later
in the period. On August 7, $100 million of a thirty-year
A-rated power company issue was priced to yield 8.80 per
cent. Interest in these bonds improved after $50 million of
Aa-rated thirty-year utility company debentures, priced to
return 8.50 percent, received a good response the next day.
The next week, two other power company issues yielding
several basis points less than comparable issues marketed
earlier in the month received favorable receptions after
slow initial sales. The month’s major corporate offering,
$300 million of Aaa-rated Bell System bonds, was mar
keted August 21. The 39-year bonds, priced to yield 8.20
percent in a negotiated underwriting, sold quickly; how
ever, an appreciable quantity of these bonds reportedly
went to professionals or to investors who swapped them
for other utility issues.
Prices of tax-exempt securities moved somewhat
higher in August. On August 8, $100 million of
Aaa-rated bonds received good interest when priced to
yield from 5 percent in 1974 to 5.80 percent in 1998.
About the same time, a $50 million Aa-rated issue received
considerable support when scaled to return from 5.30
percent in 1974 down to 5.00 percent in 1977-81 and up
to 5.75 percent in 1992. This distribution of yields basi
cally represented the prevailing term structure of interest
rates for outstanding tax-exempt securities, and the offer
ing was well received. Two small tax-exempt issues mar
keted around midmonth encountered moderate interest,
while several issues offered near the end of August were
sold quickly at yields below those available on comparable
issues marketed earlier in the month. The Bond Buyer
index of twenty tax-exempt bond yields fell from 5.48
percent on July 26 to 5.34 percent on August 30. The
Blue List of dealers’ advertised inventories fell $99 million
over the month to $485 million.
@FedFRASER