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FEDERAL RESERVE
BANK
OF NEW YORK

MONTHLY R E V I E W
SEPTEMBER

1975

Contents
Treasury and Federal Reserve Foreign
Exchange Operations, by A lan R. Holmes
and Scott E. Pardee ...................................... 199
The Business Situation ...................................... 219
The Money and Bond Markets in A u g u s t .............225

Volum e 57

No. 9

FEDERAL RESERVE BANK OF NEW YORK

Tre asu ry and Federal Reserve Foreign Exchange Operations
February—July 1975
By A la n R. H o lm e s and S c o t t E. P a rd ee*

In late 1974-early 1975 the exchange markets were
subject to an almost unremitting diet of bearish news for
the dollar. Mounting evidence showed that the United
States economy was slipping into severe recession. United
States interest rates were falling more steeply than those in
many other countries with no bottom in immediate pros
pect. United States economic policy was still under
vigorous debate, and traders were concerned over the
possibility of measures which could eventually exacerbate
domestic inflation. In the gloomy atmosphere that de
veloped, the market ignored any favorable news for the
economy, such as the underlying improvement in the trade
balance and the slackening in our rate of inflation.
Consequently, the dollar lost its resiliency in the ex
changes. Market forces drove dollar rates lower nearly
every day as trading became more and more unsettled.
Under these circumstances, the Federal Reserve and Euro
pean central banks had intervened to moderate the decline
in dollar rates. By the end of January, to finance its
intervention the Federal Reserve had drawn a total of
$412.5 million equivalent of German marks, Swiss francs,
and Dutch guilders under the swap arrangements with the
respective central banks. But, with the markets growing
increasingly nervous, a more forceful approach was clearly
needed to avoid the outbreak of disorderly conditions.
On February 1, senior officials of the Federal Reserve,
the Bundesbank, and the Swiss National Bank met in

*Mr. Holmes is the Executive Vice President in charge of the
Foreign Function of the Federal Reserve Bank of New York and
Manager, System Open Market Account. Mr. Pardee is Vice
President in the Foreign Function and Deputy Manager for Foreign
Operations of the System Open Market Account. The Bank acts
as agent for both the Treasury and the Federal Reserve System in
the conduct of foreign exchange operations.

London to conclude details of a more forceful interven
tion approach. On Monday, February 3, these central
banks countered renewed selling pressure on the dollar
with concerted intervention. Over that and the following
day, the Federal Reserve sold a total of $139.4 million
of German marks, Swiss francs, Dutch guilders, and
Belgian francs. This operation, and its confirmation by
Chairman Burns and officials of the Bundesbank and the
Swiss National Bank, prompted a sharp rebound for the
dollar.
Subsequent events, including the further decline in
interest rates in the United States and release of sharply
higher unemployment figures, nonetheless served to rein
force market pessimism toward the dollar, which soon
came under renewed and occasionally heavy selling pres
sure. The Federal Reserve continued to intervene as
necessary to avoid the outbreak of disorderly conditions
without holding the rate at any particular level. Conse
quently, although dollar rates fell back to the late-January
lows and beyond, the retreat was generally orderly. Out
right speculative pressure resurfaced, however, on February
27, despite the release of clearly improved United States
trade figures for January, and the Federal Reserve coun
tered forcibly, selling some $104.2 million equivalent of
German marks, Swiss francs, Dutch guilders, and Belgian
francs. This operation helped steady the market, and imme
diate selling pressure against the dollar lifted.
Total Federal Reserve sales of currencies in February
amounted to $620 million, of which $433.1 million was
in German marks, $123.3 million in Swiss francs, $46.9
million in Dutch guilders, and $16.7 million in Belgian
francs. These operations were all financed by drawings
under the swap arrangements with the respective central
banks, raising outstanding drawings from market oper
ations since late 1974 to $1,032.5 million.
In March and April the market atmosphere gradually

200

MONTHLY REVIEW, SEPTEMBER 1975

C hart I

SELECTED EXCH A N G E RATES*
P e rc e n t

P e rc e n t
1
|

S w is s fra n c

l
1

/ ”
/
I

/
V

/
*
/ '
* "• F re n c h fra nc

\
m ark

G e rm a n

|
__ *

P o u n d s t e r l i n g ^ —^

i
r

.
1974

1975

* P e r c e n t a g e d e v ia t io n s of w e e kly a v e r a g e s of N e w Y o rk o ffe re d rates
from the a v e r a g e r a t e s o v e r S e p te m b e r 2-6, 1974.

improved for the dollar. By that time the United States
trade accounts were shifting into surplus, in response not
only to the deeper recession here than elsewhere but also
to our improved competitive position in world markets.
Inflation was abating more rapidly here than in most
other countries. In addition, some of the temporary factors
which had depressed the dollar began to lose force. In par
ticular, reports of disagreement within the Organization of
Petroleum Exporting Countries (OPEC) eased some of the
immediate concern in the market that the group was on
the verge of collectively cutting production and of boost
ing prices further. Passage and signing of tax-relief
measures to stimulate the United States economy also
helped clear the air. Moreover, statements by United
States officials, emphasizing the fundamental strength in
this country’s trade and payments position and pointing
to the Federal Reserve’s recent substantial intervention
in the exchanges, reassured the markets that the United
States was not pursuing a policy of “benign neglect” toward
the dollar. Once immediate fears of additional dollar de
clines began to fade, traders began to respond to a
further favorable shift in interest rate differentials as rates
here firmed somewhat while those elsewhere continued to
fall. Consequently, the dollar was gradually bid up from its
lows, and by the end of April it had recovered by 4 to 6
percent against the German mark and Swiss franc and by
similar amounts against most major European currencies.
The dollar’s rise was highly tentative at first, and the
Federal Reserve continued to intervene in German marks

and Swiss francs to prevent a backsliding in rates that
threatened to undermine a more solid recovery. But
intervention tapered off as the dollar gained resiliency over
the course of March and April. In those months the Sys
tem sold a total of $161.6 million of marks, $9.5 million
of Swiss francs, and $2.1 million of Dutch guilders. In late
March, the System’s outstanding indebtedness from market
operations in late 1974-75 reached a peak of $1,066.2 mil
lion. Of this, $837.8 million was in marks, $159.4 million
in Swiss francs, $52.2 million in Dutch guilders, and
$16.7 million in Belgian francs. By that time, however,
the Federal Reserve had begun to buy currencies in the
market here and abroad and from correspondents to
repay debt. In March the System repaid $25 million of
mark drawings. As the dollar strengthened further in April,
the System repaid all of the Swiss and Belgian franc
drawings incurred in late 1974 and early 1975 and a
further $244.6 million of the German mark drawings. On
balance, therefore, the Federal Reserve reduced its out
standing swap debt incurred since late 1974 to $657 mil
lion by April 30.
The dollar’s recovery was not sustained, however, as

Table I
FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEM ENTS
In millions of dollars
Institution

Amount of facility
July 31, 1975

Austrian National Bank ...........................................................

250

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

1,000

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

2,000

National Bank of Denmark ....................................................

250

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

3,000

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

2,000

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

2,000

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

3,000

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

2,000

Bank of Mexico ............................................................................

180

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

500

Bank of Norway ............................................................................

250

Bank of Sweden ..........................................................................

300

Swiss National Bank ...................................................................

1,400

Bank for International Settlements:
Swiss francs-dollars ...............................................................

600

Other authorized European currencies^dollars ..............

1,250

Total

....

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

19,980

FEDERAL RESERVE BANK OF NEW YORK

201

Table II
FEDERAL RESERVE SYSTEM D R A W IN G S A N D REPAYM ENTS
U N D E R RECIPROCAL C URRENCY A R RANG EM ENTS
In millions of dollars equivalent
Drawings ( + ) or repayments (—)
System swap
commitments,
January 1, 1975

Transactions with

N ational Bank of Belgium .........................................

........

261.8

j + 63.4
(—487.7

-4 1 3 .5

-0-

3.2

+ 49.0

1+ 47.3
I - 90.6

-0-

378.5

+ 152.1

218.7

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

1,462.2

8.8

-1 5 9 .4

371.2

[

600.0

261.8

f+644.1
\ — 25.0

.....

T o ta l

13.1
I - 29.8

-0-

G erm an Federal Bank .......

Bank for International Settlem ents (Swiss francs) ...

+ 16.7

July

40.5

-0 -

.....

Swiss N ational Bank .............

1+ 45.6
5.1

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

N etherlands Bank ... .

System swap
commitments,
July 31, 1975

1975

1+861.9
} - 25.0

600.0
(+169.4
1-772.7

-4 6 2 .8

1,232.9

N ote: D iscrepancies in totals are due to rounding.

United States interest rates eased once again early in May.
Renewed outflows of liquid funds from the United States
and the diversion of foreign-held funds to other money
markets left the dollar vulnerable to crosscurrents in other
markets. Thus, occasional selling pressure against sterling
and bursts of demand for French francs tended to generate
demand for other continental European currencies as well,
particularly the German mark and the Swiss franc. Adding
to the dollar’s softer undertone were market uncertainties
over the implications of the collapse of non-Communist
governments in Indochina and of renewed tensions in the
Middle East.
Consequently, the dollar came on offer in periodically
unsettled markets. The Federal Reserve resumed interven
tion on May 7, selling modest amounts of German marks
and Dutch guilders. On May 12, news of the Cambodian
seizure of a United States merchant ship triggered heavy
speculative sales of dollars, and dollar rates fell by
some 1 to 1Vi percent over the next two days. To resist
a cumulative erosion of dollar rates, the Federal Reserve
intervened in German marks, Dutch guilders, and Belgian
francs, selling a combined total of $69.1 million. Several
European central banks stepped in and bought dollars in
their own markets. The selling wave broke quickly, and
dollar rates were already rising when the United States

announced that the merchant ship had been freed.
The market nevertheless settled down only briefly as
the continuing buildup of demand for French francs set
off more generalized selling of dollars by May 21. As dol
lar rates declined sharply, the Federal Reserve again inter
vened in marks, guilders, and Belgian francs. Moreover,
following the Bank of France’s heavy dollar purchases in
Paris, the Federal Reserve also intervened in French
francs in New York. In all, during May 21-23, the Fed
eral Reserve sold a total of $115.6 million of foreign cur
rencies. This concerted intervention was favorably received
in the market and the press and, as trading conditions im
proved, the dollar stabilized in late May.
Overall, during episodes of unsettled trading in May,
the Federal Reserve sold a total of $212.5 million of
currencies, of which $157.8 million was financed by swap
drawings and $54.6 million by balances. Meanwhile,
whenever market conditions permitted, the System con
tinued to buy currencies and repaid $79.2 million of draw
ings in May. On balance, therefore, outstanding drawings
rose to $735.6 million.
In June and July the balance of market forces tipped
increasingly in favor of the dollar. By that time, the
United States trade account had moved decisively into
surplus. Growing signs of a United States economic

202

MONTHLY REVIEW, SEPTEMBER 1975

recovery also helped bolster confidence in the dollar by
dispelling fears of an even more serious downturn and
clearing away the market’s expectation of further sharp
declines in United States interest rates. Economic recovery
abroad was still lagging, and the market had shifted to ex
pect additional stimulative measures, including lower inter
est rates, in several foreign countries. At first, the favorable
shift in market psychology led mainly to a firmer tone
for the dollar, in which the dollar showed greater resiliency
to potentially adverse news or events. But, following a
jump in United States interest rates in late June, the dollar
was bid up across the board. By early July, a ground
swell of demand developed, as earlier speculative positions
against the dollar were unwound, adverse leads and lags
were reversed, and arbitrage and investment funds were
drawn into New York and the Euro-dollar market.
Just as the decline of the dollar in late 1974-early 1975
had been mainly against major continental European cur
rencies, its rise was particularly sharp against those cur
rencies as well. Thus, by the end of July, the dollar had
climbed against the German mark by some 9% percent
from mid-May and by almost IIV 2 percent from the lows
of late February. Dollar rates for other continental Euro
pean currencies followed a similar pattern except for the
French franc, against which the dollar had fallen by 8 V2 per-

C h a r t II

UNITED STATES M ERCH AN DISE TRADE BALANCE
S e a s o n a l ly a d ju s t e d a n n u a l ra tes
B illio n s o f d o lla r s

B illio n s o f d o lla r s

‘

S u r p lu s

0
-5

-10

cent from February through early June before fully revers
ing that decline.
The Federal Reserve intervened on only four occasions
in June and once in July to resist abrupt declines in dollar
rates, selling a total of $39.4 million of marks out of
balances. Otherwise, the System took the opportunity of a
strengthening dollar to acquire currencies to repay debt.
The 1974-75 drawings in Dutch guilders, French francs,
and Belgian francs were fully repaid by early July. Pur
chases of marks continued through late July and, by the
month end, all drawings in that currency had been
liquidated as well.
In sum, in intervention during the six-month period
February through July, the Federal Reserve sold a total
of $1,045 million of foreign currencies, of which $848
million was financed by drawings on swap lines with the
respective central banks and $197 million was from
balances acquired in the market or from correspondents.
All of these drawings, plus some $412.5 million carried
over from late 1974-early 1975, were fully repaid by
July 31. Operations were conducted in five currencies.
In marks, the System sold $740.6 million, of which $543.6
million was drawn under the swap line with the Bundes
bank and $197 million was from balances. In Swiss francs,
sales amounted to $132.8 million, all financed by swap
drawings on the Swiss National Bank. Aggregate sales
of $96.3 million of Dutch guilders, $45.6 million of
French francs, and $29.8 million of Belgian francs were
also financed by swap drawings on the respective central
banks. On July 31, the Federal Reserve had $971.2
million of Swiss franc drawings and $261.8 million of
Belgian franc drawings, and the United States Treasury had
$1,599.3 million equivalent of Swiss-franc-denominated
obligations with the Swiss National Bank, all outstanding
from August 1971.
Finally, as previously reported, last September the Fed
eral Reserve Bank of New York acquired the $725 million
equivalent of forward exchange commitments of the Frank
lin National Bank. The last of these commitments matured
in August. The residual of funds provided by Franklin to
cover the risks of these operations therefore reverted to
the Federal Deposit Insurance Corporation as liquidator
of the Franklin National Bank.
GERMAN MARK

D e fic it

1 1 1 ___I______ I__ J___I___I___L

-1 5 __________
J

1974
S o u rc e :

U n ite d S ta te s D e p a rt m e n t o f C o m m e r c e .

1975

Coming into 1975, expectations of an early upturn in
the German economy and a still favorable outlook for
Germany’s trade provided a firm undertone for the mark
in the exchanges. A much slower pace of inflation in Ger
many than in its major trading partners, together with

FEDERAL RESERVE BANK OF NEW YORK

expanding orders from both Eastern Europe and the
OPEC countries, was expected to ensure a continuing
large trade surplus and thereby to cushion the German
economy from the recession spreading elsewhere in the
industrial world. At home, the government had responded
to the persistent slowdown in domestic demand by imple
menting in December a fiscal package to boost capital in
vestment. In addition, the Bundesbank had continued to
relax its monetary policy, reducing its discount rate in
two steps to 6 percent by December 20 and increasing
the banks’ rediscount quotas.
Against this background, highly publicized OPEC direct
investments and a reversal of the bulk of last fall’s short
term capital outflows reinforced the market’s bullish senti
ment toward the mark. Moreover, flare-ups of speculation
in the Swiss franc, which pushed that currency up sharply
in late 1974 and January 1975, also tended to pull the
mark up against the dollar. By late January the mark had
advanced some I 6 V2 percent from its early-September
1974 lows to $0.4356. The Federal Reserve and the
Bundesbank, having intervened in modest amounts on
a day-to-day basis, then began to stiffen their resistance
to further selling pressure against the dollar which threat
ened to disrupt the market. To finance its intervention,
the Federal Reserve had accumulated by January 3 1 a net
$382.7 million of drawings on the swap line with the
Bundesbank.
Immediately after the London meeting of February 1, the
German and Swiss central banks countered renewed selling
pressure on the dollar through concerted dollar purchases.
The Federal Reserve followed up in New York with large
offerings of marks as well as other currencies. Over just
two days, February 3-4, the Federal Reserve thus sold
$74.4 million of marks financed by drawings on the
Bundesbank. This joint operation, and its confirmation
by officials of the three participating central banks,
prompted a sharp turnaround in rates in which the mark
dropped by some 4 percent in two days.
Subsequent events, however, served to reinforce the
mark’s buoyancy. A tapering-off in the rise of Germany’s
unemployment rate strengthened the view that the reces
sion in Germany would be less severe and prolonged than
in the United States. In addition, the market still expected
the downtrend in German interest rates to continue to
lag well behind that in the United States. Even after the
Bundesbank cut its discount and Lombard rates another
Vi percentage point early in February and the decline in
United States money market rates began to slacken, suc
cessive reductions in prime rates here tended to confirm
the market’s expectations. Meanwhile, OPEC representa
tives were already speaking of their concern over the

203

weakness of the dollar and of measures they might take
to protect their oil revenues and international reserves
from any further depreciation. With OPEC countries now
diversifying a major portion of new dollar receipts into
Continental currencies, a rush of newly issued markdenominated Euro-bonds provided yet another outlet for
investment in marks.
In this atmosphere, demand for marks pushed the spot
rate back to and above its January peak, reaching
$0.4395 in late February. To avoid an outbreak of dis
orderly conditions, the Federal Reserve intervened on ten
of the fourteen business days from February 5 through
February 26, selling a total of $278.2 million of marks
drawn on the swap line with the Bundesbank. Even after
the release on February 27 of clearly improved United
States trade figures for January, the dollar failed to rise
and the New York market was soon flooded with specula
tive selling out of Europe. The Federal Reserve sold a
further $56.7 million of marks that day, financed by a
swap drawing on the Bundesbank. This operation, fol
lowed up with sustaining intervention the next day of
$23.7 million of marks drawn on the Bundesbank, helped
set the stage for an improved market atmosphere begin
ning early in March.
By that time, United States money market rates had

204

MONTHLY REVIEW, SEPTEMBER 1975

leveled off. In Germany, by contrast, short-term interest
rates were easing more rapidly than before, and the al
ready favorable arbitrage differentials for the dollar con
tinued to widen even though both the Bundesbank and
the Federal Reserve cut their respective discount rates
by Vi percentage point early in March. Consequently,
some of the immediate selling pressure on the dollar lifted
and the mark rate began to ease. But the turnaround
was highly tentative and, when activity thinned out in
late New York trading, the mark rate was frequently bid
up again. To avoid a resurgence of speculative demand
for marks, the Federal Reserve intervened, selling in the
first four days of March $63.3 million of marks from bal
ances— part of the $102.3 million of marks acquired in
early March from the Bank of Italy in connection with
an Italian drawing on the International Monetary Fund
(IM F). Thereafter, the market gradually settled down,
and the Federal Reserve, though still prepared to respond
to temporary unsettlements in the market, operated on
only five of the twelve business days from March 7 through
March 24. A total of $55.8 million of marks was sold,
of which $47.1 million was financed by swap drawings
and the rest by balances.
In all, to finance its intervention in February and
March, the Federal Reserve drew a total of $480.2 million
of marks under the swap line with the Bundesbank
and, using part of the balances acquired from the Bank of
Italy, repaid $25 million equivalent of drawings. Thus,
by late March, outstanding swap drawings in marks had
reached a peak of $837.8 million. Nevertheless, trad
ing conditions had become generally more settled, and the
mark had eased to around $0.4240, some 3 V2 percent

below its February highs. The Federal Reserve had, there
fore, begun to make modest daily purchases of marks in
the market both here and abroad, accumulating balances
for subsequent intervention if needed or for repayment
of debt.
By April the outlook for the German economy was
being clouded by the deeper than anticipated recession in
Europe. The volume of Germany’s export orders had
dropped some 20 percent from the level of the year before,
and the loss of export sales was keeping investment de
pressed. In addition, unemployment was again rising and,
in response to the deteriorating economic climate, the
savings rate shot up to its highest level in at least ten
years. At the same time, German interest rates continued
to ease while United States interest rates had firmed some
what. Consequently, the mark edged downward against
the dollar to $0.4180 just after midmonth. With German
interest rates now among the lowest in Europe, funds also
flowed out of marks into other European currencies. In
deed, for the first time since the third quarter of 1974,
capital outflows from Germany exceeded the currentaccount surplus, and the mark declined to its lower limits
of the European Community (EC) “snake” where it re
quired occasional support.
Nevertheless, the market remained uneasy over the ex
tent to which OPEC interests were still shifting into marks
from dollars and sterling, especially as the pound came
under heavy selling pressure late in the month. When these
concerns surfaced, the mark was occasionally bid up
sharply, and the Federal Reserve intervened four times in
April to sell a total of $42.6 million equivalent of marks,
of which $31 million was from balances and the remainder

T a b le 111

D R A W IN G S A N D REPAYM ENTS BY FO REIGN CENTRAL BANKS
A N D THE B A NK FOR INTERNATIONAL SETTLEMENTS
U N D E R RECIPROCAL CURRENCY ARRANG EM ENTS
In millions of dollars
Drawings ( 4 ) or repayments ( — )
Banks drawing on
Federal Reserve System

Drawings on
Federal Reserve
System outstanding
January 1,1975

1975
1

b o

1-45.0

{4 1 .0
1 - 1 .0

o o
t^f-‘

(4 4 5 .0

-o-

T o tal

±1

-o -

LA L/t

July

Bank for International Settlements (against German marks)

Drawings on
Federal Reserve
System outstanding
July 31,1975

-0 -

{4 6 7 .0
|—67.0

-0 -

205

FEDERAL RESERVE BANK OF NEW YORK

drawn on the swap line with the Bundesbank. Otherwise,
the System took advantage of the general weakening ten
dency of the mark to continue to buy marks in the market
and from correspondents to repay debt. Thus, with repay
ments of $244.6 million, Federal Reserve swap drawings
in marks had been reduced on balance by $233.1 million
to $604.7 million by the end of April.
As the dollar’s hesitant April recovery stalled early
in May, the mark began to firm again. Amidst concern
over a renewed fallback in United States interest rates, a
sharp run-up in the French franc revived fears of a move
ment of foreign-held funds to the Continent. When par
ticularly heavy bidding for French francs spilled over into
the market for German marks and threatened to disrupt
trading conditions generally on May 7, the Federal Reserve
sold $17 million of marks, of which $6.9 million was
drawn on the swap line and the rest from balances. Five
days later, with renewed tensions in Southeast Asia and
the Middle East already overhanging the exchanges, news
of the Cambodian seizure of a United States merchant
ship triggered another jump for the mark in somewhat con
fused trading. The Federal Reserve intervened in marks
as well as other currencies on May 12-13 to steady the mar
ket and sold a total of $46.3 million equivalent of marks, of
which $25.7 million was drawn on the swap line and the
rest from balances. The Bundesbank simultaneously inter
vened, and this concerted operation helped reassure the
market. The mark was again bid up late in May, in re
sponse to a renewed upsurge of the French franc, and
firmed briefly in early June, in the backwash of a substan
tial switch of funds from sterling into marks. The Federal
Reserve intervened during May 21-23 and, to a lesser
extent, on three occasions in early June to sell a total of
$77.5 million of marks. Of these, $19.3 million was drawn
on the swap line with the Bundesbank and the rest was
from balances. But, with the dollar gradually gaining
greater buoyancy, the Federal Reserve continued its
program of acquiring marks to repay debt whenever market
conditions permitted. After repaying in May $62.7 million
equivalent, the System reduced its mark swap indebtedness
by another $129.5 million by the middle of June.
Toward the end of June, a sudden rise in United States
interest rates triggered renewed bidding for dollars against
all currencies. Moreover, the United States economy was
showing signs of an upturn. By contrast, the recession in
Germany persisted. The Bundesbank had acted decisively
in late May to relax monetary policy further with additional
cuts in its discount and Lombard rates to 4 Vi percent and
5 V2 percent, respectively, and with successive reductions
in minimum reserve requirements. With short-term Ger
man money rates again easing, the shifting of interest arbi

trage funds out of Germany and the Euro-mark market
accelerated. In addition, earlier speculative positions were
reversed, nonresidents’ long-term investments were in
creasingly withdrawn, and commercial leads and lags
shifted against the mark. The slide of the spot mark was
therefore sustained through the end of July. By the month
end the rate had dropped to as low as $0.3894, some 9Vi
percent below its June high and almost 11 Vi percent
below its peak in February.
As the mark declined, the Federal Reserve acquired
additional balances in the market and from correspon
dents to repay debt, stepping up its purchases on days when
the mark was declining sharply. On the other hand, when
the mark was suddenly bid up in a thin market on June 24
and July 25, the Federal Reserve offered marks, selling a
total of $5.1 million out of balances. By end-July the Fed
eral Reserve had acquired sufficient marks to repay fully
the remaining $464.4 million of mark swap debt.
STERLIN G

By late 1974-early 1975 the United Kingdom had
begun to slip into recession. Britain’s already serious wageprice spiral was accelerating, in sharp contrast to slacken
ing rates of inflation in other major countries. The United
Kingdom had been financing its large trade deficit by
means of public and private borrowings abroad. By early
1975, however, the government had drawn down most of
its $2.5 billion Euro-dollar loan, and borrowings abroad by
other public-sector entities were tapering off. At the same
time, the market questioned whether the relatively high in
terest rates in London, which had exerted a pull on non
resident funds, could be long maintained in view of rising
unemployment and the still worrisome strain on corporate
profits and liquidity. Against this background, the market
had become extremely sensitive to any signs of a signifi
cant decline in new OPEC investments in the United King
dom or of stepped-up diversification of OPEC funds out
of sterling and into other currencies. Sterling had therefore
come under periodically heavy selling pressure around
the turn of the year. But the Bank of England had pro
vided forceful support and, after Middle East reassurances
of continued investment in sterling assets, the immediate
pressures had abated. The pound then began to join in
the generalized advance of European currencies against
the dollar, moving up to around $2.38 by end-January.
At that level, its effective depreciation against Smithsonian
central rates was around 21.7 percent.
By early February, the further declines in interest rates
in the United States, in the Euro-dollar market, and on
the European continent were providing scope for a modest

206

MONTHLY REVIEW, SEPTEMBER 1975

easing of United Kingdom interest rates, including a cut
in the Bank of England’s minimum lending rate. With favor
able interest incentives for sterling therefore maintained,
liquid funds were again drawn to sterling, including OPEC
placements. In addition, commercial demand for sterling,
along with regular purchases by oil companies for tax and
royalty payments and the covering of short positions which
had been taken up around the year-end, buoyed the ster
ling rate. Meanwhile, Britain’s trade account showed a
striking improvement that was to continue through the first
half of the year, as exports rebounded from depressed
fourth-quarter 1974 levels and imports fell in response to
weakening domestic demand. Thus bolstered by financial
and commercial demand, the pound was bid up to as high
as $2.4334 just before mid-March, its highest level in over
nine months. Although the rate subsequently eased against
the dollar, sterling gained ground against other European
currencies and its effective depreciation narrowed to 21.1
percent by late March. Taking advantage of sterling’s rela
tive buoyancy, the Bank of England made sizable pur
chases of dollars which were partly reflected in the $300
million increase in official reserves over February and
March.
By early April, however, market sentiment toward
sterling was turning bearish once again, as concern over
the government’s upcoming budget message shifted the
market’s focus back to the underlying conflicts in Britain’s
economic situation. Unlike elsewhere, the economic slow
down in Britain was not having a dampening effect on
domestic inflation. In fact, the rise in wages had acceler
ated even further to more than 30 percent per annum. Some
of the largest wage settlements had been in the public
sector, thereby adding to the burgeoning government
deficit and potentially intensifying inflationary pressures
all the more. Yet, in the market’s view, a major move to
narrow the deficit by raising taxes or cutting public ex
penditures threatened only to aggravate unemployment.
By that time the generalized public discussion of Britain’s
international economic policy, which developed in advance
of the June 5 referendum on United Kingdom membership
in the EC, was also contributing to exchange market
uncertainties.
As a consequence, the pound once again became vulner
able to bouts of selling. A firming of interest rates in the
United States and Euro-dollar markets early in April,
coupled with a further easing of rates in London, prompted
some shifts of funds out of sterling, and over the next two
weeks the spot rate declined to $2.3514, or an effective
depreciation of 22.1 percent. On April 15, the government
presented a budget designed to limit increases in the publicsector deficit and to improve the balance of payments

through higher taxes on personal spending this fiscal year
and public spending cuts next year. The market was im
pressed with its generally restrictive tone but remained
concerned over the still large government borrowing re
quirement, running close to 10 percent of gross national
product. The market atmosphere therefore remained un
settled and, in the wake of continued declines in British
interest rates including a further reduction in the Bank of
England’s minimum lending rate, the pound tended to
ease.
Then, over the April 19-20 weekend, a report in the
London press suggested that the British authorities would
not be concerned if the pound depreciated a further 4 or
5 percent. On Monday, April 21, the pound immediately
came on offer. Speculative selling cumulated, as the rec
ommended nationalization of the financially troubled
British Leyland Motor Corporation and growing evidence
of opposition within the Labor Party to British member
ship in the EC contributed to the market’s concern. Against
this background, there was little response in the exchanges
to Chancellor of the Exchequer Healey’s assurances that
the government did not favor a further depreciation of
the pound. Speculative positions short of sterling and long
of Continental currencies were built up, and sizable
amounts of OPEC funds were shifted into Continental
currencies. The pound was pushed down to $2.30 by mid-

FEDERAL RESERVE BANK OF NEW YORK

May. Meanwhile, sterling’s trade-weighted depreciation
had widened by nearly 4 percentage points from earlyMarch levels.
At this point, the Bank of England, which had been
intervening to moderate excessive fluctuations in the sterling
rate, stiffened its resistance to a further decline and the
immediate pressures began to subside. Meanwhile, a rise
in short-term United Kingdom interest rates was validated
by an increase in the Bank of England’s minimum lending
rate to 10 percent. As a result, interest incentives widened
once again, stimulating some reflows of funds which, to
gether with oil company and other commercial demand,
helped bid the pound back up to above $2.33 in late May.
Trading activity then slackened as market participants
awaited the outcome of the June 5 referendum.
The referendum passed with a decisive two-to-one
majority favoring continued EC membership. Sterling at
first strengthened on the expectation that the government
was now in a position to take forceful action to deal with
the accelerating wage-price spiral. Nevertheless, in the
absence of immediate policy proposals, pessimism over
Britain’s economic prospects quickly resurfaced, and the
market atmosphere soured. Sterling fell back on June 10,
when a large shift of funds out of sterling and into marks
triggered renewed selling pressures. Although discussions
were initiated between British trade unions and manage
ment representatives on a new voluntary scheme for limit
ing wage claims, sterling continued to plunge in bursts of
heavy selling through the rest of June to a low of
$2.1 IVa by July 1. This drop of more than 6 V2 percent
against the dollar since late May helped push the tradeweighted depreciation levels to a record of 29.2 percent.
By this time, sterling’s erosion in the exchanges had
riveted attention in the British press and by the public on
the need for urgent trade union, management, and govern
ment agreement on new anti-inflation initiatives. In
addressing Parliament on July 1, Chancellor Healey
promised that, if a voluntary mechanism were not estab
lished to limit wage increases to 10 percent, the govern
ment would seek legislation on statutory controls. In an
initially favorable market response, sterling rebounded to
above $2.21 and then held firm after the Trade Union
Congress agreed to go along with a voluntary wagerestraint program. The government’s specific proposals,
outlined to Parliament on July 12, called for strict acrossthe-board limits on all pay increases. These would be en
forced by fiscal spending limits in the public sector and
by stricter adherence to the price code in the private
sector.
The proposals, drawing support from both labor and
employers, were well received in the market, and some of

207

the uncertainties that had been weighing on sterling began
to lift. Over the remainder of July, the pound was buoyed
by the covering of positions short of sterling and long of
Continental currencies that had been built up in previous
weeks, as well as by substantial demand for end-of-month
oil tax and royalty payments. Although by July 31 the spot
pound had eased back to $2.15V^ against the dollar, it
had gained against major Continental currencies, and the
effective trade-weighted depreciation had narrowed to
26.3 percent.
SWISS FRANC

Through much of 1974, Switzerland’s economy had
operated at almost full capacity, as a continuing buoyancy
in the export sector helped maintain production levels
even as domestic demand slowed. Meanwhile, the inflation
rate held around 10 percent, lower than in many other
industrialized countries but still well above that for Ger
many, its major trading partner. The Swiss authorities,
therefore, continued to pursue an anti-inflationary pro
gram which, after a proposed tax increase was rejected,
depended on a relatively strict monetary stance. This policy
was relaxed only gradually as the domestic economy
weakened late in the year. As a result, liquidity remained
relatively tighter in Switzerland than in the Euro-dollar
market or in many other Continental financial centers.
Simultaneously, a scramble for francs to cover large open
speculative positions, the flight of capital seeking a haven
from political uncertainties, and OPEC efforts to diversify
their large surplus revenues generated periodically heavy
bidding for the Swiss franc. Thus, the franc spearheaded
the rise of European currencies against the dollar from
November 1974 through January.
The decline in competitiveness resulting from this sharp
appreciation of the franc put new strains on many Swiss
export industries already hurt by the deepening recession
in other countries. To prevent a rise in the rate, the
Swiss authorities as early as November 1974 reimposed
a ban on interest payments to nonresidents and a negative
charge on new inflows of foreign funds. Moreover, to
accommodate an expansion of economic activity, the Na
tional Bank adopted a target for liquidity expansion in
1975 of 6 percent. When these moves failed to contain a
further strengthening of the franc early in January, the
Swiss National Bank resumed for the first time in two
years outright foreign exchange intervention in Zurich.
The National Bank bought dollars repeatedly during the
month, at times quite heavily, supplementing its inter
vention by tightening capital controls further and by
requiring banks to balance overall foreign exchange

208

MONTHLY REVIEW, SEPTEMBER 1975

positions daily. The Federal Reserve had also intervened
to sell francs, raising new swap drawings on the National
Bank to $26.6 million. Even so, market forces drove the
franc persistently higher, and by January 27 the spot rate
had climbed to $0.4195, almost 27 percent above its
September 1974 low against the dollar and up 9 per
cent against the German mark.
With the markets generally nervous and unsettled, the
Swiss National Bank joined the Bundesbank and the Fed
eral Reserve in a coordinated intervention approach fol
lowing the London meeting of February 1. The Federal
Reserve followed up operations in Frankfurt and Zurich
on February 3 by placing offers of francs, together with
other currencies, in the New York market and selling $24.1
million equivalent drawn on the swap line with the
National Bank. Later, Swiss National Bank President
Leutwiler publicly confirmed the weekend agreement and
the Swiss intervention. The market responded favorably
to this explicitly coordinated operation, and the rate
dropped to $0.3907 by New York’s opening on February
4, fully 6 3A percent below its January peak.
Almost immediately, however, generalized pressure on
the dollar reemerged. With the franc rising once again, the
market came to fear that additional limits on capital inflows
would be imposed and funds were increasingly shifted into
those Swiss securities still available to nonresidents. The
franc’s rise accelerated toward late February, and both the
Federal Reserve and the Swiss National Bank intervened
to maintain orderly market conditions. Operating on ten
of the sixteen business days from February 4 through Feb
ruary 27, the System sold $99.2 million of Swiss francs,
bringing total sales for February to $123.3 million equiv
alent, all drawn on the swap line with the Swiss National
Bank. Largely reflecting the joint intervention, Swiss re
serves increased $321 million during that month.
By end-February, the Swiss franc had peaked at $0.4188
and upward pressure on the rate had tapered off as senti
ment toward the dollar began to improve. In response to
earlier declines in United States and Euro-dollar interest
rates, the Swiss National Bank lowered its discount rate
from 5Vi percent to 5 percent. Moreover, the National
Bank provided for the commercial banks’ quarter-end
needs, largely through dollar swaps, so that temporary
money market strains would not exert upward pressure on
the franc. It proposed a gentleman’s agreement under
which Swiss banks would report large foreign exchange
transactions to the central bank to forestall potentially
destabilizing speculative inflows. And it raised the overall
ceiling for foreign placements in the Swiss capital market
to encourage long-term outflows while simultaneously
absorbing the remaining liquidity excess that had not been

neutralized by February’s reserve requirement increase.
Meanwhile, in the exchange market, rumors had begun
to circulate, later confirmed, that the Swiss government
hoped to associate the franc with the EC snake. This pros
pect at first unsettled the market, and the Federal Reserve
supplemented its intervention in marks during early March
with offerings of Swiss francs, selling $9.5 million equiv
alent financed by further swap drawings. But soon the
market came to expect that a potential link with the snake
would limit the franc’s rise against other European cur
rencies. Moreover, interest differentials in favor of the
United States had begun to widen. Consequently, the Swiss
franc began a sustained decline that carried through the
first half of April, not only against the dollar but also
against the German mark. Toward the end of March, the
Federal Reserve began a program of moderate purchases
of francs from the National Bank against its outstanding
swap indebtedness and by April 22 had liquidated all
$159.4 million of its 1974-75 debt.
By mid-April the Swiss franc had dropped fully IV 2 per
cent from its record highs of late February to $0.3873.
Toward midmonth the Swiss National Bank moved further
to prevent renewed upward pressure on the franc and

FEDERAL RESERVE BANK OF NEW YORK

209

Table IV
U N IT E D STATES TREASURY SECURITIES
FO REIGN CURRENCY SERIES
In millions of dollars equivalent
Issues ( + ) or redemptions (—)
Amount
outstanding
January 1, 1975

Issued to

Swiss N ational B ank ......

Total ....

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

1,599.3

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

1,599.3

to stimulate a lagging Swiss economy by cutting reserve
requirements against foreign liabilities, lifting ceilings on
bank credit expansion, and instituting specific measures
to assist the hardest pressed sectors of the economy. In
addition, the National Bank intervened, buying dollars
both in Switzerland and through the intermediary of the
Federal Reserve Bank of New York. In response, the franc
held relatively steady through the last half of April.
In early May, the spot rate was bid up abruptly as pres
sure against the dollar reemerged. The Swiss National
Bank responded to stepped-up bidding for francs by spot
intervention and by dollar swaps which provided short
term liquidity assistance. But, as the dollar continued to de
cline and markets remained unsettled, the franc continued
to be pushed up sharply, with only a brief pause after the
National Bank further reduced its discount and Lombard
rates. The spot franc soon pushed through the $0.4000
level to a peak of $0.4065 on May 13. To moderate the
rise, the Swiss National Bank intensified its spot interven
tion and on May 30, for the second time since April, low
ered minimum reserve requirements against foreign liabili
ties to release additional domestic liquidity.
Early in June, market sentiment began to shift in favor
of the dollar on the prospects of an earlier economic re
covery in the United States than in Europe and a renewed
firming of short-term interest rates here. At the same time,
liquidity in Switzerland remained unusually comfortable
ahead of the quarter end, and the Swiss National Bank
was called upon to provide only about $400 million of
the $1 billion quarter-end swap assistance it offered. Even
so, the Swiss franc held steady throughout June on market
concern that large shifts out of sterling might generate
further inflows into Continental currencies.

Amount
outstanding
July 31, 1975

1975

July

1,599.3

-0 -

1,599.3

In July the Swiss franc declined in sympathy with the
generalized weakening of European currencies, dropping
9 percent to a low of $0.3697 late in the month. But the
Swiss franc’s decline lagged behind that of the mark which
was depressed by the unwinding of speculative long posi
tions in marks and the liquidation of investments in markdenominated securities. As the franc-mark rate strength
ened, prospects of an early link of the franc with the snake
faded, and those who had built up positions in the hopes
that the franc would weaken relative to the mark began to
cover their open positions. There was, therefore, sporad
ically heavy bidding in francs at times throughout the
month, which the Swiss National Bank countered with fre
quently sizable purchases of spot dollars. As it turned out,
the franc ended the six-month period virtually unchanged
vis-a-vis the mark. But against the dollar it dropped IV 2
percent below early-February levels and fully 11 V4 per
cent below its late-February peak.
FRENCH FRANC

Throughout 1974, France had been pursuing
restrictive monetary and fiscal policies to slow domestic
inflation and reduce its balance-of-payments deficit. By
the turn of the year the pace of price increases, which
had reached over 15 percent per annum, had started to
decelerate. In addition, the current account, plunged
sharply into deficit by a $6 billion higher oil bill for 1974,
was benefiting from a striking turnaround in French
trade. Indeed, an unusually heavy inventory liquidation,
a drop in energy requirements, and an improvement in
France’s terms of trade resulting from the franc’s appreci
ation since mid-1974 pushed the trade balance back into

210

MONTHLY REVIEW, SEPTEMBER 1975

surplus by December 1974— earlier than generally ex
pected— while newly announced export contracts to
OPEC brightened prospects for 1975. Meanwhile, a sub
stantial part of France’s current-account deficit had been
financed both by large-scale borrowings by French enter
prises in international capital markets, often with govern
ment encouragement, and by short-term inflows induced
by the relatively high interest rates available in France.
By late 1974, as economic recession spread through
out the industrial world, business activity in France had
also begun to contract. In response, in January 1975,
the Bank of France began to relax monetary policy cau
tiously by cutting the discount rate by 1 percentage point
to 12 percent and reducing reserve requirements. But,
with inflation still higher than in many other major coun
tries, the monetary stance remained relatively restrictive,
leaving interest rates in France above those prevailing
elsewhere and providing incentives for inflows of foreign
funds and for borrowings abroad by French enterprises.
The combination of an improved trade account and
capital inflows thus buoyed the franc in the exchanges,
and the spot rate rose almost uninterruptedly in early 1975.
In January, some covering of short positions taken twelve
months before when France withdrew from the EC snake
gave further impetus to the franc’s advance not only
against the dollar but against other continental European
currencies as well. This rise continued in February, as the
market responded to the generalized weakness of the dol
lar and became increasingly sensitive to the possibility of
large OPEC shifts into francs. By February 27 the franc
had reached a high of $0.2413, up I 6V2 percent from the
September 1974 lows. To moderate the franc’s advance,
the Bank of France purchased dollars, contributing to the
$133 million increase in official exchange reserves in
February.
In March and April, as the recession deepened and
unemployment rose to twice the level of eight months
before, France adopted selective fiscal measures particu
larly to stimulate private investment and the building
sector. The Bank of France continued to move cautiously
toward ease, lowering its discount rate in two steps to
10 percent by mid-April. Interest rates abroad were gen
erally lower, however, and arbitrage incentives favoring
the franc remained large. In the exchange markets, there
fore, the franc held relatively firm even as it joined other
currencies in easing against the dollar during late March
and early April.
In mid-April, however, the demand for francs intensi
fied. France’s trade balance was moving into sizable sur
plus. High French interest rates were generating substantial
prepayments by OPEC and other importers of French

goods. In addition, following recently imposed Swiss reg
ulations on foreign currency positions, Swiss banks were
unwinding short French franc positions. As these commer
cial, financial, and technical demands prompted large shifts
of funds from other currencies, the franc again rose against
the dollar and more generally to within reach of its
previous central rate against the mark and other EC cur
rencies. At that point, expectations of a renewed link
between the franc and the other members of the EC bloc
prompted further speculative demand.
On May 9, President Giscard d’Estaing announced
that, in view of the substantial improvement in its trade
position, France intended to rejoin the snake at an early
date. This evidence of official confidence in the franc fur
ther highlighted the remarkable turnaround in the French
payments position since early 1974. After an initial hesi
tant response, traders soon reacted by bidding the franc up
even further. Demand became so heavy that the franc
began to pull up other currencies with it against the dol
lar. The Bank of France, which had operated regularly
to moderate the franc’s rise both against the dollar and
against other European currencies, intervened more
heavily, thereby contributing to the $860 million increase
in official exchange reserves in the March-May period.
Market forces nonetheless drove the franc persistently
higher in occasionally hectic trading.
By New York’s opening on May 22 the franc, at
$0.2504, had gained almost 6 percent from mid-April
levels and, with the advance accelerating, had risen IVs
percent in just a day and a half. At that point, the Bank of
France and the Federal Reserve agreed that intervention
by the System in the New York market, in coordination
with ongoing intervention in Paris by the French central
bank, would be appropriate to avoid c n outbreak of dis
orderly trading conditions. Around midmorning, the Trad
ing Desk, which had already placed offers of marks in the
market, stepped up its intervention by offering sizable
amounts of French francs as well as Dutch guilders and
Belgian francs. The dollar soon steadied against other
Continental currencies, but the French franc remained well
bid. The Federal Reserve, therefore, continued to sell
francs throughout the day, bringing total sales to $45.6
million equivalent, financed by a drawing on the swap
line with the Bank of France.
These joint operations, widely reported in the press,
helped brake speculation in favor of the franc. Except for
a brief flurry of demand in Europe on May 26, when the
New York market was closed for Memorial Day, the franc
fell back, dropping over 2 percent to $0.2470 by May 30
on rumors of possible new French measures to deter in
flows of funds to France. The Federal Reserve took ad-

FEDERAL RESERVE BANK OF NEW YORK

211

The French government denied any intention of deval
uing the franc, and on July 10 the franc returned to the
snake at the existing central rate. Speculative pressures
against the franc quickly evaporated, and the covering of
short positions soon pushed the rate up against other EC
currencies to near the middle of the 2V4 percent band.
The franc joined in the general decline against the dollar,
however, which continued through the rest of July. By
the month end the spot rate had fallen back to $0.2288,
down 9 percent from its June peak and 1V2 percent from
the early-February level.
N ETH ER LAN D S GUILDER

vantage of the franc’s decline to purchase francs and
liquidate $3.1 million of swap debt.
In early June, the Bank of France moved further to
ease monetary policy by, among other things, reducing
its discount rate by another V2 percentage point, to 9 V2
percent, and liberalizing credit ceilings for the banks. Nev
ertheless, renewed heavy commercial demand and capital
inflows soon pushed the franc as high as $0.2516, and the
Bank of France again intervened to resist the rise. With
trading conditions for the dollar now generally more set
tled, however, the Federal Reserve did not intervene.
After mid-June the franc began to ease in line with other
currencies against the dollar. On June 26, French Finance
Minister Fourcade indicated that, in view of the improv
ing conditions in domestic financial markets and the
strengthening in the French payments position, there
was no need to borrow abroad. Since by then French
borrowers had raised well over $lVi billion abroad in
1975, the market immediately began to reassess the out
look for the franc on the expectation that it would no
longer be strengthened by substantial capital conversions.
Moreover, the franc came under heavy speculative selling
pressure in response to rumors that it would be formally
devalued before France reentered the EC currency ar
rangement on July 10. As the spot rate dropped, the Bank
of France intervened to cushion the decline through dol
lar sales, while the Federal Reserve bought sufficient
French francs in the market to liquidate the remaining
$42.5 million of outstanding swap debt with the Bank of
France.

The Netherlands was one of the first countries to take
stimulative measures last year as the economy turned
sluggish. As early as September, the government moved
to reduce income taxes, raise investment incentives, and
otherwise establish an expansionary course for budgetary
policy. On the other hand, the authorities kept monetary
conditions moderately firm in an effort to contain infla
tion which, though less severe than in many other coun
tries, was still at a rate exceeding 10 percent. In addition,
the already sizable current-account surplus was expected
to be boosted further by higher natural gas export receipts.
In view of the strong trade position and relatively taut
money market, the guilder attracted funds from abroad at
times when the dollar was generally under pressure late in
1974 and early in 1975. Although the Netherlands Bank
and the Federal Reserve intervened to buy dollars, the rate
had climbed over 13V^ percent from September 1974
lows to $0.4175 by the end of January. At that time, $3.2
million of Federal Reserve swap debt remained outstand
ing with the Netherlands Bank from operations in De
cember 1974.
In early February the guilder joined in the renewed
upsurge of Continental currencies. The Netherlands Bank
bought modest amounts of dollars in Amsterdam on
February 3, and the Federal Reserve followed up in New
York by selling $26.9 million equivalent of guilders drawn
on the swap line. This operation triggered an immediate
drop in the guilder rate. Meanwhile, the Netherlands Bank
continued to provide substantial temporary liquidity to the
commercial banks, largely by purchasing dollars spot and
simultaneously selling them forward, to prevent seasonal
cash needs from pushing domestic interest rates any higher.
It did not, however, follow other central banks in reducing
its discount rate early in February. Thus, as foreign interest
rates eased, interest incentives favoring the guilder widened.
In response, the guilder rose steadily throughout the month,
pushing toward the top of the EC snake. The Federal

212

MONTHLY REVIEW, SEPTEMBER 1975

Reserve therefore supplemented its intervention in marks
and other European currencies on February 27 with
offerings of guilders and sold $20 million equivalent of
guilders, financed by a swap drawing on the Netherlands
Bank. Nevertheless, the guilder continued to rise, reaching
a peak of $0.4285 on March 3.
On March 6, when the Bundesbank announced further
cuts in its discount and Lombard rates, the Netherlands
Bank signaled a relaxation of Dutch monetary policy with
a full percentage point reduction in its discount rate to 6
percent. This larger than expected cut generated an im
mediate response, both in the domestic money market and
in the exchanges where the guilder slipped just below the
top of the EC snake while easing back with other curren
cies against the dollar. The guilder’s downtrend proceeded
through most of March until March 25, when news of
King Faisal’s assassination briefly unsettled the markets
and prompted an abrupt rise in all European currencies.
The Federal Reserve placed small offers of guilders to
gether with marks and Belgian francs in the New York
market that day to avoid further sharp declines in dollar
rates. The market soon settled down, however, and the
System sold only $2.1 million equivalent of guilders,
financed on the swap line with the Netherlands Bank.
For the next several weeks, even though seasonal fac
tors were by now substantially easing liquidity in Amster

dam, the Netherlands continuing current-account surplus
kept the guilder relatively firm among European curren
cies, obliging the Netherlands Bank to intervene against
the German mark at the bottom of the EC band. In view
of the guilder’s position within the snake, the Federal Re
serve operated in guilders, along with marks, on four
occasions from May 7 through May 13 when, first, heavy
demand for French francs and, then, the Mayaguez inci
dent threatened to disrupt the exchanges. Guilder sales
totaling $29.3 million equivalent were financed by swap
drawings on the Netherlands Bank, which for its part
purchased dollars in moderating the guilder’s rise in Am
sterdam. Again on May 21-22, when the guilder was
pulled up in an upsurge led by the French franc, this Bank
offered guilders along with other currencies, selling an
additional $18 million equivalent financed by further swap
drawings. By contrast, on days when the guilder eased,
the Federal Reserve purchased sufficient guilders to repay
$8.5 million equivalent. On balance, guilder swap com
mitments rose to a peak of $91 million by May 27.
By the end of May, the economic slowdown in the
Netherlands was deepening as a result of the continued
recession elsewhere in Europe. Consequently, the Nether
lands Bank had adopted a generally accommodative mone
tary stance, although it temporarily absorbed some of the
excessive liquidity that emerged from time to time. By
mid-June, therefore, favorable interest rate differentials
had been eroded sufficiently to weaken the guilder against
other EC currencies as well as against the dollar, which
was generally gaining against all currencies by that time.
In addition, the government was putting into place new
stimulative economic measures. But, as the market re
sponded to the gloomier European economic situation
which now contrasted sharply with the increasingly opti
mistic outlook for the United States, the guilder declined
rapidly with other Continental currencies in late June and
through July. By the end of July, the spot rate had fallen
almost 11% percent from its March highs to $0.3780,
with the Netherlands Bank occasionally selling modest
amounts of dollars to moderate the drop. Meanwhile, the
Federal Reserve had taken advantage of the dollar’s
buoyancy to buy sufficient guilders in the market to liqui
date fully the outstanding swap drawings on the Nether
lands Bank by July 1.
BELGIAN FRANC

As in other countries, business activity in Belgium had
begun to slow down late in 1974. Nevertheless, upward
pressures on domestic prices had persisted, fueled by a
rapid acceleration of wages, rents, and pension payments

FEDERAL RESERVE BANK OF NEW YORK

that are automatically adjusted under price-indexation
schemes. Thus, the Belgian authorities had proceeded
cautiously in relaxing restrictive monetary and fiscal
policies. Following earlier reductions in interest rates in
other countries, the National Bank cut its discount rate Vi
percentage point to 814 percent on January 30. In the ex
changes, steady commercial demand, reflecting Belgium’s
widening current-account surplus, helped to strengthen the
Belgian franc both against the dollar and against other EC
currencies. By the end of January, the Belgian franc had
risen almost 15 percent from its September 1974 lows to
$0.029035, while holding firm at the top of the EC snake.
Against this background, the Belgian franc joined in
the general rise of European currencies against the dollar
in February. As part of the Federal Reserve’s multicur
rency intervention, the Federal Reserve sold $10 million
equivalent of Belgian francs on February 3. When general
ized pressures reemerged later in the month, the Trading
Desk followed up with sales of $6.6 million equivalent on
February 27. These sales were financed by drawings on
the swap line with the National Bank of Belgium. For its
part, the National Bank made small purchases of dol
lars in Brussels to moderate the advance of the franc
rate. It also continued to intervene within the EC snake
against the Danish and Norwegian kroner, the currencies
then at the bottom of the 2lA percent band. Partly reflect
ing these operations, Belgian official reserves rose $320
million in February. By March 3 the Belgian franc had
peaked at $0.029500, before subsequently easing back
with the other European currencies.
By this time, Belgium’s economic dilemma had become
more acute. By comparison with most other countries, its
inflation rate was holding rather steady around 15 per
cent, now above that of its major trade partners, even as
the rate of unemployment increased. Concerned about
the potential loss of export competitiveness, the Belgian
authorities gradually introduced a series of measures de
signed both to stimulate the economy and to contain
inflationary tendencies. The National Bank reduced its
discount rate to 6 V2 percent in three steps from March 13
to the end of May, scheduled the release of commercial
bank reserves held in blocked accounts, and allowed bank
credit ceilings to lapse when they expired. In addition, the
Belgian government announced a two-month price freeze
on May 1, extended in July for another three months, and
also outlined various fiscal measures to improve corporate
liquidity and to encourage exports.
As monetary conditions in Belgium therefore became
more comfortable, the favorable interest differentials vis-avis Euro-dollar rates narrowed. Short-term funds were
again placed abroad, and capital exports by Belgian and

213

C h a r t V III

BELGIUM

1974

1975

* S e e fo o tn o te on C h a rt III.
^ C e n t ra l rate e sta b lish e d on F ebru ary 12, 1973.

Luxembourg residents of nearly $300 million were recorded
by the end of the first quarter. Whereas these outflows
weighed on the financial Belgian franc, the commercial
rate was benefiting from the further strengthening in Bel
gium’s trade surplus that resulted from a deepening reces
sion at home. Consequently, the commercial rate remained
at the top of the EC snake, as the EC currencies retreated
from their highs against the dollar. After the German mark
settled to its lower intervention point, the National Bank of
Belgium and the Bundesbank intervened in moderate
amounts to maintain the prescribed limits.
As the dollar generally improved early in April, the
Belgian franc continued its downtrend, and the Federal
Reserve was able to acquire sufficient Belgian francs in
the market from April 8 through April 18 to repay in
full the recently incurred $16.7 million swap debt. By
April 21 the Belgian franc had fallen 33A percent from
its March highs to $0.028350. It then began to firm with
other European currencies against the dollar. In May,
therefore, the Federal Reserve supplemented its interven
tion in other currencies with sales of Belgian francs on
two occasions when the markets became unsettled. On
May 13, after the markets reacted to Cambodia’s seizure
of a United States merchant ship by marking dollar rates
sharply lower, the System sold $4.3 million equivalent of
Belgian francs along with marks and guilders. Then on
May 22, as a further sharp rise in the French franc led to
generalized bidding for Continental currencies, the Desk
sold $8.8 million equivalent of Belgian francs along with

MONTHLY REVIEW, SEPTEMBER 1975

214

three other currencies. These Belgian franc sales were
financed by further swap drawings on the National Bank
of Belgium. Subsequently, with the dollar generally steadier,
the Belgian franc leveled off and then began to ease in early
June. At the same time, the franc remained relatively firm
against other EC currencies. As market conditions per
mitted, the Federal Reserve purchased modest amounts of
francs to liquidate swap debt and by June 23 had repaid
the drawings incurred in May.
When the dollar rallied against other major currencies
in late June and through July, the Belgian franc fell off
sharply as well. By the end of July the commercial rate had
fallen to $0.026080, some WV 2 percent below its March
highs. In July the commercial franc also eased somewhat
against other EC currencies and settled toward the middle
of the EC band.
ITALIAN LIRA

During 1974 the Italian authorities had pursued a policy
of severe monetary restraint to deal with a massive oilinduced payments deficit, high and accelerating inflation,
and a weakening lira. By early 1975, price inflation was
slowing dramatically from the 25 percent level of last year.
Moreover, Italy’s trade deficit had narrowed sharply, as
imports were down drastically and exports were holding
up, bolstered by a sharp rise in sales to OPEC countries.
These improvements had spurred growing confidence in
the lira which, coupled with record-high interest rates in
Italy, stimulated substantial reflows of funds that had left
the country during recurrent crises last year. The Bank of
Italy was therefore able to begin cautiously easing its
restrictive monetary policy to counter the deepening do
mestic recession.
In this generally more favorable climate, the lira joined
in the overall advance of European currencies against the
dollar during February. It rose 3 percent to a high of
$0.001597 by March 3, and the Bank of Italy had resumed
purchasing dollars. Accordingly, the Bank of Italy repaid
on March 5 the first $500 million instalment of the $2 bil
lion gold-pledged credit it had received from the Bundes
bank in 1974. The repayment was financed in part from
recent reserve gains and in part by a further Italian drawing
of $375 million on its outstanding standby credit tranche
with the IMF. Of this amount, $102.3 million was drawn in
German marks, which were then purchased by the System
to be held in connection with its operations in German
marks.
Unlike other currencies, the lira held relatively firm
even as the dollar began to recover in March and April.
A further narrowing in Italy’s trade deficit to $1 billion

in the first quarter and continued easing of inflationary
pressures provided an improving undertone to the lira.
As Italian interest rates remained well above those else
where in Europe, the repatriation of previous capital out
flows intensified. The Bank of Italy therefore was able
to purchase substantial amounts of dollars. Even after
Italy’s repayment to the Bundesbank, liquidation of some
$400 million of Euro-dollar borrowings by Italian public
corporations, and large interest payments on foreign debt,
Italy’s official reserves were by the end of April about
$300 million above end-January levels.
Meanwhile, output in Italy in the first quarter had
dropped some 13 percent below the previous year’s level.
A worsening business outlook and a plunge in corporate
profits had severely depressed investment, while the pros
pect of rising unemployment had contributed to a down
turn in private consumption. The Italian authorities
therefore took further steps to relax gradually some of their
restrictive policies. On March 24, they lifted the 50 percent
import-deposit requirement, thereby releasing liquidity
to the banking system. Furthermore, new selective credit
facilities for agriculture, exports, and construction were
introduced and the 15 percent ceiling on bank credit growth
was suspended. As liquidity eased, the commercial banks
lowered their deposit and lending rates, and in late May the
Bank of Italy followed up by cutting its discount rate 1
percentage point to 7 percent. Under these conditions,
capital imports slowed and the Bank of Italy’s net dollar
purchases tapered off. But the rise in European currencies

215

FEDERAL RESERVE BANK OF NEW YORK

generally against the dollar during May pulled the lira
higher to $0.001608 by June 3.
By early summer the deep and protracted slowdown
in Europe had dimmed hopes for a strong growth of Italian
exports that might lead the country out of its recession.
With unemployment in Italy rising and growing dissatis
faction over the economy dramatized by the strong show
ing of the Communist and Socialist Parties in the June
15-16 local and regional elections, expectations mounted
that the government would be forced to take substantial
reflationary measures. Market sentiment toward the lira
worsened, short-term capital flows reversed direction, and
commerical leads and lags shifted against Italy. Conse
quently, pressure against the Italian lira began to reemerge
after mid-June, and the lira joined the subsequent drop of
all European currencies. At the end of July the government
announced a $5 Vi billion package of stimulative economic
measures. Amidst warnings from outgoing Bank of Italy’s
Governor Carli that this new program could reignite infla
tion and set the stage for a renewed surge of imports, the
lira dropped to $0.001505 by the end of July. To cushion
the decline, the Bank of Italy resumed heavy dollar sales
which contributed to the $ 1.2 billion fall in gross official
reserves during June-July. Nevertheless, the lira closed
4 percent lower on balance against the dollar than its level
at the beginning of the reporting period. The lira rate had
advanced, however, against other European currencies.
JAPANESE YEN

Faced with virulent domestic inflation, the Japanese
authorities had pursued a policy of economic austerity
through 1974. By February 1975, consumer price increases
had slowed to about 13 percent, just half the rate the year
before. In addition, as domestic demand fell off and inven
tory financing became increasingly burdensome, Japanese
manufacturers accelerated their export shipments and cur
tailed imports, swinging Japan’s balance of trade dra
matically from a sizable deficit to a $2.2 billion surplus
by the second half of 1974. The market was therefore
quickly regaining confidence in the near-term prospects
for the Japanese yen. Moreover, strong reaffirmations by
officials of the Bank of Japan and incoming Prime Min
ister Miki of Japan’s determination to persist in a policy
of monetary restraint contrasted sharply with the world
wide trend toward lower interest rates. Consequently, the
spot rate began to strengthen by mid-January from the
levels around which it had traded for several months.
The yen extended its advance throughout February,
partly in sympathy with the sharp rise of European cur
rencies against the dollar. In addition, sizable net capital

Chart X

JAPAN
M O V E M E N T S IN E X C H A N G E R A T E *
P erc e nt

P e rc e n t

1974
*S e e

197 5

fo otn o te on C h a r t III.

inflows helped sustain the rise. New foreign issues by Jap
anese corporations picked up, following the relaxation of
restraint on borrowing abroad for domestic financing
needs, and part of the proceeds were converted into yen.
Foreign purchases of Japanese stocks and bonds also
accelerated. As capital inflows built up, the market pre
sumed there was some OPEC diversification into yen,
a prospect which further encouraged bidding for the cur
rency. By March 4 the spot rate therefore had advanced
4 V2 percent to $0.003517, the highest level since June
1974. The Bank of Japan, intervening to moderate the
rise, bought dollars during February and early March,
which contributed to a $644 million official reserve in
crease during those two months. Once the generalized
pressure against the dollar began to fade during March,
however, the yen also began to ease back from its peak.
By the month end the yen had dropped by some 3 percent
to around $0.003400, before steadying in April.
During the spring, economic indicators gave increasing
evidence that Japan was experiencing its worst recession
since the war. Output had actually dropped, and unem
ployment had topped one million persons. At the same
time, the rise in consumer prices slackened further to an
annual rate of only about 6 percent in the first quarter,
wholesale prices remained steady, and annual wage settle
ments averaged only about 13 percent, compared with
close to 30 percent the year before. The government there
fore was prepared to shift to a cautiously expansionary
policy to stimulate an incipient recovery in industrial pro
duction. It accelerated public works expenditures and took
other selective relief measures. But, despite two Vi per
centage point cuts in the Bank of Japan’s discount rate to

MONTHLY REVIEW, SEPTEMBER 1975

216

8 percent, monetary policy remained relatively restrictive
and Japanese interest rates remained high. In April and
May, foreigners took advantage of a premium on the for
ward yen to place funds in Japanese government securi
ties on a covered basis. Partly as a result of these inflows,
the yen firmed again in May, reaching $0.003443 toward
the month end. But, as the premium on the forward yen
decreased, these inflows tapered off and, with the de
mand for dollars to meet import settlements increasing,
the yen rate began to drift lower in early June.
By that time, revised forecasts in the Japanese press
and elsewhere were pointing to a deeper and longer last
ing worldwide recession than had been anticipated earlier
and, consequently, projections for Japanese exports were
drastically revised downward. In addition, OPEC was dis
cussing the possibility of a substantial hike in oil prices
in the fall, raising fears of another large bulge in Japan’s
oil import bill. This significantly worsened outlook for
Japanese trade turned the market abruptly bearish toward
the yen, and the spot rate dropped back sharply just
after midmonth. As the rate fell through the ¥295
($0.003390) level, Japanese banks moved to buy dollars.
The yen then came heavily on offer, and the Bank
of Japan intervened to sell dollars to moderate the fall
in the rate. These sales reassured the market, and in late
June the yen bottomed out at $0.003356 in Tokyo. Trad
ing then quieted and, as the market came into better bal
ance, the yen held steady throughout July to close the
period at $0.003362, slightly above last February’s levels.
CANADIAN DOLLAR

Market sentiment toward the Canadian dollar grew
increasingly bearish in late 1974 and early 1975, as the
deepening recession in Canada’s major export markets—
particularly the United States— led to a serious erosion in
Canada’s trade balance. Unlike other industrial countries,
which were hard hit by costlier oil imports, Canada main
tained a small surplus in petroleum and natural gas
products. But nonenergy exports fell rapidly and, with im
ports rising, Canada’s current-account deficit widened to
over Can.$1.6 billion in 1974. Moreover, that deficit was
generally expected to grow further k early 1975 until
economic activity abroad began to recover. The deteriora
tion in Canada’s trade position exerted a heavy drag on
domestic economic activity. As early as November 1974,
the government had provided some budgetary stimulus
and monetary policy was also relaxed. Canadian money
market rates therefore dropped off about in line with de
clining United States interest rates early this year, provid
ing little inducement for inflows of arbitrage funds. Pros

C h a rt X I

C AN ADA
M O V E M E N T S IN E X C H A N G E R A T E *
P e rc e n t
12

P erce nt
12

10 -

2 1

0
J

1
A

1
S
1974

1
O

1 1 1 1 ...

1
N

1
J

1.
J

0
A

1975

^ M e a s u r e d a s p e rc e n ta ge d e v ia tio n s from the $0.92/2 offic ia l parity e sta b lish e d
in M a y 1962. The C a n a d ia n d o lla r h a s been flo a tin g since June 1, 1970.

pects were also uncertain for a substantial increase in
long-term foreign borrowings to finance the mounting
current-account deficits.
Against this background, the Canadian dollar generally
remained on offer in the exchanges. It fell by some 4 per
cent against the United States dollar between mid-1974
and early-February 1975, when it slipped below the $1.00
level for the first time since late 1973. The spot rate then
stabilized, as Canadian interest rates did not follow further
interest rate declines in the United States and as some
short positions taken up during the currency’s protracted
decline were covered. Moreover, OPEC investors, in seek
ing to diversify the currency composition of their holdings,
began making sizable placements in Canadian dollars.
Conversions of Canadian provincial issues abroad and
positioning ahead of expected future placements also
helped buoy the Canadian currency over the rest of
February, pushing the rate to as high as $1.0050 by the
month end. As these financial demands subsided, the Cana
dian dollar then settled back to trade quietly around $1.00
through late March.
The market remained pessimistic over the Canadian
dollar’s near-term prospects, however, leaving it vulner
able to renewed downward pressure. Even as unemploy
ment mounted, large wage settlements raised concern that
an upsurge of prices in Canada at a time when inflation
was abating elsewhere could undermine the competitive
ness of Canadian goods in world markets. Already Can
ada’s trade and current-account deficits had deepened
during the first quarter. In addition, unsettled conditions in
the United States bond markets early in April led to post
ponement of several planned Canadian borrowings, which

217

FEDERAL RESERVE BANK OF NEW YORK

left a temporary but sizable shortfall in long-term capital
inflows to finance Canada’s ongoing current-account defi
cit. As market participants responded to these develop
ments and attempted to unload the Canadian dollars they
had acquired in anticipation of forthcoming borrowings,
the Canadian dollar was driven down progressively through
most of April and early May. The Bank of Canada inter
vened with increasing forcefulness to cushion the decline,
and the spot rate bottomed out at $0.9659 on May 13, a
four-year low.
The rate steadied over subsequent days, and by the
end of May the bearish market sentiment toward the
Canadian dollar began to lift somewhat. By that time,
Canadian borrowings abroad had resumed and Canada
had announced a small trade surplus for April. Moreover,
short-term Canadian interest rates had moved up while
United States interest rates were temporarily declining,
thereby widening incentives for short-term funds to flow
into Canada. In response, the Canadian dollar rebounded
to $0.9779 by the end of May. In moderating the rise, the
Bank of Canada bought United States dollars and reduced
the net reserve loss in April-May to $429 million.
Over June and July the market for Canadian dollars
was steadier, with the spot rate drifting gradually lower
in less active trading. Prospects for an early recovery of
the United States economy bolstered expectations of a
recovery of Canadian exports, as did news of potential
Canadian grain sales to the Soviet Union and announce
ment of a large trade agreement between Canada and
Iran. Moreover, despite the recession in Canada, the gov
ernment’s broadly neutral budget, announced in late June,
was taken as evidence of official concern over the con
tinuing high rate of inflation. The budget message also
included the proposed elimination of withholding taxes on
foreign purchases of long-term Canadian securities, pro
viding scope for further inflows. Meanwhile, conversion
of bond issues picked up and helped buoy the Canadian
dollar rate from time to time. These positive factors were
more than offset, however, by Canada’s continuing
current-account deficit. Consequently, the Canadian dollar
rate eased to $0.9696 by the end of July, still above the
early-May low but some 3 percent below early-February
levels. The Bank of Canada continued to intervene to
smooth abrupt movements in the rate, and official reserves
declined by a net of $577 million for the February-July
period as a whole.

confidence in international banking that had occurred
over much of 1974. The hard-hit interbank segment of
the market, which had actually contracted last summer,
had begun to expand again, although at a very hesitant
pace. The multitiered structure of interest rates that
emerged in the wake of several bank failures in major
countries had narrowed. The wide premiums of Euro
dollar rates over comparable United States deposit rates
had contracted. Many of the banks that had largely with
drawn from the market were cautiously stepping up their
activity. As confidence in the market improved, many who
had turned away from the market during last year’s dif
ficulties began to increase their Euro-currency holdings.
With the dollar coming under pressure in the exchange
markets in the first quarter, however, much of the expan
sion in the Euro-currency markets was concentrated in the
nondollar sectors, particularly in Euro-marks.
By the second quarter, expansion in Euro-currency activ
ity had become more broadly based and soon began to pick
up momentum. The revival in medium-term syndicated
loans was especially pronounced. With the worldwide re

C h a rt X II

INTEREST RATES IN THE UNITED STATES, C A N A D A ,
A N D THE EURO-DOLLAR MARKET
T H R E E -M O N T H M A T U R IT IE S *

Chart X III

SELECTED INTEREST RATES

EURO-DOLLAR

During the early months of this year the Euro-currency
markets continued to recover from the severe setbacks to

W e e k ly a v e r a g e s of daily, rates.

218

MONTHLY REVIEW, SEPTEMBER 1975

cession deepening and imports dropping in nearly all of
the industrial countries, developing countries that had em
barked on ambitious projects at the crest of the boom of
world commodity demand increasingly looked to the
Euro-currency markets to finance a shortfall of receipts.
Substantial loans were extended to several Latin American
countries, such as Mexico and Brazil. Indeed, with the
fall in petroleum demand worldwide, several OPEC coun
tries reappeared on the borrowing side of the market.
Eastern European countries were also heavy borrowers.
In addition, large sums were raised by institutions and
firms of a number of major industrial countries, notably
France. A high degree of selectivity continued to charac
terize the medium-term markets, however, reflecting the
banks’ concern over mounting balance-of-payments pres
sures in many parts of the world and the desire of many
major international banks to pay more attention to their
capital-asset ratios.
Subsequent to the steep decline of Euro-currency rates
late last year, investor interest in Euro-bonds revived
significantly, too. Thus, borrowers seeking to raise funds
for longer terms than they had been able to secure in
1974, or even for medium-term Euro-currency loans
in 1975, gradually increased their new issues both
through international syndicates and through private place
ments. A noteworthy feature of these issues was that most

were no longer denominated in United States dollars but
in the major Continental currencies, notably the German
mark and also the Dutch guilder and the Swiss franc. In
addition, several issues were denominated in the Euro
pean unit of account, in the European composite unit, and
in special drawing rights until the growing strength of the
dollar in recent months reduced the attractiveness of such
multicurrency issues. In sharp contrast to past years,
virtually all issues were offered by non-United States bor
rowers, mostly European governments as well as public
and private corporations in industrial countries. The ac
ceptance of this flood of issues was facilitated by strong
interest by OPEC investors.
Euro-dollar interest rates, having declined sharply
along with United States domestic money rates from
the fall of 1974 on, leveled off in February and March but
eased back again to two-year lows in early June. But in
response to a rebound in United States rates later that
month, Euro-dollar rates bounced back in July, so that
by the month end the three-month rate stood at 7 per
cent. Reflecting the still strong preferences of many sup
pliers of funds to the market for short-term maturities,
the yield curve for Euro-dollar deposits tended to be steeper
than for United States money market instruments, with
differentials between one-month and twelve-month rates
rising at times to more than 2 percent.

FEDERAL RESERVE BANK OF NEW YORK

219

Th e Business Situation
There now appears little doubt that the economy is
emerging from the most severe postwar recession. Re
vised estimates of gross national product (GNP) con
firm that a turnaround in economic activity occurred in
the second quarter.* Even more importantly, the latest
readings of the monthly business statistics suggest that the
nascent recovery has been picking up momentum. Con
sumption spending has provided the essential base of the
recovery, both directly by adding to the demand for final
goods and indirectly by facilitating the liquidation of ex
cessive inventories. Indeed, the massive inventory correc
tion seems to be diminishing, although some inventory
imbalances remain in certain sectors. In July, new durables
orders rose for the fourth consecutive month and industrial
production climbed for the second consecutive month. To
be sure, capital spending and residential construction are
lagging, but the beginnings of a recovery in home building
are visible. Moreover, recent developments in the labor
market have been, on balance, encouraging. Although the
civilian labor force increased sharply in August, the rate
of joblessness remained unchanged from the July level as
employment advanced strongly.
The price situation, however, has taken a turn for the
worse. After having eased a bit in earlier months of the
year, the rise in the consumer price index, propelled by
bulges in food and energy prices, advanced more sharply
in June and July. Moreover, wholesale prices rose rapidly
in August, as fuel and power prices jumped. Further in
creases are in the offing for some foods and for oil, alumi

*In contrast to the slight decline in real GNP in the second
quarter that had been indicated by the preliminary estimate, the
revised data show a modest advance of 1.6 percent at an annual
rate, the first increase since 1973. Inventory liquidation was re
vised downward from the preliminary figure, while final sales
were revised upward primarily as a result of an upward revision
in net exports. Released along with the GNP revisions was a pre
liminary estimate of pretax corporate profits (adjusted for changes
in inventory valuation). This estimate shows a rise of $6.2 billion
during the second quarter to a $100.5 billion seasonally adjusted
annual rate.

num, steel, and automobiles, despite the pronounced slack
that still remains throughout the economy.
PERSONAL INCOME, CONSUMER SPENDING, AND
R ES ID EN TIA L CONSTRUCTION

A $5.7 billion decline in personal income in July was
the result of a special situation. The previous month,
one-time payments of $50 had been made to recipients of
social security, railroad retirement, and supplemental secu
rity benefits. These transfer payments had amounted to
almost $20 billion at an annual rate, approximately three
and one-half times the size of the July decline in total
personal income. Wage and salary disbursements have
been expanding in recent months, after having reached a
nadir last February. In coming months, these disbursements
should continue to rise, assuming employment continues
to increase and the average workweek to lengthen. Aftertax
income should grow even faster, as lowered withholding
rates take effect in the second half of the year.
Consumption spending has recently been in the fore
front of the recovery. Total retail sales increased $1.2
billion in July. Sizable advances had also been recorded
in the preceding three months. As a result, for the four
months ended July, growth amounted to 26 percent at an
annual rate. Durable goods sales, led by a rebound in
automobile sales, have accounted for the bulk of this
upsurge in consumption spending. No doubt the recent
gains in personal income, on an aftertax basis, have been
a major factor in this advance. Just as important, but
harder to measure, has been the diminution in the mani
fold uncertainties that have dogged consumers for some
time, especially those related to inflation and employ
ment prospects. This development may explain the appre
ciable improvement in consumer confidence recorded
since late last year, as measured by the Conference Board
and the Survey Research Center of the University of
Michigan. It remains to be seen, however, what damaging
effect the latest price acceleration might have on the
growth of consumer spending. In any case, it seems clear
that the recent strength in consumption spending has
been instrumental in enabling retailers to pare their

220

MONTHLY REVIEW, SEPTEMBER 1975

inventory stocks to the point where little imbalance, if
any, remains in this sector. Thus, consumption spending is
having a dual effect in stimulating the economic recovery.
The sharp rebound in automobile sales in recent
months is reminiscent of developments in past recovery
periods (see Chart I). In the previous postwar cyclical re
coveries, real consumer outlays on automobiles have in
creased, on average, about 37 percent over the twelve
months following the trough. Whether new car purchases
in the current recovery will fully conform to this historical
pattern remains to be seen. Auguring a strengthening in
the demand for new cars is the presumably growing need
to replace the aging and less efficient stock of existing auto
mobiles. However, the replacement decision is fundamen
tally an economic one, based on income and employment
expectations and on the cost of purchasing and maintain
ing the car. In the latter regard, the recently announced
price hikes on the new 1976 models, coupled with the
prospect that the 1977 models will be more economical to
operate, might well induce many car owners to postpone

purchasing a new car until the 1977 models become avail
able. Judging by their production schedules and tentative
forecasts, the automobile manufacturers themselves do not
appear to be overly bullish about sales prospects over the
remainder of the year. In the event that purchases of the
1976 car models do not increase very much above those
of the previous year, thus departing from the pattern of
past recoveries, consumers can either save the retained
purchasing power or spend it on other goods. Which option
they choose will have a significant bearing on the scope
of the economic recovery.
The long-awaited upturn in residential construction
now appears to be getting under way. Housing starts
rose to a seasonally adjusted annual rate of 1.24 mil
lion units in July, up 16 percent from the average rate of
the second quarter and 41 percent above the low-water
mark recorded last December. Whereas virtually all of the
recovery in starts earlier in the year had been in single
family units, the July increase was centered in multipleunit dwellings. Spurred in part by the 5 percent tax credit,

Chart I

C O N S U M E R EXPENDITURES O N A U T O M O B IL E S
Billions of 1958 dollars

1953

Seasonally adjusted

Billions of 1958 dollars

N o te: S h a d e d a re a s re present re ce ssion pe rio d s, in d icate d by the N a t io n a l B ure au of Econom ic Re se arch (NBER) ch ro n o lo g y .
h a s not yet been d ate d by the NBER.
S o urce:

U nited State s D epartm e nt of Com m erce, B ure au o f Econom ic A n a ly sis .

The latest recession

FEDERAL RESERVE BANK OF NEW YORK

sales of new single-family homes by merchant builders
have risen substantially in recent months. Although such
sales edged down a bit in June, they continued, as had
been the case in the previous four months, to exceed the
additional new homes put up for sale. As a result, the
stock of unsold new single-family homes has receded to
the lowest level in three years, and an increasing propor
tion of this inventory has come to represent homes under
construction rather than completed dwellings.
Developments in the mortgage market have played a
key role in the recent upturn in home building. The flow
of deposits into thrift institutions in the last few months
has been heavy, although it is uncertain that the inflow
will continue at the recent high pace. In July, the savings
flows amounted to a 17.8 percent seasonally adjusted
annual rate, about equal to the growth over the first half of
the year and almost three times as large as that experienced
during the year ended December 1974. While the thrift in
stitutions have, in turn, channeled a large proportion of
these funds into securities, they have also been issuing
mortgage commitments. Indeed, outstanding mortgage
commitments of all savings and loan associations and
mutual savings banks in New York State increased at a 63
percent seasonally adjusted annual rate from February to
July, whereas they had actually decreased 26 percent
over the twelve-month period ended February 1975.
Since mortgage commitments must generally be secured
before construction financing can be arranged, the recent
growth in outstanding commitments suggests that home
builders are currently planning to undertake a large num
ber of new construction projects. However, while lending
terms for new mortgages eased slightly early in the year,
they currently are inching higher. Reflecting this increase
in rates on conventional mortgages, the maximum allow
able interest charge on Federally insured mortgages was
raised at the end of August by
percentage point to 9
percent. In addition, at the Federal National Mortgage
Association’s auction held at the end of August, secondary
market interest rates on four-month forward commitments
for insured mortgages were 33 basis points above those of
the previous month’s auction.
IND USTRIAL PRODUCTION, INVENTORIES,
AND C A P ITA L SPENDING

The Federal Reserve index of industrial production,
which had advanced 0.5 percent in June, increased by an
equal amount in July, bringing a halt to the 14 percent
decline that had been registered between November 1973
and May 1975. Most of this contraction took place be
tween September 1974 and February 1975, as firms

221

throughout the economy struggled to get out from under
the huge overhang of excess inventories. Early in 1974,
manufacturers had engaged in an all-out effort to rebuild
their stockpiles of raw materials and intermediate products,
items that had been in extremely short supply at the end
of 1973. As this replenishing was going on, however, the
aggregate demand for final goods faltered and then
plunged. At that point, what had been an inventory short
age suddenly turned into a glut.
This past June, higher output of both consumer goods
and nondurable materials finally more than offset con
tinued declines in other sectors. Output of textiles, paper,
and chemicals posted sharp rises in June and again in
July, suggesting that inventory liquidation may be nearing
completion in these industries. On the other hand, further
declines in production of most durable materials and of
business equipment indicate continued efforts to pare
inventories. The iron and steel industry has been especially
hard pressed; in July, output of iron and steel declined
for the sixth consecutive month to the lowest level since
1971. In retrospect, it appears that the strong demand for
steel in 1973 and through most of 1974 had depleted
steel-mill inventories. Thus, when the demand by large
steel customers dropped, part of the slack in demand
was offset by the rebuilding of steel mills’ own inventories.
By October, however, the mills had restored their inven
tories of ingots and semifinished shapes, such as rods and
wire. Iron and steel production then plummeted, at about
double the rate for all other industries. Despite the con
tinuing sluggish demand, several steel companies have
announced that, to offset increased production costs, they
intend to raise prices in early autumn. As a result, demand
for steel has apparently picked up in an effort by mill
customers to beat the announced price hikes.
New orders received by durable goods manufacturers
spurted in July by $1.7 billion, or 4.3 percent. The July
advance was broadly based and marked the fourth con
secutive monthly gain. Indeed, the expansion in new
durables bookings between March and July amounted to
15 percent, far greater than the growth in production. As
a result, the backlog of unfilled durables orders increased
in July for the first time since September 1974.
While nonfarm businesses are probably still in the
process of liquidating their inventory stocks, the pace
appears to be slackening a bit. The reduction of exces
sive inventories had begun late last year in the wholesale
and retail trade sectors, and had spread from there to the
nondurables manufacturing sector and then to durables
manufacturing. The liquidation in the retail trade sector
seems to have diminished considerably. According to re
cent data on the book value of inventories, retail and

222

MONTHLY REVIEW, SEPTEMBER 1975

C h a r t II

RATIO OF REAL INVENTORIES TO REAL SALES
S e a s o n a lly a d ju ste d
R a tio

R a tio

S o u r c e s: In v e n t o rie s in c o n stan t 1958 d o lla rs: U n ite d S t a t e s D e p a rtm e n t of
C o m m e rc e , B u re a u of E c o n o m ic A n a ly s is . S a le s in con stan t 1967 d o lla rs:
U n ite d S t a t e s D e p a r t m e n t o f C o m m e rc e , B u re a u

of the C e n s u s d a ta

d e fla te d by the N a t io n a l B u re a u o f E c o n o m ic R e se a rc h . In v e n tory d a ta
c o n v e rte d to 1967 b a s is a n d ra tio s c a lc u la te d

by the F e d e ra l R e serv e

inventory imbalances continue to exist in manufacturing;
inventories relative to sales fell only slightly in the second
quarter after having reached exceedingly high levels earlier
in the year. Monthly data on the book value of manufac
turers’ inventories indicate that the liquidation continued
in July. Manufacturing inventories fell that month at an
annual rate of $11.4 billion, with the bulk of the decline
in the durable goods sector. Moreover, the August survey
by the National Association of Purchasing Management
indicates a further runoff in the stocks of purchased
materials.
According to the Commerce Department survey taken
in July and August, businessmen again lowered their
planned expenditures on new plant and equipment. Capi
tal outlays over the second half of 1975 now are projected
to rise at an annual rate of only 1.9 percent. The weaken
ing outlook for capital spending is also reflected in capital
appropriations. As reported by the Conference Board’s
survey of large manufacturers, capital appropriations were
slashed by 17.7 percent in the second quarter, marking
the third consecutive quarterly decline and the largest
cutback on record. While most manufacturers continued
to reduce appropriations, automobile manufacturers raised
the level of their appropriations by about 40 percent. This
reflected the large retooling expenses associated with the
changeover to the 1977 models.

B a n k of N e w York.

LABOR M AR K ET D EVELO PM EN TS

wholesale distributors, apparently encouraged by the re
bound in sales, added to their inventories in June for the
first time in the current year. Of late, however, the book
value data have tended to be a rather unreliable indicator
of inventory conditions. The accounting conventions used
to value inventories give rise to distorted measurement
during periods of inflation, regardless of whether it is a
period of accelerating, decelerating, or steady inflation.
Hence, to gauge the extent of inventory imbalance it is
more useful at the present time to examine ratios of real
inventories (i.e., inventories valued in constant dollars
rather than book value) to real sales (see Chart II).
Within the retail trade sector, the real inventory-sales
ratio had backed of! considerably by the second quarter
of this year from the peak attained in the last quarter of
1974. On the other hand, hardly any improvement
occurred in the real inventory-sales ratio for the whole
sale trade sector, with the level in the second quarter just
about equal to the cyclical peak. Moreover, substantial

The labor market showed signs of strengthening in
August. Based on the household survey conducted by the
Department of Labor, employment rose by 274,000 work
ers on a seasonally adjusted basis. With the civilian labor
force growing by a comparable magnitude, the overall
rate of joblessness remained unchanged at July’s level of
8.4 percent. Over the five months ended August, the
household survey has recorded an increase in nonagricultural employment of 1.3 million (see top portion of
Chart III). However, the survey of establishments, the
so-called payroll survey, shows a much less favorable
employment situation, with an advance of only 667,000
workers. While month-to-month divergences between the
two series are not infrequent, these divergences tend to be
offsetting over longer periods (see bottom portion of Chart
III). The large August gain of 528,000 workers in pay
roll employment helped reduce the discrepancy that had
developed since March between the increases indicated
by the two series. The percentage of industries recording
employment increases rose above 70 percent, to the highest
level since late 1973, underscoring the August pickup in
payroll employment.

FEDERAL RESERVE BANK OF NEW YORK

The divergent behavior in recent months of the two
nonfarm employment series reflects, in part, differences in
sample coverage. The household survey measures the
number of persons holding jobs, while the payroll survey
seeks to gauge the number of filled job slots. For example,
a person holding two jobs would be counted twice in the
payroll survey but only once in the household survey.
Nevertheless, measured household employment is always
greater than payroll employment, since the coverage of
the household survey is more comprehensive. While both
surveys count employed wage and salary workers, the
household survey includes the self-employed, certain
unpaid workers of family-operated enterprises, and pri
vate household workers, none of whom appear on estab
lishment payrolls. Also, unlike the payroll count, the
household survey includes unpaid absences associated with
illness, bad weather, strikes, vacation, and other personal
reasons. Although there are also other differences in cov
erage, the above discrepancies are usually responsible for
most of the divergent monthly behavior of the two series.
However, only some of these elements of disparate cover-

C h a r t III

N O N AGRICULTURAL EM PLOYM ENT
S e a s o n a lly ad ju ste d
M illio n s of pe rso n

M illio n s of p e rso n s

223

age can be readily quantified with published seasonally
adjusted monthly data. In recent months, the measurable
sources of disparity have fallen far short of accounting for
the divergent movements in the two series.
Some of the remaining unexplained discrepancies be
tween the two surveys arise from differences in sampling
techniques and in collection and estimation methods. The
household survey is gathered from a scientifically selected
sample of about 50,000 households during the week that
includes the twelfth of the month. The establishment
survey, reflecting the payroll period that also includes the
twelfth of the month, is based upon payroll reports from
a sample of firms employing over 30 million wage and
salary workers, roughly 40 percent of the estimated total
number of workers on establishment payrolls. The large
size of the payroll sample reduces sampling variabil
ity and results in a more stable monthly data series. Al
though both series are subject to similar seasonal fluctu
ations, the monthly patterns of the seasonal adjustment
factors do differ somewhat and may contribute signifi
cantly to the disparity between the series. In addition,
there are also other methodological details that can con
tribute to divergent monthly behavior of the two surveys.
During periods in which these major surveys are giving
different signals, it is important to look at movements in
other labor market indicators. Data on labor turnover
rates in manufacturing, which are available only through
July, suggest some improvement in the labor market.
In July there was a jump in the rate at which new workers
have been hired, marking the fourth consecutive monthly
increase. At the same time, the layoff rate—the number
of workers laid off in a month per 100 employees—fell to
the lowrest level since late 1974. Improving employ
ment prospects are also reflected in the increase in the
number of individuals voluntarily leaving their present
jobs; in July, such quits exceeded the layoff rate for the
first time since October. A gauge of the demand for labor
in all industries is provided by the Conference Board’s
index of the volume of newspaper help-wanted advertising.
While still low by historical standards, this index rose in
July to its highest level in seven months.
T H E PRICE SITUATIO N

S o u r c e : U n it e d S t a t e s D e p a r t m e n t o f L a b o r , B u r e a u o f L a b o r S t a t is t ic s .

Rapid inflation erupted again in July and August, pro
pelled by a bulge in energy and food prices. Outside these
troublesome sectors, price increases remained relatively
moderate. But the near-term outlook for an easing of in
flation is not very encouraging. Significant increases will
probably occur soon for some foods and for oil, aluminum,
steel, and automobiles.

224

MONTHLY REVIEW, SEPTEMBER 1975

After moderating for several months, consumer prices
jumped sharply in June and July. In the latter month, the
consumer price index rose 1.2 percent, the sharpest rate of
increase in ten months. Food prices, led by price hikes on
meat and poultry, surged. Consumer energy prices, pri
marily on gasoline and motor oil, also rose at extremely
rapid rates. Excluding energy prices, nonfood commodity
prices rose 0.6 percent. However, the announced increases
in auto prices will soon be felt. There could be additional
shocks to the consumer price index in the near future as a
result of higher energy prices. This would occur if mem
bers of the Organization of Petroleum Exporting Countries
increase their oil prices this fall. Although the legislation
authorizing controls on prices of domestically produced
“old” oil lapsed at the end of August, no sharp price in
creases have been posted—perhaps reflecting expectations
of the imminent reimposition of controls for a temporary
period. Prices would be expected to rise, however, if a
program of gradual decontrol were to be enacted. Such a
program might well be accompanied by an excess profits tax
on oil companies and by tax credits to consumers to off
set, at least partially, the impact of higher prices. In these
circumstances, the resulting increase in the consumer
price index would exaggerate the inflationary impact on
consumers, since fuel costs are a direct component of the
consumer price index whereas taxes (and tax credits)
are not.

At the wholesale level, prices rose in August at a 0.8
percent seasonally adjusted rate. Prices of fuel and power
continued to accelerate, increasing at a rate of about 3
percent; part of this upsurge probably reflects the recently
enacted import fees on crude oil and refined petroleum
products. Industrial commodity prices other than power
and fuel rose 0.3 percent. Over the six months ended
August, these prices have risen at an annual rate of only
1.5 percent. Prices of farm products and processed foods
and feeds declined nearly 1 percent in August, after having
jumped the month earlier. This turnaround was led by
prices of fresh meats and vegetables.
Over the four weeks ended August 26, the Bureau of
Labor Statistics index of basic commodities jumped 3.5
percent. Industrial commodity prices rose 6.9 percent, as
prices surged in mid-August, led by price increases for
lead and steel scrap. It is possible, however, that to a large
extent the advances in these metal prices was the result of
buyers hedging against higher future mill prices. Thus, it
need not be expected that these prices will continue to
shoot up. Prices of raw foodstuffs have edged down in
recent weeks. Improved growing conditions have raised
prospects for corn and wheat production, although con
cern over increased foreign demand for United States
exports remains. The latest Department of Agriculture
estimates now suggest that carry-over stocks of these key
crops may increase only slightly.

FEDERAL RESERVE BANK OF NEW YORK

225

Th e Money and Bond Markets in August
A cautious atmosphere prevailed in the financial mar
kets in August. The large financing needs of the Treasury
continued to be a major source of concern. Investor un
certainty was heightened by reports of recent sharp
increases in both consumer and wholesale prices and the
surprising drop in July’s unemployment rate. Money mar
ket participants interpreted these developments as indicat
ing that economic activity was perhaps recovering faster
than expected and that underlying inflationary pressures
might be building. In addition, the continuing financial
crisis of New York City weighed heavily on the municipal
sector. The city was able to meet its commitments in
August with funds provided from several sources, includ
ing loans by the Municipal Assistance Corporation (MAC)
and by the major New York City banks. Legislation to
provide additional revenues for the city and to establish
an Emergency Financial Control Board to oversee the
city’s fiscal operations was passed by the New York State
legislature early in September.
In this problematical environment, most interest rates
continued to advance in August until late in the month,
when they retraced part of their upward movement. In the
money market the increases were generally mild, compared
with those of recent months. The Federal funds rate
changed little over the period from its average level in
July, and the rates on Treasury bills rose by 14 to 25 basis
points, less than half the increase in bill rates from June
to July. However, as dealers acted to distribute $4 billion
of new notes and $2 billion of additional bills issued by the
Treasury during the month, sizable increases were regis
tered in yields on intermediate- and long-term Government
securities. The heavy volume of borrowing by the Trea
sury was even larger than had been anticipated by inves
tors as a result of unexpected redemptions of nonmarketable issues and from outlays running ahead of projections.
Toward the close of the month, yields on Treasury coupon
issues receded somewhat, partly in response to an antici
pated lull in borrowing during the remainder of September.
Yields in the corporate and municipal sectors also experi
enced strong upward pressure over most of the month, but
the pressure eased late in the period in sympathy with the
improved tone in the Treasury market. In reaction to the

adverse market conditions that prevailed over most of the
month, many planned corporate and municipal issues were
reduced in size, canceled, or postponed. Nonetheless, a
number of new issues sold well at higher yields.
According to preliminary data, the growth rate of the
narrow money stock (M i) showed a moderate increase in
August from the very modest growth registered in July.
At the same time, consumer-type time deposits at com
mercial banks advanced more slowly than in the previous
month; thus, growth in the more broadly defined money
stock (M2) was essentially unchanged. Largely because
of a further drop in the volume of large negotiable certifi
cates of deposit (CDs), the bank credit proxy continued
to decline.
T H E M ONEY M AR K ET AND T H E
M O NETAR Y AGGREGATES

Interest rates on most money market instruments rose
in August for the third consecutive month, but the in
creases were generally mild (see Chart I). The rate on
90- to 119-day dealer-placed commercial paper, for
example, advanced only Vs percentage point over the
period, while rates on bankers’ acceptances rose about Vs
to 5/s percentage point. The average rate on ninety-day
CDs in the secondary market continued to show consider
able fluctuation and closed the month up 28 basis points
from its end-of-July level. Most money-center banks
boosted their prime lending rate Va- percentage point to
13A percent, following an increase of Vi percentage point
by most banks in the previous month. In contrast to
other money market rates, the Federal funds rate showed
no uptrend in August. For the month as a whole, the
effective rate on Federal funds averaged 6.14 percent, com
pared with 6.10 percent in July.
Weakness was still quite evident in business demand
for short-term credit in August. At large commercial
banks, commercial and industrial loans declined by $1,527
million over the four statement weeks of the month.
This contrasted with an average increase of $325 million
during comparable periods in the previous four years.
Thus far in 1975, business loans at large banks have

226

MONTHLY REVIEW, SEPTEMBER 1975

Chart I

SELECTED INTEREST RATES
June-August 1975
Percent

M O N E Y MARKET RATES

June

N o te:

July

B O N D MARKET RATES

August

June

July

Percent

August

D a ta are show n for b u sin e ss d a y s only.

M O N E Y M A R K ET RATES Q U O T E D : Prime com m ercial loan rate at most m ajor banks;
o ffe rin g rates (quoted in terms of rate of discount] on 90- to 119-day prime com m ercial
p a p e r q uo te d by three of the five d e ale rs that re p ort their rates, or the m idpoint of
the ra n g e q u o te d if no co n se n su s is a v a ila b le ; the effective rate on F ede ral funds
(the rate m ost representative of the tra n sa ction s executed); clo sin g bid rates (quoted
in terms of rate of discount) on newest o u ts ta n d in g three-m onth T reasury bills.
B O N D M A R K E T Y IEL D S Q U O T E D : Y ields on new A a a -r a t e d pu b lic utility b o n d s are b ase d
on prices a s k e d by underw riting syndicates, adjuste d to m ake them e q u iv ale n t to a

dropped by $12.3 billion. In the last two months, how
ever, after allowance for normal seasonal variations, the
declines have been much smaller than in earlier months of
the year. This may indicate that a turning point in busi
ness demand for short-term credit is close at hand.
In response to the continued weakness in business loan
demand at banks, major commercial banks allowed a
further large runoff of CDs in August. The volume of
CDs outstanding has paralleled movements in business
loans all year. Over the eight months ended in August,
CDs dropped $11.8 billion. In recent months, however,
as in the case of business borrowing from banks, the de
clines in CDs have been comparatively small.
Preliminary data indicate that the growth rate of
—

s ta n d a rd A a a -ra t e d b o n d o f at le ast twenty y e a rs ' maturity; d a ily a v e r a g e s of
y ie ld s on se a s o n e d A a a -r a t e d corporate b o n d s; d a ily a v e r a g e s of y ie ld s on
long -term G o v e rn m e n t securities (bo nd s due or ca lla b le in ten y e a rs or more)
an d on G o v e rn m e n t securities due in three to five y e a rs , com puted on the b a s is
o f clo sin g b id prices; T hu rsday a v e r a g e s of y ie ld s on twenty se a s o n e d twentyye ar tax-e x e m p t b o n d s Ica rryin g M o o d y 's ratings o f A a a , A a , A , a n d Baa).
Sources: Federal R eserve B a n k o f N e w York, B o ard of G o v e rn o rs of the F e d e ra l
Reserve System , M o o d y 's Investors Service, Inc., a n d The B o nd Buyer.

private demand deposits adjusted plus currency outside
commercial banks— rose moderately in August from its
very low growth rate in July. In the four-week period
ended August 27, seasonally adjusted
averaged 5.3
percent at an annual rate above its average during the
four weeks ended July 30. The change from June to July
had been much smaller. Indeed, the fluctuation in monthly
Mi growth has been particularly sharp this year, ranging
from double-digit growth in May and June to negative or
near-zero growth in January and July. Changes in Mx over
longer periods are shown in Chart II.
The expansion of consumer-type time deposits at com
mercial banks slowed considerably in August, compared
with its growth over recent months. The deceleration prob

FEDERAL RESERVE BANK OF NEW YORK

ably reflected, at least in part, the rise in interest rates
on competing market instruments relative to rates on
consumer-type time deposits. The latter are of course con
strained by the legally set rate ceilings. As a result of the
slowdown, the expansion of M2—which includes these
time deposits plus M 1— was little changed in August from
its growth in July. The adjusted bank credit proxy— a
measure which encompasses all deposits at member banks
subject to reserve requirements plus certain nondeposit
sources of funds— declined in August for the second con
secutive month. The drop was largely due to the decline
in the volume of CDs outstanding. This decline offset
demand and consumer-type time deposit growth. Member
banks continued to make little use of the discount window
in August, when borrowings averaged $208 million (see
Table I) as compared with the revised figure of $326
million for July.

227

auction rose to 8.25 percent; this was 75 basis points
above the average yield at the July auction of securities
of comparable maturity. The auction of $2 billion of 49month notes on August 21 encountered similar investor
resistance, resulting in an average yield of 8.54 percent,
the highest rate on a Treasury-backed note in over a year.
At the close of the month, yields on coupon issues de
clined as dealers found their inventories to be modest,
given the expected reduction in Treasury borrowing. Mar
ket participants were also encouraged by Chairman Burns’s
comment in a letter to Henry S. Reuss, Chairman of the
House Banking Committee, that the Federal Reserve
would continue purchasing coupon securities in coming
months. Over the month as a whole, the index of
yields on intermediate-term Government securities rose

T H E GOVERNM ENT SECURITIES M AR K ET
C h a rt II

Yields on Treasury securities rose sharply during
August. Investor uneasiness was heightened by growing
concern about renewed inflationary pressures. This con
cern was nurtured by substantial increases during July in
both wholesale and consumer prices as well as by a sharp,
unexpected drop that month in the unemployment rate.
The large financing needs of the Treasury also contributed
to the cautious tone in the market for Treasury securities.
On August 6 the Treasury announced plans for meeting
the bulk of its cash needs through early September. The
level of borrowings, even larger than had been anticipated,
called for $6 billion in new cash. The package of new
money included the immediate sale of $1 billion in
eighteen-day bills, which were subsequently to be added
to the auction on August 20 of the outstanding 52-week
bill issue. Also included in the package were the addition
of $1 billion to the auction of three- and six-month bill
issues on August 18 and the auction of $2 billion of new
two-year notes on August 14 and of $2 billion of new
49-month notes on August 21.
The large supply of Treasury securities, as well as ex
pectations that the supply would continue heavy through
out the year, reduced the incentive for investors to bid
aggressively. Each of the auctions for coupon securities
was characterized by investor wariness and the need for
the Treasury to offer substantially higher yields than it
had during June and July. Much attention was focused
on the auction of $2 billion of two-year notes on August
14. Looking ahead to large auctions in almost every week
of August and early September, investors held back, and
the average yield on the securities at the August 14

C H A N G E S IN M O N ETA R Y A N D CREDIT AGGREGATES
S e a s o n a lly a d ju ste d a n n u a l rates
Percent

Percent

Note-. Growth rate* are computed on the basis of four-week ave rages of daily
figures for periods ended in the statement week plotted, 13 weeks earlier and
52 weeks earlier. The latest statement week plotted is A u gu st 27, 1975.
M l = Currency plus adjusted dem and deposits held by the public.
M 2 = 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
borrow ings and the proceeds of commercial paper issued by bank holding
com panies or other affiliates.
Source: Board of Governors of the Federal Reserve System.

228

MONTHLY REVIEW, SEPTEMBER 1975

14 basis points to 8.02 percent. The yield on the 8 V2 per
cent Treasury bond of 1994-99 rose to 8.43 percent at
the end of August, up 9 basis points from its level at
the end of July.
Movements in Treasury bill rates paralleled move
ments in rates on coupon securities. During early and
mid-August, rates on bills rose. The average yield on
52-week bills at the monthly auction on August 20 was
7.33 percent (see Table II), up 55 basis points from the
average yield at the July auction. At the weekly auction
of three- and six-month bills on August 25, the average
yields on three- and six-month bills were 6.59 percent
and 7.09 percent, the highest rates on three- and six-month
bills since January of this year. But, as in the case of
coupon securities, rates declined during the final week of
August, and the average rates on three- and six-month
bills at the August 29 auction were 6.38 percent and 6.87
percent, 14 and 15 basis points above the rates on these
bills at the final auction in July. Over the month as a
whole, yields on most bills rose 14 to 25 basis points.
Rates on agency securities also rose during August.
On August 7, the Federal Home Loan Banks issued $500
million of seven-year bonds at 8 5/s percent. These bonds
traded near par during most of the month. Later in the
month the Federal National Mortgage Corporation issued
$650 million of five-year debentures at 83A percent. These
rates compare with a yield of 8.20 percent on IV 2 -year
bonds issued by the Federal Land Banks early in July.
During the month, the Banks for Cooperatives issued
$505.6 million of 7.4 percent bonds due March 1, 1976,
and the Federal Intermediate Credit Banks issued $725.2
million of 7.6 percent bonds due June 1, 1976. Both
issues were reasonably well received.

Table I
FACTORS T E N D IN G TO INCREASE OR DECREASE
M EMBER B A N K RESERVES, A U G U ST 1975

In millions of dollars; (+) denotes increase
and (— ) decrease in excess reserves
Changes in daily averages—
week ended

Aug.

Investor uncertainty over the financing needs of the
Treasury as well as increased concern over inflation
affected the corporate and municipal bond markets in
August. The tax-exempt sector was additionally troubled
by the financial problems of New York City. Yields came
under strong upward pressure throughout the month, al
though a number of cancellations and postponements of
new issues served to limit the advance.
Throughout the year, corporations have been issuing
bonds in order to lengthen the maturity structure of their
liabilities. Since corporations can postpone the issuance
of bonds that are used to restructure their liabilities, sev
eral corporations, including the New Jersey Bell Tele
phone Co., postponed bond offerings indefinitely because
of adverse market conditions. Analysts estimated that at

Aug.
13

Aug.
27

Aug.
20

|
“ M arke t” factors

Member bank required reserves .................. +
Operating transactions (subtotal)

373

— 267

- f 241

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

811

4- 1,102

—

828

— 858

Federal Reserve float ...................................

105

300

101

— 348

158

Treasury operations*

667

4-1,017

—

— 879

726

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

Gold and foreign account ..........................

190

537

227

—

4 - 60

Currency outside banks ............................... —

119

— 433

—

731

4 -5 7 7

4 - 176

4 - 226

—

— 268

Total “ market” factors ............................... 4-1,184

4-1,292

— 1,095

— 617

764

........... — 1,155

— 1,522

4- 1,866

4- 575

236

Treasury securities

........................................ — 1,113

— 1,506

4-1,496

— 207

— 1,330

Special certificates

........................................ 4 - 231

—

— 206

8 —

—

706

Other Federal Reserve liabilities

Direct Federal Reserve credit
transactions

Open market operations (subtotal)
Outright holdings:

Bankers' acceptances ...................................

1 —

—

Federal agency obligations ........................

4- 336

336

Repvirchase agreem ents:
Treasury securities

........................................ — 243

Bankers’ acceptances ................................... —

Federal agency obligations ........................

—

Member bank borrowings ............................... _
Seasonal borrowings! ...................................

368

4- 568

693

4 - 68

2 4-

Other Federal Reserve assetst .................... —

5 , — 541

Total

T H E OTHER SECURITIES M AR KETS

Net
chanaes

Factors

.................................................................. — 1,261

Excess reservest

...................................... —

— 542

— 1,515

4-1,350

4- 666

— 223

255

700

M onthly
averages!

D a ily average levels

Member bank:

Total reserves, including vault casht

Excess reserves
Total borrowings

...

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

34,563

34,150

34,672

34,480

34,466

34 345

34,155

34,422

34,181

34,276

218 —
176

250

299

191

178

204

272

208

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

34,387

33,972

34,468

34,208

34,259

N et carry-over, excess or deficit (— ) | | . . .

180

141

111

Seasonal borrowings! ...................................
Nonborrowed reserves

N ote: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
t Included in total member hank borrowings,
t Includes assets denom inated in foreign currencies.
§ Average for four weeks ended August 27, 1975.
|] N ot reflected in data above.

229

FEDERAL RESERVE BANK OF NEW YORK

the time of the postponement on August 6 the yield on the
$75 million Aaa-rated issue of New Jersey Bell bonds
would have been about 35 basis points higher than the
yield of 8.80 percent on approximately comparable bonds
issued by the Bell Telephone Co. of Pennsylvania on July
15. Other postponements of Aaa-rated issues included
$150 million of seven-year notes of J. P. Morgan & Co.
Incorporated. A lesser rated issue of $80 million of Con
solidated Edison Co. of New York, Inc. bonds was also
postponed on two separate occasions during the month.
A number of corporate issues brought to market during
the month at relatively high rates sold fairly well. On
August 4, the Chicago-based Commonwealth Edison Co.
sold $125 million of Aaa-rated eight-year bonds at 8.85
percent. During that same week, Public Service Co. of
Indiana, Inc., an Aa utility, sold out an $80 million
issue of thirty-year bonds at 9.6 percent, compared with
a yield of 9.43 percent on a comparably rated thirtyyear issue in late July. On August 12, British Petroleum
North American Finance Corporation successfully nego
tiated a two-part sale of Aa-rated securities, guaranteed
by the British Petroleum Co. Ltd.: $50 million of five-year
notes yielding 9 percent and $100 million of 25-year
debentures yielding 10 percent. On August 19, Pfizer Inc.
sold $100 million each of ten-year notes and 25-year
debentures. The Aa-rated securities were priced to yield
8% percent and 9.30 percent, respectively, and were
quickly sold out. In comparison with the yields of 9
percent and 8% percent on the intermediate-term Aarated issues of British Petroleum and Pfizer, a similarly
rated issue of eight-year bonds had been sold by Arco
Pipe Line Company to yield 8.46 percent in mid-July.
Over the month, the Federal Reserve Board index of yields
on recently offered Aaa-rated corporate securities rose
7 basis points to close the period at 8.94 percent.
During most of August, attention in the tax-exempt
sector was centered on the need for New York City to
raise $960 million to meet current expenses and to pay
$791 million on notes and interest due on August 22. The
$960 million aid plan for New York City arranged by
MAC consisted of the placement of $350 million of
bonds with New York City banks (including $100 mil
lion in exchange for maturing New York City notes), pur
chases of $215 million of bonds by various city and state
pension funds, $120 million in advance aid from the state,
and the negotiated public sale of $275 million of bonds
on August 14. After a one-day delay because of insuffi
cient presale demand, the negotiated sale, consisting of
$70 million of 10 percent bonds due in five years,
$65 million of IOV2 percent bonds due in six years, and
$140 million of 11 percent bonds due in eight years, was

Table II
AVER A G E ISSU IN G RATES
AT REGU LA R TR EASURY BILL AUCTIONS*
In percent

Weekly auction dates— August 1975
Maturity

Three-month
Six-m onth

Aug.

6.456
6.864

6.349
6.809

Aug.

Aug.
25

6.452
7.000

6.593
7.085

Aug.

Monthly auction dates— June-August 1975

Fifty-tw o weeks .....................................

June
24

July
24

Aug.
20

6.29 2

6.782

7.331

* 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 m aturity. Bond yield
equivalents, related to the amount actually invested, would be slightly higher.

completed on August 15. The success of this second public
offering of A-rated MAC bonds was assured when a group
of underwriters agreed to take any unsold bonds. Sub
sequently, prices on outstanding MAC issues weakened
as market participants focused on the city’s September
cash needs.
The problems faced by New York City, and earlier in
the year by New York State’s Urban Development Corpo
ration, have had a particularly adverse effect on the market
for state agency issues. During the month, the Massachu
setts Housing Finance Agency was forced to reject all bids
on a $63.8 million issue of bond anticipation notes maturing
in 1976 and 1977. The New York State Housing Finance
Agency twice postponed its $110 million note offering
and finally scaled it down to $92 million. The net interest
cost to the agency on these notes was 10.848 percent, com
pared with an 8.87 percent cost on a similar sale in July.
In the municipal sector, the largest issue of the month
(except for M AC)— $180 million of Commonwealth of
Pennsylvania bonds— was well received. These A -l
(Moody’s) bonds sold out on August 7, with yields ranging
from 4.80 percent for the 1977 maturities to 7.25 percent
for those maturing in 1995 or about 10 to 40 basis points
higher than a similar sale by Pennsylvania last May. The
Bond Buyer index of twenty bond yields on twenty-year
tax-exempt bonds on August 28 was 7.18 percent, up from
its level of 7.09 percent on July 31. The Blue List of dealers’
advertised inventories rose by $84 million and closed the
month at $631 million.

Full text of Economic Policy Review (Federal Reserve Bank of New York) : September 1975, Vol. 57, No. 9

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