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FEDERAL RESERVE BANK OF RICHMOND MONTHLY REVIEW Flexible Exchange Rates Local Government Expenditures Foreign Purchases of Domestic Securities The Fifth D istrict Flexible Exchange Rates Proposals for international monetary reform fall into tw o ca teg ories: those aimed at shoring up the T o the extent that the adjustm ent mechanism c o r rects deficits, the need for liquidity is lessened. those T he approach to reform reviewed here involves a aimed at a fundamental change in the nature of the greater degree of flexibility of foreign exchange rates. present international monetary system and system. M ost of the official emphasis in recent years Flexibile exchange rates have long been advocated has been on supplementing the existing system, p ri by a large segment of the academic com m unity, and marily by providing additional liquidity and credit recently the idea of greater exchange rate fle x i facilities for financing international deficits. bility has received increased attention in “ official” C on cern over the a d e q u a cy of in tern ation al circles. T he Subcommittee on International E x liquidity has led to tw o general increases in the quotas change and Payments of the Joint E conom ic C om of the International M onetary Fund since its incep mittee tion, and a third increase is in prospect for next year. M onetary Fund to study the possibility of greater e x T he I M F ’s lending potential was further enhanced in change rate flexibility within its present fram ew ork. of Congress has urged the International 1962 by the General A rrangem ents to B orrow , under Several of the official delegates to the recent I M F which the G rou p -of-T en nations stand ready to lend meetings, including Secretary of the Treasury K en the Fund up to $6 billion if needed. nedy, T he G rou p-of- called for official study of the question. T en recently agreed to extend this line of credit Finally, interest in exchange rate flexibility received through 1975. A nother provision for international new impetus from the recent German decision to liquidity initiated in 1962 is the network o f reciprocal allow the mark to float until a new parity was currency or “ sw ap” arrangements. established. These standby agreements provide for the mutual exchange of cu r rencies between tw o countries, with the international reserves thus created used by one or both countries to defend existing exchange rates against balance of payments pressures. A n e x ch a n g e rate is s im p ly a price— the price of one currency in terms o f an other currency. D ow nw ard pressure is placed on the exchange rate of a country experiencing a deficit in its balance o f payments as its currency is in excess The most recent and fundamental step in providing for adequate grow th in w orld liquidity is the facility for Special D raw ing Rights finally adopted in 1969 after several years of study and negotiation. SDRs are intended to supplement existing reserve assets as a means of financing external deficits. T hey are to serve the same general role as official gold does presently, as their nickname, “ paper g o ld ,” suggests. M any econom ists believe, however, that while ad ditional liquidity may be desirable, the m ore urgent need is fo r an im proved international adjustm ent mechanism to correct deficits. G en era l P rin cip le s A cco rd in g to this supply in the foreign exchange market. Conversely, upward pressure is placed on the exchange rate o f a surplus country since its currency is in excess demand at the existing rate. In perfectly free foreign e x change markets, exchange rates presumably w ould adjust until international equilibrium is restored. But foreign exchange markets today are not free markets. Balance o f payments pressures on e x change rates are currently offset by official interven tion which permits only nominal changes in rates. W ith exchange rates pegged within a narrow band under the present system, these pressures fall first view , trying to solve current international ills with on the monetary reserves of the countries involved, m ore and m ore liquidity is like trying to solve family and financial problem s by getting another credit card. ultimately on their domestic econom ies. A n d the d o 2 the burden o f international adjustm ent falls mestic goals of full em ploym ent and price stability little to recom m end a flexible-rate system. are sometimes in sharp conflict with the require many advocates of flexible rates w ould be just as A ctually ments of international equilibrium. Substantial in happy with fixed rates if internal prices and wages flation may be required to eliminate an external sur were as flexible in both directions as a free market plus exchange rate. while unemployment and recession may be But since prices, and particularly T he natural re wages, tend to be rigid in a dow nw ard direction, the luctance to subject the dom estic econom y to such deflation necessary to cure a deficit under a fixed- necessary to cope with a deficit. harsh external discipline is largely responsible for rate system w ould exert dow nw ard pressure on the the increasing reliance on governm ent controls over employm ent level. W h ile exchange depreciation is not painless and usually involves a reduction in real foreign trade and capital movements. Proponents of flexible exchange rates argue that income, it presumably w ould avoid the employm ent their system is the only alternative to nationalistic effects o f dom estic price and wage rigidities. controls over international trade and investment on ble rates are thus seen as a means o f rendering rigid F le x i the one hand, or wide fluctuations in the dom estic internal prices and wages flexible in terms o f foreign econom y on the other. currencies. Instead of forcing the in ternal econom y to adjust to a predetermined fixed Even if flexible exchange rates alleviated pressure exchange rate, they say w e should let the exchange on employm ent resulting from dow nw ard price and rate itself do the adjusting. w a g e rig id ity , u n e m p lo y m e n t co u ld E xchange depreciation still resu lt would normally tend to make a deficit country m ore fro m re so u rce im m o b ility . competitive internationally by making its exports ment through the current account requires a realloca cheaper abroad and its im ports m ore expensive at tion o f resources between dom estic and foreign-trade home. E xchange appreciation in surplus countries sectors o f the econom y whether induced by fluctua would tend to stimulate im ports and depress exports. tions in the exchange rate or by fluctuations in the The idea is simply to extend the free market into domestic econom y. the area of international finance. I f external pay In tern a tion a l a d ju st If resources are not sufficiently mobile, unemployment could result under either e x - ments do not balance at the existing exchange rate, change-rate system. U nder flexible rates, however, the rate w ould adjust in the market until equilibrium resource w ould is restored. immobility probably increase the magnitude of exchange-rate adjustm ent necessary to T o say that exchange rate adjustm ent can p ro maintain external balance since it w ould reduce the mote external equilibrium does not mean that the se n sitiv ity o f o u tp u t o f v a rio u s s e cto rs o f the internal econom y is left unaffected. e c o n o m y to rela tiv e p rice ch a n ges. E xchange d e preciation raises im port prices relative to domestic prices and induces a shift in consum ption patterns away from im ports in favor of domestic good s co m peting with imports. L abor and other productive re sources shift out of dom estic production into export industries. E xchange appreciation in a surplus country w ould shift the patterns o f consum ption and 1 production in the opposite direction. T he under D o m e s tic P o lic y In d e p e n d e n ce U n d e r a fix e d - rate system there is a potential conflict between d o mestic policy objectives and the requirements o f in ternational equilibrium. Such a conflict w ould be most apparent in the case of a deficit country e x periencing a dom estic recession. Easy m onetary- fiscal policies may well restore dom estic prosperity, but at the expense of a w orsened external deficit. lying shifts in production and consum ption patterns Policies designed to correct the external deficit would necessary to restore equilibrium are thus similar to tend to aggravate the recession. those required under the present system o f fixed dilemma has usually resulted in controls over inter rates. T he principal difference is that under flexible rates these internal adjustm ents would respond to changes in the exchange rate rather than to defla tion or inflation in dom estic prices and money incomes. Since the underlying adjustments are ideally the same under the tw o systems, there would seem to be In recent years this national trade and investment rather than the sacri fice of dom estic stabilization objectives. A t the other extrem e is the case of a surplus country experiencing internal inflation. Successful efforts to curb the inflation w ould increase the e x ternal surplus while expansionary policies to reduce the surplus w ould intensify the inflation. T his par 3 ticular policy dilemma led to the Canadian adoption F lexible exchange rates may provide a degree of of flexible exchange rates in 1950; it also led the insulation from foreign price and incom e changes by Germans to revalue the mark in 1961 and again neutralizing the net effect of a change in exp ort d e this year. mand on the balance of trade. A foreign recession Proponents of flexible exchange rates argue that w ould still reduce export demand, but exchange d e their system w ould reduce or eliminate external co n preciation should limit the deterioration of the trade straints on domestic policies. balance. M onetary and fiscal policies could pursue the desired combination o f price T he depreciation w ould discourage the fall in exports while encouraging a decline in im ports. stability and full em ploym ent while exchange-rate If potentially com plicating capital flows could be adjustm ents ignored, exchange depreciation could be expected to w ould maintain equilibrium in the balance of payments. D om estic policy could influence prevent any worsening of the trade balance. the total level of expenditure for dom estic stabiliza no change in net foreign spending on dom estic ou t W ith tion purposes because the exchange rate w ould be put, there should be no im ported recession. free to adjust to the extent necessary to induce the versely, a foreign inflation w ould increase export shifts in consum ption and production patterns re demand, quired for external equilibrium. H ence, in the pre but the resulting exchange C on appreciation w ould discourage the expansion o f exports while en vious exam ple of a deficit country with an internal couraging im port grow th. recession, expansive policies could raise the total currency, which w ould not be possible under a fix ed - T he appreciation o f the level o f output while the resulting exchange de rate system, w ould intercept the im ported inflation. preciation shifts a larger portion of it into export in Flexible-rate advocates recognize potential com p li dustries. In the case o f the surplus country e x cations in this insulation mechanism, especially those periencing internal inflation, policy could be tightened arising out of interest-sensitive capital flo w s ; but to reduce the excessive level of total spending while they still maintain that a nation w ould have m ore exchange appreciation increases the portion o f total econom ic sovereignty under flexible rates than under spending goin g for im ports and reduces the portion the present system. of total output being exported. A related advantage often claimed for flexible e x change rates is that they block the international transmission of econom ic fluctuations com m only as sociated with fixed-rate systems. flexible rates are said to In other words, insulate the domestic econom y from foreign inflationary or deflationary pressures.1 A foreign recession may be transmitted to the d o mestic econom y under fixed exchange rates through A r g u m e n ts an d C o u n te ra rg u m e n ts S ev era l o b jections have been raised against the use o f flexible exchange rates. T he m ost important, perhaps, is the argument that international traders and investors require the certainty of stable rates to d o business. T he possibility of loss due to an adverse m ovem ent in the exchange rate, it is said, w ould discourage international trade and investment. Propenents of flexible rates counter with several arguments. First, they reject any automatic associa a decline in export demand and a reduction in the tion of free-m arket rates with unstable rates. foreign trade balance. In the absence o f offsetting cite other com m odities and other markets that e n jo y influences elsewhere, the reduction in net foreign spending for domestic output means a reduction in relatively stable prices in the absence o f governm ent price fixing. Second, they argue that exchange risks total spending, and thus total income. are not entirely absent under the present system, A foreign boom or inflation w ould increase export demand, im prove the balance of trade, and thus raise the levels of total spending, m oney income, and prices. The Germans in particular have found that this trans since official abruptly. par values are sometimes T h ey changed T hird, exchange risks can be hedged in the forw ard exchange market in much the same way as com m odity traders hedge in the com m odity mission mechanism makes it difficult to maintain futures market. H edgin g does involve extra costs, however, and the cost o f hedging some important price stability in an inflationary world. kinds o f transactions may be prohibitive. Finally, they maintain that there are all kinds o f risks in 1 R obert D. M cTeer, Jr., “ E conom ic Independence and Insulation through Flexible E xchange R ates,” N icholas A. Beadles and L. A u brey D rewry, J r. (e d s .), M oney, the M arket and the State (A th en s: U niversity o f Georgia Press, 1968), pp. 102-183. 4 international trade, and official measures taken to protect a fixed rate may create m ore problem s for traders and investors than w ould the adjustm ent they seek to avoid. T he risk o f exchange fluctuation must be weighed against the alternative risks o f co n trols over trade and investment and other restrictive measures designed to maintain fixed rates. Certainly the cause of international trade and investment lias not been advanced by the recent measures taken by several countries, including the United States, to support official exchange parities. A nother argument often heard is that speculation such a system, however, are not g ood . T he w o rld ’s monetary authorities are understandably reluctant to make such a radical departure from orth odoxy, and do not always have the pow er to make such changes even if they wished to. Rather, official at would be destabilizing if rates were flexible— that the m ost attention today involve some version of speculators w ould take a given change in the rate as a signal for further changes in the same direction and act accordingly. Supporters of flexible rates, on the other hand, argue that the present system is m ore “ wider bands,” “ crawlings pegs,” or a com bination o f the two. Both these approaches aim at obtaining some o f the assumed advantages o f exchange fle x i bility without sacrificing the basic nature o f the par conducive to destabilizing speculation since rates are value system. held rigid while huge deficits pile up. Faced with rates that are clearly out of line with reality, specu lators or traders with an uncovered position stand to make large gains if they are right and have little T he wider band proposal involves extending the range of permissible exchange rate variation around to lose if they are w rong. T he events of the past couple of years illustrate the potential for one-way speculation under the present system. O n the other hand, it is argued, if rates were determined in the free market, they w ould presumably adjust gradually to changing econom ic conditions, and speculators would not be faced with rates that are clearly under valued or overvalued. T he potential gain through speculation w ould thus be diminished and w ould be matched by a greater chance o f loss. A nother argument against flexible rates is that they would eliminate an important external co n straint against inflationary policies. U nder fixed rates, it is argued, inflationary policies w orsen the balance o f payments and lead to a loss o f gold or foreign exchange reserves. T he reserve loss de mands attention and forces the monetary authorities to adopt more restrictive policies. H ow ever, policies that w ould lead to reserve losses under the present system w ould lead to exchange depreciation if rates were free, and exchange depreciation may also be something to be avoided. It raises im port prices and usually worsens the terms o f trade. T he question i s : which provides the greater constraint on inflationary policies— reserve losses or exchange depreciation ? W h ile often asked, such a question misses the point that inflation is undesirable in itself and should be avoided, external constraint or not. tional financial system can force N o interna responsible do mestic policies or substitute for them. tention has been directed recently to m ore limited form s o f flexibility that w ould not break com pletely with the par value system. T he suggestions for limited flexibility receiving the par value beyond the present 1 % limit sanctioned by the IM F . Presumably, many, though not all, o f the advantages (an d disadvantages) claimed for flexible exchange rates w ould apply to a lesser extent to a wider band. In urging official study o f this proposal in 1965 the Joint E conom ic Committee of Congress gave its possible advantages as fo llo w s : Broadening the limits for exchange rate variations could discourage short-term capital outflows through free market forces, on which we should continue to place our main reliance; permit greater freedom for monetary policy to promote domestic objectives; dis courage speculation against currencies by increasing the risk; and to some extent promote equilibrating adjustment in the trade balance through somewhat greater exchange rate variations than are now per mitted.2 A wider band w ould represent only a one-shot in crease in the ability of the exchange rate to adjust. Divergent national policies still would tend to push rates to their upper or low er support limits, and their ability to adjust in that direction w ould be “ used up.” T he craw ling peg proposal, on the other hand, provides for a gradual, but continuing, adju st ment o f the par value itself. T he speed o f adjustm ent might be determined in advance, say a m axim um of one sixth o f 1% per month, or it might depend on past market perform ance. F or exam ple, the peg could be set each month or each week at a level equal to the m oving average of the actual market rate over a specified time period. Either way, the adjustm ent over short time periods w ould be too small, presumably, to make large scale speculation worthwhile. T h e d iscu ssion so far has R ob ert D . M cT cer, Jr. assumed com pletely free exchange rates to focus on - 1965 Join t E conom ic R ep ort, R ep ort o f the Join t E conom ic Com mittee on the January 1965 E conom ic R ep ort o f the President, M arch 17, 1965, p. 15. L im ited F le x ib ility general principles. T he near-term prospects for 5 LOCAL G O V E R N M M T EXPENDITURES LOCAL EXPENDITURES BY PURPOSE OTHER" DIRECT GENERAL EXPENDITURES UNITED STATES FIFTH DISTRICT Fiscal Y ears Fiscal Y e ar 1968 $ Billions 80 $ Million Total expenditures by local governments in creased 60% between 1961 and 1968. Education expenditures ranged from 39% of total exp e n d i tures in 1961 to almost 42% in 1968 while utility expenditures, the second largest category, re mained a relatively stable 9%-10% of the total. H ighw ay disbursements declined from 8.5% in 1961 to 6.5% in 1968, but public w elfare increased a full percentage point over the period to 6.7%. Payments for hospitals and health remained close to 5% of total outlays. 70 60 50 40 "Other" expenditures by local governments went largely for sanitation and sewerage and for interest payments on general debt. Interest on general debt accounted for a little over 13% of total expenditures for all local governments, the same level as in 1961. In the District, interest payments ranged from a low of around 6 % of the total in the District of Columbia to a high of almost 19% in Virginia, as compared with a 1961 low of less than 4% (District of Columbia) and a high of over 18% (Maryland). Local government ad m in is tration expenditures as a percentage of total e x penditures declined throughout the District except for the District of Columbia and Maryla nd. 350 300 250 ' 30 - - ....... ■ 20 DISPOSITION OF TOTAL LOCAL EXPENDITURES UNITED STATES 10 . $ Billions 80 ___ 1961 ■ 1965 Education H ighw ays [jj Public W elfare 1966 1967 MD. F~] Hospitals and Health □ Utility □ Other N. C. VA. S. C. Sanitation and Sew erage Local Parks & Recreation Financial Adm inistration State Govt. Adm inistration LOCAL DIRECT GENERAL EXPENDITURES BY PURPOSE 1968 Total local direct government expenditures in the Fifth District exceeded $1 billion in three District states, M aryla nd ($1.4 billion), Virginia and North Carolina ($1.1 billion). Total local outlays exceeded $530 million in the District of Columbia, $464 mil lion in South C arolina, and $350 million in West Virginia. Education outlays, the major expendi ture throughout the District, ranged from $125 million in the District of Columbia to almost $660 million in M aryland. M aryla nd is the only District state in which local expenditures more than doubled from 1961 to 1968, but local expenditures in South Carolina increased 99%. Fiscal Years FIFTH DISTRICT W. VA. Q □ D. C. Interest on G e n e ral Debt M iscellaneous Fiscal Y e a r 1968 Per Cent 100 1961 MD. H | [I N. C. S. C. Education H ighw ays Hospitals and Health VA. Q H Q W. VA. D. C. Public W elfare Police and Fire O ther 1965 1966 1967 1968 Capital outlays accounted for approximately 20% of total expenditures from 1961 to 1968, and construction expenditures accounted for over threefourths of capital outlays. Local governments made some payments to their state governments, but these amounted to only about 0.5% of total expenditures over the period. The percentages of total expenditures accounted for by the categories of outlays shown in the chart remained relatively stable during the period. Compensation of local officers and employees, which comprises a part of each of the illustrated categories, has also con sistently been around 48% of the total. | Current O peration fj| C a p ital O utlay £3 Assistance & Subsidies and Insurance Benefits & Repaym ents |j§ Interest on Debt and Intergovernm ental K atherine M . Chambers Source: U. S. Departm ent of Com merce. Foreign Purchases of Domestic Securities F oreign purchases of U . S. securities have con tributed significantly to the recent shifts in the United ‘ ‘below the line” as a balancing item in the official balance of payments accounts. Since transactions in States balance of payments position. Net foreign purchases of U . S. corporate stocks and bonds, in particular, helped the U nited States achieve its small both external surplus in 1968, the first on a liquidity basis purposes. since 1957. A decline in such purchases contributed categories of securities are considered, the statistics used here are not strictly com parable to those used for official balance of payments accounting T he charts show net purchases and sales by to the sharp deterioration in the overall payments foreigners of long-term U . S. securities by area and position in across national boundaries is im portant fo r reasons other than balance of payments considerations. In by type. L ong-term securities are those with no contractual maturity (equities) or those with an original maturity of over one year. “ F oreign ers” ternational capital movements can contribute to e co are defined by the T reasury Department to include nom ic welfare in much the same way as international all individuals and institutions located outside o f the United States, including U . S. citizens. F oreign 1969. O f course, the flow o f capital trade in goods and services. N et foreign purchases o f U . S. securities, other than Treasury issues, represent a capital inflow into the United States, a plus item in our balance o f pay ments accounts. Conversely, net foreign sales o f such securities represent a capital outflow, or a negative item. O n the other hand, foreign transactions in marketable U . S. Treasury securities are recorded institutions include foreign subsidiaries of U . S. busi nesses and banks, foreign pension and mutual funds, foreign governm ents and central banks, other o f ficial institutions of foreign countries, and interna tional and regional institutions such as the Interna tional Bank for R econstruction and Developm ent. Transactions undertaken by residents o f the U nited NET P U R C H A S E S ( + ) A N D S A L E S ( - ) O F L O N G - T E R M S E C U R IT IE S B Y A R E A 1968 a CORPORATE AND M A R KETA B LE OTH ER CO RPO RA TE STO CK BONDS U. S. G O V T S . 1967 T CO RPO RATE AND JO T H E R BONDS 1966 1..... 1 1 t — 600 -4 0 0 1 I -2 0 0 I____I____ I____I____I____I____I____I____I____I____I------ 1 ------ 1 ------1 ------ 1 ------ 1 — 0 200 400 600 800 1 ,0 0 0 $ M illio n s N o te : S o u rc e : 8 N e t p u r c h a s e s o r s a le s fo r a g iv e n a r e a U. S. T r e a s u r y D e p a rtm e n t. o f less th a n $ 1 0 m illio n a r e in clu d e d a s " O t h e r " . 1 ,2 0 0 1 ,4 0 0 States are also counted if the transactions are re corded for the account o f foreigners. T he transactions are shown for each country or geographical area in w hich the buyer or seller of record resides, but this may not in all cases be the residence of the ultimate buyer or seller. F o r e x ample, Swiss banks handle transactions for cus tomers in many countries, and Switzerland is credited with these transactions even though the ultimate ow ners are not necessarily Swiss. U nited K in gdom ($522 m illion) the m ajor pur chasers. Germany, France, and B elgium -L uxem bourg were also large net purchasers. T hough Europeans in general were net sellers of U . S. G ov ernment securities in 1968, the United K ingdom was a net purchaser at $52 million. M ost transactions in U . S. securities from the Latin A m erican area com e from the Netherlands Antilles and Surinam and the Bahamas and B er muda. T he Bahamas and Berm uda had net pu r chases of $140 million of U . S. corporate stock in M a jo r P u rch a sers o f U . S. S ecu rities T h e first 1968, the highest in the area, while the Netherlands chart shows that E urope continued to be the source Antilles and Surinam were the largest purchasers of of most of the foreign transactions in U . corporate and other bonds. M uch o f this activity is the result of actions by investment trusts which at tract funds largely from Europe, but also from the curities through 1968. S. se T he m ajor European “ pur chaser” of U . S. corporate stock was Switzerland with net purchases of $822 million, follow ed by the Netherlands, France, and Germany. Part o f the Dutch purchases were accounted for by a large direct investment in the United States by a Dutch company. U . S. corporate and other bonds, which include issues of states and municipalities, and o f agencies United States and other areas. Transactions in U . S. Government securities in this area were small in 1968. T he A sian category also showed net purchases o f U . S. corporate stock in 1968 with the largest pu r chases ($ 5 4 m illion) from the “ Other A sia ” group which includes Vietnam. Other m ajor purchasers of the U . S. Governm ent which are not guaranteed were H o n g K on g ($ 3 7 m illion ), the Phillipines ($20 m illion ), and Israel ($ 9 m illion ). Transactions by the U nited also popular am ong in U . S. Governm ent securities and corporate and Europeans with Switzerland ($510 m illion) and the other bonds were minimal with net purchases o f the form er and net sales of the latter for 1968. International and regional organizations, such as the International Bank fo r Reconstruction and D e States, were H U | [ CO RPO RA TE STO CK velopment, have generally invested the proceeds o f new security offerings in the United States in n on liquid U . S. assets. ] CORPORATE AND OTH ER BONDS In 1968, these organizations were net sellers of LT S. Governm ent securities . ($161 m illion) but net purchasers of corporate and other bonds ($117 m illion) and o f corporate stock ($12 m illion ). A frica and Australia have both been relatively inactive in U . S. long-term securities, except for $10 million of corporate and other bonds purchased by Australia in 1968. R e a s o n s fo r F o r e ig n P u rch a se s o f U . S. S ecu rities T he foreign demand for U . S. long-term securities E u ro p e La tin A m e r ic a □ ■ E3 l~] Canada A s ia □ O th e r com es from both official and private sources. M any foreign central banks and Treasuries hold a sizable part of their international reserves in the form of dollars. In order to earn a return on these holdings, they are invested in dollar-denom inated securities. U . S. securities are generally attractive to both o f I 1,600 I ____ - - ------ -------1 » I____ I____I------ 1----- 1----- 1 1 1 ,8 0 0 2 ,0 0 0 2 ,2 0 0 2 ,4 0 0 2 ,6 0 0 ficial and private investors because of the relative econom ic and political stability of the United States (thus a relatively low exchange risk) and because o f the broadness of the U . S. securities markets. T he increase in foreign purchases of U . S. stocks 9 NET FOREIGN PURCHASES ( + )& SALES ( - ) OF LONG-TERM DOMESTIC SECURITIES BY TYPE (A S REPORTED BY BAN KERS AN D BROKERS IN U. S.) $ Millions through 1968 coincided with a period of rising stock p rice s; foreign purchases declined as stock prices turned dow n in 1969. T h e prospects of capital ap preciation may also be a reason fo r the increase in the foreign private demand fo r U . S. debt securities. Prices o f all types of bonds have fallen consistently since 1965. T he average yield on M o o d y ’s corporate A aa bonds in 1965 was 4 .4 9 % per annum as co m pared with 6 .1 8 % in 1968. T o the extent that rising yields give rise to expectations of a reversal in the bond market, there is an opportunity fo r capital appreciation. Other attractions of U . S. securities have been relatively stringent U . S. disclosure policies applied to companies listed on the m ajor exchanges, the maintenance of overseas branches by U . S. brokers, and the F oreign Investors T a x A ct of 1966. T he d is closure practices in the United States are stricter than those in other countries thus allow ing the investor to becom e better inform ed. T he brokers’ foreign branches make it relatively easy, at least fo r E u ro peans, to make transactions in U . S. securities, and the F oreign Investors T a x A ct liberalized U . S. in com e tax policies on capital gains and the dividends for foreign individuals holding U . S. securities. In addition, potential foreign investors may be in tro duced to U . S. equities through convertible E u ro dollar bonds. H olders of these bonds have the option of converting those bonds into the com m on stock o f the parent U . S. com pany. R e c e n t D e v e lo p m e n ts N et fo r e ig n p u rch a ses o f U . S. securities decreased sharply in the first half of 1969, contributing to a serious deterioration in the U . S. balance o f payments. T he decline in net foreign purchases was largely attributable to declining U . S. stock prices and the relative attractiveness o f com peting investments such as E urodollar deposits. In June, foreigners sold m ore U . S. corporate stock than they bought, for the first time since 1966. A c cording to preliminary figures, sales o f stock e x ceeded purchases in July also, but in A ugust net purchases by foreigners were again recorded. Net sales by foreigners of corporate and other bonds and marketable U . S. Governm ent notes and bonds also took place in June, but net purchases were re corded fo r both in July and A ugust, again according to preliminary data. Recent behavior w ould seem to indicate that while foreign purchases o f long-term dom estic securities have fluctuated in 1969, there has Note: 1968 and 1969 d ata are qu arterly figures at a nn ual rates. Source: U. S. Treasury Department. been a long run increase in foreign demand for U . S. securities. K atherine M . Chambers 10 The Fifth District MEMBER BANK BORROW ING Daily borrow ings at Fifth District member banks T he Federal R eserve discount w indow extends credit to member banks on a short-term basis to reached record highs in the first six months o f 1969. O n M ay 23 borrow ings outstanding from the Federal enable them to adjust their asset positions when Reserve Bank o f R ichm ond climbed to a record $132.7 million and on June 27 hit a new high of necessary because of developments such as a sudden withdrawal of deposits or seasonal requirements for credit beyond those which can be met by use o f the $137.7 million. Daily borrow ings in the District averaged $44.8 million in the first half o f 1969— over bank’s own resources. T o use the discount w indow a banker simply places a telephone call to the F ed ’s half again the $29.3 million which District banks borrow ed in 1966, another year of stringent credit conditions. In this year of record borrow ings, it Discount and Credit Department specifying the amount he w ould like to borrow , the collateral he will use, and the number of days he intends to seems particularly appropriate to review the m e chanics of the discount process and outline some of the characteristics of the borrow in g banks. borrow . T he telephone request must be confirm ed by a signed note. Bankers located in the Charlotte MEMBER BANK BORROWINC 7 IN THE FIFTH DISTRICT FOR 1967, 1968, AND THE FIRST HALF OF 1969 Deposit Classification O ver $250 Million Number of banks in District* Total number of banks borrowing 1967 1968 First half 1969 Total bo rro w in g s! per borrow ings per $5-10 Million Under $5 Million 42 116 102 72 11 14 14 5 8 10 8 14 12 7 12 12 25 26 26 13 10 11 9 5 5 87,540 370,317 378,814 115,320 144,135 190,385 9,832 6,419 6,561 2,655 5,591 6,022 2,826 1,202 606 240 1,015 2,081 316 395 1,046 27 18 36 7 15 33 8 3 3 Thousands of do llars 25,914 58,154 52,649 9,314 38,813 30,425 Thousands of do llars 71 115 289 26 106 167 D ollars borrowed per $1 million in total deposits+ 274 1,262 2,678 1,677 2,224 7,222 1,076 1,530 3,745 8 (1-32) 24 (7-62) 22 (1-55) 28 (4- 80) 43 (4-117) 3 7 (7 - 77) 22 (4- 42) 39 (3-130) 29 (3-110) A verage num ber of borrow ing days per borrowing bank (Range of borrowing days) 1967 1968 First half 1969 $10-25 Million 20 Adjusted daily borrow ings per bor row ing bank 1967 1968 First half 1969 $25-50 Million 11 borrowing bank 1967 1968 First half 1969 $50-100 Million 15 borrowing bank 1967 1968 First half 1969 Daily $100-250 Million 890 3,018 4,589 2,130 1,209 2,387 997 1,773 4,179 2,017 785 772 11 (2- 30) 32 (3-104) 2 6 (1 - 70) 38 (2-114) 21 (1- 95) 1 5 (1 - 58) 17 (2-47) 22 (1-82) 27 (2-78) 31 (7-78) 9 (2-25) 6 (2-19) Days * Based on December 1968 C all Report, t Sum of borrow ings outstanding each d ay. | Deposits as of a nn ual call date. 11 and Baltimore Branch areas contact their respective from their correspondent banks. branch offices. markable for 1969, however, when monetary policy A fter specifying the amount to be borrow ed, the banker must indicate the kind of collateral he intends was to use. T w o types of collateral are used most often : tightening stantially below bill rates. and the discount It does seem re rate the Federal funds and was sub Treasury U . S. Government obligations and eligible paper. M em ber banks in the smallest size class had the U . S. Governm ent securities are the simplest means o f securing a loan since a member bank usually main tains an inventory o f Government securities at its lowest rate of borrow in g in 1969 even after a d ju st Federal R eserve Bank. V erification of these se ment for the deposit size of the bank. F or exam ple, the table indicates that the average member bank having over $250 million in deposits had total b o r curities is easy and quick, and the bank is able to have the loan that day. row ings per day of $2,678 for every $1 million in F or borrow in g purposes a member bank’s note may not have a maturity of more than 15 days. A t the maturity of the note the amount of the loan is 1969. T he average bank in the under $5 million class had total borrow ings per day of only $772 for every $1 million o f total deposits held. T he largest automatically charged to the bank’s account, but the bank is then free to take out a new loan. This sort of borrow ing occasionally continues for months. A bank may partially or fully repay its loan at any time. average borrow ings fell in the $100-250 million and $25-50 million groups. If there is one outstanding theme shown in the table, it is that fewer of the smaller banks borrow , T he table included in this article shows member bank borrow ings in the Fifth District for the past tw o and a half years. Total borrow ings, which are defined as the sum o f borrow ings outstanding on each day, clearly show that all but the smallest banks are borrow in g substantially more this year than in either 1967 or 1968. T he table also indicates that smaller banks, on the whole, do not use the discount w indow to the extent that the larger banks do. F or total deposits that it held during the first half of and if they borrow , they borrow less often and for relatively smaller amounts. In 1969, for exam ple, the percentages o f District banks which borrow ed were, from smallest to largest size groups, 7 % , 1 1 % , 2 2 % , 6 0 % , 9 1 % , and 9 3 % . O f the 72 banks in the under $5 million size group, only five borrow ed during both 1968 and the first half of 1969. The number of borrow in g days did not show such a positive relationship to bank size, but the smallest example, 24 out of 25 banks having deposits o f over banks in the District again showed a reluctance to $100 million used the discount w indow sometime during the first part of 1969, whereas only 42 o f 290 b orrow very often. member banks with deposits o f under $25 million during 6 days in the first half of 1969 and 9 days borrow ed from the Federal Reserve during the half- in 1968. year. T h e average borrow in g bank in the under $5 million class ow ed money to the Fed T his does not necessarily mean that the small Carla R. G regory and banks have not needed funds, for they often borrow W illiam E. Cullison 12