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E CO N O M IC R EV IEW

Additional copies of the ECONOMIC REVIEW may
be obtained from the Research Department, Federal
Reserve

Bank

Cleveland,

Box

6387,

Cleveland, Ohio 44101. Permission is granted to
reproduce any material in this publication providing
credit is given.

MAY 1971

jiiji

EUROBONDS AND THE
EUROBOND MARKET
The Eurobond is a creature of the 1960's and only a few
years younger than Eurocurrency, its companion phenom

IN THIS ISSUE

enon in international finance. Just as a Eurocurrency
deposit is denominated in a currency other than that of the
nation where the bank accepting the deposit is located,1 a

Eurobonds and the
Eurobond M a rk e t.........3

Eurobond issue is denominated in a currency other than
those of the nations where most or all of the issue is
initially marketed. Also, just as most Eurocurrency deposits
are United States dollar deposits, most Eurobonds are

The 1972 Federal Budget and
Economic A ctivity . . . . 18

denominated in dollars.
1

For a discussion of Eurocurrency and, in particular, the Euro

dollar,

see

The

E u rodollar M arket,

Federal

Reserve Bank of

Cleveland, June 1 970.

ECONOMIC REVIEW

The first Eurobond issues appeared in 1963.

firm wished to float an international bond issue to

The volume of these offerings has grown rapidly

provide additional capital fo r its subsidiary in

since that time, and this type of issue has become

Italy, the firm might float a bond issue denomi

an important source of capital for United States

nated in lire and marketed in Italy by an Italian

firms seeking to expand their foreign operations.

underwriting syndicate. This would be a foreign

This article describes some of the features of

bond. On the other hand, the firm might issue

Eurobonds and the Eurobond market, briefly

bonds denominated in Deutschemarks (or dollars)

relates the events that led to the development of

to be sold in several nations of western Europe by

the Eurobond, and discusses the supply of and

an underwriting syndicate comprised of firms in

demand for Eurobonds. The yields on various

several nations. This would be a Eurobond.
This article focuses on Eurobonds and United

types of Eurobonds are also compared w ith each
other and w ith domestic bond yields, and the

States participation

relationship between the United States balance of

When separate information on Eurobonds is not

payments and the Eurobond market is explored.

the

Eurobond market.

available, data on international bonds as a whole
are used. Lack of separate data on Eurobonds,

D E F IN IT IO N OF EUROBONDS
International

however, is not a serious handicap because these

bonds are debt issues floated

issues have accounted fo r about three-fourths of

outside the country in which the borrower resides

the annual sales o f international bonds since 1965.

or is incorporated. Currently outstanding inter
national

bonds

can

c a te g o rie s —foreign

divided

bonds

and

into

two

CHARACTERISTICS OF EUROBONDS

Eurobonds.

Foreign bonds, sometimes called conventional or

The most prevalent denomination of Eurobonds
has been the United States dollar; the Deutsche-

classical bonds, are issues sold in and denominated

mark has been the second most common currency

in the currency

of a nation

foreign to the

denomination.

The

Dutch

guilder,

British

borrower. These bonds are underwritten by a

pound, and Belgian, French, and Swiss francs have

national syndicate resident in the country in which

also been used fo r denominating relatively minor

the issue is floated. In contrast, Eurobonds are

amounts of Eurobonds. It is not unusual fo r the

usually underwritten by a multinational syndicate

currency of denomination to be different from the

and are floated simultaneously in several nations.

borrower's domestic currency; e.g., United States

The bonds are denominated in currencies other

corporations occasionally float Eurobond issues

than those of the nations where most or all of the

denominated in Deutschemarks.

issue is marketed. For example, if a United States

Most Eurobonds are publicly placed issues and
have maturities in the range of eleven to fifteen

There is some variation in the nomenclature used by

years, although other maturities are used. Only

participants in and observers of the world's bond markets.

about

The most important variation is the use of the term

privately placed, and most of these issues have

international

bond

for

Eurobond.

This eliminates a

general term for debt issues floated outside the borrower's
country of residence.

percent

Eurobonds

have

been

maturities of less than five years. Since their
inception, the great majority of Eurobonds have

MAY 1971

been

straight

debt

6fferings,

but

sometimes

burdensome of the European exchanges.3

warrants and conversion features have been used

Unusual Features. Perhaps the most interesting

to enhance the marketability of specific corporate

features of the Eurobond market are the parallel

issues. Periodic data on the frequency and terms of

loan, the currency option clause, and the use of

call

have

unconventional denominating units—specifically,

apparently not been published. However, an exam

the European U nit of Account and the European

ination of the Eurobonds issued in 1969 reveals

Currency Unit. These features, which appear in

o ptions

Eurobond

contracts

that—fo r that year at least—most Eurobonds were

relatively few issues, are the product of efforts to

callable, usually in from three to eight years at

reduce the risk that a lender incurs by acquiring an

prices generally ranging from 102 to 105.

asset denominated in a foreign currency that

Eurobond issues tend to be relatively modest in
size when compared w ith debt offerings in the

may—during the life of the asset—be devalued
relative to the lender's domestic currency.

United States. For example, in 1969 less than

A parallel loan is, in effect, several bond issues

twelve percent of all Eurobond issues were for

offered simultaneously in several national markets,

amounts of $40 m illion or more. To date, the

with each portion denominated in the currency of

largest issue floated amounted to $125 m illion and

the nation in which it is sold. One such loan was

was issued in May 1970 by ENEL (Ente Nazionale

issued by ENEL in July 1965. This loan was

Elettricita), the Italian electrical energy agency.

composed

The typical denomination of a dollar Eurobond is

Deutschemarks, Belgian, French and Luxembourg

six

portions,

denominated

francs, Dutch guilders, and Italian lire, and had a

$ 1,000.
Most Eurobonds are bearer bonds w ith coupons

total value equivalent to $60 m illion.4
The currency option clause first appeared in

attached. Although normally unsecured general
obligations, Eurobonds are usually guaranteed by

1957 in an issue by Petrofina of Belgium.

the parent corporation when they are issued by a

The holders of these bonds were per
mitted to demand payment of interest
and principal in Swiss francs, German

financial subsidiary, or they are obligations of a
government (or its agency) whose power to tax
provides assurance that interest and principal will
be paid. Sinking fund provisions in the bond

For more detail on the customary features of Euro

bonds, see John F. Chown and Robert Valentine, The

contract are quite common.
Although only a small proportion of Eurobond

Inte rn a tio n al B ond M arket in the 1960's, (New York:
Frederick A. Praeger, 1968), pp. 40-54 and 66-67, and

trading takes place on organized exchanges, Euro

The Financing o f Business w ith Euro-dollars, (New York:

bonds are usually listed on at least one European

Morgan

stock

14-17.

exchange

help

assure

a successful

Guaranty

Trust Company,

April

1969), pp.

flotation. Issues by subsidiaries of United States

firms are usually listed on the Luxembourg Stock

Lloyds Bank Review, October 1967, p. 53. An alternative

Exchange, probably because its fees and other
registration

requirements are among the least

See H. Robert Heller, "Foreign Bond Issues in Europe,"

view would be to consider the Italian lira portion as a
domestic bond issue, and each of the other portions as a
foreign bond issue.

ECONOMIC REVIEW

The relationship between one EUA and each

marks, Belgian francs or Dutch
guilders, the currency being change
able at w ill for each and every interest
payment. In many subsequent issues
the freedom of the lender was
restricted to a single choice of
currency among a given number of
different currencies.5

reference currency is determined by their respec
tive gold values throughout the life of the bond.
For example, if a contract for an EUA bond had
been written on January 15, 1971, the following
rates of exchange would have existed between the
reference currencies and the EUA:

One unconventional denominating unit is the
European U nit o f Account (EUA). Bonds denomi

1 EUA =

26.0000 Austrian schillings

50.0000 Belgian francs

5.5542 French francs

discussion. In the 1961-1970 period, th irty EUA

30.0000 Greek drachmas

issues, totaling the equivalent of $336.1 million,

88.0000 Icelandic krona

nated

currency

7.5000 Danish kroner

EUAs are in reality more complex
option bonds and warrant a special

3.6600 German marks

0.4167 Irish pounds

were floated. Although there was some variation
among

the

terms

the th irty

EUA

bond

contracts, a general outline of their main features

= 625.0000 Italian lire
=
=

can be presented here.6 The principal amount of
these bonds is expressed in EUAs, w ith one EUA
equal to 0.88867088 gram of fine gold, which is
also the gold value of the United States dollar. A

50.0000 Luxembourgoise francs
3.6200 Dutch guilders
7.1429 Norwegian kroner

28.7500 Portuguese escudos
5.1732 Swedish krona

=
=

holder of an EUA bond, however, cannot receive

4.3728 Swiss francs
1 5.0000 Turkish liras
0.4167 United Kingdom pounds sterling

interest and principal payments in gold or in

If there are no changes in the gold values of the

EUAs. He must elect to be paid in any one of the

reference currencies by the time the bond matures,

17 reference currencies listed in the bond contract.

the holder of a 1,000 EUA bond could elect to

The reference currencies are those of the members

receive either 26,000 Austrian schillings, 50,000

of the former European Payments Union.

Belgian francs, or 7,500 Danish kroner, etc. If,

however, the gold value of one of the reference
Heller, op. c it., p. 52. Subsequent issues have given

lenders options between the pound sterling and the

currencies

is changed, e.g., the Belgian franc

Deutschemark, between the Deutschemark and the rand,

devalued by ten percent, one EUA would then be

and between the pound sterling and the dollar. See The

equal to 55.0 Belgian francs, and a 1,000 EUA

Financing o f Business w ith E urodollars, op. cit., note to

bond could be redeemed at m aturity fo r either

Table 2; and W orld Financial Markets, Morgan Guaranty
Trust Company, Statistical Supplement to the December

26,000 Austrian schillings, 55,000 Belgian francs,

1969 issue, note on p. 4.
O
For more detail on EUA contracts, see "The European

or 7,500 Danish kroner, etc. In contrast, if the

Unit

Federal

five percent, one EUA would then be equal to

Reserve Bank of Cleveland, April 20, 1970, and The

only 24.7 Austrian schillings, and 1,000 EUA

Account,"

Econom ic

Commentary,

European U n it o f A ccount, (Brussels: Kredietbank N.V.,
January 1967). An important point that is not discussed

Austrian schilling had been revalued (upward) by

bond could be redeemed at m aturity for either

here is the possibility of a change, in special circum

24,700 Austrian schillings, 50,000 Belgian francs,

stances, of the gold value of an EUA.

or 7,500 Danish kroner, etc.

MAY 1971
An EUA bond provides an advantage for lenders

currency, but also provides him w ith the possi

in countries that devalue and for borrowers in

bility of a speculative gain from a revaluation of

countries that revalue upward during the life of

any of the five reference currencies (except his

the bond. If there were both a revaluation of the

own, if it is one of the five).

borrower's domestic currency and a devaluation of

Regulatory Legislation. Eurobonds are generally

the lender's domestic currency, both borrower and

free

lender would reap a speculative gain from the use

countries. In contrast, European countries usually

of an EUA bond.7

issue

restrictions

most

European

have quite stringent regulations regarding the issue

The most recent innovation in the denomi

of foreign bonds in their capital markets.

nation of Eurobonds is the use of the European

The purchase of Eurobonds by residents of

currency unit, which is represented by the symbol

European nations is subject to foreign exchange

In December 1970, the European Coal and

regulations, but these have often been unimpor

Steel Community floated a $50 m illion, 15 year, 8

tant, depending on the stability of the currency

percent bond issue denominated in the European

and the nation's balance of payments. Austria,

currency unit—the first such issue. An ^ bond

Belgium,

Germany,

Italy,

Luxembourg,

the

holder can choose to receive interest and repay

Netherlands, and Switzerland are quite liberal

ment

regarding the purchase of Eurobonds by their

principal

Deutschemarks,

Dutch

guilders, Italian lire, or French or Belgian francs.

citizens.

The ^ bond differs from an EUA bond in that the

exceptions to this liberal attitude. For example,

Great

Britain

and

France are major

bond contract provides for unchanged conver

residents of Great Britain are restricted in their

sion rates between the unit of denomination (^)

purchases of foreign securities by the requirement

and the five currencies. Whereas the EUA bond

that the funds used may only be derived from the

provides the lender with a speculative gain only in

sale of other holdings of foreign assets. These

the case of devaluation of his home currency, the

foreign investment funds may be purchased by

f t bond not only provides the lender w ith a

residents of Great Britain, but only at a substantial

speculative gain from devaluation of his home

premium over spot exchange rates.

7The term "speculative gain” is used here and in the

DEVELOPMENT OF THE
EUROBOND M ARKET

discussion of the & bond to mean that when a bond is
redeemed, the lender can receive, directly or indirectly,

The Eurobond market is generally considered to

more units of his domestic currency than he originally

have originated in 1963. Foreign bond issues had,

invested. In the case of the borrower, speculative gain is

of course, been floated prior to that time. In fact,

used here to mean that to redeem a bond a borrower must
pay out fewer units of

his domestic currency than he

could have purchased with the proceeds from sale of the

New York City was the most important market for
foreign borrowing between the end of the war and

bond (at par, and disregarding costs of the sale) at the

1963. Although a substantial portion of foreign

time the bond was issued. It is assumed that both lender

bonds floated in the New York market were

and borrower measure their wealth in their domestic
currency. Changes in the "value" (however measured) of a

purchased by foreigners, sales of foreign bonds to

unit of domestic currency caused by revaluation, devalu

United States residents amounted to almost $944

ation, or the causes thereof are disregarded.

million in 1962 and reached $938 m illion in the

ECONOMIC REVIEW
first half of 1963.8 In an e ffo rt to stem this

1967; in 1968 they were replaced by mandatory

outflow of capital, which was contributing to the

restrictions on capital outflows fo r direct foreign

United States balance of payments deficit, the

investments. Both the voluntary and mandatory

Interest Equalization Tax (IET) was proposed by

balance of payments programs stimulated the

President Kennedy in July 1963. The IET, which

borrowing by United States firms in the Eurobond

was enacted in September 1964 and made retro

market.

active to July 1963, levies a tax on purchases by
United States residents of bonds (and stocks)
issued by borrowers in developed nations.9 Thus,
if foreigners issuing bonds subject to the IET wish

THE NATURE OF THE
EUROBOND M ARKET
United States corporations usually issue Euro

to be successful in selling their securities to United

bonds

through

financial

subsidiaries that are

States residents, they must offer a rate of interest

specifically established fo r this purpose. Most of

high enough to compensate the buyer for the tax.

these subsidiaries are incorporated in Delaware,

The IET, therefore, encouraged foreign borrowers

Luxembourg, or the Netherlands Antilles. United

to float issues on European markets instead of in

States corporations use subsidiaries to issue Euro

the United States.

bonds for two reasons. First, since the funds

A second measure that was intended to improve

derived from sale of the bonds are fo r use overseas,

the United States balance of payments and that

the United States balance of payments program

encouraged development of the Eurobond market

necessitates that the securities be issued in a

was the voluntary balance of payments program

manner that provides substantial assurance they

announced

by President Johnson in February

w ill not be purchased by Americans. This is

1965. As part o f this program. United States firms

accomplished if the securities are issued in a way

were encouraged to borrow abroad, rather than

or fo r a purpose that makes them subject to the

export capital, to finance their direct foreign

Interest Equalization Tax. Bonds issued by a firm

investments.10 The guidelines of the voluntary

incorporated in Luxembourg or the Netherlands

program became more demanding in 1966 and

Antilles are subject to the IET. Bonds issued by a

Q
See Heller, op. c it., pp. 49-50. For additional detail on

firm incorporated in Delaware or another one of

borrowing in the period 1958-1963, see "Foreign Capital
Borrowing in the

United States," Econom ic Review,

Federal Reserve Bank of Cleveland, January 1964, and
"Investment
Borrowed

Characteristics

in the

New

Foreign

Capital

U. S.,” Econom ic Review,

Federal

Reserve Bank of Cleveland, June 1964.

the fifty states are also subject to the IET i f the
firm was formed fo r the purpose of obtaining
funds for use by a foreign affiliate.
American firms also issue Eurobonds through
financial subsidiaries to avoid withholding taxes on
interest payments to bondholders. Freedom from

Canadian issues are exempt from the tax. In 1965, a

partial exemption was granted to Japanese issues.

withholding taxes enhances the attractiveness of a
Eurobond and makes it marketable at a lower
coupon rate. In fact, competition for lenders'

10 For more information, see "Direct Foreign Investment

funds has made the Eurobond market a market in

of the United States," Econom ic Review, Federal Reserve

tax-free bonds. Under current United States tax

Bank of Cleveland, March 1971.

laws, interest payments on bonds issued by a

MAY 1971

domestically incorporated firm that receives over

are never invited to subscribe, and press advertise

80 percent of its gross income from

ments are either

foreign

sources are not subject to withholding tax. Interest
payments on bonds issued by subsidiaries incor
porated

Luxembourg

the

Netherlands

for information

only or are

required for stock-exchange q u o ta tio n /'

The secondary market fo r Eurobonds is mainly
over-the-counter, although most issues are listed
on at least one organized exchange. Two clearing

Antilles are also free from withholding tax.11
The marketing of a Eurobond issue involves a

systems, Euro-clear and CEDEL, were established

large organization. The underwriters of an issue

to expedite the delivery o f bonds traded in the

form a marketing organization with several levels;

secondary market. Euro-clear, operated by Morgan

each level accepts the bonds at successively smaller

Guaranty Trust Company, commenced operations

discounts from the ultimate offer price.

in December 1968. CEDEL (Centrale de Livraison

What happens is that a group of
managers (which may only consist of
one firm...) having formed a team of
underwriters, enter into an agreement
w ith the issuing company to purchase
all the bonds at an agreed price. This
price w ill stand at a small discount
from the ultimate offer price in order
to compensate for the risks involved,
the discount usually being in the range
of 2 to 3 percent. This underwriting
group (or "purchase group” ) then
forms a large international selling
group to which the bonds are offered
at a smaller discount (usually about 1
1/2 percent), and the selling group in
turn can offer the bonds to dealers at a
discount o f 1/2 percent.12

des Euro-Obligations, or Center of Deliveries of

The typical marketing organization includes firms

disparities often amount to as much as a 25

in several nations, primarily in Western Europe and

percent difference between the highest and lowest

the United States. The Eurobond issues are sold by

figures reported for an item. Whenever possible,

direct contacts between firms in the marketing

the Morgan Guaranty Trust Company was used as

Eurobonds), an independent organization, was
organized through the initiative of the Banque
Internationale a Luxembourg and the Kredietbank
S.A. Luxembourgeoise and began operations in
1971.14

SUPPLY OF EUROBONDS
Data on the supply of Eurobonds are available
from at least four highly regarded sources, but the
data often differ substantially (see Table I). The
disparities among the data are probably due to
differences in definitions of Eurobonds as well as
from difficulties in collecting data, particularly on
privately

placed

issues.

Caution

therefore

required when using Eurobond data because the

organization and prospective buyers: "...the public
13Ibid., p. 71.

11 This section has relied heavily on the following article,
which may be consulted for further detail on the taxation

14 For more detail on the secondary market and the

aspects of Eurobonds issued by United States firms:

operation

Morris

Yassukovich, "The

Mendelson,

"Some

Tax

Considerations

the

clearing

systems, see Stanislas M.

Development of the International

American Eurobond Flotations," National Tax Journal,

Capital Market," Eurom oney, January 1971, pp. 18-19,

June 1969, pp. 303-310.

and "The Primary and Secondary Eurobond Markets,"

■To

Chown and Valentine, op. cit., p. 68.

Weekly B u lletin,

Kredietbank,

August 28,

1970, pp.

337-341.

ECONOMIC REVIEW
TABLE I
Sales o f Eurobonds and Foreign Bonds as Reported by Four Sources
1963-1970
(mil. o f $)
1963
Eurobonds
Bank for International Settlements
International Monetary Fund
Morgan Guaranty Trust Company
Organization for Economic Cooperation
and Development
Foreign bonds sold in Europe
Bank for International Settlements
International Monetary Fund
Morgan Guaranty Trust Company*
Organization for Economic Cooperation
and Development
Total international bonds
Bank for International Settlements
International Monetary Fund
Morgan Guaranty Trust Company*
Organization for Economic Cooperation
and Development

1964

1965

1966

1967

1968

1969

696
629
n.a.

$1,046
1,116
1,041

$1,107
1,417
1,142

$1,889
2,231
2,002

$3,368
4,115
3,573

$3,110
3,386
3,156

n.a.
n.a.
2,966

258

650

836

1,408

2,148

3,846

3,406

n.a.

449
375
n.a.

340
330
n.a.

251
267
376

530
645
378

400
458
403

1,030
1,738
1,135

819
1,570
827

n.a.
n.a.
378

274

478

565

594

416

1,490

1,466

n.a.

586
585
n.a.

1,036
959
n.a.

1,297
1,383
1,417

1,637
2,062
1,520

2,289
2,689
2,405

4,398
5,855
4,708

3,929
4,956
3,983

n.a.
n.a.
3,344

533

1,127

1,401

2,002

2,564

5,336

4,872

n.a.

$137
210
n.a.

1970

n.a. Not available.
* Figures from this source include all foreign bond issues sold outside the United
States.

the primary data source for this article because

In addition to issues by American corporations,

that bank provides the most detailed information.

Eurobonds are issued by foreign corporations,

When necessary, other sources have been used and

governments, state enterprises, and international

are, of course, identified in the tables and charts.

organizations. In the 1965-1970 period, over one

In recent years, the international bond market

third of all Eurobonds were issued by United

has been dominated by new issues of Eurobonds.

States companies; about one fourth, by foreign

Since 1964, the annual volume o f Eurobond issues

companies; one third, by state enterprises and

has been from two to five times as great as the

governments; and the small remainder, by inter

annual volume of foreign bonds (see Table I). A

national organizations (see Table III).

major cause of the divergence has been that United

Eurobonds are issued almost exclusively by

when

borrowers in developed nations; more than two-

market

thirds o f all Eurobonds have been issued by

because their access to foreign capital markets has

borrowers in the United States and continental

been substantially limited by foreign authorities.

Europe. A major portion of the growth in Euro

States

firms

borrowing

usually
the

issue

Eurobonds

international

bond

In the 1965-1970 period. United States borrowers

bond volume in 1965-1968 was attributable to the

raised $5,201 m illion in the Eurobond market in

increase in volume of issues floated by United

contrast to only $499 m illion in the foreign bond

States firms, particularly in 1968 when United

market (see Table II).

States borrowing jumped to $2,059 m illion from

MAY 1971

TABLE I!
United States Corporate Issues of Eurobonds and Foreign Bonds
(mil. of $)

Eurobonds
Foreign bonds
Total international bonds

1969

Total for
19651970

1965

1966

1967

1968

1970

$358
10

$439
24

$562
48

$2,096
139

$1,005
223

$741
___ 55

$5,201
499

$368

$463

$610

$2,235

$1,228

$796

$5,700

Source: Morgan Guaranty Trust Company

TABLE III
Eurobonds by Category of Borrower
(mil. of $)

1965
United States companies
Other companies
State enterprises
Governments
International organizations
Total

358
319
110
189
65

$1,041

1967

1966
$

439
376
118
108
101

$1,142

Percentage
Distribution

1968

1969

562
575
442
303
120

$2,096
603
349
500
25

$1,005
817
682
584
68

741
1,065
594
351
215

$ 5,201
3,755
2,295
2,035
594

37.47%
27.05
16.53
14.66
4.27

$2,002

$3,573

$3,156

$2,966

$13,880

100.00%

1970

Total for
19651970

Source: Morgan Guaranty Trust Company

$527 m illion in the previous year (see Table IV).

that are convertible into equity shares of the

Similarly, the decline in total Eurobond volume in

issuer. The warrant is another device used to

1969 and 1970 (not shown in table) was caused by

enhance

a reduction in the volume issued by United States

Warrants, detachable from the bond, are options

borrowers.

to buy shares o f the issuing corporation (or the

th e

attractiveness

Eurobonds.

As mentioned earlier, the United States dollar is

parent corporation if the bond is issued by a

the currency used most frequently to denominate

financial subsidiary) at a specific price w ithout

Eurobonds

surrendering the bond. In the years 1963-1970, 27

both

American

and

foreign

borrowers. In the 1963-1969 period, 78 percent of

percent of all Eurobonds issued

were convert

all Eurobonds issued were denominated in dollars,

ible or had warrants attached.

while the Deutschemark was the currency of

was atypical w ith regard to convertible issues; in

denomination for 17 percent of the Eurobonds

that year 54 percent o f all Eurobond issues had an

issued. The remainder were denominated in the

equity feature. Pessimism about the prices of

European U nit of Account, the pound sterling, or

shares in American firms (most convertibles are

other western European currencies (see Table V).

issued by United States firms) in 1969 and 1970,

Eurobonds have generally been straight debt

however, lessened the attractiveness of a convert

issues, but some corporations have issued bonds

ible feature and reduced convertible issues as a

The year 1968

ECONOMIC REVIEW
TABLE IV
Eurobonds by Country o f Borrower
(mil. of $)

United States
Continental Europe
United Kingdom
Canada
Japan
Rest of the world
International institutions
Total

1963

1964

1965

-0 $ 88
-0 -0 20
25
5

-0 $408
-0 -0 162
5
121

$138

$696

$1,048

331
456
25
-0 25
83
128

1968

1969

Total for
19631969

527
886
51
-0 -0 305
120

$2,059
658
134
38
180
259
40

$1,032
1,082
235
228
246
247
40

$ 4,388
4,004
485
266
633
1,025
555

38.64%
35.25
4.27
2.34
5.57
9.02
4.88

$1,889

$3,368

$3,110

$11,356

100.00%

1967

1966
$

439
426
40
-0 -0 101
101

$1,107

Percentage
Distribution

Source: Bank for International Settlements

TABLE V
Eurobonds by Currency o f Issue
(mil. of $)

1963
United States dollar
Deutschemark
Belgian franc
Pound sterling
French franc
Netherlands guilder
Swiss franc
European unit of account
Total

1964

1965

1966

1967

1968

1969

Total for
19631969

Percentage
Distribution

$196.5 $550.5 $671.5 $1,167.0 $1,935.3 $2,962.1 $2,364.3 $ 9,847.2
-0 75.0
100.0
737.7
964.9
146.3
161.3
2,185.2
-0 40.0
-0 40.0
-0 -0 -0 -0 64.4
-0 14.0
20.2
147.0
19.6
28.8
-0 -0 -0 -0 12.2
20.3
-0 32.5
-0 -0 -0 -0 -0 -0 -0 16.6
16.6
13.9
-0 -0 -0 -0 -0 -0 13.9
19.0
57.0
60.0
48.0
10.0
-0 75.6
269.6

78.45%
17.40
0.31
1.17
0.25
0.13
0.11
2.14

$258.4 $649.5 $835.9 $1,408.5 $2,148.0 $3,845.9 $3,405.8 $12,552.0

100.00%

Source: Organization for Economic Cooperation and Development

proportion of all new issues to 36 percent in 1969
and to 8 percent in 1970 (see Table VI).

DEMAND FOR EUROBONDS
It is believed that the demand for Eurobonds

A preponderance of straight debt Eurobonds

comes largely from "private investors scattered

have been long-term; i.e., with maturities of 8

throughout the world whose funds are managed,

years or more.

In the 1965-1970 period, 80

sometimes on a discretionary basis, by a wide

percent of straight Eurobonds were long-term. The

range of bankers and other financial advisors."15

proportion of straight debt Eurobonds issued in a

Very little is known about the distribution by

single year accounted for by medium-term (3-7

country of Eurobond investors. It has been esti-

years) maturities has ranged, however, from 9

15Stanislas M. Yassukovich, "The Secondary Market in

percent to 30 percent (see Table V II).

Eurobonds," Eurom oney, June 1970, p. 9.

MAY 1971
TABLE VI
Eurobonds by Type of Issue
July—
December
1963
Convertible bonds*
Millions of dollars
Percent of
Eurobonds issued
Straight debt
Millions of dollars
Percent of
Eurobonds issued
Total issues

5
5.6%

$ 85
94.4%
$ 90

1964
$ 97

13.3%

$631

86.7%
$728

1965

1966

110

242

10.6%

21.2%

931

$ 900

89.4%
$1,041

1968

1969

260

$1,910

$1,131

13.0%

53.5%

$ 1 ,74 2 t

$ 1 ,6 6 3 t

87.0%

46.5%

78.8%
$1,142

1967

$2,002

1970
$

35.8%

$2,025

$3,156

8.0%

$2,728

64.2%

$3,573

238

92.0%
$2,966

Total for
19631970
$ 3,993
27.2%

$10,705
72.8%
$14,698

* Includes bonds with warrants attached,
t Includes small amounts of certificates of deposit.
Sources: Organization for Economic Cooperation and Development and Morgan
Guaranty Trust Company

TABLE V II
M aturity Distribution of Straight Debt Eurobonds

1965
Medium-term issues (3-7 years)
Millions of dollars
Percent of
Eurobonds issued
Long-term issues (8 years or more)
Millions of dollars
Percent of
Eurobonds issued
Total issues

$ 95

$225

10.2%

$836

25.0%

$675

89.8%
$931

1967

1966

15.4%

$1,427

75.0%
$900

260

84.6%
$1,687

1968
$

1969

480

173

30.2%

$1,108

8.5%

$1,852

69.8%
$1,588

1970

91.5%
$2,025

$2,728

Source: Morgan Guaranty Trust Company

mated that 25 percent of Eurobond issues are sold

remainder is placed through intermediaries in

through banks and brokers in Switzerland, 16

other nations of Western Europe. Although these

percent through banks and brokers in the United

estimates indicate

Kingdom, and

12 percent through such inter-

mediaries in the United States.

Most of the

the

locations of the inter

mediaries through whom investors purchase Euro
bonds, they are not indicative of the residence of
the investors themselves. Eurobonds sold through

1 fi

Rothschild & Sons, The Eurobond Market,

American

intermediaries, fo r example, can be

(London: Metcalfe, Cooper & Hepburn Limited, February

presumed to be purchased by foreign investors

1969), Table V III.

because the IET makes the bonds unattractive to

ECONOMIC REVIEW
TABLE V ! I i
Public Issues and Private Placements of
By Maturity
U 'tii. u i <j>/

1963
Bonds with a maturity of
5 years and over
Public issues
Private placements
Total
Bonds with a maturity of
under 5 years
Public issues
Private placements
Total
Total public issues
Total private placements
Total issues

1964

1965

1967

1966

1968

1969

Total for
19631969

Percentage
Distribution

$112.4 $534.5 $682.4 $1,071.5 $1,772.0 $2,993.3 $2,810.4 $ 9,976.5
977.9
487.1
146.0
160.3
53.5
110.0
6.0
15.0

91.1%
8.9

$118.4 $549.5 $735.9 $1,181.5 $1,918.0 $3,480.4 $2,970.7 $10,954.4

100.0%

-0 -0 - $
-0 $140.0 $100.0 $100.0

7.0
220.0 $

-0 - $
230.0

25.0 $
340.5

35.0 $
67.0
400.0
1,530.6

4.2%
95.8

$140.0 $100.0 $100.0 $

227.0 $

230.0 $

365.5 $

435.1 $ 1,597.6

100.0%

$112.4 $534.5 $682.4 $1,078.5 $1,772.0 $3,018.3 $2,845.4 $10,043.5
2,508.5
560.4
376.0
827.6
330.0
146.0
115.0 153.5

80.0%
20.0

$258.4 $649.5 $835.9 $1,408.5 $2,148.0 $3,845.9 $3,405.8 $12,552.0

100.0%

Source: Organization for Economic Cooperation and Development

TABLE IX

International Bonds Sold in 1969
By Issuer and Method of Placement
Public Issues

U. S. companies
Other companies
State enterprises
Governments
International and
regional organizations
Total

Mil. of $

Percent

$1,132.4
859.6
580.1
578.1

89.2%
91.0
73.5
84.7

226.3
$3,376.5

66.8
83.9%

Private Placements
Mil. of $
$137.3
85.5
208.8
104.3
112.6
$648.5

Total Issues

Percent

Mil. of $

Percent

10.8%
9.0
26.5
15.3

$1,269.7
945.1
788.9
682.4

100.0%
100.0
100.0
100.0

33.2
16.1%

338.9
$4,025.0

100.0
100.0%

Source: Morgan Guaranty Trust Company

United States investors. Similarly, foreign invest

A substantial amount of Eurobonds is privately

ment restrictions discourage the purchase of Euro

placed each year. In the 1963-1969 period, the

bonds by residents o f Great Britain. It has also

total volume of privately placed bonds amounted

been estimated that only 30 to 40 percent of the

to $2,509 million. There is a strong tendency for

Eurobonds sold through Swiss intermediaries are

private placements to be shorter m aturity issues

placed w ith residents of Switzerland.17

and fo r the shorter term issues to be privately
placed. In the 1963-1969 period, 61 percent of all

17Ib id . , para. 22.

Digitized for14
FRASER

private placements were issues w ith maturities of

MAY 1971

CHART

C O M P A R A T I V E Y I E L D S ON B O N D S

I S S U E D BY U . S .

CORPORATIONS

* N E M S E R I E S FOR D O L L A R E U R O B O N D S A N D D E U T S C H E M A R K E U R O B O N O S S T A R T S O E C E M B E R 1970.
L AS T E N T R Y : M A R C H 1971
S O U R C E OF DA TA : B O A R D OF G O V E R N O R S OF THE F E O E R A L R E S E R V E S Y S T E M

less than five years; and of all Eurobonds w ith

that "no other national market after New York

maturities of less than five years, 96 percent were

and London can match the Eurobond market

privately placed (see Table V III).

today in terms of daily turnover, so that it

International and regional organizations and

represents the third largest market for debt secu

state enterprises seem to be the most likely to have

rities in the w orld.” 18 The same observer states

their Eurobond issues placed privately, while the

that "sinking fund activity represents the single

opposite obtains for private corporations. In 1969,

most consistent and powerful source of volume

33 percent of the Eurobonds sold by international

and support of the secondary m arket."

Sinking

and regional organizations were privately placed;

fund provisions may usually be satisfied by pur

in contrast, only 9 percent of the Eurobonds of

chases of bonds in the secondary market. Rising

non-United States companies were privately placed

interest rates have caused most outstanding bonds

(see Table IX).

to sell

An active secondary market in Eurobonds could
be expected to have a favorable influence on the

below

par, making secondary market

purchases an attractive way for the borrower to
perform his sinking fund obligations.

initial demand for Eurobonds. In general, investors
are more w illing to purchase any asset if there is a
market in which the assets can be readily resold.

18Yassukovich, "The Secondary Market in Eurobonds,"

Most secondary market trading in Eurobonds is

op. c it., p. 9.

co n d u cte d

over-the-counter,

but

there

are

apparently no published data on the volume of

Eurobond trading. One observer, however, believes

Capital Market," op. cit., p. 19.

Yassukovich, "The Development of the International

ECONOMIC REVIEW

RATE RELATIONSHIPS
The yields on Eurobonds trended upward after
January 1966,

but June 1970 may have been a

turning

Eurobond

point.

yields

have

moved

downward since that time (see Chart 1).
Over the long run, the trend of Eurobond yields
can be expected to be generally parallel to the
trends of bond yields in the capital markets of the
United States and Europe. Rather than examining
in more detail the trend of Eurobond yields alone,
the follow ing discussion w ill look at the relation
ships between the yield on straight dollar denomi
nated Eurobonds and the yields on three other
debt instruments that might be of interest to a
United States corporate borrower: United States
corporate Aaa bonds, dollar denominated convert
ible Eurobonds, and Deutschemark denominated
straight-debt Eurobonds.
The yield on straight dollar denominated Euro
bonds issued by United States corporations has
been consistently higher than the yield on Aaa
domestic bonds. The spread between the two
yields

averaged

about

103

basis

points

1966-1968, but declined to an average of only 47
basis points in 1969 and 1970 (see Chart 1).
From June 1967 through December 1970 (the
period for which data are available), yields on
convertible dollar denominated Eurobonds were
lower

than

yields

straight

dollar

Euro

bonds (see Chart 2). Apparently, some lenders
have been w illing to accept lower yields to obtain
the possibility of future gains from the conversion
privilege. The spread between the yields on con
vertibles and straights averaged 224 basis points in
20

Another series of Eurobond yields, published less

regularly than the series used here, shows yields rising
since at least March 1964. See OECD Financial Statistics,
Organization for Economic Cooperation and Develop
ment, Supplement 1 B, 1970, pp. 64-65.

Digitized for 16
FRASER

MAY 1971
the period September 1967 through December
1968; in contrast, the spread averaged only 127

CONCLUDING COMMENTS
A

major force in the development o f the

basis points in the period June 1969 through June

Eurobond market has been the United States

1970. In the former period, high and rising United

Government's efforts to improve its balance of

States stock prices apparently induced investors to

payments. This raises an interesting question con

pay higher premiums (over the investment value of

cerning the relationship between the Eurobond

the bond as straight debt) for the conversion

market and this country's balance of payments;

feature than they were willing to pay in the latter

that is, what are the effects of the Eurobond

period, when stock prices were low and falling.

market on the United States balance of payments?
The opportunity for United States firms to raise

In comparing the yields on dollar Eurobonds

funds in the Eurobond market has eased the

and Deutschemark Eurobonds, a substantial spread

burden placed on them by the restrictions on

can be noted for 1968 and 1969 (see Chart 1).

capital outflows fo r direct foreign investment. This

Yields on Deutschemark Eurobonds averaged 111

opportunity has undoubtedly made the balance of

basis points below the yields on dollar Eurobonds

payments program less onerous to those American

in the period December 1967 through September

firms that desire to initiate or expand foreign

1969, and the spread between yields was as wide

operations and, therefore, has reduced opposition

as 138 basis points in June 1968. Lenders appar

to the program. In this way, the Eurobond market

ently were w illing to hold the lower yielding

may have helped the balance of payments. In the

Deutschemark

long run, the direct foreign investment that the

instruments

because they were

anticipating a revaluation

of the mark. That

Eurobond market has made possible, despite the

currency was revalued in October 1969, and the

balance o f payments program, may also aid the

spread between average bond yields fell substan

United States balance of payments, in the form of

tially, averaging 28 basis points in the following six

earnings repatriated after the Eurobond debt has

months.

been serviced.

ECONOMIC REVIEW

THE 1972 FEDERAL BUDGET
AND ECONOMIC ACTIVITY
The Federal budget for fiscal year 1972 reflects

output widened progressively during 1970 and was

an attempt to accelerate economic growth suffi

reduced only slightly in the first quarter of 1971

ciently to bring about a reduction in unemploy

(see chart). Although the overall rate of inflation

ment and at the same time reduce the overall rate

has moderated only gradually, increasing attention

of inflation. These objectives represent the latest

is being focused on accelerating economic growth

phase of a longer-term effort to achieve a more

and reducing unemployment. Proposed budget

between

policy, supported by a "complementary monetary

economic growth, prices, employment, and the

policy," would presumably lead to achievement of

balance of payments than has occurred since the

the Administration's economic goals fo r fiscal year

mid-1960's. From the fourth quarter of 1965 to

1972.1 Budget policy

the third quarter of 1969, the operation of the

centers

economy at or above its productive potential

employment budget, which was adopted by the

s a tis fa c to ry ,

balanced

relationship

largely

this economic plan

implications

the

f un

generated the longest inflationary wave in the

Administration fo r the coming fiscal year as the

post-World War II period. Largely as a result of the

appropriate

Revenue and Expenditure Control Act of 1968,

objectives.

framework

fo r

overall

economic

the Federal budget posture shifted to restraint to
eliminate excess demand and inflationary pres

"complementary" monetary policy is not explicitly

sures. The Act, passed in June 1968, held down

defined, but the 1971 A n nual R eport of the Council of
Economic Advisers states that as "a basis for considering

Federal Government spending while revenues were

what the outcome for the year would be with a specified

sharply boosted. On a national income accounts

combination of policies, it is convenient to assume that

basis, the Federal budget swung from a $10.5

the money stock will continue to grow at about the rate

billion deficit in the second quarter of 1968 to a
$13.4 billion surplus in the second quarter of
1969.
Since mid-1969, economic activity has been
marked by a growing margin of underutilized

that has prevailed since the turn early last year." See
Council of Economic Advisors, 1971 A n nual Report,
(Washington, D. C.: U. S. Government Printing Office,
1971), p. 84. The narrowly defined money supply, which
includes currency plus demand deposits, rose at a 5.4
percent rate in 1970, after a 3.1 percent increase in 1969.
The money supply expanded at an 8.9 percent annual rate

resources and sustained upward price pressures.

in the first quarter of 1971, following a sluggish 3.4

The gap between the nation's actual and potential

percent rate of expansion in the final quarter of 1970.

MAY 1971

GROSS

NATIONAL

PRODUCT

IN 1 9 5 8 P R I C E S
B I L L I O N S OF D O L L A R S

900

800

700

600

500

19 6 3

L A S T E N T R Y : IQ '71
S O U R C E S OF OflTfi: U . S .

DEPARTMENT

OF C O M M E R C E A N D C O U N C I L OF E C O N O M I C flOVISERS

Federal Budget Concepts. There are several
budget concepts that describe Government fiscal
activities, and each budget concept has specific

national income accounts budget (NIA) and the
fu ll (high)-employment budget.
The

N IA

budget,

which

includes

Federal

uses. The unified budget, which consists of a

expenditure and revenue activities consistent w ith

comprehensive set of accounts that includes the

the overall national income and product account

total spending, lending, and financing activities of

ing framework, differs from the unified budget

the Federal Government, is the Government's

both in concept and in accounting procedures. For

financial operating plan. However, for most analyt

example, lending activity

ical purposes, economists generally refer to the

actions of the Federal Government (i.e., loan

and financial trans

ECONOMIC REVIEW
disbursements and loan repayments) are excluded

fo r

from the N IA budget because they do not con

adjusted to reflect the difference between actual

unemployment

compensation,

which

tribute directly to national income and product.

and full-employment estimates of unemployment

Moreover, in national income accounts, Govern

compensation. Because of different assumptions

ment receipts are generally recorded on an accrual

used in estimating techniques—especially revenues

basis (i.e., when the tax liability is incurred). The

and prices—estimates of the level of the full-

only exception is personal income taxes, which are

employment surplus can vary considerably.

recorded when

payment is received.

This

On the

article reviews Federal Government fiscal activities

expenditure side of the N IA budget, most pur

as reported in the unified budget and the budget

chases of goods and services are recorded when

ary impact as measured by the full-employment

delivery is made; other expenditures (such as

budget.

transfer payments) are recorded on a cash basis. In
the unified budget, all receipts and expenditures
are recorded on a cash basis (i.e., when receipts are

FEDERAL FISCAL A C TIV ITIE S :
THE U N IF IE D BUDGET

collected and expenditures are paid). Because of

The annual budget documents, in conjunction

these differences in accounting procedures, the

w ith the Annual Report of the Council of Eco

overall budget surplus or deficit can vary by

nomic Advisers, reveal the stabilization objectives,

several billion dollars annually between the two

priorities, and economic assumptions of an Adm in

budgets. The level of Federal revenues in both

istration. The basic stabilization objectives for

conventional budgets, however, reflects changes in

fiscal year 1972 are to reduce the unemployment

the

fu II-

rate to about 4.5 percent and to slow the overall

employment surplus budget was developed in an

rate of inflation (i.e., as reflected in the GNP

level

economic

activity.

The

effort to separate discretionary changes in Federal

im plicit price deflator) to about 3.0 percent by

expenditures and revenues from the effects of

mid-1972. An overview of the financial plan of the

fluctuations in economic activity on the budget.
The full-employment surplus is an estimate of

Federal Government for fiscal year 1972 is shown
in Table I.

the budget balance that would be generated if the

The two major components of the unified

economy were operating at a hypothetical level of

budget are the "expenditure account" and the

full

"loan account." The expenditure account includes

employment. By linking revenues w ith a

prescribed

level

potential

Gross

National

Product (GNP) instead of actual levels of GNP, the
influence o f the economy on

For

a description

of the

mechanics and problems

involved in estimating the full-employment surplus, see

the budget is

Nancy H. Teeters, "Estimates of the Full-Employment

separated from the influence of the budget on the

Surplus, 1966-1964," Review o f Economics and Statis

economy. The main difference between the full-

tics, Vol. 47 (August 1965), pp. 309-321; Michael E.
Levy, Fiscal Policy, Cycles, and G row th, (New York:

employment budget and the NIA budget is in

Conference

computations of revenues, which in the former

Employment

concept are estimated on the assumption of a
fu ll-e m p lo y m e n t

economy.

Full-employment

expenditures are the same in both budgets except
Digitized for 20
FRASER

Board,

1963);

Budget:

"Estimates

1947-1967,"

the

Review,

HighFederal

Reserve Bank of St. Louis, June 1967; Arthur M. Okun
and Nancy H. Teeters, "The Full-Employment Surplus
Revisited," Brookings Papers on Econom ic A c tiv ity 1,
1970.

MAY 1971
TABLE 1
Budget Receipts, Outlays, and Financing
Fiscal Years 1969—1972
(bil. of $)

Receipts, expenditures, and net lending:
Expenditure account:
Receipts
Expenditures (excludes net lending)
Expenditure account surplus or deficit
Loan account:
Loan disbursements
Loan repayments
Net lending
Total budget:
Receipts
Outlays (expenditures plus net lending)
Budget surplus or deficit
Budget financing:
Net borrowing from public or repayment of
borrowing
Other means of financing
Total means of financing

1971
Estimated

1972
Projected

$193.7
194.5
- 0.7

$194.2
211.1
- 17.0

$217.6
228.3
- 10.7

13.1
11.6
1.5

8.3
6.2
2.1

8.8
7.2
1.6

9.4
8.5
0.9

187.8
184.5
3.2

193.7
196.6
- 2.9

194.2
212.8
- 18.6

217.6
229.2
- 11.6

- 1.0
- 2.2
- 3.2

3.8
- 0.1
2.8

17.6
1.0
18.6

10.6
1.0
11.6

1969
Actual

1970
Actual

$187.8
183.1
4.7

Source: The Office of Management and Budget

both

Federal

Government receipts and expen

rapid as in fiscal year 1971 (8.1 percent and 8.5

ditures. The unified budget identifies the lending

percent, respectively), and another sizable budget

activity (the loan account) of the Federal Govern

deficit ($10.7 billion) (see Table I). One of the

ment by recording loan disbursements and repay

main underlying assumptions affecting projections

ments separately from other expenditures. Thus,

of revenues and the size of the budget deficit is

the loan account includes financial transactions,

that GNP w ill expand at an average annual rate of

such as Federal Government purchases of m ort

about 11 percent per quarter during fiscal year

gages, financing of farm credit, and financing of

1972.

urban renewal programs. This account is identified

The loan account of the unified budget shows a

separately because loans and loan repayments

continued reduction in the Federal Government's

presumably have a different economic impact than

net lending activity for fiscal year 1972. The

the expenditure account.

transfer of several Government lending agencies to

In general, the expenditure account o f the

private, Government-sponsored enterprises, how

proposed 1972 budget is marked by a strong

ever, understates the real impact of the budget,

projected

particularly on financial markets. Until fiscal year

growth in

percent from

fiscal

Federal revenues (up 12
year

1971), a continued

growth in Federal expenditures at a rate nearly as

1968, loan disbursements and net lending activity
of the

Federal Government rose year-by-year.
21

ECONOMIC REVIEW
Although loan disbursements constituted a rela

Federally-sponsored

agencies were not removed

tively small portion of total outlays, deficits in the

from the budget, total Government outlays (i.e.,

loan account contributed significantly to the total

expenditures plus net lending) would be larger

budget deficits during 1965-1968.

than indicated, net lending activity would be well

For fiscal year 1972, net lending is projected to

above projections for fiscal year 1972, and the

decline to $0.9 billion, compared w ith $6.0 billion

total budget deficit would be considerably larger

in fiscal year 1968. This reflects the elimination
from the Federal budget of former Government

than the projected $11.6 billion for fiscal year
1972.

agencies, notably the Federal National Mortgage

Expenditure Patterns. The 1972 budget incor

Association and Farm Credit Administration, as a

porates a continued, gradual shift in allocation of

Government-

resources from national security and space pro

sponsored private corporations. The borrowing

grams to social services. The proposed $16.5

activity of these and other Government-sponsored

billion expenditure increase in the budget is just

enterprises has grown and is projected to grow

slightly larger than the $16.2 billion

through fiscal year 1972, especially in support of

estimated fo r fiscal

the housing market. This means that nearly $9.2

percent increase in the 1972 budget amounts to

result

their

conversion

into

year

increase

1971, although the

billion of net lending activity by Government-

7.7 percent, compared w ith an 8.2 percent gain

sponsored agencies w ill be outside the 1972 fiscal

estimated for the 1971 budget. The bulk of the

year budget, a factor which tends to minimize the

proposed increase in fiscal 1972 outlays is for

real impact of the Federal budget. Thus, although

domestic programs, comprised mainly of income

Federal borrowing from the public is projected to

security (up $5.2 billion), revenue sharing (up $4.0

decline by $7.0 billion from fiscal year 1971

billion), natural resources (up $1.2 billion, of

(reflecting a smaller overall budget deficit), net

which $0.6 billion is for water pollution control),

b o rro w in g

and health programs (up $1.4 billion) (see Table

from

extra-budgetary,

Federally-

sponsored enterprises is expected to increase.

II).

When

both the Federal and Federally-assisted

programs represents retirement and social insur

borrowing is taken into account, total borrowing is

ance payments, a result of both higher social

projected to increase $2.3 billion during fiscal year

security benefit payments and a larger number of

1972.3 In effect, if the lending transactions of

recipients. The remainder of the proposed increase

in outlays fo r income security programs primarily

Federally-assisted borrowing is carried on by seven

Most of the increase in income security

Federal departments (mainly Agriculture, Health, Edu

involves higher spending fo r low-income families

cation and Welfare, and Housing and Urban Development)

and aid to aged, blind, and disabled persons. The

and

proposed increase in spending for national security

seven agencies (mainly

Veterans Administration,

Import-Export Bank, and Small Business Administration)
that guarantee objectives of private lenders, primarily for

in fiscal year 1972 ($1.1 billion) would bring total

mortgage loans. Federally-assisted borrowing is expected

expenditures in this area up to the 1969-1970

to make up $20.8 billion of the $40.6 billion total

levels, following a decrease in fiscal year 1971. The

Federal borrowing projected for fiscal year 1972. Special

proposed increase, however, reflects a 279,000

Analysis: Budget o f the U. S. Government, Fiscal Year
1972, (Washington, D. C.: U. S. Government Printing
Office, 1971), pp. 38-40.

reduction in the size of the armed forces (com
pared w ith an estimated 406,000 decrease in fiscal

MAY 1971
TABLE II
Distribution of Federal Government Outlays
Unified Budget
Fiscal Years 1969—1972

Bil. of $

Percent
of total

$184.6
T O TA L O U TLA Y S
92.6
National security
81.2
National defense
3.8
International affairs and finance
7.6
Veterans benefits and services
Total Government outlays less
92.0
national security
55.9
Social services
6.5
Education and manpower
11.7
Health
37.7
Income security
18.2
Physical resources
6.2
Agriculture and rural development
2.1
Natural resources
7.9
Commerce and transportation
Community development and housing
2.0
15.8
Interest
2.9
General government
4.2
Space, research and technology
-0 Allowances
-0 Revenue sharing
-0 Pay increase
-0 Contingencies
- 5.1
Deductions and unallocable

100.0%
50.2
44.0
2.1
4.1

Bil. of $

Percent
of total

$196.6
92.6
80.3
3.6
8.7

1972

1971

1970

1969

100.0%
47.1
40.8
1.8
4.3

Bil. of $
$212.8
90.0
76.4
3.6
10.0

Percent
of total
100.0%
42.3
35.9
1.7
4.7

49.8
30.3
3.5
6.3
20.4
9.9
3.4
1.1
4.3
1.1
8.6
1.6
2.3
-0 -

104.0
64.1
7.3
13.0
43.8
21.0
6.2
2.5
9.3
3.0
18.3
3.3
3.7
-0 -

52.9
32.5
3.8
8.1
20.7
10.7
3.3
1.3
4.7
1.6
9.3
1.7
1.9
-0 -

122.8
78.7
8.3
14.9
55.5
23.2
5.3
2.6
11.4
3.9
19.4
4.4
3.4
0.8

57.7
37.0
3.9
7.0
26.1
10.9
2.5
1.2
5.4
1.8
9.1
2.1
1.6
0.4

-0 -0 -2 .8

-0 -0 - 6.4

-0 -0 - 3.3

0.5
0.3
- 7.2

0.2
0.1
- 3.4

Bil. of $
$229.2
92.1
77.5
4.0
10.6
137.1
85.5
8.8
16.0
60.7
25.4
5.8
4.2
10.9
4.5
19.7
5.0
3.2
6.0
4.0
1.0
1.0
- 7.8

Percent
of total
100.0%
40.2
33.8
1.7
4.6
59.8
37.3
3.8
7.0
26.5
11.1
2.5
1.8
4.8
2.0
8.6
2.2
1.4
2.6
1.7
0.4
0.4
- 3.4

NOTE: Details may not add to totals because of rounding.
Source: The Office of Management and Budget

year 1971) that is more than offset by civilian and

larger than for national security for the first time

m ilitary pay increases and the initial phases of the

in recent history, is not materially different from

proposed all-volunteer armed force. Defense pro

fiscal year 1971 (37.3 percent and 37.0 percent,

curement outlays are expected to decline slightly

respectively). The only sizable increase in the fiscal

in fiscal year 1972, although a sizable increase for

1972 budget allocations shows up in physical

future obligations w ill be requested of Congress.

resources and centers largely on pollution control.

Despite

the

proposed

$16.5

billion

total

(Proposed outlays for natural resources are up

increase in Federal outlays, the composition of the

from 1.2 percent of the total fiscal year 1971

1972 budget is not significantly different from

budget to 1.8 percent of the fiscal year 1972

fiscal year 1971, which suggests little further

budget.) Thus, despite the continued reductions in

progress in the reallocation of resources to meet

allocations for defense outlays and space, budget

pressing social needs. The portion o f the budget

leeway

that is being allocated for social services, although

trollable'' outlays—such as insurance programs,

remains

limited.

"Relatively

uncon

ECONOMIC REVIEW
interest on the national debt, public assistance

TABLE ill

grants, and farm price supports—account fo r about

Estimated Changes in Federal Tax Receipts
Unified Budget
Fiscal Year 1972
(bil. of $)

70 percent of the total budget and contribute
significantly

the

d iffic u lty

re-ordering

national priorities. Stated differently, the amount

Estimated
Change From
Fiscal Year 1971

of funds being allocated to meet social needs of
the county—such as public mass transit, housing

Gain

Loss

and community development, education and man
power

training—is

still

relatively

small.

For

example, of the proposed $229.2 billion in total
spending for fiscal year 1972, $13.6 billion, or 5.9
percent of total outlays, is for these purposes.
Projected Revenues. Total Federal Revenues are
projected to rise $23.4 billion (or 12 percent) in
fiscal year 1972, following an estimated $0.5
billion increase in fiscal year 1971. This sharp
growth in revenues would generally be appropriate
if the aim of fiscal policy were restraint rather
than stimulus to achieve growth and employment
objectives. In fact, however, little fiscal stimulus is

Estimated revenue changes under
existing legislation:
Income tax surcharge
Repeal of investment tax credit
Reform and relief provisions—
Tax Report Act of 1969
Social security rate increase (1/1/71)
Unemployment tax increase
Acceleration of estate and
gift tax payments
Total changes under
existing legislation
Estimated proposed revenue changes:
Social security base increase (1/1 /7 1 )
Other net changes
Acceleration of tax payments
Acceleration of depreciation writeoff

forthcoming from the revenue side of the budget.

Total changes proposed

The projected gain for fiscal year 1972 is nearly as

Total changes in revenues due to
existing and proposed tax legislation

large as the record gain in fiscal year 1969 when
the

income tax

surcharge was imposed. The

-0 $0.7

-$ 1 .1
-0 -

-0 1.9
0.1

- 3.0
-0 -0 -

1.4

-0 -

4.1

2.7
0.1
-0 -0 -

-0 -0 - 1.2
- 2.0

2.8

- 3.2

$6.9

- $ 7 .3

Source: The Office of Management and Budget

depressed level of revenues in fiscal year 1971
reflected the slowdown in economic activity, the

are projected to rise rapidly in fiscal year 1972.

expiration of the income tax surcharge in mid-

The proposed increase in the social security tax

1970, and the continuing effects of the Tax

base and tax rate would also add substantially to

Reform Act of 1969 that raised the personal tax

receipts from social insurance taxes.

exemption from $600 to $650 as of July 1, 1970.

On the other hand, revenue gains and losses

All of the projected gain in revenues for fiscal

from existing and proposed changes in tax legisla

year 1972 is associated with economic expansion,

tion just about offset each other (see Table III).

while little growth is expected from changes in tax

Acceleration of estate and g ift tax payments,

rates

Economic assumptions

repeal of the investment tax credit, and an increase

accompanying revenue projections include a 9

in social security tax rates would boost estimated

(see

Table

III).

percent year-to-year increase in GNP,an 8 percent

revenues by about $4.1 billion for fiscal year

rise in personal income, and a 20 percent gain in

1972. Estimated revenue loss would also amount to

corporate profits before taxes. Asa result. Federal

about $4.1 billion, chiefly as a result of the Tax

receipts from both individual and corporate taxes

Reform Act of 1969, which provides further tax

MAY 1971
relief for individuals. Among the changes proposed

The Federal budget also reflects Congressional

by the Administration, the only major tax increase

action or inaction on proposals o f each Adminis

is on the social security tax base; the only major

tration. Congressional action has already altered

tax relief is the accelerated depreciation w riteoff.

both the spending and revenue estimates for fiscal

The effect of these proposed changes amounts to

year 1972. Congress passed—and the President

only a $0.4 billion revenue loss. In summary, the

signed—a bill

increasing social security benefit

net effect of existing and proposed legislation

payments by 10 percent instead of the proposed 6

amounts to about a $0.4 billion loss in revenues

percent increase and deferred (until 1972) consid

for fiscal year 1972.

eration of the proposal to increase the social

Projected Deficit. On balance, if proposed out

security

tax

base

(from

$7,800

$9,000

alone.

Federal

lays and revenues materialize, the Federal budget

annually).

would be in deficit by $11.6 billion in fiscal year

spending estimates were increased by nearly $0.7

1972, or $7.0 billion

billion for fiscal year 1972, and estimated Federal

less than the estimated

these

actions

deficit for fiscal year 1971. However, the Federal

revenues were reduced by about $2.7 billion. If

budget is not only the product of the Adminis

growth of the economy falls short of the GNP

tration's program, but also of the economy oper

target and Congressional actions in the budget-

ating on the budget to produce revenues above or

making process continue on the expansionary side,

below Administration estimates. For example, on

the deficit in the Federal budget would equal, if

the expenditure side of the budget, interest pay

not exceed, the deficit for fiscal year 1971. In

ments on the public debt w ill apparently amount

fact, as of May 6, "b y the various actions taken to

to about $0.9 billion less than the $19.7 billion

date the Congress has increased estimated outlays

projected in the budget, a reduction that the

for fiscal 1971 and 1972 by about $610 m illion

Treasury Department attributes to lower rates of

and

interest than were assumed when the expenditure

decreased estimated receipts for these two fiscal

estimates for fiscal year 1972 were developed. Of

years

$1,370

m illion,

by $157

m illion

respectively,
and

$2,657

and

has

million,

greater significance, a shortfall in economic growth

respectively."

from the Administration's GNP target of $1,065

sional actions is to boost the unified budget deficit

The cumulative effect of Congres

billion would enlarge the deficit by several billion

for fiscal year 1971 to $19.3 billion; and for fiscal

dollars. For example, if the economy grows only

year 1972, to $15.7 billion. According to esti

in line w ith the ''standard'' forecast of $1,045

mates of the staff of the Joint Committee on

billion, the $20 billion shortfall in GNP would add

Internal

about $5 billion to the projected deficit fo r fiscal

deficits would be $20.3 billion for fiscal year 1971

year 1972.4
4

and $21.7 billion for fiscal year 1972. The Joint

According

Herbert

Stein,

Member,

Council

Economic Advisers, "...the deficit will be $11.6 billion
plus about 25 percent of any shortfall of the GNP from
$1,065 or minus about 25 percent of any excess of the

Revenue Taxation, however, projected

Committee based their figures on both Congres
sional actions to date and an assumption of slower
5

Joint Committee on Reduction of Federal Expenditures,

GNP above $1,065..." See Herbert Stein, Remarks a t the

Congress of the United States, 19 7 2 Budget Scorekeeping

Annual

Report, (Washington, D. C.: U. S. Government Printing

Financial

O u tlo ok

Conference,

Conference Board, February 17, 1971).

(New

York:

Office, 1971), p. 2.

ECONOMIC REVIEW

economic growth than is assumed in the official

w ill be different as the economy grows over time.

budget.6

A way of accounting for this difference is by
expressing the surplus or deficit as a percent of

BUDGETARY IMPACT:
THE FULL-EM PLO YM ENT BUDGET

potential GNP. The full-employment budget, like
conventional budgets, also provides little indica

A large budget deficit is appropriate if the

tion of the different economic impacts that could

economy falls short of the target path for real

result

growth. Because a deficit in the Federal budget

spending and revenues. Despite limitations, the

can reflect the effects of an economic slowdown

full-employment budget is still considered to be a

(which

turn

contributes to

a shortfall

from

changes

the

composition

useful measure of both discretionary fiscal policy

revenues) or of discretionary changes in spending

and of fiscal impact. For example, the $15.8

and/or in tax rates, a deficit is not necessarily an

billion swing from a surplus to a deficit in the NIA

indication of the posture of fiscal policy. For

budget from fiscal year 1970 to fiscal year 1971,

example, a major portion of the budget deficit in

which was largely the result of the economic

calendar year 1970 was the result of the drop in

slowdown,

suggests

stimulus

from

the

revenues associated w ith the economic slowdown

Federal budget than actually occurred. On the

and the strike in the automotive industry in the

other hand, various published estimates of the

fourth

quarter. Therefore, neither the unified

full-employment budget show only a nominal

budget nor the N IA budget is considered an

reduction in the surplus from fiscal year 1970 to

appropriate indicator of fiscal policy; both budgets

fiscal year 1971.7 Similarly, the proposed $10.8

reflect changes in the levels of economic activity as

billion reduction in the deficit (N IA basis) for

well as changes in spending and in tax legislation.

fiscal

year

1972

is actually

a product of a

The concept of the full-employment surplus was

projected recovery in economic activity, rather

developed to overcome the limitations in conven

than a shift in the posture of fiscal policy. In

tional budgets. Because the effects of changes in

contrast, official Administration estimates show

the

little

level

of economic activity

are removed,

behavior of the full-employment budget w ill fre
quently

diverge

from

conventional

change

the

full-employment

budget

position on either a fiscal or calendar year basis.

budgets,

For example, the Administration projects a full-

particularly in periods of economic slack when

employment surplus of $0.1 billion for fiscal year

conventional budgets show substantial deficits.

1972, compared w ith an estimated $1.4 billion

Estimates of the full-employment budget surplus

surplus for fiscal year 1971. These year-to-year

or deficit, however, are not precise. Economists

changes are rather insignificant and suggest little

generally follow changes rather than levels as an

additional thrust to overall economic activity,

indicator of the posture of fiscal policy, although

especially when measured against a trillio n dollar

simply

economy. Some private estimates also show little

tracing

out

movements

the

full-

employment budget is not always adequate on
several counts. The impact of a surplus or deficit

quarterly
^Nancy

movement

the

full-employment

H. Teeters, “ Budgetary Outlook at Mid-Year

1970," Brookings Papers on Econom ic A c tiv ity 2, 1970,
6lb id „ p. 2.

pp. 303-312.

MAY 1971
TABLE IV
Percent D istribution o f Federal Government Expenditures
National Income Accounts Budget
Fiscal Years 1969-1972
Purchases of goods and services
Defense
Nondefense
Transfer payments
Grants-in-aid to state and local governments
Net interest paid
Subsidies less current surplus of
government enterprises
Total

1969

1970

1971

1972

53.0%
41.2
11.8
27.2
10.6
6.8

48.3%
37.1
11.2
30.1
11.9
7.0

45.5%
34.4
11.1
32.2
12.6
6.8

44.4%
32.2
12.2
32.6
15.0
6.2

2.4

2.7

2.9

1.8

100.0%

Sources: U. S. Department of Commerce and The Office of Management and
Budget

budget

mid-

absolute and relative terms. In part, the increase in

1971.8
The composition of spending and of revenues

surplus

from

mid-1970 through

transfer payments is nullified by higher taxes. As
mentioned earlier in this article, the net effect of

does not reveal much new stimulus from the

changes in existing and proposed tax changes w ill

proposed budget for fiscal year 1972. As indicated

be offsetting; reductions in tax rates exceed tax

in the N IA budget. Federal government purchases

increases by a negligible amount.

of goods and services have been accounting for a
declining share of the budget in recent years, and a
continuation of this trend is projected for fiscal

CONCLUDING COMMENTS
The proposed Federal budget fo r fiscal year

year 1972 (see Table IV). In absolute terms.

1972,

Government purchases w ill increase again, but all

monetary policy, was presumed to provide the

of the pickup is associated with the proposed

stimulus needed to achieve the Administration's

increases in Federal civilian and m ilitary pay and

output and manpower objectives, while permitting

the costs of the volunteer armed force. Thus,

further progress toward

conjunction

w ith

a complementary

reducing the rate of

defense purchases, which are presumed to have a

inflation. The discretionary changes proposed in

relatively
output,

large
income

m ultiplying

effect

on overall

the budget, however, may not be sufficient to

and employment,

have been

achieve these objectives. Spending is estimated to

declining. On the other hand, transfer payments

rise less than in fiscal year 1971, and tax changes

(such as retirement and disability benefits,

under existing and proposed legislation are largely

erans' insurance,

and

hospital

and

vet

medical

insurance) and Federal grants-in-aid to state and

offsetting.

It may be necessary, therefore, to

consider the use of additional expansive fiscal

local governments, have been growing in both

measures to promote achievement of output and

81bid., p. 306.

employment goals.