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FEBRUARY 1 973
The Long-Run Growth of Consumer
Instalment CreditSome Observations . . . . . . . . . . .. page 3
Capital Flows in a Foreign
Exchange Crisis . . . . . . . . . . . . . . page 14
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The Long-Run Growth of
Consumer Instalment CreditSome Observations
By Michael J. Prell
A
n e no rm o us e pansion o f" co ns umer in s ta lm e n t d e bt ha s occ urr ed in th e yea rs s in ce
World War 11. At th e e nd o f 1946, in st a lm e nt
c red it o utst a ndi ng a m o unted to o nl y $4. 1 billi o n , but by the e nd of 1971 th e total o ut s tandin g stood a t $ 111.3 billion , or a n average of
a bo ut $1,700 per U. S . hou se hold. In contra st to this 27-fold growth of in stalm e nt
c redit , "on ly" 5-fo ld increases were reg is tered
in U . S . g ro ss na ti o na l product a nd in tot a l
ne t publi c a nd private d eb t between 1946 a nd
197 1. In fac t , th e grow th o f co nsum e r instal m e nt c redit ha s o utp aced by ge nero us marg in s the increases in m os t o ther imp o rtant
eco nomi c agg rega tes .
Surpri s in g ly, ve r y littl e a ttenti o n a nd eve n
less se riou s stud y h ave bee n d evo ted to th e
lon g -ru n expa n sion of instalm e nt credit. While
man y stateme nt s of alarm ha ve been hea rd
from observe r s who associated that expansion
of ind e btedness with moral deca y and impendin g eco n o mi c co ll apse, thoug htful in vestigati o n s o f the determinants of in stalm e nt c redit
g rowth or the re la tion ship between in st a lm e nt
c redit and ec o nom ic ac ti vit y have been re lati ve ly rare . T hi s a rticl e re prese nt s a n effo rt to
hi g hlig ht the co ntours o f in st a lm e nt c redit
g row th in the 1946-71 period a nd to exa min e
som e of th e fac tor s th at m ay have in0u e nced
that grow th .
Monthly Review • February 1973
The disc ussion be lins w ith a s um mar o f
th e postwar be hav ior o r co ns um er instalment
c redit o uts ta ndin g ( IC O) a nd it s major
co mpo ne nts. Emp has ized a re the appare nt d ece lera ti o n of C ICO grow th over time a nd , in
parti c ular , th e marked re tardation of C ICO
expansion in the la te I 960's. Th e sea rc h for an
ex pl a na ti o n of th ese phenomena co mpri ses th e
re maind e r of the a rticle . Thi s sea rch lea d s fir st
to a brief d esc ripti o n a nd a pp ra isa l of two
fo rm a l m od e ls o f in s ta lm e nt c redit grow th d eveloped by ea rli e r resea rc he rs. Beca use th e
model s a re fo und to be in a d equate as explana ti o ns of
I CO behavior in th e po t war
yea rs, a m o re eclec ti c inv es ti ga ti o n is mad e
of th e pro x im a te so urces of C IC O grow th a nd
of so m e s pec ia l factors inv o lved durin g th e
late I 960's. Th e co ncludin g section s umm a ri zes the finding~ a nd co mm e nts briefly on
th e lik e ly growth path of in stalment credit in
th e years ahead.
THE PATTERN OF GROWTH
In th e te rminology of Federa l R ese rve acco untin g, ''con s um e r c redit " e nco mp a ses all
s ho rt - a nd int e rm edi a te- te rm c redit ex te nd ed
throu g h reg ul a r business c ha nn e ls to finan ce
th e purc hase of co mmoditi es a nd se r vices for
pe rso na l co ns umpti o n, or to re finan ce d eb ts
in c urred for s uch purpo ses. "Consumer inst a l3
The Long-Run Growth of
Chart 1
CONSUMER INSTALMENT CREDIT
B i ll ions of Dolla r s
Ratio Seo le
Bi llions of Dollars
Ratio Scale
400
PERCENTAGE DISTRIBUTION FOR SELECTED DATES
100
75
50
25
1955
19 63
8
6
4
?--1/
I
.6
100
//
--
_, ,,, ...
----
Pa per
----~
.,,.------
utomob i le Poper
197 1
~
_//
10
.8
200
Home Repair and
Modernization Loans
Othe r Consumer
Good s Pap er
Automob i le
1946
2
Personal Loan s
-
----
,-----,---------
-- -- --
_.........----Per sonal
__ .,,,,, ,,-----
----
Loons
80
60
----
me r
Go ods Pope r
___ ,__------- ----
_ , , - - - - Home Repa i r and
__ _,
Mode rn ization Loons
40
20
10
8
6
4
2
I
.8
.6
.4 ,.___.___ _._____.__ _._____.__ _._____._ _.__ .___.___......___.__ __.____.__ __.______.__ _._____._ _._---''-----'--......_---'-_..._____.______. .4
1965
1970
1960
1946
1950
1955
SOURCE: Federa l Rese rve Sys tem .
men t credi t" represe nt a ll co nsum<..:r cr<..:dit
sc hed ul ed to be repaid in two or mo re pa yme nts. According ly, insta lm ent credit includ es
revo lvin g credi t, budge t, a nd co u pon acco unts,
whi ch prov ide for chedu led repa ym ent on a
per iod ic bas i , whil e non in stalm e nt credi t incl ud es single- payme nt loans, cha rge acco unts,
a nd se rvice credit, whi ch are schedul ed to be
repa id in a lum p sum. T here a re four major
cl asses of insta lment cred it : auto m obile paper,
o th er co nsum e r goods pape r (w hi ch in clud es
bank c redit card loans), home repair and
mode rni za ti o n loans, and per o na l loa ns.
C hart I indica tes th e po twar behavior o r
C ICO and its majo r co m po ne nts. T he be havior
shown is ge nera ll y one of ra pid growt h- both
1
I/ Fo r a m o re detaikd descr ipti o n of th e dassifi ca t ion sc heme.
th e reader ma y co nsult ··co nsum er C redit ," Section 16 of the S upplem ent 10 Banking and M o netary S 1a1is 1ics . Boa rd o f Gove rn ors
of th e Federal Rese rve System , 1965 .
4
fo r the agg rega t<..: and its co mponents but
th ere a rc so me readi ly di scc rn ibk suhp a ttan s.
Fir st, it is clea r that th e co m po nen ts hav<..:
va ricd in re lative importance over the postwa r
yea rs. Automobi le paper co mpri sed a la rge
a nd inc reas ing share of C ICO unti l th e mid19 50's; therea fter , persona I loa ns and oth er
con sum er goods pa per ro se in re lative importan ce at the expense of a uto paper. The declin e in relative importance of auto pa per was
mo st prono un ced in t he last 8 years of the
peri od . Seco nd, the grow th rate o f C ICO has
tcnd<..:d to rl uctuate cycl ica ll y. In fa ct, C ICO
is in clu ded among the lagging indi ca tors uti li zed by bu iness cycle ana lys ts. Finall y, th e
trend grow th rate o f IC O ha s var ied durin g
the postwa r e ra , bein g appreciabl y grea ter
durin g the late I940's and ea rl y I 950's than it
was in th e remaind er of the period.
Federal Reserve Bonk of Kansas City
Consumer Instalment Credit-Some Observations
Chart 2
PERCENT AGE CHANGES
IN CONSUMER INSTALMENT CREDIT OUTSTANDING
Per Cent
Per Cent
70
70
60
60
50
50
40
40
30
30
Current
20
20
10
10
0
Constant Dollars
~
0
~ - '-''---'--'-'~~.~ ~ ~ ~ 10
'6 5
' 70 ' 72
SOURC . F ti ral Re orv , y-, 1o m , ut11or' ca lcu l t1ons
Since th e trend be ha vio r of C ICO 1s th e
focus or thi s ar ti cle, it is wo rth whil e exa minin g additi onal data doc um enting th e dece leration in it s growth rate. C ha rt 2 depicts yearto-year percenta ge cha nges in C ICO , with current dol la r, or nominal, figures traced by th e
so lid cu rve and cons tant dollar , or denated,
fi g ures plotted by th e dotted cur ve. Th e ra ti onale fo r ex~1111ini ng the latter se ri es is th a t
mu ch o r th t. : ex pansion or C ICO is attr ibutab k
to inl"bti on, whic h ha s in c reased no min a l in co mes a nd the pr ices co nsumers pay fo r th e
goods th ey purchase on credit. The d e ll a ted
fi g ures, th ere rore, ma y be rega rd ed as pro vidin g a be tter meas ure of th e rea l eco nomi c role
of in sta lm ent c redit. Th e con tour s of bo th
curves in C ha rt 2 tell essent ia ll y the sa me
sto ry: there we re sharp cyclical nuctuations in
th e C ICO growt h ra te throu ghout the period /
bu t th e grow th ra te up to th e mid- I 950's was
ge ner a ll y g rea ter th a n in subseq uent yea rs.
Th is dece le ra ti o n is a lso t:vident in Table I,
where perc<-: nt age cha nges in C ICO ove r co nsec uti ve 5-yea r a nd ove rl app ing 10- yea r spa ns
a re tab ul a ted.
2/ It sho uld be no tt:d that C ICO grow th wa s und o ubtt:dl y afft.:c ted
in so me dcgrt.:e by Federa l Reserve regul atio n of insta lment lendin g
in 1948-49 and 1950-52 .
Monthly Review • February 1973
EXPLAINING THE GROWTH OF CONSUMER
INSTALMENT CREDIT
In see kin g to accou nt fo r th e grow th pattern of in stalm e nt credit, it is reaso nab le to
beg in by exa minin g th e in come a nd ex penditure o r U. S. co nsum ers. Ri sin g in co me impli es both a grea ter capac ity fo r debt a nd increased co nsum pti o n ex penditure; a lso, co nsumpti o n ex pe nditure m ay influ<.:n ce (and be
influ enced by) c redit use. The ra ti os of C ICO
to perso nal in come a nd per so nal co nsumpti o n
expe nditure a re ex hibited in T ab le 2. It may
be see n that th ese rati os ro se rap idl y in th e
fir st I O year s o f th<-: pos t war pe ri od, in creased
a t ; 1 slowt.:r pace in th t. : seco nd I O yt.: ars, and
le ve led o il tli t.:re ~tl"tt.:r. Stated dillc ren tl y, th e
1 row th
r ..1tc or ins t~il rn t..:n l dt. : ht tt..:n dcd ovt..: r
Table l
CHANGES IN CONSUMER INSTALMENT
CREDIT OUTSTANDING
(In per cent)
Current
Dollar
Constant
Dollar
1946-51
1951 -56
1956- 61
1961 - 66
1966-7 1
360
106
41
71
44
246
97
28
60
17
1946-56
1951-6 1
1956- 66
1961 -7 1
848
191
142
146
581
153
101
87
SOURCE : Feder al Rese rve System. Con sumer Price Ind ex use d as d efl ato r in co n stant d ol la r ca lc ul ati on s.
Table 2
RELATIONSHIP OF CON SUMER INSTALMENT
CREDIT OUTSTANDING TO PERSONAL INCOME
AND EXPENDITURE
CICO as Percentage of
Personal Income
Vear
Level
1946
1951
1956
1961
1966
1971
1.78
5.72
9.04
10.20
12.42
12.14
Change
>
>
>
>
>
3 .94
3.3 2
1. 16
2.37
-0 .62
CICO as Percentage of
Personal Consumption
Expenditure
Level
2.21
7.08
11 .29
12.68
15.63
15.7 3
Change
>
>
>
>
:>
4.87
4.29
1.39
2.95
0.10
SOU RCE S : Federal Reserve Sys te m ; Survey of C urrent Business;
a uth o r's ca lcu lat ion s.
5
The Long-Run Growth of
time to fa ll into lin e with the growth rates
of perso nal income and expenditure.
In th e mid-1950' s, ma ny observers of' th e
rapid ri se of th e debt-inco me ratio ex pressed
considerab le co ncern that th e trend wa s inco mpatibl e with co ntinu ed pro sperity . They
argued that th e uptrend of th e ra ti o was un sustainable, that eventuall y ho usl: ho ld s would
be overburd ened with deb t, and th a t th e econo my wou ld th e n be vuln era bl e to a sharp co ntra ction . Th e poss ibl e need for renewed regulation of in sta lm ent lendin g was di sc ussed,3
but th e Federal Rese rve Boa rd ex pressed th e
view th at. se lec tive co ntr o ls were no t then
necessa ry, a nd no such mea sures werl: in vo ked . /\mong th e eco nomi sts who resr onckd
to the co nce rn ·1bo ut in stalm ent credit was
A lain Enth ove n. In a 1957 a rti c k ,' 1 he a ttemp ted to show that na ive lin ea r ex tr apo la ti o ns of
th e debt-in co me ratio tr end we re without
merit. Hi s ana lys is indi ca ted th a t th e rati o
could indeed be expected to continue to ri se,
but thi s upward movement would occur at a
decelerating pace and would be consistent
with continued fin a ncial and eco nomi c stability.
Enth ove n visua li zed a " life cycl e" process
as a criti ca l element in the ex planati o n o f co nsumer credit grow th . Specifica ll y, he he ld th at
most in stalment bo rrowing would be d o ne by
yo un g household s purcha sing th e ir co mpl ement of dur a bl e goods (a uto s, furnitur e, appliances, etc.), while o ld er hou se hold s would
do relatively little borrowing. As time passed,
the number of hou seho ld s would increase and
so would the average income per household .
Enthoven assumed that these two trend s taken
togeth er would res ult in a steady growth rate,
3/
In pa rti cular . in ~~ six -vo lu1m: st_ud y prepared under th e directi on of the Board of Gove rn ors o f the Federal Reserve Sys tem,
Co nsu111 er !11swlm e111 Credit (W ashin gto n: U .S. Govcn1mcnt
Printin g O ffi ce. 1957). A use ful revi ew o f thi s stu_dy wa s wrnt cn by
Warren L. Smi th . " Co nsumer In sta lment C redi t: /\ Rev iew Articl e," A m erican Econorn ic R e ,,ie w. Vol. 47 (Dece m ber 19 57). pp .
966-84 .
.
r
4/ "T hc G row th or In sta lment C red it and th e Future o, Prospe rit y," Am erican E cono mic R e ,,ie w. Vol. 47 (December 195 7).
pp . 9 13-29.
6
Chart 3
DEBT-INCOME RATIO: ENTHOVEN MODEL
R'ati o
Ratio
. 16
.16
. 14
.14
. 12
.12
.10
.10
.08
.08
.06
.06
.0 4
.0 4
.02
.02
0
0
19 4 6
55
50
60
70
65
72
r, or tot ,il person ,il in co me . 11 is sl:cond ,1ssumption was that th e in c re ..1se in in stalm ent
debt durin g any year will be a fi xed proportion, k, of per sona l in co me in th a t yea r . From
these simpl e ass umption s, Enth oven derived
th e re sult th a t th e ratio of CICO to perso na l
in come will tend over tim e to approac h a limiting co nstant given by k( \+r) . 5 For examp_le,
if we ass um e hypothetically that personal income grows a t 6 per cent a year and that the
CICO inc rease in a ny year is equal to I per
ce nt of persona l in co me, th en th e deb t- in co me
.06)
rat .io would te nd towa rd a va lu e o f .0 1( _1+
,
06
or abo ut . 18. It wa s Enthov e n's be lief that wa rtim e co nt ro ls had res ulted in a n a rtifi ca ll y low
(di sequilibrium) debt-in co me rati o. Durin g
th e postwar yea rs, th erefo re, th e ratio co uld
be ex pec ted to ri se and approac h asymptoti ca lly from below the limiting constant.
5/ The model may be expressed a lgebra ica lly as :
(I) Pl
11
=
Pl
0
(I
+ r/
(2) Cl e o , - C IC O I _ 1 = kPlt
whe re Pl t is perso nal in come in year I a nd
debt out standin g a t the end o f th e t th year .
I 0
1
is in sta lm ent
T he conclu sio n is that tlirn
C _l
ICO
t
k (I r+- r) ·
.. oo _ P
_
t - = -ln his or ig in a l arti c le, c it ed in fo o tno t_c 4. Ent_h oven in c lu ded two
addi ti ona l equ a ti ons. In repl y to certain c~1t1c1s111s. __he eli111_1,n a ted
those an d stated th a t (I) and ( 2) were log1ca ll y suff1c1ent. O n a
Debt - In com e Mode l of C onsum er In sta lm ent C redit G ro wth : Reply," Am erican Economic R e,,ie w. Vol. 54 (June 1964), p. 4 18.
Federal Reserve Bank of Kansas City
Consumer Instalment Credit-Some Observations
Howeve r, beca use thi s ri srn g ratio would no t
impl y th a t indi vidu a l house ho ld s we re incurrin g eve r-in creas in g debt burden s relative to
th eir in co mes, U. S. prosperity wou Id not be
e ndan ge red.
Enth ove n's model is imperfect. It is quite
obv io us, for examp le, that the rate of gro wth
of perso nal in come ha s not bc1..:n cons tan t a nd
th at th e ra ti o of the change in C ICO to th e
leve l of perso na l income has va ried co nsiderab ly fr o m year to year.<• Despite thi s and oth er
poss ibl e cr iti cisms, th e mode l see ms to capt ure
so me s ig nifi ca nt c lem ents in the C ICO grow th
process . Furth ermore, th e model ma y be rc1~1rd ed as suppl in, a r1..:asonah l 00d e post
tra ck in or th e 1011 •-run heh ~1vior or ' I ·o .
( /_-,'.x pos t in th e sense th ~,t the cst inrn tes or
th e parameter s r and k arc der ived from obse rved re lat ions durin g the 1946-7 1 period .)
This is demonstrated in Chart 3, where ac tu a l
deb t-in co me ratios for 1946-71 a re plotted
aga in st the rati os predicted by th e m ode l. For
1971 , th e predi cted valu e is . 139 as co mpa red
to the observed ratio of . 129. The implied
limiting ra ti o is . 172. What the chart see ms to
sugges t is th a t the mod est dec line of the debtincome rati o after 1965 was a cyclica l phenome no n within a long- run uptre nd and that , in
the yea rs ahead, C I O cou ld be expec ted
again to grow somewhat faster than persona l
in come. /\ final judgment o f this inte rpre tati o n will be ve ntur ed after further ana lys is.
Enth oven's assertion that a life cyc le process und er lay consumer borrow ing pat terns
was support ed by the results of num ero us
cross-sectional stu d ies of househo ld behavior .
Hi s mod e l was not, however, th e only one th at
mi g ht be in spired by cross-sect iona l evide nce .
1
l
6 / Fo r more de t a il ed criticism o r E nth ove n' s m o del. see F . R .
O li ver, ··o n a Debt - Inco me Modc.:I or Co nsumer In s t a lm ent Cred it
G ro wth : o mm ent ," American Eco nu111ic R e 1'iew. Vo l. 54 (.lune
1964), pp . 4 15- 17 : J o hn S . Y . C hiu and John J . Bros k y , " On a
Dc.:b t- l n co m e M o dc.:I of
onsumer In stalment C redi t G row th:
o mmc.:nt ." A m erica n 1:::co110 111ic R e1'iew. Vol. 57 (December
1967) , pp . 1244-49: Warrc.:n L. Smi t h, " Is th e Grow th o f Private
Debt a Cause for Concern· 1•· M onetar v Process and Policy: A
Symposium. ed. G . H orwich ( H omewood, Ill. : Ri c hard D. Ir win,
In c .. 1967), pp . 78-88 .
Monthly Review • February 1973
Chart 4
DEBT-INCOME RATIO: HUNTER MODEL
.14
.14
. 12
.12
.10
.10
.08
.0 8
.06
.06
.04
.0 4
.02
.0 2
o ~_,_-'-_.__._.__._._._._-'-.._._._-'-,_._.__._._.__.___,_,'-'--' o
1946
' 50
'55
'60
'65
' 70 '72
I Id en Mannin g I lu nte r suhse4ucnt ly prcs1..: nt1..:d a model or~,, 1r1..: 1 ak co nsu1111..:r borrowing behavior th a t differed in so me impor ta nt
re spects from Enth ove n' s. 7 In particular,
where Enth ovcn's rea so nin g led him to co nclude th at consum e r indeb tedn ess wo uld bear
a simpl e lin ear rela ti on to in come, Hunter deri ved a more co mpl ex equati on th a t rel a ted
consumer ind e btedn ess to income, the square
of income, the number of incom e- re ce ivin g
units, a nd the level of liquid assets held by
th e house ho ld sec to r.8
Hunt er' mod el led her to a n exp la na ti o n of
th e rapidit y or I O growt h in th e first postwar
decade that differs from Enth ovc n's. Ra th er
th a n th e cr iti ca l factor being "an ab normall y
low ratio of deb t to in co m e a t th e e nd of th e
war. .. a rap id in crease in th e number of inco me-rece iving unit s, a nd a dec rease in th e pos twar leve l of liquid assets were chie 0 y res ponsible for the ra pid postwar growth of credit extended , a nd were th e m ajor in nuences on credit
7 / "A Be haviora l Model or th e Long - Run Growth of Aggregate
Co ns umer
red it in th e United States." R e ,•iew of Economics
andStatistics .Vol.48(May 1966),pp. 124- I.
8 / In a lgeb ra ic form, Hunt e r 's bas ic equa ti on was :
Dt
= o+ /3 N1+
oY 1 '
y Yi+ -
Nt
+c L/\t . 1·
where fJ . Y. c) > 0. c< 0 . D = co nsum e r credit, N = n um ber of
in co me- reeeiv in g u nit s, _Y = di sposab le in come. and LA = li quid
asse ts- D , Y, and LA denated by th e
o nsumer Pri ce In dex .
She est im a ted thi s eq ua ti on (and ce rt a in va ri a nt s of it) for three differen t credit agg ret a tes ove r the 1923-62 spa n . In her fina l reg ress io n equa t ions, the Y t term was dropped fo r tec hni ca l reasons .
7
The Long-Run Growth of
outstanding, increases in in co me accounting
for th e rest of th e change . " 9 Hunter' s co nclus ion s were ba sed on th e va lu es of th e coefficient s in the equ a ti on she es timat ed from data
for I 923-62.
Th ere is reaso n to qu es ti o n wheth e r Hun te r's equ a ti on accurately re nec ts th e processes a t work in th e po stwar yea rs. Pe rhap s revea lin g in thi s rega rd is the present writer's
attempt to update Hunter's reg ress io n a nal ys is
by fittin g a version o f her eq uati o n to d a ta fo r
1946-7 1. 10 A number of sta ti sti ca l problem s
were enco unte red, among th e most import ant
being th e ve ry hi g h co rre lat io n be tween the
hy poth esi1.cd cxphnatory va ri ables. Su ·h a
si111il :1rit o l' movement , or multi co llin c:1rit ,
111 :1kcs it diffi c ult to c.lctcrrnin c what th · iml ividu a l inrluences or th sc va riables a rc, i.e ., th e
es timated coe ffi c ie nt. may be mi slead in . tr,
howeve r, one ta kes th e es timated equation a t
face va lu e, co nsid erab le d o ubt is cast up on
Hunte r's ex pl a na ti o n o f CICO beh av io r. For
in stan ce, the upd a ted reg res ion sugges ts tha t
a positi ve rel a tion ex isted betwee n changes in
liquid asse ts a nd changes in CICO durin g th e
1946- 7 1 period , ra ther th a n th e nega ti ve rela ti o n impli ed by th e coe ffi cient in Hunt er's re9 / Hunter, p. 139
10 / The re ult ant equa ti o n was the fo ll owi ng:
C l ·01 =2. -l-1 111 -2. 00l) Pl1
(0.23)
(J .X I ) 111
2
Sl: R = 2 . 17
=
=
0 . 12-11./\1 - 1 - 111 ..
(0 .044)
(10 . 1)
DW = .XI S
wh ere CICO
in stalment c redit o utstandin g at end of
year, in $billions; H
numb e r of U. S. hou seholds, in
millions; DPI
disposable in come, in $billions; LA
liquid assets ( currency and demand deposits, savings
accounts, and U. S. savings bonds) held by household
sector a t end of year, in $billions; a nd CICOt, DPI ,, and
LA,-1 all a re defl ated by CPI , (1967
1.00). Numbers
in parentheses are sta nd ard errors.
The ap parent prese nce of se rial corre la ti on ma kes it
d ifficult to a sess the sta ti sti ca l ignificance of the igns
of the coefficie nts, but it may be noted th at the es timated sign s of the DP I ,:.! / H , a nd LA, - 1 te rm s in the
equa ti o n a bove are th e opp site of th ose o bta inc I by
Hunte r in her rcgre ion s. Jn an a lt erna tive regres ion
in which LA, - 1 was deflated by
Pl , - 1, th e es tim ated
coeffic ient of DP l ,:.! / H , and LA , _, we re both positivebut with t-stati stics of 1.03 a nd 0.85, respec ti ve ly. Th e
al ternative regress ion eq ua ti on also showed apprec iabl y
grea ter tand a rcl e rror of e tim ate.
=
=
=
8
gress ion. If a positive re lat ion d ocs ind eed ex ist,
th e dec lin e in rea l liquid assets between 1946
a nd 195 1 tended to de press CICO expa nsio nno t stimulate it, as Hunter concl ud ed . The updated regression poin ts to the co nc lu s ion that
th e rapid increase in the number of incomerecei ving unit: was an eve n more impo rtant
fac to r in th e 1946-5 1 surge of C I O grow th
than Hu nt er th o ught.
It is poss iblc, of co ur se, fo r a reg ression
equa ti on to be a n unreli ab le indicator o r the in dependent effec ts of va ri ous exp la nat o ry var iables and ye t a good predictor of th e joi nt effects or these var iab les o n th e dependent v~1r iab lc . T he upc.hted I lunt er-typc equa ti on is perh;1p s such :111 in st an · ·, fo r as see n in C h:1rl 4 the
equatio n docs ;1 rc . ,sl> nahl · jo b of predi c t in, th e
tr enc.l o r th e deb t- in co me r .. ,ti o . It is int eres tin g
to no te, howeve r, that desp ite the retardation o r
rea l liquid asse t grow th in the la te I 960's (w hi ch
the mode l impli es sho uld have slowed C ICO expansio n) the eq uation d oes not predict as
mark ed a reta rdati o n of CICO growt h as actuall y occu rred durin g th a t period.
How far , th en, do th e Enth oven and Hunter
mode ls go in ex plaining th e pattern o f C ICO
grow th obse rved in th e pos tw ar yea rs? J\nd
what uo they tell us abo ut what the grow th
trend might be in th e years a head? The major
stren gth or En th ove n's mode l it s elegant sim pli city may also he it s m ._1j o r wea kn ess, for
the simplifying ass umpti ons th a t mak e it a ll
possib le see m so mewha t ext reme in th eir abstrac ti on fr o m rea lit y. There are strong gro und s
for be li ev ing that factors over looked, or assum ed away, in th e Enthoven mod el m ay have
played significa nt roles in th e expa nsion of
C ICO. Hunter' s approac h ee m s to offer a
g reater ri chn es , in the desc ripti on of be havior,
but stat istical problems prevent a clea r int erpretation or the infl ue nces o r th e particul:tr
fa cto rs she noted . Her model, unlike ~nth ovcn's, doc s not ie ld an obvious co nc lu s ions
about th e future g row th path o r I 0 . e ith er
model fu ll y e plain s th e marked retardation of
I CO g rowth in th e late I960's, a l th oug h a plot
Federal Reserve Bank of Kansas City
Consumer Insta lmen t Credit-Some Observations
o f' ac tu a l ve rsus pred icted debt-in co me ra ti os
fo r th e Enth oven model suggests th a t it was a
cyc li ca l pheno menon within a tre nd th a t should
see C ICO growing re la ti ve to pe rsona l in co me
fo r man y mor e ye ar s. 11 One is co m pe lled to
co nc lu de that an alternative approac h to th e
m a tt e r or C IC O g rowt h may be useful.
SOME ADDITIONAL FACTORS IN CICO GROWTH
A p riori reasoning sugges ts a large num be r
o f economic ph enome na that might have inrlu enced , direc tly or indirectly, the pos twar grow th
o f' C ICO. In thi s sec tion, so me of the prox imate
dete rmi nants or the rate of C ICO ex pan sion a re
exam ined . In add it ion, to prov ide a bas is fo r
j udg in g wheth er the m a rk ed rclctrda ti o n o f
C l ·o g rowth duri11 g the bte !%O's represe nt ed
ct tr c111 sito ry dev i:1tiu11 1·rn111 ct ll ex istin ) tn.: nd o r
th e es tab lishment ol' ct new trend , a kw spcc ictl
factors that may have bee n in vo lved d urin g tha t
peri od arc discussed.
Growth and Cha nging Compos ition of Expenditure
As was asser ted earlier, one o f' th e fir st
pl aces to look for an ex planat ion o f' C IC O
grow th is th e growth or co nsum er expe nd iture.
H oweve r, th e ri si ng ratio of C IC O to persona l
co nsumpti on expe ndit ure documented in Ta bl e
2 indi cat es that in creas in g cons ume r expe ndi ture is not the whok story behind the pattern
o r C ICO ex pa nsi o11 in the post wa r yea rs. T he
o bse rved deceler a ti on ur t he C IC O gro wth
ra te mu st be t.:xplained in some other way.
A n exam ination o r the changing compos iti o n of ho use ho ld ex pend it ure in th e postwar
yea rs suggests o ne lik ely factor in th e dece leration of C ICO grow th. Conventional wisdom is
that th ere is a strong t ie bet ween purchases of
"l a rge ti cket " item s, 12 partic ul a rl y cons ume r
dur a bl es, and ex tension s of in stal men t credit.
(Thi s link age be tween debt and household capi11 / T he eo rresr,o ndin g gra ph l'o r the I lunt cr mude l is a lso suggesti ve o r a sim ilar co nclu sio n. but th e under lying mod el docs not
provide the clear projecti o n o f the C ICO growth Lrcncl which is
nccess..1ry to j ust ify suc h . 1 11 int er pretat ion o f the g ra ph .
12/ La rge t ick et it ems, as de fin ed in th is ar ticle. cons ists of je welr y
a nd wa tches, furni ture. kit chen app liances , ph ysi cians' and dentis ts'
fees, new cars and net used ca rs. fun era l and hur ia l expenses . radi os
a nd T V 's, pri vate education a nd rese..1rch, foreign tr avel, a nd addi ti ons an d a lt era ti o ns to no n far m res id ences.
M onthly Review • February 1973
ta l fo rm a ti o n has its a na log in th e re lati onship
between co rp ora te de bt a nd bu sin ess ca pit a l
fo rm a ti on.) Co nseq uentl y, it is interes tin g to
no te th a t th ese types o r ex penditure g rew mu ch
m ore ra pidl y in th e 1946-56 spa n th a n th ey did
in subsequ ent yea rs, a nd th a t th ey rose m o re
rap idl y rela ti ve to to ta l co nsum pti on ex pendi ture a nd perso na l in co me in th e ea rli e r th a n in
th e la te r subpe ri od. Fo r exa mpl e, perso na l co nsumpti o n ex pe nditure on dur <1b les rose a t an
a nnu a l ra te of 9.4 pe r ce nt in 1946-56 a nd a t a
6. 7 pe r ce nt ra te in 1956- 7 1. Purchases o f la rge
tic ket ite m s rose at a 10.9 per ce nt ra te betwee n
1946 a nd 1956 a nd a t a 6.9 per cent ra te fr o m
1956 to 197 1. T hese figures m ay be com pa red
with th t.: g row th r~1tes fo r th e s;1mc pcr iods o r
to ta l pt.: rso nal co nsumpti o n expend it ure, 6.4 pe r
ct.: nt cllH..I 6.J pe r ce nt , respec tive ly, a nd pe rsona l
in co me, 6.4 pe r ce nt a nd 6.5 per ce nt , respecti vely. M o reove r, a ft er ris ing significa ntl y
in th e fir st IO yea rs of th e pos twar pe ri od ,
th e ra ti os of du ra bl es a nd la rge ti cket purchases to tota l ex penditu re a nd perso nal incom e rem a ined rath er sta ble.
Th e simpl est, a nd proba bl y m ost accur a te,
expl a na ti on of thi s pattern is th a t house hold s
we re und erstoc ked · with du rab les after World
Wa r 11 a nd proceeded to sa ti sfy th e bac kl og of
de m a nds in th e fir st pos tw a r decade. Wh eth er
or no t dur a bl es purchases will co ntinu e to grow
in future yea rs a t a pp rox ima te ly th e same pace
as th e broade r agg regates is impossible to say
with ce rt a int y- co nsum er tas tes, res ponses to
tec hni ca l inn ovati ons, a nd rela ti ve pri ce moveme nts will a ll pl ay rol es in th e ou teo me. If one
loo ks a t th e a ltern at ive va ri a ble , la rge ticket
pur chases, which includes a number of lu xury
goods a nd serv ices, perh a ps a stron ge r case
co uld be m ade fo r th e judgment that ex penditures in thi s ca tego ry will grow a t leas t as fas t
as tota l spe nd in g o r pe rso na l in co me.
Credit Use
C ha nges in the inte nsity of in stalm e nt credit use have tend ed to accentu a te th e effec ts of
cha ng ing ex penditure co mpos iti o n on C ICO
growt h. T hu s, not onl y has th e re lati ve 1mpor9
The Long-Run Growth of
ta nce o f du ra bles a nd la rge ti cke t purchases in creased during th e pos tw a r yea rs, but th e proporti on of ex pe nditur e o n th ese item s fin a nced
by credit has also ri se n. F urth erm ore, thi s intensifi ca ti on of credit use occ urred in such a tim e
pa ttern as to he lp produ ce th e o bse rved dece lera ti on of C ICO growth . Fo r exa mpl e, in 1946
th e rati o of co nsum e r in stalm ent credit ex tended (C l E) to co nsum er durabl es ex penditure
was .54; by 19 56, th e ra ti o had ri se n to 1.02;
but in 1971 it was o nl y sli ghtl y hi gher a t 1. 20. 13
S imil a rl y, th e ra ti o o f C ICE to la rge t icket
purchases was .56 in 1946, .93 in 1956, a nd 1.09
in 197 1. Furth erm o re, it m ay be no ted tha t
mos t o f th e pos t- 19 6 in cre,Jsc in th ese ra tios
occurred bcl'o rc th e m id - I960's.
;\ number o r L.1cto rs th ~,t mi g ht h:1vc co ntri buted to thi s in c rease in c n:dit use co ul d be
cited ; howeve r, definiti ve co nfirm a ti o n o r th ei r
ro les wo uld , in mos t cases, be di fficu lt given
ava il ab le da ta. S ur veys of Co nsum er Fin ances
sugges t so me cha nges in co nsum er a tt itud es towa rd th e use o f in sta lm e nt credit , but th e S ur veys we re less co mpr ehe nsive in th e ea rl y pos twa r peri od and th e re leva nt qu es ti ons we re no t
as ked in every yea r's Survey. N oneth eless, it
would see m fair to d ra w th e fo ll ow ing co ncl usio ns fro m the S urveys: fir st, co nsumers over
tim e have co me to rega rd th e use of ins ta lme nt
cred it as :..iccept ab le r r a g rea ter va ri ety o r purposes; 1·1 seco nd , th e pe rce nt age o f fam ili e th at
rega rd ed in stalm ent buyin g ge ne ra ll y as a good
idea in creased signifi ca ntl y durin g th e I950's
but was mu ch lower in ea rl y 1965 a nd ea rl y
1967 th a n it was in la te 1959; 15 third , th e perce nt age of fa milies ac tu a ll y using in sta lm ent
cred it rose in th e l 950's but leveled off th ere13 / The difference between the amou nt of in sta lment c redit extended during a yea r and the amount o f debt repaid wi ll equa l the
change in C I O fo r that yea r. after a ll owa nce is made for losses and
charge-o ffs . C IC is a less amhig uous mea sure of the degree o f
credi t usage in co nsumer purcha ses than is I 0. for I O ma
ri se with o ut a chan ge in C l E whe n loan ma tur it ies arc.; len gthened
and the pa ce o r repa yme nt s th ereby red uced. T hi s point is g iven
fu rth er emp has is in th e sub seq uent sect ion o n cha nges in loa n
ma tur ities .
14 / 196 7 S 1.1r1·ey ofCons11111 er Vi11ances. p. 144 .
15/ Ibid .. p. 14 1: 1965 S11r1 •ey of Co ns11111er Fina nces. p.42.
16/ 1970 un ·e_1• of Co nsum er Finan ces. p. 2 1: 1960 Sun-ey of
Consumer Finances . p. 155.
10
a fte r;16 a nd, fo urth, th e repl acement in th e po pul a ti on of a n o lder ge nera ti o n less di sposed towa rd th e use of credit by a-new ge nera ti o n mo re
di sposed towa rd do ing so has co ntributed to
th e ove ra ll cha nge in c redit use. 11 Wh e n co nsid ered along with deve lopm ents on th e suppl y
sid e of th e in sta lm ent loa n bu sin ess (in cludin g
lega l refo rm s, cha ng ing vie ws rega rdin g loa n
ri sk a nd approp ri a teness o f uses o ff und s, plu s
th e geograp hi ca l a nd ph ys ica l expa nsio n a nd
compet it iveness of th e firm in th e indu stry) ,
th ese observat io ns help to exp la in th e postwa r
pa tt ern of C IC O grow th . Furth e rm ore, they
support th e view tha t C I O grow th ra tes wi ll
not re turn to th e leve ls obse rved in the fir st
postwar dcc~1d c, h~1rrin 1 l"urth cr inn ov~1ti o ns
tha t si lnil"i c~111 1ly spur credit usc _1x
Maturities of Instalment Contracts
I t can be den1o nstra tcd th a t a n in crease in
the numbe r of mo nth s ove r whi ch a n in sta lmen t loa n is re pa id lead s by ma th em a ti ca l necessi ty to a n in crease in th e a m ount of ins ta lme nt cred it out sta ndin g pe r d o ll a r of in sta lme nt credit exte nd ed. A s a co nsequ ence, it is
possib le to co nclud e th a t th e leng th enin g o f loa n
mat urit ies du r ing th e pos tw a r peri od has accounted in pa rt for th e ra pid grow th of I 0 . 19
n rort un atc ly, it is no t poss ible to ca lcu la te
the aver:..ige matur it y o r in sta lm ent debt from
avai lab le data. It wo ul d be a simp le ma tter to
do so if th e vo lu me of ex te n io ns did no t va ry,
but thi s is clear ly not th e case . S till , pa rti a l ev idence o f th e cha ng in g m a turiti es is ava il a bl e,
a nd the re latio n hi p betw een th e grow th o f
17/ l960Sun ·eyofConsumer Finan ces. pp . 164-5 .
18/ Th e adve nt of the bank credit card a nd the switch from cha rge
accounts to revolving credit plans are de velopmen ts th a t co nceivab ly cou ld in crease the proport io n of expenditure finan ced
throu gh insta lm e nt credit. In the la tter case. a shift from a form o f
no nin stalmc nt credit to a type o f in sta lment credit is involved.
whic h co u ld res ult Llircct ly in a s m..1 11 boost in I 0 . /\s rcg.i rd s
bank cred it cards. their conve nience mi >ht lead to fu rt her grow th
in to ta l in stalme nt c red it use. but it see ms likely that th ey will in
part mere ly subs titute for o t her in sta lment credit forms . In short .
it is felt tha t r ises in the
I E - cx 1cnd itu rc ra t io res ul ti ng from
these par t icular institu t ional c hanges will be of ra th er modest si1.c.
19/ Len g th ening or ma turities a lso tend s to redu ce mo nthl y pa yments. which in turn ma y indu ce in crea sed dem a nd fo r credit anLI
a g reat er vo lume o f extensions . T h is interrelati o nship ma y be
igno red for the purposes of the di sc uss ion in thi s sect ion .
Federal Reserve Bank of Kansas City
Consumer Instalment Credit- Some Observations
C ICE a nd th a t of C I O m a kes clea r th e impac t of th e leng th enin g.
On e so ur ce of in fo rma ti o n rega rdin g m a turiti es is sur veys by th e N a ti o na l Co nsum er Fina nce Assoc ia t io n. Th e ir d a ta show th a t th e
ave rage lengt h of loa n co ntrac t was 18 m onth s
in 195 0 , 20 mon ths in 1954, 22 mo nth in 1958 ,
25 mo nth s in 1968, and 26 mon th in 1969. 20
Fig ures co m pi led by the Fede ra l Rese rve o n
ne w a ut o loa ns by major sa les fin a nce co mp ani es indi ca te an average len g th of 22 m o nth s in
1954, JO mo nth s in 19 55, 3 1.7 mo nth s in 1957
and 32 .2 mon ths in 196 3. So me furt her in c reas~
in th e ave ragc lcn 7 th o f new a ut loa n co ntr ac ts
has occ ur red , hut it is most ·cr tain ly still si ,_
niri ca ntl y be low 1() months . A lt ho ug h th c d ~1ta
011 lo~,n 111 ~1t uriti ·s i~ limit ·c.L :111 ind in.:c t mca sur c o r maturiti ·~ is avt1 il ah lc . s statcd ea rli c r
th e Ion er the lo ~n contract the g rea ter will b~
th e amount or ere lit outstanding fo r a g ive n
vo lum e of c redit ex tended . In fact, " th e ultima te difference in amount o utsta ndin g is ve ry
nea rl y in proportion to th e differe nce in m a turity. " 2 1 Thu s it may be noted that , wh ile C ICE
gre w 369 per cent between 1946 and 1956 a nd
2 12 per cent between 1956 and 197 1, C ICO
grew 848 per cent in the ea rlier period a nd 24 8
pe r cent in the la te r. ·'" The figures ind ica te clea rly that th c len gthe nin g or m~1turitics w~,s mos t
dram a t ic in the fir st half or the postwar per iod ,
pa rtl y because or the removal or contro ls on
in sta lme nt lending terms . The con tribution of
matur ity leng t henin g in more rece nt year.
see m s to have been much mo re modes t, tho ugh
still sig ni ficant. In the future, so me fur th er
movem ent in thi s directi on may be expected,
pa rti cul a rl y if mobile hom e loans increase furth e r in re lative importa nce and thereby rn ise
th e average loa n length . However, that moveme nt m ay we ll proceed at a moderate pace be-
_s.
20/
ccs 13 00 th . !.9 7 1 Finan ce Facts )'l'llrh uo/.. . (Washington :
Na ti onal onsumcr hnanec /\ ssoe1a t1 o n. 19 7 1). p. 6 5.
2 1/ Consum er lnsta/111e11t Credit. Vol. I. p. 120 .
22/ On t he basis or year-end dat a rather than annual -average
da ta C l O g rew 660 per ce nt between 1946 and 1956. and 24 5
per cent bd wcen l 956ancl 19 7 1.
Monthly Review • February 1973
ca use th e acce pted rul es o f so und fin a ncia l pr acti ce di c ta te a reaso na bl e ra te o f repay me nt of
loa n prin c_ipal , es pec ia ll y when de precia tin g
good s pro vide th e sec urit y fo r th e loan.
Special Factors in the late 1960' s
T re nd s in th e co mp os iti o n o f co nsum e r expe nditure, in c redit use , a nd in in sta lm e nt loa n
m a turiti es have bee n cited as imp ort a nt fa cto rs
in ex pl a ining th e dece leration of C l O g rowth
towa rd a rate in lin e with th e grow th tre nd o f
perso na l in co m e.
eve rth eless, so me furth er
ex pl a na ti o n wo uld see m wa rra nted rega rdin g
th e vc r sha rp reta rd a ti o n o f I O row th in
th · lall: 1960 's. To he sur e, ·1 spec i~tl h c to r
proh ~1hl y wo uld h~1ve e c rt ed it s influ e nce
th ro u lh a n imm e li a te im pact o n th e precedin g
thr ee prox im a te so ur ces o r IC O grow th , but
a ny phe no me no n th a t brin gs abo ut wha t appea rs to be a sig nifi ca nt dev ia ti on fr om und e rlyin g tr end be hav io r dese rves a ttenti o n. Th e
hypoth es is sketch ed in thi s sec ti o n is th a t u nusua ll y strin ge nt fin a ncial co nditi ons, in0 a ti o n,
a nd a ttend a nt uncert a inty res ulted in a curt a ilment of insta lment bo rro win g. Thi s set o f circum stan ces mi g ht be rega rd ed as a so m ew ha t
exagge rat ed cycli ca l epi sode, thu s impl y ing no
las tin g a ltera ti o n o r th e I O grow th trend .
Th e infl a ti o nar y spiral o f th e 1965-7 1 peri od
i. we ll - known a nd we ll-d oc um ent ed, as a rc th e
"c redit c run c hes" expe ri e nced in 1966 a nd
1969-70. Wh a t require elu cidati o n is th e process by whi ch th ese ph eno me na m ay have co ntributed to th e dece lerati o n of C I O g ro wth
during th a t spa n. Th e mere ex iste nce of in0 atio n d oes no t impl y a slow ing of co nsum er
credit ex pa nsion- in fa ct, o ne might a rgue th a t
th e dem an d fo r instalm ent c redit wo uld be
boos ted , a t give n int eres t rat es, by thc de s ire
to huy befo re pri ces ri se. With rega rd to c redit
cr unc hes, a p ric ri log ic sugges ts th a t sw ings towa rd m o ne ta ry ti g htn e ·s wo uld tend to redu ce
insta lme nt lendin g, but th ere is a frequ entl y
heard view tha t co nsum er credit is not hi ghl y
respo nsive to ge neral m o neta ry po li cy (thu s,
11
The Long-Run Growth of
the ca ll for selec ti ve controls on in stalment
credit).
Thoma s Ma ye r, in a rece nt article, has a rg ued th at th e re is empiri ca l ev ide nce of a direc t
impact of ti g ht mon etary policy on in stalm ent
cred it. 2-1 Hi s approach is simpl y to observe a
po siti ve co rr ela tion between th e rates o f nom ina l mon ey stoc k g rowth and in lalm enl credit
or debt- in come rati o growth . While Ma ye r's
ap proac h may no l be co mpl etely co nvin c in g
to a ll analysts , one may point to additional fa cts
supp o rtin g th e asse rti on that lh e sharp rise in
interes t rates re ta rd ed C ICO grow th in th e la te
l960's .
au ht in a r, ro rit squeoe helween slctlutor y
u .: ilin gs o n co nsumer lo:1n rctles and th e ri si n,
cost o r fund s, fin a n ·ial institutions und o ubted ly were less willin g to mak e instalm t.: nl lo~1n s.
Commercial banks, perhap s rccog n izi ng th e
lo ng- run profitability of es tabli shed relati o nships with other bu s iness c ustome rs, beca me
less willing to m a ke in stalment loa ns, according to Federa l Rese rve sur veys of bank len din g
prac ti ces. The surv eys also sho w that th e will in g ness of banks to extend lin es of cred it or to
mak e loa ns to finance co mpanies cha nged wi th
the swin g in ge neral credit co nditi o ns as d id
the terms o r loa ns mad e. /\ Ith o ug h th e large l"i n~1nce co mpani es mct y ha ve been abk lo l"ind
ot her so urces o f fund s (e .g., comme rcial paper) ,
small er compa ni es probabl y fo und it more diffi c ul t to do so . Thi s may have been a factor
in th e decl ine of the finan ce co mpanies ' sha re
of th e instalment loan m a rket fr o m 33 per ce nt
in 1966 to 26 per ce nt in 1971.
In additi on to th ese suppl y sid e effec ts on
in sta lm ent borrowing, a case can be m ade for
contractionary financial impul ses on th e dem a nd s id e. Du rin g th e late I960' s th e househo ld sec tor expe rien ced th e slowes t rise in it s
real liquid asse t ho ldings sin ce the marked decline of 1945-5 1. This ma y be see n in the Federal R ese rve Flow of F und s acco unt s; howeve r,
th e ho usehold ca tego ry th e re inclu des perso nal
tru sts a nd no nprofit orga ni za ti ons and ma y,
co nsequently , be a n in exac t portrayal of th e
fi nancia l positi on of co nsumers. Th e Sur veys
of Consumer Finances do , th oug h, pro vid e
so me furth er substan ti a ti o n fo r th e view that
potential borrowers ma y ha ve fell th emse lves
in un co mfortable circumstan ces. Thou g h medi a n liquid asse ts of a ll fam ili es ta ken toget her rose signifi ca ntl y betwee n 1965 a nd 1970,
acco rdin g to th e Surveys, th e median assets
of fa mili es in th e middl e in co me ($5 ,000 lo
$ 15,000) gro up whi ch d o th e bu lk o f in stalm ent
borrowing dr opped a pprec iabl y . Perhap s m ore
signi l"i c;1nt than this quanlit ctti vc resu lt is th e
l':1ct th at dur in, thi s per iod co nsu1nt.:rs vo iced
th t.: l't.:e lin g th;1l thei r ho ldin •s o r liquid :1sscts
were inadcqua lt.: . In 196 2, 5 I pt.:r ce nt o f ·ur vey
responden ts ex pressed d issa li sfac li on wilh th e
reserves th ey had acc umul a ted, whereas in 1969
a nd 1970, lhe fi gures were 59 per cen l and 54
per ce nt , res peclivel y. 2-1 Di ssa ti sfac ti on was
greatest in 1970 among th e afo remention ed
midd le in co me gro up a nd a mo ng th e und er 45
age gro up (s uch breakdown s a re un ava il ab le
fo r o th er yea rs).
Whi le it ca n be a rg ued that co nsum ers will
tend lo borrow mo re to m a ke urgent purcha ses
when th e ir liquid asse ts arc low, th ere is a well documented r,atlern o f co nsum ers ho ldin g liq uid asse t in excess of th e ir in sta lm ent indebted ness. /\ ig nifi ca nt propo rtion of co nsum ers
appa rentl y feel the necess it y to re ta in a liquid
rese rv e ag ain st emerge ncies a nd prefer Lo pa y
the added cost of borro wing ra th er than running
down th a t liquid bal a nce. It is clear from most
measures of cons umer se ntim ent that the acce lerat ion of in na ti on in th e la te 1960's crea ted
co nsid erab le un ce rtainty abo ut future econo mi c
pro spect s. Th e in flati o n ma y ha ve red uced rea l
di sc reti onary in come be low pre vio usl y expec ted
leve ls and thu s n.:ducecl th e willin g ness o f co nsum ers to bo rrow. In a ny event, th e red ucti o n
23 / .. Finam.: ial Guidelines and C redit Co ntrols. " J o urnal of M onn.
Credit . and Banking . Vo l. 4 ( M ay 1972). pp . 362-64 .
·
24 / 1970 Sun ·e_1' of Consum er Finan ces. p. 96 .
12
Federal Reserve Bank of Kansas City
Consumer Instalment Credit-Some Observations
in consu mer confid ence ce rta inl y in creased
th e desi red level o f liquid asse ts a nd reduced
th e desi re to borrow. ~'
It would appear , th en, th a t the marked and
prolonged retarda tion of C IC O growt h in th e
la te l960's was not simp ly th e res ult of und erlying trend forces, but was bro ught about in
co nsid erab le part by even ts of a cyclical natur e- fo rcmos t amon g them ep isodes of seve re
finan cia l stringen cy a nd ,rn acce lera ti on o r in fl a ti on. The revt.:r sa l of these cycl ical processes
ma y be seen in the resurge nce of in sta lm ent
cred it growth that accomranied th e easi ng o f
int eres t rates ,rnd dccelcr ~1tion of infl a ti o n late
in 1970.
CONCLUDING REMARKS
Th is ar tick has so ught to exp lain th e pattern
of in sta lment credi t g rowth witnessed in th e
po stw ar years . In par ti cular, a n effo rt was m ade
to determi ne wh eth er the ve ry slow real growt h
of co nsum er in sta lm ent credi t out standing
durin g the late I 960's represented th e basic
trend or wa s th e resu lt of shorter-run infl uences.
Two fo rm al m odels o f long-run C ICO grow th
were examin ed , but neither seemed who ll y satisfa ctory as an explanati on o f postwar phenomena .
In a more eclecti c aprroa ch, three pro ximate so urces of C IC O g rowth were disc ussed,
25/ The Su rvt:y Research C l: nter's " Inde x or Co nsum er Sen ti ment " dec lin ed from 102.9 in Novem ber 1965 to 75. ➔ in OctoberN ovember 1970. with th e sha rpes t d rop, in 1966 a nd 1969-7 0 the ea rlie r-m ent io ned periods of pro noun ced fi nan cial stringency.
1970SurveyofConsum er Finances. p. 207.
Mon thly Review • February 1973
i.e., grow th a nd changing co mpos iti o n of consum er ex penditure, in creased use of credit , and
leng th enin g of in sta lm ent contracts. It was
co nclud ed that eac h of th ese factors co ntributed
to th e growth of C IC O a nd did so in such a
way that th e dece lera ti on of C ICO grow th
see med large ly ex pl a in ed . Th e maj o r elements
in th a t dece leration see m to have been th e ea rl y
po stwar surge in durables purchases, which
co nstituted a ca tch up with demand s un sa ti sfi ed durin g th e wartime yea rs, th e deco ntrol of
in stalm ent credit, th e widening accepta nce of
credit use, a nd th e expa nsio n of th e co nsum er
lending busi ness. By the mid-19 50's , most of
th ose fo rc1.,;s had spen t th emselves, and th e im pul se for ' I ' O gro wl h in excess o f rason ~d
in co me g rowth c<.1me largd y from ~1 furth er
modcrnte kn g th e nin g o r av1.,; rage loa n maturi ti es a nd a continued widenin g o f th e ra nge of
accep tab le uses fo r in stalm ent credit. The co nclu sion offe red here i ~~ that these la tter tw o forces will also dec lin e in qu a ntitative sig nifi cance
in th e yea rs ahead a nd, as a res ult, the rate of
CICO growth may not exceed by much that of
personal incom e during the I 970's .
Examination of th e forces at work in the
la te I 960' s led to th e c~ nclu sion that th e mark ed retard a ti on o f C ICO grow th durin g that
period was in part du e to stro ng influen ces o r a
cy cli ca l na ture. On th e basis o r thi s findin g, a
recovery of C ICO grow th , in cluding a signifi ca nt ri se in th e in stalm ent deb t-perso nal in co me ratio, mi ght be ex pected durin g 1972-7 3unl ess interes t ra tes ri se sha rpl y or th e pace of
inflati o n quick ens.
13
Capital Flows
•
a
Foreign Exchange Crisis
By Donald L. K ohn
M
ass ive m ove me nt s o r cap it a l between
co untrie s hav e bee n a promin e nt featur e of rece nt int ernati onal mo ne ta ry cr i ·es.
Although th e und erl y ing causes of eac h c ri sis
ca n usua lly be identifi ed with lo nger-run co nsid era tion s, like differences in infl a ti o n rates
between co untri es, its ac ut e phase is o ft en
m a rked by extremely large carital ll ows . In
thi s <1c ut e phase, ca rit a l m oves fro m the wc . tk
curren cy to th e stron g curr ency co untry, th ereby in cre as in g the rese rve losses and g .. ,in s
which mu st be o ffse t o r fin a nced in o rd e r to
maintain ex istin g par va lues. /\!though suc h
flow s ar e no t a new phenomen o n, their size
see ms to have increased greatly ove r th e las t
few yea rs. Contributing to thi s tre nd has
been th e growth of international capital markets, th e ex pa ndin g link s between co mm ercia l
banks a nd all fin a nc ial m a rk ets, a nd th e enlarged volume o f inte rnati onal trade in financia l assets as we ll as goods a nd se rvices .
1
1/ So mc co untri cs no w usc ce ntral rat cs. ra th c r th a n p;1r va lu cs.
to s pcc ify th c rcl a ti vc wo rth or thcir currcn c ics. S in ce there is
no substa nti vc ditlcrcn cc bct wccn thcsc two co nccpt s fo r th c purposes o r thi s arti clc . the tcrm "par va lu e" wi ll be used cxc lu si vc ly.
a lth oug h 11 shou ld al so bc und e rs tood 10 co nn olc centr a l ratc .
14
The disruptive potential of cap it a l fl ows
was amply illu strat ed in 197 1 when cri sisindu ced ca pit a l move ment s int e rfered with
th e ac hi eve ment of d o mes ti c mo neta ry objecti ves and has tened worldwide exc han ge rate
adj ustm ent s. As a res ult , meth od s o r dea lin g
wi th th ese fl ows have become an impo rt an t
it em on the agenda o f the c urrent nego ti a ti ons
ove r th e future shape o r the intern a ti o n .. il monel..t ry system . To illu111in a tc so me o r th e problem s o r cop in g with cap it;.11 n ows , thi s a rti c le
fir st di sc usses th e ca uses o r cap ital 111 ove 111ents
in an exc han ge c ri sis, a nd then exam in es th e
U.S . balance o r paym ent s for 197 1 to ob tain
a 111 o re co ncrete id ea of th e form and 111ag nitud e cap ita l flo ws ca n ta ke durin g a cri sis.
INSTITUTIONAL AND MARKET FACTORS
AFFECTING CAPITAL FLOWS IN A CRISIS
/\n cxc ha nge cri sis occurs whe n th e re is ..,
ge ner ali1.ed loss o f co nfi ck ncc th a t a c urrcncy' s
par va lu c c;,.111 be 111aintain ed. U nd er th e International M one tary Fund (IMF) rules gove rn in g exchange rate movemcnts, 111ember co un tri es a re ob li ga ted to m a intain the price o r
Federal Reserve Bank of Kansas C ity
Capital Flows in a Foreign Exchange Crisis
th eir cu rrencies wi thin specific buyi ng a nd sellin g margins around a par va lu e. The limit s of
th e marg in s are known as int erventi o n po int s.
Wh en offic ia l t ran sactions und ert aken to preve nt price movements o ut s ide an interve nti o n
point result in large a nd pc rsis tent in creases
o r decreases in a country's international re se rv e
assets , expcct L1t ions beg in to build that a change
in par vctlu c may be necessL1ry . Persi stent deficit s in th e balance or pa y ments can signal deva lu at ion, jus t as surplu ses can sig nal reva lu ati o n. Ir th ese reserv e chan ges co ntinu e witho ut indicati ons or re li c!' in the under lyin g
economi c L1ctors, such LIS co rrective actions
by th e governm ents in volved, there c<1n be
1 rn w1n I
cxpcc L1ti n11s :thn 11t :1 ch:111 1 e in 11:1r
v: tlu c.
The cxc h:111 ge crisi:-. of 197 1, in whic h th e
U .S . d o ll a r wL1s th e currency under d ow nw :_1rd
pressure , wa s c haractc ri/.ed by large reserve
moveme nt s durin g the period preceding th e
cri sis. In I 9"/0, th e Un ited StL1tes incurred a
sizab le balance or payme nt s deficit of $9 .8
billion on an officia l rese rve transac ti o ns
ba sis (measurin g changes in U.S. offic ia l reserves a nd liabilities to foreign o ffi c ial age ncies), with stead il y l:1rgcr de fi cits be ing regi stered in eL1ch 4u arter of the ycLtr . Thc con tinu :_1ti o n o r th is tren d in to 197 1, co upled with
disappointin i.?. tr L1dc b<tl :1n ce l"i gu rcs through
th e ear ly summ er , wc rc suffi cient to co nvince
trn nsac tors or the in ev itab ility of d o llar deva lu a ti on and to precipitate th e fo rei g n exchan ge c ri sis that c lim axed with the suspe nsio n of dollar con vertibility on A ug ust 15 ,
1971 . A di sproportionate amo unt o f U .S . liabi liti es generated in 1970 a nd th e firs t quarter of 197 1 were accumulated by West German y as surp lu ses. ;\s a result , th e mark came
under consider <tblc up wL1rd prcssun.:, :rnd in
Ma y 197 1 the Germ L1n authorities stopped
pu rch::.1s ing do Ila rs and Ltl Iowed the va Iuc or
the mark to l"loal. This rirst ph L1sc or the 197 1
cr isis seemed at th e time to be as much in
favor o r the m:_1rk as a !)_ainst the dolbr . I lowMonthly Review• February 1973
eve r, th e co ntinuin g dollar buildup in th e rese rves of man y o th er co untri es, es pec ia ll y
Japan , mad e th e very weak pos ition of th e
d o ll a r m o re obvio us as th e yea r wore o n and
led to expec ta ti o ns o f more widespread reva lu a ti ons aga in st th e dollar.
In such cases o f prolonged rese rve ac c umul a ti o ns and decumulations , the rat es o f
excha nge between stron g Lind wea k curre nc ic
arc genera ll y at th e ir intervention point s fo r
some tim e bcrore th e o nse t o r an exchange
c ri sis. The exc han ge rat es will remain near
th ese leve ls th ro ug ho ut th e cri sis so lo ng as
the par va lu es co ntinu e to be offic ia l! supported . But a co untry's pledge to maintain
its pL,r v<tlu c rcl'c rs to th e rri cc :_1t whi ch it s
c urr e ncy is tr L1d cd fo r irnrncdi L1tc cxcl1a ngc,
i.c ., th e spo t exch ..111 1 c r ..1le. T here a re no le ) ..ti
co nstr ain ts concerning prices negotiated now
fo r c urr ency exc ha nges to be co nsumm a ted .. ,t
so me spec iri c tim e i:i th e futur e. Such an
agree me nt for a future c urr ency tr ansac ti o n
is ca ll ed a fo rw a rd co ntr act and the price em bodied in th e co ntrac t is th e forward ra te.
Since forward rates naturall y renect parti c ipants ' expec tatio ns of what spot ra tes a re
lik e ly to be in th e future, movem ent s in forward ra tes outside th e normal spot inter ve nti on points arc o rt c n the fir st sign<tl of the
c hange in expec ta ti ons th a t produces a fore ig n
exchange cri s is . 2
While forward rate mo ve ment s in a crisi s
arc mostly th e result of ac ti o ns by speculators ,
the primary function of th e forwa rd m a rk et
is to a ll ow an intern atio na l trad e r or in ves tor
to elimin ate th e ri sk of une xpected excha nge
rat e movements over th e life of a tr a nsaction.
2/
It has hccn s ugges ted th a t in stan ces o r forward rates outside
i111cr vcn1ion po int s be us..:d to dcfin ..: crisis peri od s. H owcvc r.
govc rnmrnl inlcr vc nti o n in the ro rward mark ..: t. whi ch i, not un common. would kad lo a n undcrsla lcmcnl o f th e scv..:r it an d
dur a t io n of th e c ri si, ir thi , were th e sole crit eri o n used . Sec
Ed ward E. I.ea rner :ind Ro hcrt M . S t..:rn. Q 110 111 iu11i1 ·e l 11t er 1111t i o110/ £ co 11 0 111ics ( Bos to n. Ma ss .: /\ ll yn a nd Ba co n, 1970). p.
<)7_ In 19 7 1. th.: forwa rd ra te on th e Gc rm :1n mark did no t m ovc
o ut sid e its s pot i111cr vc 111i o n po int until /\pril. While thi s ac cu r:11c l\ sign :ilcd th e upwa rd ll oa tin g. o r th.: mark. whi ch occurr..:d
in M a y. German cen tr a l bank sa les o f forwa rd marks dd aycd
the appca ra nc..: o f thi s cr is is indi ca to r.
15
Capital Flows in a
Fo r exa mpl e, an importer mi g ht be faced wi th
pa y in g fo re ig n c urr ency fo r goo d s so metim e
after th e price had bee n ag reed up on. In thi s
case, he ca n m ake a forw a rd purc hase o f th e
fo rei g n curr enc y in o rd er to es tab li sh th e d omestic cost o r thl'. goods a l th e tim e th e fo reign
pricl'. is fi xed .
The forward market ca n also be used by eln
importt.:r who wishL: s to bo r row m o nq to pay
for goo ds . While borrowing d o mestic cill y wo ul d
necess itate a n imm ed iat e s pot purcha se of fo re ig n exc ha ngl'., bo rr ow in g abroad will rl'. lJUire
fo re ig n L'.Xc ha nge when t hL'. dL:ht mu st hl'. repel id . I 11 th e lel ttt.: r G ISI.'.. if t hL'. I r:1d cr d ocs not
wish lo •:1mhlc o n lh l'. fu t ur e s po t pri ce or
lh l'. bo r rowed c urrcnc , he ·:111 pur ·h;1sc it
now in th l'. fo r wa rd lll e1rk c t. Thu s, in lkeid i11,
wheth e r lo borrow domesti ca ll y or ahro :1d ,
an im po rt er mu st no t o nl y co nsidL:r forl.'. ign
ve rs us domestic le ndin g ra tes but a lso the
relation ship between the spo t a nd forward excha nge rates. Similarl y, an in ves to r comparing
return s o n dom es ti c and fo re ig n assets mu st
co nsid e r not o nl y relati ve int eres t rat es but
a lso th e price o f do m es ti c c urrency at th e tim e
he will wish to repatriate hi s forei g n ho ldin gs.
ThL: in ves to r can use th e fo rwa rd m c1rk ct to
climinak th e risk o r un fo rL:SL'.l.'. n L:xc hange re1k
chan ges bct wec:n the time when th l'. in vL:s tm cn t
was madl'. a nd when it m at ur es . /\ n in ves tor
cove rin g hi s in ves tment in th e forward mark et
in thi s m a nn er is ca lled a n arb itrage r. Like
th e tr ade r finan c in g hi s purchase, th e arbitra ge r co mpar es the do m es ti c interes t rate
with a "covered " foreign ra te, whi ch co nsists
of th e foreign interest rate a dju sted by a ny difference bet wee n th e spot a nd fo r wa rd rat es .
In a c ri sis, forward mark et s pec ul a ti o n
a lters th e relati o nship between th e forward a nd
spo t rates a nd affects th e fin anc ial !l ows o r
a rbitr c.1ge rs and trade rin ,rn c iers. For exa mple ,
ass um e th a t th e spo t dollar / mark L'. chc1n ge
rak was $.27 = OM I, but th a t s pec ulat o rs
ce rt a in o r a d o llar deva lu i.1ti o n relati ve to the
m ark bid th e 3-m o nth fo rwa rd mark to $.28 =
16
DM I (th e dollar here 1s sa id to be at a rorwa rd di sco unt and the mark at a premium).
In thi s case, a dollar e1sse t ho ld er ca n co ntr ac t now to exc hange d o ll ars int o mark s at
$.27 and to co nve rt th e marks back int o dolla rs in J m o nth s a t $.28, gainin g $ .0 1 for eac h
mark in vested in add ition to the interest earned
o n th e investm en t. U nle ss U.S . intl'.res t re1tcs
WL: re wdl above Germi.tn raks , th e re wo uld
bl'. an indu ce ment for sa les o r U.S. assets in
favor o r purcha sl'.s 0 1· Gc rm<.1n assets . /\lso,
th ere wo uld be an indu ce ment to bo r row do llars for co nve rs io n int o 111 :1r ks in th e spo t
rn c1rk ct. with sirnul1 :1n L:ous purc hase o r ro rw:1rd do l l:1rs needed whc 11 the lo:1n h:1d to he
r ·p:1id . No rm :tll , th ese tr:111 s: 1c1i o 11 s W(Hild
con tinu e unti l th e s:,le o r 1·o rw:1rd 111 :,rk s (p ur c h:1sl'.s o r fo rward dull e1rs) moved th e pr L: mium
on th e m a r k b:1ck d ow n lo where cidditi o ncil
capi tal ll ows we re no lo nge r pro fitable . In a
crisis sit uat io n, howeve r, the impact o r speculat ive ac ti vit y o n forwa rd ra tes is ty pi ca ll y so
st ro ng th a t th e profitabl e a rbitrage m arg in
tend s to be susta in ed. 3
Widel y held expectat ions or par va lu e
cha nges :il so ha ve impor ta nt effects o n ot her
kinds o r ba la nce sheet deci sio ns. I I' an in vL:s to r o r Lr c1d c r wishes to ~1vo id loss l'.s fro m
;_ 111 e. pee led de veilu c1tion , he will nol wa nt to
have :1 nel asse t pos iti o n in th l'. wec1k c urrenc
o r a net li ;_1hility pos ili o n in thl'. stro ng cur renc y. /\ nd asse t pos iti o n in the weak cur ren cy is a vo ided because if the weak currency
is de va lu ed it s assets will be wor th less in
term s o r th e stron g currency. A net li ab ilit y
3/ Specul a to rs take pos itio ns o nl y in th<.: fo rw a rd m a rket. cxpcctin g to makc profit s from simultanco us purc hases a nd ,aks
o f for..: ign ..:xc ha ng<.: when th<.: fo rwar d co ntract matur<.:s . Sin e<.:
thi s r..:yui r..:s littk ca p it a l. :1 pract ica l! un limi1 ..:d suppl o r fo rwa rd ..: , c han i.te is ;11':1i l:1hlc to for ce th e fo rward r:1t e lo the e, pec led fu ture , pot rat e when th e l:1tt er is held with cert :1int ) .
:1, 111 :1 c·r1, 1, .
In :1ddi 1ion 10 acti ve s pern l:11i o n. a co ntinui n,• arhi 1r:1gc in centi ve rc quire, th a l in teres t r:11 es no t m ov<.: 10 o ffs<.:! 1he chan g ·
in the relati o ns hip heiw<.:en fo rward and , po t ra le, . Th..: c:1pi1 :d
ll o w from 1,1..:ak to stron g curr..:n c) co untr ie, wi ll indu ce.: sum c.:
lll LJVc.: 111 c.: nt in thi s dirc.:c li u n. I lo wc vc.: r. lhc.: arhit1·ai.tc.: rn :ir i.t in i,
usua ll y so witlc that elimin a tin g it wou ld necc.:,si 1:11<.: mu c h 1:irgc.: r
cha nge.:, in dom..:stic c rc.:dit condi ti o ns than th e monelar • auth o ri ti<.:s a rc.: usua ll y wil li ng to to lerate.: .
Federal Reserve Bank of Kansas City
Fo reign Exchange Crisis
pos 1t1 o n in a stron g c ur re ncy 1s avo ided beca use a ft e r deva lu a ti o n it will ta ke m o re o f
th e weak c urr en cy to rep..i y c..1 deb t d cno mina ted in th e stro ng c urre ncy _J Thu s, a sse ts
de no min a ted in a currency abo ut to be devalued will be d ivc.- tcd a nd stro ng c urren cy
assets c1cc um ub tcd. Wcc1k curren cy liabili ties will be sou g ht, while stro ng curren cy li abiliti es a rc liqu id <1ted . In sho rt_ th ose who
wi sh lo pro fi t 1·ro111 the exp ec ted deva lu a ti o n
will tr y to ob t ai n <l net ..1ssc t positi o n in th e
str o ng c ur re ncy c1nd cl ne t liab ilit y pos iti o n
in th e wc c1k o ne.
O r co urse . :1 tr :1ns ;1ct or m ig ht l"ind him se lf
with ; 1 w ·:1k cu r-r t:11 ·y ;1s:-.. el (o r :-..tro n~ cur rency li :1li ili1 y ) which he c: 111 11 ut se ll i111111 cdi ;1tcl y. Su c h ;111 c1..,:-..e 1 u llr ld ;iri :-. e o ut o r trad e
tr <1n s.i c ti o ns or he . , :-..cl'. urit y o r l"i xed in ves tment whi ch is eith er nu t li q ui d en o ug h to sell
with o ut a la rge loss or wh ich m ..1y loo k prol'itabk over th e lon ger r un ii" the exc ha nge ri sk
can be minim iLed . O ne m ethod of elim inatin g
such a n exposed pos itio n is by ba la nc in g th e
asse t with a liab il it y (or vice versa ) in th e
sam e c urr ency, thus mc..1intai ning a n ove rall
ne utr a l pos iti on . A lte rn a t iv ely. a fo rwa rd co ntr c1ct Ccln be pu rcha :-..cd to es ta bli sh cl d o mes ti c
curren cy v<tl uc ror the investmen t. '
nd cr
no rm;tl co 11<li tio 11s, the ru r w. 1rd 111a rk e1 opc r.i ti o ns arc prefe rred hcec1use thl'.y d o no t tic ur
c1sset s or gi ve rise to ho r rl)\-\ in g cost:-.. . I Iowev cr, in .. , crisis . the ro rv, ;1rd di:-.. co unt o n the
weak c ur re ncy ca n bec o me so L1 rge th c1t ba lancin g asse ts an d li abi li t ies in the spot ma rke t
is less expe nsive. A lso , th ere m ay be a d rying
up o f th e fo r ward mark et a t the heig ht o f a
c ri sis fo rc in g tr a nsac to rs to u e th e s pot market. 1' Bo th o f th ese tend e ncies will lead to an
in crea se in the vo lum e of c"1pital !l o ws.
In bri ef, an ex ch a nge cri sis enco urages
ca pit a l fl ows o ut of th e wea k currency int o
the st ro ng c urr e ncy . These n o ws occur when
weak curren cy a sset s arc di vested and stron g
c urr ency asse ts a rc in crea sed , and when weak
c urr ency li ab ilities a re in crea sed a nd st ro ng
c urre ncy li ab ilities a rc decreased . The tran sac ti o ns ec1n be o n bo th a cov ered a nd un covered
bas is. Th e deep di sco unt th a t de vel o ps o n the
fo rw ..1rd rc1te o r the wea k curr ency m a kes it
rr o fi t:1b le fo r cove red a rhitra ~e o ut o r wcc1k
:111d int o stron g curr enc :1sscts. c1nd o ut o r
stron g :1ml int o we c1k c urr ency li :1hilitics.
Simibr lfo ws ca n resu lt fro m un cove red :1ssc l
a nd li c1h ilit y 111 :,ni pu bti o ns by th ose who a rc
tr yin g to pro l'it fr o m th e pros pecti ve exchL1n gc:
rate chan ge and by th ose wh o find the fo rw a rd
mark et no nexistent o r too expensive to use
ro r ri sk minimi za ti o n. U ncovered n ows a re
lik ely to pred omin a te ove r cove red fl ows a t
th e ve ry hei g ht o f th e cri sis becau se the m o re
ce rtain is th e ex pectati o n of a cha nge in par
va lue th e les s lik ely tr a nsacto rs will be to cove r
th eir pos iti o ns. C o ve red fl ows . o n th e oth er
ha nd . arc m o re lik e ly to occ ur in th e initi a l
st:1 ges o f the c risis when the i"l) rward rc1te hc1s
m oved to c rea te an a rbitr c1gc in centi ve, hut
befo re ex r ec ta ti ons as to the in ev it ab ilit y o r
siLe or th e deva lu a ti o n a rc un iversa ll y held.
PRIVATE CAPITAL FLOWS IN
THE U.S. BALANCE OF PAYMENTS IN 1971
A m o re prec ise idea of th e size and fo rm
tha t ca pit a l n ows m ay tak e during a cri sis ca n
-I /
Fo r cxa n1r,k . :1 ( icr111.1n hn ld1 11 1:! ;1 $ 10() U .S. bo nd ;11 the rnd
o r 1970 wou ld h;11·c l';il ucd it .11 .1(, 5 111 ;1rl.. s in hi , ha l.i ncc , heel.
/\ t the e nd of 197 1. a 11d :1r1c r do ll;1r dcl':il1 1al HH l. th:1 1 ,:1 111 c ho nd
w:" 11 n rth 0 11 11 .1 27 111 .1 rl.. , . On th e ,,th e, h:1ml. .111 :\ 11 11: ri c;rn 11ho
h:1d hn rro 11 cd · .1(,5 111 .1rl.. , rrrn n :1 Ci c rn1:in h;111k .1 1 th , end o l
1970 :, nd C() ll l'e rt cd it 1111 0 $ l()() llt )lll d ri nd ;11 th e e nd o r 1'>7 1
th :11 he need ed $ 112 tu rcp:1) th e pri nci pa l or the ( ic rm .111 deb t.
5/ Th e 1·n rw:1rd s:1k o r rorc ig n c11rr, 11n cqu ;,I 1,1 th e v;il uc n r the
asset !:! U:1 r:111 tee, :i do mc, t ic c u rrc nc) , q 11 i, :1k 111 11 0 11 o r,c tha n
I ha t c, ta hli, hcd h) the price 111 the rum :1rd co nt r.1e1. S hou Id the
ro rci l! n c urrcn n he dc1·.il ucd ll\ :1 11 .111 w u111 l!rc. ,tc r than di ,co unt cd 111 th e for 11 a rd r,11 c,. the· c, tr:i I,>" in :1~" cl 1·:il uc II ill he
made ur h) un c,pcctcd rrori1, in the ru r11ard cont ra..: t.
Mo n th ly Review• February 1973
6/ /\ !th o ug h there a rc 110 d a ta o n th e 1·o l11 mc o r ror 11 a rd tr;111 ,;1c ti o ns. it i, no t un co mnrn 11 fo r e xc ha nge cri,cs a nd un :iva il ah ilit)
~-o ,llra c t, to be .issocia tcd . (S ec. for c:-.a rnpk. Lea me r
:i nd St e rn . Qtl/11ll ita1i1·e !111 en 101 iu 110/ 1:·n )lto 111ics . r . 96 . ) l-l,> 11 c1·c r.
;1 p.1rti c1p;1111 has re po rted 1h ;11 th e ro rw ard 111 :1rkc 1, gcn c r:ill)
rc111 :1incd o pe ra ti ve throu g h 197 l a nd th a t, whe re im r, cd im e nt s
were e nco unt ered . the \' cn uld he tr aced to gove rn me nt co ntro ls.
nut 111 :1r ke t i nst; 1bi lit\ : Rc n:ild o Lc l'I . ·· L,cl1:1nl!c M a rk c h in a
Pcr i,>d o r C ris is. ·· i"n Th e lnt enw1iu 11 al M u 11; 111r r Srs 1e111 in
Fm11s itiu 11 (C h ical!ll . Ill. : Fede ra l Rcscrl'c Ba ni.. . ll r · c h i,.i go .
1972). pr, . --1 2---1 7. ~
or fo r11 :1 rd
17
Capital Flows in a
Table l
ERRORS AND OMISSIONS AND SECURITY TRANSACTIONS
(In million s of dollar s, not sea sonally ad ju sted )
1971
____:uuQ_
II
1971
I
-2,532
Errors and Omissions
- 1,174
- 10,927
- 1,097
-372
Foreign Securities
-942
-909
-361
+ 196
U.S. Securities
+2, 190
+2 ,282
559
Credits+ : Capital inflows (increase in U.S. liabiliti es or decrease in U.S. assets).
De bits- : Capital outflows (decrease in U.S. liabilities o r increase in U.S. asse ts).
be obL..1incd from an inspection of 11riv c.1t c
cari ta l llows in th e U. ·. balan ce or pa yment s
in 197 1. Lxpcct:1Lions o r U .S. d ollar de v:tlu :1 t ion we re pr ·se nt fur mu ch or th e yc:1r, )rowin) stron )es t i111111cdiatcl prior to th · /\u •ust
suspens ion o r doll :,r conva tihilit y.
onsequcntl y, for th e yea r as a whole and particu la rl y for th e third quarter , the e ffects of th e
cris is sho uld be ev ident in th e U.S. account s.
Of co ur se, the foreign exc han ge crisis
was not the only factor in0u enci ng private
ca pital movements in 1971 . Bu sin ess and cred it
cyc le deve lopments may also account for so me
of th e 1971 res ult s. In 1970, a la rge defic it in
pri va te cap it a l accounts was caused by a si111 u Ita neous ec.1 sing of mo nct:1ry pol icy in Lhe
nit cd ' talcs in rea cti on to a business recess ion, and a ti g htenin g o r European credit
market s Lo fo resta ll inll a ti o n. The rel a tive
phasing or th e cyc le was felt most directl y
by U.S. bank s which repaid previou s Eurodo ll ar borrowing and by German busin esses
which rebo rrowed th e dollar s to use for dom estic expansion. These same forces continued
to work thro ugh the first quarter of 1971.
Howeve r, from April 1971 throu gh th e end
of the yea r, c redit condit ions in th e United
talcs were no lo nge r casing relati ve to mos t
other industrialized co untries. Because thi s
shift did not slow down or re ve rse the ca pital
outl'low from the United States , it is necessar y
to look at the abnormal circ um sta nces of
1971 for the ca uses of capita l flow s throu g h
the la st thr ee quarters of th e yea r.
18
1972
Ill
- 5,006
-2 49
606
IV
-2,293
+73
+ 921
I
+77 4
-393
1,067
Erro rs and Omi ss ion s
The balance o r pa yments accoun t which
showed the mos t pronoun ced e ffec ts or the
curr ·nc -r isis in 197 1 w:1s e rrors :111d l)111issio ns. This :1 ·cou nt w:1s in deficit I $ 10,9 _7
mi II io n in 197 1 with nea rl y ha II' o r th a t de fi cit
occ urrin g in th e third qu ,.trter when th e cri sis
was at it s pc:1k (Table I) . Errors and om ission s is th e res idu a l or balancing account in
th e sys tem o f doub le entry bookkeeping used
in th e balance o f pa yment s sta ti sti cs. Under
thi s sys tem eac h tran sac ti o n is sup posed to be
ent e red twi ce, once as a credit (plus) and once
as a debit (m inu s), so that th e total of all
such tran sac ti o ns equal s zero. Howe ve r,
er ro rs c.1nd o missions ca n occ ur u ndcr th is
system whe n for ms arc not fi lled out, whcn
th e Governme nt r:,i ls to reque st th e ncccss:1ry
info rmati on, or when the tw o s ides o f a lrc.1nsactio n ,He recorded a t di ffcrcnt time s. The
valuc for err o rs and omissions, th e refo re,
equa ls th e net ba lance or a ll the tran sac tion s
in whi ch o nl y one entry is reco rd ed durin g the
spec ified reporting period .
One rea so n errors and omissions was so
large in 1971 was th e in creased volume of unrec o rd ed capi tal outflows fr o m the United
Statcs. There arc likel y to be m o re unrepor ted
cap it a l movc mcn ts in a c risis as the total
vo lume o r capital movements is inc rea sed and
as the large potent ia l pr ofits a ttra ct tran sactors who are so sma ll they arc no t required
to report, arc unaware o r the repo rtin g rul es,
or a re ig no rin g th e ru les. In the 197 1 crisis
Federal Reserve Bank of Kansas City
Foreign Exchange Crisis
large profit s co uld be made by cove red and
unco ve red cap ital tran s fer s from
th e U.S.
dollar Lo stron g currency assets. Also, foreigners bid up Eurod o ll ar rates in Ma y and
Augu st as th ey attemp ted to borrow dollars
to obtain liabili ties in th e currency about to
be devalued , and thi s provided a stron g in centive to move doll ;.ir assets o ut o r the United
tatcs into th e Eurodollar ma rket. So me o f
this outrlow und oubtedl y went unreported,
adding to error s and o missions. 7
C han ges in the rel;iti vc timing of me rchan di se shipm ents and their ba lanc in g pa menls
were ..1 second cause or the la rge e rrors ·ind
omissions in 197 1. Su ch :1llcr:1tions in int e rn;1ti on; tl lr;1di11 1 :11HI p;1y 111c11t pron.:dures,
called lc ;1d s ;1nd l;1•s, ;ire ;1 co mmon res ult
o r expectations o r ch;.tn ges in p:.1r v;tlu cs . Le ..1ds
res ult in greater pa y111cnls for impo rt s by a
weak c urrency country. For examp le, if th e
dollar is expected to be devalued, a foreign
exporter's knowledge that the dollars he ea rn s
by selling goo d s to the Unit d Sta tes will be
worth less after devalu <-1t ion induces him to
speed up hi s shi pments and demand faster
paym ent to be abk Lo convert the larges t possib le vo lum e o r doll;i rs before de va Iua Li o n.
The accounts receiv . 1hie rrnm U.S . im porh.:rs
..1re view ed ;is we;1 k c urrency assets by l he ro reign l.:Xporter ,.tnd he wants as re\,\, or th e m i.lS
poss ible . Lags resu lt in a smaller vo lume or
pa yment s for th l.: weak cu rrrncy count ry's export s. In 197 I, foreign impo rt ers cou Id see
that dollar-d e nomin a ted exports and ex po rt
bill s (weak currency li abilities) wo uld be less
expensive after deval ua ti on, and co n equen tl y
th ey dela yed paymen t and orders for U.S.
goods a long as po ssib le . Thu s, inc reased
leads and lags result in hi gher import payments o ut o r th e wc:..1k c11rrl.:ncy coun try ;1nd
7 / Although llo\1 , lrom th ..: Unit<.:d Stat..:s to 1: urodollar rn .,rl-...:ts
w..:r..: un lik<.:I) to h:iv..: h..:..:11 a maj o r l:t ctllr 111 197 1. ~,stud ' CO\'C.:rin, the.: pc.:rind 1')52-6--1 round thc.:111 th..: , in gk 111 ost impo rt an t
co m ponc.:nt ,)r c.:rrnrs and o mi ss ion s. Sc.:c.: \Villr :1 111 11. Br c111son .
Fi11a11 cial Ca11iwl l- '/011 ·s i11 th l' IJ. S . /Ja/an ce oj Pa 1·111 c111.1 (i\111 stcr cLtm : N o rth Ho ll .ind 1-'uhli s hin gCon1 pany , 1968). p. 15 1.
Monthly Review• February 1973
lowe r ex port pay m ent s into it. Most lead and
la g be havior . hows up in errors and omission s du e to c han ges in the timin g of payment s,
rather th an in th e trade account due to c han ges
in th e vo lume or import s and exports beca use
or th e g rea ter nex ibilit y of pa y ment procedur es over produ c ti o n sc hedul es.
Securities Transactions
In contrast to errors and omiss ions, recorded tran sac tion s involvin g foreign and U.S _
sec uriti es see m ed to show littl e e ffec ts of th e
exc hange c ri s is. 8 Des pite th e potential ga in s
to be 111 ad e fr o m re va luati on o r foreig n curre nc il.:s,
.S. in ves tors incre;1sl.:d I he ir ho ld in 'Sor ror ·i 1 n securi ti es in 11)7 1 onl in about
the sam e :1nrnunts ;1s th ey did in 1970. Moreove r, foreigners app:.trl.:ntl y ig no red the po ten ti a l losses to be suffe red fr o m a d o ll a r dev a lu ation by purc ha sin g abo ut thl.: sa me d o llar
amount of u_s_ sec uriti es in 197 1 as th ey did
in 1970(Tabl e I) .
Th ere are a numbe r of reaso ns why sec urity
tran sac tion s m ay not adapt well to th e ty pes
of bal a nce sheet manipulation s ex pec ted in a n
exc han ge crisis. First, for balan ce or pa yment s
purposes, the sec urities re ported in thi s account ~trl.: by d e finition long-tl.:rm securitil.:s
the y have a m a turit o r over I yea r. ' in ci.: ro rward co ntr ac ts ge nerall y d o not c tend beyond
I yea r under the m os t stab le co nditi o ns, it is
diffi cult lo ca rry out interc ·t arbitrage operation s in lo ng-term sec urities. Second, where
they arc available, shor ter maturity instrument s are mor e lik ely to be used for purcha ses
of un cove red asse ts to even out balance sheet
positions or to pec ulate on a deva luation as
th eir va lu e is less subject to la rge capital gains
o r losses. And, third , int ernational sec urit y
tr a nsac ti o ns art.: o ften di sco ura ged by governml.:nt rcg ul :..1tion s. An exa mple o f the se reg-
8 / or cour~c.: . as ..:,p la in ..:d in the prc.:vious section , th..:r..: wc.:r..:
probab ly ~omc.: unr..:p ort..:d sc.:cu rit y transa ct ions in th ..: ..:rrors and
omiss ions outflow . This s..:ct io n is addrc.:ss..:d to th..: qui te: s trik ing
fa ilure.: or th <.: r..:co rd..:d data to r..:spond to th ..: c.: risi s.
19
Capital Flows in a
Tab le 2
TRANSACTIONS OF U.S. BUSINESSES
(In m ill ions of dollar s, not seasona ll y ad justed )
197 1
197 0
U.S . d irec t investm ent abroa d
-4.4 00
lnterco mp any acco unts
-969
Fo r e ign d ir ec t investm e nt
in Un ite d States
+ 1,030
lnte rco mp a ny acco unts
+2 06
U.S . non b a nk s
+ 1.4 18
Cl aims
-596
Long- term
-586
Short- term , non liq uid
- 361
Shor t- term , liquid
+ 351
+2,014
Liabi lit i s
I 1, 1 12
ong - t rm
S l1or t- te rm
I 90 2
in U . . li a bili li ,
red it I : Capi t I in fl o w s (i n rea
De bi t -: Capi ta l o ut flo w s (d er
e in U. . liabilili
1972
Ill
IV
- 4 ,765
- 1,7 18
- 1,560
- 1, 125
- 1,687
-813
-1 ,330
-692
-188
9 12
- 1,561
-1,047
-67
-384
-9 95
- 1,170
- 109
-555
-5 06
+ 175
I 233
- 58
+ 124
+ 85
-522
-424
-33
-67
- 3 24
-9 8
I 16'1
- 6?
1
-6
-2 26
- 179
- 11
- 160
-8
- 47
I 32
- 79
-374
-538
-300
-238
-31
-64
- 143
-62
- 2 18
I 156
+ 18 1
75
+53
- 329
-34
- 264
-3 1
I 38 2
I 255
I 1 7
-360
-439
-426
-403
-78
+ 20
-345
- 23
- 11 9
I 6
ul at io ns is th e U.S. ln tacs t Equa liza t ion
Tax whi ch redu ces th e yie ld th a t a U.S. c iti ze n
ca n ea rn o n m os t fo reign bo nd s.·
1
D irect Investment
Di rec t in ves tm ent outfl ows from U.S. businesses to th eir fo reign a ffil ia tes d id no t reac t
un ifo rm ly to th e ex pec ta ti o n o r exc ha nge ra te
cha nges. 111 Fo r 197 1 as ~1 who le , U.S . direc t
in ves tment a broa d was o nl y m od era tely g re~1tcr th a n th e in c rease in asse ts th c ye~1 r bef"o rc
(Tab le 2). H oweve r, th c sma ll increasc in to ta l
o ut fl ow maskcd a la rge in c rease in th e o utll ow
o n inte rco mpan y acco unt s whi ch co nsis t mos tl y
o f sho rt-t e rm tr a nsfers. Ind eed, th e 197 1 o utfl ow o n int erco mpan y acco unt s was nea r ly
twice it s 1970 level, des pite a n ex trao rdin a ril y
la rge infl ow in t he fo ur th qu ar ter of 197 1 in
') / l lowcv<.: r. th <.: in c r<.: :i s<.:d proh:1h il i1 , in :i c ri sis o r th <.: w<.::1k <.: ur r<.:ncy <.: uu nt ry int<.:rk r ing w1111 th<.: rcpa t ri:i ti on ur <.: :tpita l f'rom it
shou ld r<.:du c<.: f'or<.:ign capi ta l in fl ows . In this ligh t. th <.: m :1int<.:n anc<.: ,>I' a hi g h k v<.:I o r f'or<.:ign purcha s<.:s o f U .S . s<.: c uriti<.: , in
197 1 is quit<.: ,u rpri sing. It 111 :1) h:11'<.: o<.:c urr<.:d h<.:c:i u,<.: :i l:ir •<.:
propo rti o n u r th<.: , <.: curiti <.:, \\ <.:r<.: o lTs hor<.: is,u<.:s or U .S . uirp,1ra ti o ns whic h in <.:st o rs kit would b<.: k,s suhj<.:cl to gm<.:rnm<.: nt
contrul.
10/ l·or th<.: purpus<.: of U .S . reg ula t ions and sta tis ti cs. a l'o r<.:ign
comp:tn~ i, an a lTili:tt<.: ii' it is :t i ka s t 10 per c<.:nt ow n<.:d hy a
U.S. inv<.:s tor . /\ U .S . co mpan y m ust b<.: a t kast 25 p<.: r c<.: nl own<.:d
by a foreign r<.:sid<.:nl to be conside red a ffili ated with a f'or<.:ig ner.
20
II
197 1
in U . . a
in U . . a
t ).
l ).
response lo the S mith so ni a n ag recmcnt a nd
to co nfo rm to U.S. reg ula ti o ns cove rin g net
inves tmc nt 111 fore ign a ffi lia tes and liquid
asse ts held abroa d . Th e la rge 197 1 outfl ow is
no t too sur pri s ing th o ugh, beca use in a crisis
compan ies use int ercompa ny acco unts to accum ul ate strong currency asse ts a nd weak cu rrcncy li ab iliti es . T hey do so by acce lerating
p:1y men ts l'ro m su bs id ia rics in wc:1k c u rrcn cy
co untr ics to th ose in str o ng c urr ency co untries , by de l.Jy in g a ny revc rsc nows as long
as possib le, a nd by co nce nt ra ting com pa ny borrow ing in the weak curr ency su bs id ia ri es.
N o nint crco m pa ny acco unt s, o n the o th e r ha nd,
a rc prim a ril y ca pit a l stoc k a nd o th er equit y
pos iti ons in fo re ign a ffil ia tes. Th e perm a nence
a nd lowe r li quid ity of th ese in ves tm ent s di cta te tha t they be und ert a ken in res po nse to
long-r un profit co nsidera ti ons, ra th e r th a n
th e sho rt- run gc.1ins to be m ade l'ro m d eva lu ati o n.
In co ntr as t to U.S. dircc t in vcs to rs, l'o rcig ncrs no t o nl y rcd uccd their int ercomp:rny
acco unt in ves tmen ts in th e U nit ed S ta tes from
1970 to 197 1, but a lso redu ccd th e ra te a t
whi ch th cy ad ded to no nint e rco mp a ny acco unt s. T he in tcrco mp a ny acco unt s fe ll $384
Federal Reserve Bank of Kansas City
Foreign Exchange Crisis
milli on in 1971 an d their nonintercompany acco unt s ro se $3 17 million , about $500 milli o n
less th a n their ri se in 1970 . The pa ttern of redu ced investm e nt re fl ec ted th e co ur se of th e
cr isis as th e on ly reduction in tot a l in ves tments to o k place in the third quarter o f 1971.
No nbank In stit utions
Th e transactio ns of U.S. bus in esses, o r
nonb a nk institu ti o ns, with un a ffiliated foreig ners contribu ted m uch more heav il y lo
the deterioration in th e ba la nce of pay ment s
th an di d thcir direc t inves tm ent s with a ffiliat es . In 19 7 1, U.S. nonh a nks had net ca pita l
export s l'rnrn Ili c l J11i t ·d Sli ll cs o r $995 bil lion , :11'tcr c;1p it..tl illlpor ts or $ 1,4 18 111illi o n in
I 9 70 CL 1h le 2).
/\II t. pes u l' claims of
.S . nonbank in stituti ons regist ered increases in 1971 . Like
man y ot her lo ng- term in ves tme nt s, long-term
claim s did no t reac t to th e cn s1s a nd grew
less ra pidl y than in prev io us yea rs. Howeve r,
sho rt -te rm nonliq uicl claims , wh ich a re loans
to fo reig n importers and loa ns by brokers to
finan ce secu rit y purc hases, rose sub sta nti a ll y.
S hort-te rm li4uid claim s o f no nb a nk s, consistin g mu .-t ly ol' do ll a r deposits a t bank s ove rseas , ~tl so in c re~1scd r:1pidl y in 197 1. Mu c h o r
th e 111 crcase 111 th ese li4uid cla im s came in
the first qu a rt e r o f 1971, sugges tin g th a t th ey
may have been acc umul a ted as tr a nsac tion
ba la nces held to mak e acce lerated payments
for imports a s pa rt of the leads and lags behav ior.
Th e large increase in nonbank claim s on
fore ig ners wa acco mp a ni ed by on ly a sm a ll
grow th in li abi lities due to foreigners. Tota l
no nb ank ind eb tedness to forei gners rose onl y
$ 175 million in 197 1 after an increase of
$2,0 14 mil lio n in 1970. Th e slow grow th in
li abilities also co nform s to beha vior that wou ld
be a nti cipa ted when th e doll ar is ex pec ted
to be deva lu ed . U .S. bu sin esses wou ld try to
avo id str ong c urren cy li abi liti es and their abi lit y to borrow dollars from forei g ners wou ld
he imp:1ired by th e L.1tl e r's unwi llin 1 ness to ~,ccumu l~tle dolL,r assets.
U .S. Bank s
U.S. bank s co ntribut ed $9,890 milli on
to th e pri va te ca pit a l o utfl ow in 1971 (Tab le 3) .
Th e ir fo reign assets, or claims o n foreigne rs,
ro se $2,93 8 million and their liabilities to
foreigners declined $6,952 million . Unlike
businesses, bank s fe lt the effects of the crisis
in a ll m atu riti es of their balance sheets.
Most of th e decline in U.S. ba nk s' fo reign
liabi liti es in 197 1 res ultc:d from the rep ayment o f Eurod o ll ar loa ns by the banks to their
for eig n branches. Whi le th ese Eurod o ll a r
Table 3
TRANSACTIONS OF U.S. BANKS
(In m ill ions of dollars, no t seasonally adjusted)
1971
__
I_
1970
_II_
__JjU_l
-9 ,890
-2,7 01
-409
- 7 ,660
U.S . ba nk s
-2 ,938
-5 08
-947
+134
Claim s
-5 65
- 153
+ 25
+ 175
Long - term
- 1,80 7
+ 111
-3 77
-1, 0 23
Shor t- term , nonliquid
-2
-566
-99
+22
Shor t- term , liqu id
-2, 835
- 6,7 13
- 6,952
+ 99
Li ab iliti es
-2
49
152
- 61
+23
Lo ng - term
-2,
683
-6,7
0
3
+
160
-6
,736
Sh o rt- te rm
Cred it s + : Ca pital inflows (i nc rease in U.S . liabilities or decrease in U.S . assets).
De bit s -: C apita l ou tflow s (decrease in U.S . liabi litie s or increase in U.S . asse ts) .
Monthly Review• February 1973
1972
__Ill_
-3 ,237
- 1,059
-237
-48 1
-3 41
-2, 178
- 71
-2, 107
_I_V_
-3 ,543
- 1,505
-200
- 1,060
-2 45
-2,038
+ 35
-2, 073
_I_
-461
-933
- 177
-332
-424
+ 47 2
+2 03
+ 269
21
Capital Flows in a
tran sac ti ons did no t invo lve th e sa le o f do ll ar s
for foreign currency, a nd so had no direc t
impa ct on the foreign exc ha nge mark ets, th ey
did hav e a co nsid erabl e indirec t effec t. That
is beca use th e lowe r Eurodo ll a r interes t rat es
produ ced by thi s large repa yment enco ura ged
fo reigners to borrow do ll ars and exc han ge them
for use in th eir own co untri es. These exc ha nges
co ntribut ed to the onse t o f th e c ri sis by depress in g the d oll a r exc hange rat e far eno ug h
to require supp o rtin g purcha ses from seve ra l
Europea n ce ntral ba nk s. Th e rem a inin g declin e in U.S. banks' forei g n li ab iliti es in
1971 resu lted fr om ror e il2, ners redu cin, th eir
h O Id i11 'S Or d O 11 ~I r le p OS it S c.l We ~I k · II r re 11 · y
~,sset. This portion or th e o utrl ow w<1s more ;1
res ult th ._111 a ca use o r th e c ri sis, (,ind requir ed
o nl y th a t U .S . banks acco mm odate the a ttempts of others to adjust Lo th e c ri sis.
The sa me acco mmod a tiv e ro le ca n be ascribed to U.S. bank s with respec t to mu ch o f
th e increase in th e ir foreign asse ts. Specifica lly , U.S. bank s' long-term a nd shor t-t erm
nonliquid asse ts , whi ch a re primari ly doll a r
loa ns to for eigne rs, rose $2,373 million 111
1971 . Thi s increase mainl y reflected bank efforts to mee t a n in crease in loa n dem ~1n d by
fore igners who so ught to t'-1k c ·1d va nL.1 1 e o r
the fa vo rable arb itrage marg in ro r cove red
do llar borrowing and to acc umulate un cove red
do ll ar loa ns as weak c urr ency li abi liti es. 1 1
H owever, so m e act ive attemp t by U.S. ba nk s
or th eir custom ers- in wh ose behalr th e bank s
may be holding depo sits- to obtain stron g
currency assets undoubtedly occurred in 197 1.
Thi s attempt is indicated by a sub stantial increase in U .S . bank s' short-term liquid claims
on foreigners , whi ch co ntain a sizab le foreig n curren cy component.
11 / The g row th o r sho rt -term non liquid claims in th e fo urth qu :1rtcr
wa s not cntirely rel ated to th e.: c ri sis. It was ma inl y du e.: to a loos<.: nin g o r the Vo lunt ary Fo r cig n C rcdi t Restraint guid cl i ncs to <.:x clud c ex port c r..:dit s fro m ba nk fo rcign assc t c..: i l in gs. Sce /\ndrcw
F. Brimmer , "Co mmcrcial Ba nk Lend in g /\b r oa d and th e U.S.
Balancc o r Pay m ent s," in T he l nt em a tio 11al M onetart' S)'s te111
i11 Tra nsition (C hi cago, Ill. : Fcdcr al Rcscr vc Bank o f' ·c hi cago).
pp . 76-9 1.
22
CONCLUSION
A cri sis 111 th e foreign exc hange mark ets
is prec ipit a ted by ex pec ta ti o ns th a t ex istin g
currency pa r va lu es will cha nge. Th e anticipated pr o fit s or losses that acco mpan y th e
expec ted rea li gnm ent o f exchange ra tes in du ce ba lance sheet adjustment s that res ult in
a !'l ow o f capit...1 1 o ut o r the co untry wh ose
currency i · threa tened with devaluation . Alth oug h th e pr in cipl es guidin g tran sac tors
a rc few a nd un co mpli ca ted, the ex peri ence o f
th e U nit ed S t;,i tcs in 197 1 dcmo nstr ~1ted that
c..t piul ou tfl ows c~111 be quit e br c ~,nd th ~,t
th · c:tn 1n :1ni l'cs t th emse lves in m:111 dirl'crcn l l'or ms, dcpendin, o n th e spcc iri c lll\..: th od
o r in strum ent chose n to aclctpt to th e c ri sis
situ a ti on. In term s o f size, pri va te ca pit a l
o utll ows a nd erro rs and o mi ss io ns acco unted
for $25 bi 11 io n of th e $30 bi 11 ion offic ia I
rese rve tr a nsac ti ons deficit in th e U.S . ba lance
of pay ment s in 197 1. A maj o r portion of th e
$25 billion outflow was m os t prob ab ly ca used
by th e cris is. Among th e sa li en t fea tur es o f
th e 1971 outfl ow was its predominantly shortterm na ture, it s hi gh proporti o n o f unreco rded
trn nsc1cti o ns , :rnd the prom i ncnt ro le pla yed
by dollar tr ~1nsa cti ons lx:twccn U .S . a nd l'orcign res id ent s throu gh the Eurod o ll c1r market.
These chara cteri sti cs o r c ri sis- re lated cap ital fl ows ma ke th e prob lem o f cont ro llin g
th em quite co mp lex. The large vo lum e o f' unrepo rt ed transac ti ons, es pec iall y th e diffi cu lt-t o-p inpoi nt leads and lags, would see m
to doom a tt empts at detailed reg ul ation. Also
int ernation a l agreements on Eurodo ll ar tran sactions would need to be a part of th e rule s
go vernin g ca pital no ws. Mo re impo rtantl y,
co ntr o ls o n ca pit ~tl , o r other interferen ces with
the fr ee fl ow o r mo n<.:y o r goo ds between
co untri es, do no t dea l with th <.: cxpecLJtions
o f' exc han ge rat e cha nge which are th e fun da ment al ca use o f these ca pital fl ows .
On e meth od o f co pin g with such expectati o ns is to fulfill th em , by a ll ow in g exc hange
Federal Reserve Bank of Kansas Crty
Foreign Exchange Crisis
rat es to cha nge. Proposa ls for a g rea te r range
of permiss ibl e nu ctu a ti ons aro und par va lu e
("wid er bands") and mo re fr eq uent par va lu e
cha nges embod y thi s approac h. A seco nd
meth od is to co rr ec t th e co nditi o ns in the nati o na l eco no mi cs which led to the persistent
b~tlancc or payments imbalan ces that gcner ..1tcd
the cxpccL1ti o ns. T hi s approac h requir es th a t
large qu cint it ics o r int erna ti ona l rese rves be
ava il ab le to th e ddici t co untry to givt.: it tim e
to make th e necessary co rrec ti ons a nd to have
these cha nges pcrct: ived by tr an ac tors. The c rea ti o n or lar:r e poo ls or temporar y c red it avail-
Monthly Review• Feb, uary 1973
able to supp o rt c urrencies, such as dr aw ings on
th e IMF, and additi onal permanent liquidit y,
such as SDR's (Spec ia l Drawing Ri g ht s), a re
steps th a t ha ve been taken in thi s direc ti o n.
H oweve r, th e m ag nitud e o f th e 1971 cap it a l
fl ows indi ca tes that when tran sac tors perceive
that und e rl yin g conditions are not be in g
changed suffi cientl y, chan ges in exc ha nge rates
become necessa ry. Therefore, it is lik e ly that
m ore fl exib ilit y in exc ha nge rates comb in ed
with add iti o na l reserves will be necessa ry to
red uce th e di sruptive effec ts of cri sis-related
cap ita l fl ows.
23
@FedFRASER