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Authorized for public release by the FOMC Secretariat on 5/27/2020




APR 27


April 8,

Federal Open Market



SUBJECT: Commentary on Mr. Baker's
Memorandum Entitled "Federal Reserve
Operations in Foreign Exchange 1962-1965"

Charles A. Coombs


Baker's lengthy survey of System foreign exchange operations

concludes by stating "there would seem to be a clear case for continuing the
System's foreign currency operations as an experimental undertaking." In the
course of arriving at this conclusion, however,

Mr. Baker makes a number of

references to System operations which were "less than completely effective"
or were subject to other shortcomings.

As I understand the Baker memorandum,

the operations in which Mr. Baker seems to find certain difficulties are those
listed on pages 24-35.

In each of the cases cited, I and the other officers of

the Foreign Department of the New York Bank feel that Mr.
either explicit or implied,

can be readily refuted.

Treasury would take the same view,

Baker's criticisms,

I believe that the U. S.

as would virtually all of our central bank

partners in the swap network.
The first of the critical comments by Mr. Baker appears on page 25
in connection with a discussion of our forward operations in Dutch guilders in

The Baker memorandum acknowledges that these operations were

effective in holding down the gain in official Dutch holdings over an eight- to
nine-month period.

But it goes on to say:


as it turned out, the

System exposed itself to exchange risks (within the exchange spread) which

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persisted for a number of months. "

This is a misstatement of fact which was

brought to the attention of the author in an earlier draft, but seems to have
inadvertently remained in the final draft.

Our forward operations in Dutch

guilders during this period were all negotiated at forward rates for the guilder
above the spot ceiling.

There was, therefore, no System exposure whatsoever

to loss within the existing margins,

and the eventual complete liquidation of

these contracts left us with a profit of nearly $400, 000.

Furthermore, we had

negotiated with the Netherlands Bank arrangements fully protecting us in the
event of a revaluation upward of the Dutch guilder.

The "extended exposed

position" cited by the Baker memorandum simply did not exist.
Secondly, the Baker memorandum recounts on page 26 our operation
in the late summer of 1964 to widen the forward discount on sterling through
buying spot and selling forward in order to prevent an undue arbitrage incentive
for moving funds from New York to London.

Here again the Baker memorandum

acknowledges that this operation proved effective, and the Bank of England
welcomed our action since the spot side of the operation brought an immediate
reinforcement of the British reserves.

The Baker

memorandum goes on, how-

to note that the forward contracts matured around the time of the November

sterling crisis,

and "The System therefore appeared to be placed in the position

of working at cross purposes with the Bank of England."

Leaving aside the

point that none of us in August could predict a crisis in Novemb er, the maturing
of the approximately $25 million in System market forwards in November 1964
was a drop in the bucket compared with the enormous reserve losses then
suffered for other reasons by the Bank of England.

We have not had a single

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suggestion from any source that the market was even aware of the System's
forward maturities or that any erroneous impression was given of our "working
at cross purposes with the Bank of England. "

The dominating fact in the market

in November 1964 was rather the display of our cooperative attitude in the form
of the increase in U. S.

credit lines to the U. K. from $500 million to $1 billion.

Third, the Baker memorandum discusses on pages 26-29 the
$500 million authorization to acquire forward lira contracts from the Bank of
Italy and suggests that this Committee authorization raises two "difficult
questions ":

Is it appropriate for the System to engage in a transaction which

enables another central bank to obscure its published accounts even though the
transaction will reduce or postpone demands on the U. S. gold stock?
I do not find this question difficult at all, nor would the U. S.


The Bank of Italy chooses not to publish immediately its forward obligations.
This is a practice which is followed by all of the central banks with which I am
familiar, including the Federal Reserve.

I am at a loss to understand,


fore, what possible grounds we could have for suggesting that the Bank of Italy
should revise its accounting procedures,

more particularly since the lira

forward operation was suggested by the Italians as a means of saving us gold
and protecting the Euro-dollar market.

The Baker memorandum goes on to

suggest that the volume of forward contracts in lire "is

bound some time to

attract the attention of some observer, with detrimental consequences for the
credibility of System data. "
Treasury in

But the forward lira contracts assumed by the

1962-63 were fully reported after a time lag of a year or so, and

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aroused no adverse comment whatsoever.

The market already knows that the

System has authorized the acquisition of up to $500 million of such lira contracts and will be given after some time lag a full accounting of these and other
forward operations in our regular semiannual reports.

The second "difficult question" arising out of the forward lire

according to the Baker memorandum, is whether the exchange

guarantee given under the Italian forward contracts does not establish an
undesirable precedent.
This question seemingly overlooks the fact that the central feature
of the joint Treasury-Federal Reserve exchange operations undertaken over
the past five years has been the offer of exchange guarantees to foreign central
banks in the form of swap drawings, forward market contracts,
currency bonds.

and foreign

In general, the U. S. Treasury and Federal Reserve have

stood prepared to mop up through such exchange-guarantee

operations surpluses

of dollars appearing on the books of foreign central banks within the swap network.

The problem is hardly one of avoiding an undesirable precedent, but

rather of converting such countries as France, which rejects the exchangeguarantee technique and insists on gold, to accept our approach.
Fourth, in its discussion of swap drawings on pages 29-32, the Baker
memorandum states that "it

is sometimes difficult to assess clearly the reason

for individual swap operations,

especially in the cases where the initiative for

the System's actions came from the other party to the transaction rather than
from the System itself. "

But there is no reason at all for any obscurity on this

point; in virtually every instance swap drawings by the System were expressly

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and clearly intended to forestall gold purchases by the foreign central bank concerned and in this sense they were fully effective,

dollar for dollar.

The same

applies to most of our forward operations.
Next, the Baker memorandum notes that some repayments of swap
drawings were accomplished only by recourse to exceptional sources such as
foreign currency bond issues or gold sales, and draws from this the inference
that "despite what was thought at the time of their execution, the System's
operations did not always turn out to have been in response to temporary flows
of funds ...


Of the total of $2, 353 million of swap drawings made by the

System during the past four years, $1, 864 million or 79% has been repaid
without the assistance of gold sales, foreign currency bonds, U.S. drawings
on the IMF,

or third currency swaps.

In view of the impossibility of accurately

predicting the balance-of-payments trends of a dozen countries,
U. S.,

including the

I am inclined to think that we may have achieved within the last four

years a higher percentage of repayments through market operations than we
can count upon in the future.

In most instances of drawings on the swap line,

neither the foreign central banks concerned nor the Federal Reserve Bank of
New York has ever made a firm prediction that the drawing could be reversed
within a specified period of time.

We have rather been confronted with an

immediate problem of absorbing surplus dollars in order to forestall gold

In most cases we could see hopeful signs of a prospective swing in

the market situation which might enable us to reverse the drawing in less
than a year's time.

In a good many instances,


the very fact of

these swap drawings have probably encouraged foreign central banks and

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governments to undertake policy moves which assisted


in unwinding the swap

But what is most important here is not whether we can in all cases

accurately forecast the prospective duration of the market swing, but whether
we are prepared, if the swing continues beyond the term appropriate to central bank operations,

to substitute other forms of financing.

criterion, the record is clear.

Measured by this

Both the Federal Reserve and foreign central

banks drawing on the swap network have rigidly adhered to the principle of
paying off, if necessary through gold sales,
currency bonds,

recourse to the IMF, and foreign

any swap drawings which threatened to drag on too long.


total central bank drawings of $6 billion on the swap network during the past
four years,

93% have been paid off within six months and all have been com-

pletely liquidated in less than a year.

Finally, the Baker memorandum suggests

that our swap operations have not succeeded in encouraging foreign countries to
hold an increased amount of uncovered dollars.

We have never made any efforts

to link the two, and I am at a loss to understand what this complaint is all about.
Quite obviously, foreign willingness to hold uncovered dollars primarily depends
on confidence in the dollar and this raises questions which go far beyond System
exchange operations.
Fifth, the Baker memorandum refers on pages 32-33 to the sale to
the Bank of England in the spring and summer of 1965 of $28 million of outright
sterling held by the System.

The basic reason for this action was that the

$56 million balance in outright sterling previously built up by the System, plus
another $79 million acquired by the U. S.
side in


was clearly on the high

relation to our joint prospective needs for such sterling balances,


Authorized for public release by the FOMC Secretariat on 5/27/2020
had been pushed to this level in late 1964 partly in order to encourage a very
shaky British government to keep its nerve.
ing Desk at the New York Bank planned,
Bank of England,

Both the Treasury and the Trad-

and this intention was conveyed to the

to reduce such outright holdings of sterling at the earliest

convenient opportunity.

As the pound sterling failed to register any significant

recovery, during the winter and spring months of 1964-1965 we faced a mounting risk that no convenient opportunity for bringing down our sterling balances
might ever appear and that we were thereby exposed to a possible loss on a
devaluation of sterling.

This problem was discussed with Treasury, FOMC,

and Bank of England officials and a joint decision was taken to reduce both
Treasury and System holdings by a total of $56 million, divided equally between
the two agencies.

Since then the Treasury has run down its balance almost to

zero, while we have retained a working balance of roughly $20

million equiva-

The comment in the Baker memorandum that such transactions "put added

pressure on the Bank of England's reserve position at a time potentially adverse
to it"

would seem to overlook the fact that we provided during the same period

on combined Treasury and Federal Reserve account a total of $1,290 million
of short-term credit.

In effect, we made a minor shift during the summer of

1965 in the form or our assistance to the Bank of England while very considerably increasing the total amount.