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A meeting of the Federal Open Market Committee was held in the
offices of the Board of Governors of the Federal Reserve System in
Washington, D. C., on Tuesday, March 2, 1965, at 9:30 a.m.
PRESENT:
Mr. Martin, Chairman
Mr. Hayes, Vice Chairman
Mr. Balderston
Mr. Bryan
Mr. Daane
Mr. Ellis
Mr. Mitchell
Mr. Robertson 1/
Mr. Scanlon
Mr. Shepardson
Mr. Clay, Alternate for President of Minneapolis Bank
Messrs. Bopp, Hichman, and Irons, Alternate Members
of the Federal Open Market Committee
Messrs. Wayne, Shufcrd, and Swan, Presidents of the
Federal Reserve Banks of Richmond, St. Louis,
and San Francisco, respectively
Mr. Young, Secretary
Mr. Sherman, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Noyes, Economist
Messrs. Baughman, Brill, Garvy, Holland, Koch,
and Taylor, Associate Economists
Mr. Stone, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Account
Mr. Molony, Assistant to the Board of Governors
Mr. Farrell, Director, Division of Bank Operations,
Board of Governors 2/
Messrs. Partee and Williams, Advisers, Division
of Research and Statistics, Board of Governors
Mr. Reynolds, Associate Adviser, Division of
International Finance, Board of Governors
Entered the meeting at the point indicated.
Left the meeting at the point indicated.
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Mr. Axilrod, Chief, Government Finance Section,
Division of Research and Statistics, Board
of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
Miss Roberts, Secretary, Office of the Secretary,
Board of Governors
Mr. Strothman, First Vice President of the
Federal Reserve Bank of Minneapolis
Messrs. Eisenmenger, Eastburn, Mann, Ratchford,
Parsons, Tow, Doll, and Green, Vice Presidents
of the Federal Reserve Banks of Boston,
Philadelphia, Cleveland, Richmond, Minneapolis,
Kansas City, Kansas City, and Dallas,
respectively
Mr. Lynn, Director of Research, Federal Reserve
Bank of San Francisco
Mr. Bowsher, Assistant Vice President of the
Federal Reserve Bank of St. Louis
Mr. Meek, Manager, Securities Department,
Federal Reserve Bank of New York
In the agenda for this meeting, the Secretary reported that
advices had been received of the election by the Federal Reserve Banks
of members and alternate members of the Federal Open Market Committee
for the term of one year beginning March 1, 1965, and it appeared that
such persons would be legally qualified to serve after they had executed
their oaths of office.
The elected members and alternates were as follows:
George H. Ellis, President of the Federal Reserve Bank of Boston,
with Karl R. Bopp, President of the Federal Reserve Bank of
Philadelphia, as alternate;
Alfred Hayes, President of the Federal Reserve Bank of New York,
with William F. Treiber, First Vice President of the Federal
Reserve Bank of New York, as alternate;
Malcolm Bryan, President of the Federal Reserve Bank of Atlanta,
with Watrous H. Irons, President of the Federal Reserve Bank
of Dallas, as alternate;
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Charles J. Scanlon, President of the Federal Reserve Bank of
Chicago, with W. Braddock Hickman, President of the Federal
Reserve Bank of Cleveland, as alternate;
The person who is on March 1, 1965, or who shall thereafter
become, the President of the Federal Reserve Bank of
Minneapolis, with George H. Clay, President of the Federal
Reserve Bank of Kansas City, as alternate.
At the time of this meeting no person had as yet been named
President of the Federal Reserve Bank of Minneapolis.
All other elected
members and alternates had now executed their oaths of office.
Upon motion duly made and seconded,
and by unanimous vote, the following of
ficers of the Federal Open Market Committee
were elected to serve until the election of
their successors at the first meeting of the
Committee after February 28, 1966, with the
understanding that in the event of the dis
continuance of their official connection with
the Board of Governors or with a Federal
Reserve Bank, as the case might be, they
would cease to have any official connection
with the Federal Open Market Committee:
Wm. McC. Martin, Jr.
Alfred Hayes
Ralph A. Young
Merritt Sherman
Kenneth A. Kenyon
Arthur L. Broida
Howard H. Hackley
David B. Hexter
Guy E. Noyes
Ernest T. Baughman, Daniel H. Brill,
George Garvy, Robert C. Holland,
Albert R. Koch, Charles T. Taylor,
and Parker B. Willis
Chairman
Vice Chairman
Secretary
Assistant Secretary
Assistant Secretary
Assistant Secretary
General Counsel
Assistant General Counsel
Economist
Associate Economists
Upon motion duly made and seconded,
and by unanimous vote, the Federal Reserve
Bank of New York was selected to execute
transactions for the System Open Market
Account until the adjournment of the first
meeting of the Federal Open Market Committee
after February 28, 1966.
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Upon motion duly made and seconded, and
by unanimous vote, Robert W. Stone and Charles
A. Coombs were selected to serve at the pleasure
of the Federal Open Market Committee as Manager
of the System Open Market Account and as Special
Manager for foreign currency operations for such
Account, respectively, it being understood that
their selection was subject to their being
satisfactory to the Board of Directors of the
Federal Reserve Bank of New York.
Secretary's note:
Advice subsequently
was received that Messrs. Stone and Coombs
were satisfactory to the Board of Directors
of the Federal Reserve Bank of New York for
service in the respective capacities indicated.
Upon motion duly made and seconded, and
by unanimous vote, the minutes of the meeting
of the Federal Open Market Committee held on
February 2, 1965, were approved
Consideration then was given to the continuing authorizations
of the Committee, according to the customary practice of reviewing such
matters at the first meeting in March of each year, and the actions
set forth hereinafter were taken.
Chairman Martin noted that a memorandum from Mr. Stone had
been distributed to the Committee proposing certain revisions in the
continuing authority directive regarding transactions in U.S. Govern
ment securities and bankers' acceptances, and he invited Mr. Stone
to comment.
(A copy of this memorandum, dated February 17, 1965, and
entitled "Maturity limitation on repurchase agreements during Treasury
refundings," has been placed in the files of the Committee.)
Mr. Stone said that his memorandum outlined a technical problem
the Account Management often encountered during Treasury financing
operations, particularly advance refundings, because of the 24-month
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maturity limit on Government securities that might be held under repur
chase agreements specified in Section 1(c) of the continuing authority
directive.
As indicated in the memorandum, this limit at times had
caused the Management to terminate repurchase agreements against "rights"
in refundings the day after the subscription books closed and several days
before settlement.
The rights in question were those that dealers had
committed for exchange for new securities of longer than two years to
maturity.
These terminations often were burdensome to the market and
inconvenient to the System.
He recommended a revision of the directive
that would make them unnecessary, in order to maximize the effectiveness
of operations during periods when Treasury refundings were in process.
From the dealers' standpoint, the change would mean that the "rights"
turned in for exchange could be carried to the settlement date of the
financing if the Desk chose to make agreements running that long.
The
simplest procedure would be to eliminate the maturity limit on Govern
ment securities held under repurchase agreements altogether.
Alternatively,
the limit coulc be waived during Treasury refundings and retained at other
times.
In either case repurchase agreements would continue to be made for
a maximum of 15 days.
Mr. Mitchell said he had no objection to the alternative procedure
Mr. Stone had mentioned but he would not favor removing the maturity limit
entirely.
In his judgment the latter action might encourage dealers to
hold larger amounts of longer-term securities and to speculate in them,
thereby hampering operations of the Committee.
-6
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Mr. Stone said that there might be occasions when a considerable
part of the dealers' financing needs were concentrated in longer-term
securities.
But whether the Desk would help finance those holdings
would depend strictly on the reserve situation at the time; the Desk
would not make repurchase agreements against the securities in question
if there was no need to provide reserves.
Mr. Daane agreed that it was desirable to avoid recurrences
of the situation in which it was necessary to terminate repurchase
agreements at inconvenient times.
But he shared Mr. Mitchell's
reluctance co remove the maturity limit entirely, even though the
Desk would retain discretion with respect to whether to enter into
particular agreements.
He asked whether it would be feasible to take
the more limited step of authorizing repurchase agreements only against
rights turned in for longer-term securities which dealers had already
sold on a when-issued basis.
Mr. Stone replied that such a procedure was a possibility.
He would not recommend it, however, because it would require policing
operations by the Account Management of a kind that he would not consider
desirable.
Mr. Bryan said he also favored the alternative Mr. Stone had
mentioned of removing the maturity limit only during the periods of
Treasury refunding operations.
In response to Mr. Hayes' request that the Manager clarify his
recommendation, Mr. Stone said that in the memorandum he had recommended
removal of the maturity limit entirely.
But he had never found the
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limit to disadvantage operations except at times of Treasury financings.
Accordingly, he thought the alternative to which Mr. Bryan had referred
would solve the problem.
Mr. Hayes said he would register a mild dissent.
As a practical
matter he agreed that the alternative would meet the problem Mr. Stone
had described, but he did not think any purpose would be served by
retaining the maturity limit for periods when refundings were not in
process.
He could not believe that removing the limit entirely would
have any significant effect on dealers' willingness to hold longer-term
securities in their portfolios.
Thus, he would prefer the broader
authority.
Chairman Martin commented that, in view of the questions that
had been raised about the desirability of removing completely the
maturity limit on Government securities held under repurchase agreements,
it might be desirable for the Committee to vote on a continuing authority
directive amended in line with the alternative suggestion of removing
this limit only during periods in which a Treasury refunding was in process.
Mr. Mitchell then said he would like to raise another question
with respect to the directive under discussion, concerning Section 1(b)
which authorized transactions in bankers' acceptances.
His question
was whether it would be appropriate to let the System's inventory run
down by reducing holdings of the types of acceptances that the System
was trying to discourage under the voluntary foreign credit restraint
program.
He had heard that as much as one-third of all U.S. bankers'
acceptances financed third-country trade.
In this connection he thought
3/2/65
-8
it would be desirable at some point for Mr. Stone to report to the
Committee on the nature of the bankers' acceptances held by the
System Account.
Mr. Hayes commented that he was not sure about the present
status of the draft guidelines for the voluntary credit restraint
program, but he did not think there would be a general ban on financing
third-country trade.
By far the largest part of such trade financed by
U.S. bank acceptances involved Japan, and as he understood the arrange
ments worked out on a Governmental level, it was agreed that the total
amount of U.S. bank credit to Japan would be kept roughly at present
levels.
In his judgment it would be unwise for the System to begin
making distinctions in its acceptance operations that would not be
reflected in the guidelines.
Mr. Mitchell said that he did not think the System should take
acceptances off the hands of banks if that would free funds for the
banks to use in extending other foreign credits.
The System's portfolio
of acceptances should be going down; it should be buying a minimum
number, reducing its purchases of those given a low priority under the
program.
Having launched a voluntary restraint program, the System
should make sure its own actions were consistent with what it was asking
others to do.
Mr. Hayes remarked that the amounts involved were quite small;
the dollar maximum of System holdings of acceptances specified in the
directive was $125 million, and actual holdings usually were less than
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that.
-9
While the principle Mr. Mitchell had expressed was a good one,
he questioned whether it was workable.
Mr. Mitchell commented that it should be workable if detailed
information was available on the make-up of the System's portfolio of
bankers' acceptances.
Mr. Stone observed that he could arrange to have
an inventory of the portfolio prepared.
Mr. Scanlon noted that when the Committee had authorized an
increase in the dollar limit on System holdings of acceptances on
November 10, 1964, it had agreed that it would reassess its participa
tion in the bankers' acceptance market at the time of this annual
organization meeting.
Chairman Martin indicated that the annual meeting was an
appropriate time to discuss this matter.
Mr. Shepardson said that in the earlier discussion, as he
recalled it, it had been noted that the Committee originally had
authorized operations in acceptances to help re-establish the market
for this type of instrument.
But there had been a significant expansion
of the acceptance market in recent years.
This raised the questions of
whether the Committee's objectives had been accomplished, and, if so,
whether any purpose would be served by its continued participation in
the acceptance market.
Chairman Martin said he questioned whether the Committee's goals
had been fully accomplished.
He asked whether Mr. Stone would like to
comment on this general subject.
3/2/65
-10Mr. Stone observed that this market was capable of still
further growth.
The Committee's efforts to encourage its development
had been eminently successful; it had grown to a point at which it was
contributing significantly to U.S. foreign trade.
Moreover, the market
now could provide a highly useful supplement to the Government securities
market in open market operations.
As a result of the balance of payments
problem the System now was operating in ways that no one had contemplated
seven or eight years ago, and it was drawing on all available resources.
The acceptance market had now become such a resource; by buying accept
ances it was possible to supply substantial amounts of reserves at times
without putting downward pressure on short-term bill rates.
Furthermore, Mr. Stone said, under the terms of the Federal
Reserve Act and several Board regulations, the System was concerned
with the field of bankers' acceptances.
By dealing in acceptances and
holding them in portfolio, the Account Management kept continuously
before it a view of what was going on in the field.
This continuing
surveillance of the market was important in determining whether acceptance
financing was in accordance with the statute and with Board regulations.
In his judgment it was highly desirable for the Committee to continue
to participate in the acceptance market.
Mr. Mitchell commented that the Committee's policy with respect
to the acceptance market had been developed at a time when the United
States had a large surplus in its international payments.
But now
that the nation had a deficit he doubted whether it was desirable to
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continue to encourage the development of the market if such actions
contributed to the volume of capital outflows.
What was necessary,
he thought, was an analysis of the characteristics of the System's
portfolio of acceptances.
Mr. Daane observed that such an analysis would be useful.
On
the whole, however, he was inclined to agree with Mr. Stone; he thought
the acceptance market promoted U.S. foreign trade, and that one should
not consider it simply in terms of its effects on capital flows.
Mr. Hayes thought that Mr. Mitchell's argument was based on
an overly short-run view of the acceptance market.
In his (Mr. Hayes')
opinion, its development was highly desirable from a longer-run stand
point.
The market would be affected by the voluntary restraint program,
but he did not think the Committee should stop participating in it
and thereby diminish the vitality of an instrument that had proved to
be generally useful over the years.
Chairman Martin said he doubted whether the Committee should
act today to change the nature of its operations in the bankers' accept
ance market; further study was required.
He suggested that Mr. Stone be
asked to prepare a memorandum on the System's portfolio of acceptances,
and that the Committee plan to discuss the matter further at its next
meeting.
There were no objections to this suggestion.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the Federal Reserve Bank of New York
was authorized and directed, until
otherwise directed by the Committee,
to execute transactions in the System
Open Market Account in accordance with
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-12the following continuing authority
directive relating to transactions in
U.S. Government securities and bankers'
acceptances:
1. The Federal Open Market Committee authorizes and
directs the Federal Reserve Bank of New York, to the extent
necessary to carry out the most recent current economic
policy directive adopted at a meeting of the Committee:
(a) To buy or sell U.S. Government securities in
the open market, from or to Government securities
dealers and foreign and international accounts maintained
at the Federal Reserve Bank of New York, on a cash,
regular, or deferred delivery basis, for the System
Open Market Account at market prices and, for such
Account, to exchange maturing U.S. Government securities
with the Treasury or allow them to mature without
replacement; provided that the aggregate amount of such
securities held in such Account at the close of business
on the day of a meeting of the Committee at which action
is taken with respect to a current economic policy
directive shall not be increased or decreased by more
than $1.5 billion during the period commencing with the
opening of business on the day following such meeting
and ending with the close of business on the day of
the next such meeting;
(b) To buy or sell prime bankers' acceptances of
the kinds designated in the Regulation of the Federal
Open Market Committee in the open market, from or to
acceptance dealers and foreign accounts maintained at
the Federal Reserve Bank of New York, on a cash,
regular, or deferred delivery basis, for the account
of the Federal Reserve Bank of New York at market
discount rates; provided that the aggregate amount
of bankers' acceptances held at any one time shall
not exceed $125 million or 10 per cent of the total
of bankers' acceptances outstanding as shown in the
most recent acceptance survey conducted by the
Federal Reserve Bank of New York;
(c) To buy U.S. Government securities with
maturities as indicated below, and prime bankers'
acceptances with maturities of 6 months or less at
the time of purchase, from nonbank dealers for the
account of the Federal Reserve Bank of New York under
agreements for repurchase of such securities or
3/2/65
-13acceptances in 15 calendar days or less, at rates not
less than (1) the discount rate of the Federal Reserve
Bank of New York at the time such agreement is entered
into, or (2) the average issuing rate on the most
recent issue of 3-month Treasury tills, whichever is
the lower; provided that in the event Government
securities covered by any such agreement are not
repurchased by the dealer pursuant to the agreement
or a renewal thereof, they shall be sold in the market
or transferred to the System Open Market Account; and
prov:ded further that in the event bankers' acceptances
covered by any such agreement are not repurchased by
the seller, they shall continue to be held by the
Federal Reserve Bank or shall be sold in the open
market. U.S. Government securities bought under the
provisions of this section shall have maturities of
24 months or less at the time of purchase, except that,
during any period beginning with the day after the
Treasury has announced a refunding operation and
ending on the day designated as the settlement date
for the exchange, the U.S. Government securities bought
may be of any maturity.
2. The Federal Open Market Committee authorizes and
directs the Federal Reserve Bank of New York to purchase
directly from the Treasury for the account of the Federal
Reserve Bank of New York (with discretion, in cases where
it seems desirable, to issue participations to one or more
Federal Reserve Banks) such amounts of special short-term
certificates or indebtedness as may be necessary from time
to time for the temporary accommodation of the Treasury;
provided that the rate charged on such certificates shall
be a rate 1/4 of 1 per cent below the d.scount rate of the
Federal Reserve Bank of New York at the time of such purchases,
and provided further that the total amount of such certificates
held at any one time by the Federal Reserve Banks shall not
exceed $500 million.
Upon motion duly made and seconded,
and by unanimous vote, the Authorization
Regarding Open Market Transactions in
Foreign Currencies, as reaffirmed March 3,
1964, was reaffirmed:
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AUTHORIZATION REGARDING OPEN MARKET TRANSACTIONS IN
FOREIGN CURRENCIES
Pursuant to Section 12A of the Federal Reserve Act
and in accordance with Section 214.5 of Regulation N (as
amended) of the Board of Governors of the Federal Reserve
System, the Federal Open Market Committee takes the following
action governing open market operations incident to the
opening and maintenance by the Federal Reserve Bank of New
York (hereafter sometimes referred to as the New York Bank)
of accounts with foreign central banks.
I. Role of Federal Reserve Bank of New York
The New York Bank shall execute all transactions
pursuant to this authorization (hereafter sometimes referred
to as transactions in foreign currencies) for the System Open
Market Account, as defined in the Regulation of the Federal
Open Market Committee.
II.
Basic Purposes of Operations
The basic purposes of System operations in and
holdings of foreign currencies are:
(1) To help safeguard the velue of the dollar in
international exchange markets;
(2) To aid in making the existing system of inter
national payments more efficient and in
avoiding disorderly conditions in exchange
markets;
(3) To further monetary cooperation with central
banks of other countries maintaining convertible
currencies, with the International Monetary
Fund, and with other international payments
institutions;
(4) Together with these banks and institutions, to
help moderate temporary imbalances in inter
national payments that may adversely affect
monetary reserve positions; and
(5) In the long run, to make possible growth in the
liquid assets available to international money
markets in accordance with the needs of an
expanding world economy.
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III.
Specific Aims of Operations
Within the basic purposes set forth in Section II,
the transactions shall be conducted with a view to the following
specific aims:
(1)
To offset or compensate, when appropriate, the
effects on U.S. gold reserves or dollar liabil
ities of disequilibrating fluctuations in the
international flow of payments to or from the
United States, and especially those that are
deemed to reflect temporary forces or transi
tional market unsettlement:
(2) To temper and smooth out abrupt changes in
spot exchange rates and moderate forward
premiums and discounts judged to be dis
equilibrating;
(3) To supplement international exchange arrange
ments such as those made through the Inter
national Monetary Fund; and
(4) In the long run, to provide a means whereby
reciprocal holdings of foreign currencies may
contribute to meeting needs for international
liquidity as required in terms of an expanding
world economy.
IV.
Arrangements with Foreign Central Banks
In making operating arrangements with foreign central
banks on System holdings of foreign currencies, the New York
Bank shall not commit itself to maintain any specific balance,
unless authorized by the Federal Open Market Committee.
The Bank shall instruct foreign central banks regarding
the investment of such holdings in excess of minimum working
balances in accordance with Section 14(e) of the Federal Reserve
Act.
The Bank shall consult with foreign central banks on
coordination of exchange operations.
Any agreements or understandings concerning the
administration of the accounts maintained by the New York Bank
with the central banks designated by the Board of Governors
under Section 214.5 of Regulation N (as amended) are to be
referred for review and approval to the Committee, subject to
the provision of Section VIII, paragraph 1, below.
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-16V.
Authorized Currencies
The New York Bank is authorized to conduct trans
actions for System Account in such currencies and within the
limits that the Federal Open Market Committee may from time
to time specify.
VI.
Methods of Acquiring and Selling Foreign Currencies
The New York Bank is authorized to purchase and sell
foreign currencies in the form of cable transfers through spot
or forward transactions on the open market at home and abroad,
including transactions with the Stabilization Fund of the
Secretary of the Treasury established by Section 10 of the
Gold Reserve Act of 1934 and with foreign monetary authorities.
Unless the Bank is otherwise authorized, all trans
actions shall be at prevailing market rates.
VII.
Participation of Federal Reserve Banks
All Federal Reserve Banks shall participate in the
foreign currency operations for System Account in accordance
with paragraph 3 G (1) of the Board of Governors' Statement
of Procedure with Respect to Foreign Relationships of Federal
Reserve Banks dated January 1, 1944.
VIII.
Administrative Procedures
The Federal Open Market Committee authorizes a Sub
committee consisting of the Chairman and the Vice Chairman of
the Committee and the Vice Chairman of the Board of Governors
(or in the absence of the Chairman or cf the Vice Chairman of
the Board of Governors the members of the Board designated by
the Chairman as alternates, and in the absence of the Vice
Chairman of the Committee his alternate) to give instructions
to the Special Manager, within the guidelines issued by the
Committee, in cases in which it is necessary to reach a
decision on operations before the Committee can be consulted.
All actions authorized under the preceding paragraph
shall be promptly reported to the Committee.
The Committee authorizes the Chairman, and in his
absence the Vice Chairman of the Committee, and in the absence
of both, the Vice Chairman of the Board of Governors:
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(1)
(2)
(3)
IX.
With the approval of the Committee, to enter
into any needed agreement or understanding with
the Secretary of the Treasury about the division
of responsibility for foreign currency opera
tions between the System and the Secretary;
To keep the Secretary of the Treasury fully
advised concerning System foreign currency
operations, and to consult with the Secretary
on such policy matters as may relate to the
Secretary's responsibilities;
From time to time, to transmit appropriate
reports and information to the National
Advisory Council on International Monetary and
Financial Problems.
Special Manager of the System Open Market Account
A Special Manager of the Open Market Account for
foreign currency operations shall be selected in accordance
with the established procedures of the Federal Open Market
Committee for the selection of the Manager of the System Open
Market Account.
The Special Manager shall direct that all transactions
in foreign currencies and the amounts of all holdings in each
authorized foreign currency be reported daily to designated
staff officials of the Committee. and shall regularly consult
with the designated staff officials of the Committee on current
tendencies in the flow of international payments and on current
developments in foreign exchange markets.
The Special Manager and the designated staff officials
of the Committee shall arrange for the prompt transmittal to the
Committee of all statistical and other information relating to
the transactions in and the amounts of holdings of foreign
currencies for review by the Committee as to conformity with
its instructions.
The Special Manager shall include in his reports to
the Committee a statement of bank balances and investments
payable in foreign currencies, a statement of net profit or
loss on transactions to date, and a summary of outstanding
unmatured contracts in foreign currencies.
X.
Transmittal of Information to Treasury Department
The staff officials of the Federal Open Market
Committee shall transmit all pertinent information on System
foreign currency transactions to designated officials of the
Treasury Department.
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XI.
Amendment of Authorization
The Federal Open Market Committee may at any time
amend or rescind this authorization.
Chairman Martin then noted that Mr. Coombs had proposed
certain revisions in the guidelines for System foreign currency
operations in a memorandum to the Committee dated February 25, 1965,
and he invited Mr. Coombs to comment.
(A copy of the memorandum
referred to has been placed in the files of the Committee.)
Mr. Coombs observed that the changes he proposed were
primarily matters of form rather than substance.
As indicated in
his memorandum, they involved deletions of certain language relating
to the original launching of operations, consolidation of certain
material, and other clarifying revisions.
Mr. Mitchell remarked that he had no objection to the proposed
changes, but would like to raise a question.
It was his recollection
that when the Committee began operations in foreign currencies it was
concerned with the position of the dollar as such rather than in its
role as a reserve currency.
However, in Mr. Coombs' annual report, as
submitted for publication in the Board's Annual Report for 1964, the
dollar was discussed primarily from the reserve-currency standpoint.
Unless this was appreciated, the purposes for which the Account
Management had intervened in foreign exchange markets on many occasions
during the year were rather obscure.
His question was whether the
proposed revised guidelines adequately reflected consideration of the
dollar as such, as opposed to its reserve-currency status.
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Mr. Coombs replied that he thought the U.S. gold stock was
under two kinds of pressure--that of direct flows from the United
States to other countries, and that of third-country flows arising
because the dollar was a reserve currency.
This distinction was
not spelled out in the guidelines; rather, it was taken for granted
that the dollar was a reserve currency and the Account Management
had operated in that context.
Mr. Mitchell suggested that thought might be given to making
this distinction explicit.
It seemed to him that many of the Account
Management's operations were concerned with the dollar in its reserve
currency role.
Mr. Coombs said he would find it difficult to make the distinc
tion in practice, although he agreed with Mr. Mitchell that many opera
tions actually undertaken would be unnecessary if the dollar was not a
reserve currency.
Mr. Daane remarked that in talking about safeguarding the dollar
one necessarily had both of its roles in view.
He thought it would be
unwise to attempt to make explicit the distinction to which Mr. Mitchell
had referred.
Messrs. Hayes and Bryan concurred in this view.
Mr. Ellis noted that in Section 4 of the proposed new guide
lines it was said that transactions in forward exchange "may prove
desirable" under certain described circumstances.
This was a rather
indefinite statement; in his judgment it would be better to indicate that
forward operations were specifically authorized in the circumstances
described, consistently with the construction in other passages of the
guidelines.
3/2/65
-20After discussion, in the course of which the relationship
between the guidelines and the continuing authority directive for
foreign currency operations was touched on, Chairman Martin suggested
that the Committee vote on the guidelines as proposed in Mr. Coombs'
memorandum, with the understanding that revisions to deal with the
problem Mr. Ellis had noted might be considered at the next meeting.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the Guidelines for System Foreign Cur
rency Operations were amended to read
as follows:
GUIDELINES FOR SYSTEM FOREIGN CURRENCY OPERATIONS
1.
Holdings of Foreign Currencies
Until otherwise authorized, the System will limit
its holdings of foreign currencies to that amount necessary
to enable its operations to exert a market influence.
Holdings of larger amounts will be authorized only when the
U.S. balance of international payments attains a sufficient
surplus to permit the ready accumulation of holdings of major
convertible currencies.
Foreign currency holdings shall be invested as far
as practicable in conformity with Section 14(e) of the Federal
Reserve Act.
2.
Exchange Transactions
System exchange transactions shall be geared to
pressures of payments flows so as to cushion or moderate
disequilibrating movements of funds and their destablizing
effects on U.S. and foreign official reserves and on exchange
markets.
In general, these transactions shall be geared to
pressures connected with movements that are expected to be
reversed in the foreseeable future; when expressly authorized
by the Federal Open Market Committee, they may also be geared
on a short-term basis to pressures connected with other
movements.
3/2/65
-21-
Subject to express authorization of the Committee,
the Federal Reserve Bank of New York may enter into reciprocal
arrangements with foreign central banks on exchange trans
actions ("swap" arrangements), which arrangements may be wholly
or in part on a standby basis.
Drawings made by either party under a reciprocal
arrangement shall be fully liquidated within 12 months after
any amount outstanding at that time was first drawn, unless
the Committee, because of exceptional circumstances, specif
ically authorizes a delay.
The New York Bank shall, as a usual practice,
purchase and sell authorized currencies at prevailing market
rates without trying to establish rates that appear to be
out of line with underlying market forces.
If market offers to sell or buy intensify as System
holdings increase or decline, this shall be regarded as a
clear signal for a review of the System's evaluation of inter
national payments flows.
It shall be the practice to arrange with foreign
central banks for the coordination of foreign currency trans
actions in order that System transactions do not conflict with
those being undertaken by foreign monetary authorities.
3. Transactions in Spot Exchange
The guiding principle for transactions in spot exchange
shall be that, in general, market movements in exchange rates,
within the limits established in the International Monetary Fund
Agreement or by central bank practices, index affirmatively the
interaction of underlying economic forc.s and thus serve as
efficient guides to current financial decisions, private and
public.
Temporary or transitional fluctuations in payments
flows may be cushioned or moderated whenever they occasion
market anxieties, or undesirable speculative activity in
foreign exchange transactions, or excessive leads and lags in
international payments.
Special factors making for exchange market instabilities
include (i) responses to short-run increases in international
political tension, (ii) differences in phasing of international
economic activity that give rise to unusually large interest
rate differentials between major markets, or (iii) market
rumors of a character likely to stimulate speculative trans
actions.
3/2/65
-22-
Whenever exchange market instability threatens to
produce disorderly conditions, System transactions are appro
priate if the Special Manager, in consultation with the Federal
Open Market Committee, or in an emergercy with the members of
the Committee designated for that purpose, reaches a judgment
that they may help to re-establish supply and demand balance
at a level more consistent with the prevailing flow of under
lying payments. Whenever supply or demand persists in in
fluencing exchange rates in one direction, System transactions
should be modified, curtailed, or eventually discontinued
pending a reassessment by the Committee of supply and demand
forces.
Insofar as is practicable, the New York Bank shall
purchase a currency through spot transactions at or below
its par value, and sell a currency through spot transactions
at rates at or above its par value.
Spot transactions at rates other than those set
forth in the preceding paragraph shall be specially authorized
by the Committee or by the members of the Committee designated
in Section VIII of the Authorization for Open Market Trans
actions in Foreign Currencies, except that purchases of exchange
to meet System commitments may be executed without special
authorization at rates above par when necessary.
4.
Transactions in Forward Exchange
Transactions in forward exchange, either outright or
in conjunction with spot transactions, may prove desirable:
(1)
When forward premiums or discounts are incon
sistent with interest race differentials and
are giving rise to disequilibrating movements
of short-term funds;
(2)
When it is deemed appropriate to supplement
existing market supplies of forward cover,
as a means of encouraging the retention or
accumulation of dollar holdings by private
foreign holders;
(3)
To allow greater flexibility in covering System
commitments, including those under swap arrange
ments;
(4)
To facilitate the use of holdings of one
currency for the settlement of commitments
denominated in other currencies.
-23-
3/2/65
Forward sales of authorized currencies to the U.S.
Stabilization Fund out of existing System holdings or in con
junction with spot purchases of such currencies may also prove
desirable in order to allow greater flexibility in covering
commitments of the U.S. Treasury.
In all other cases, proposals of the Special Manager
to initiate forward operations shall be submitted to the Com
mittee for advance approval.
Upon motion duly made and seconded,
and by unanimous vote, the following con
tinuing authority directive to the Federal
Reserve Bank of New York with respect to
foreign currency operations was approved:
The Federal Reserve Bank of New York is authorized
and directed to purchase and sell through spot transactions
any or all of the following currencies in accordance with the
Guidelines on System Foreign Currency Operations as amended
March 2, 1965; provided that the aggregate amount of foreign
currencies held under reciprocal currency arrangements shall
not exceed $2.35 billion equivalent at any one time, and
provided further that the aggregate amount of foreign currencies
held as a result of outright purchases shall not exceed $150
million equivalent at any one time:
Pounds sterling
French francs
German marks
Italian lire
Netherlands guilders
Swiss francs
Belgian francs
Canadian dollars
Austrian schillings
Swedish kronor
Japanese yen
The Federal Reserve Bank of New York is also authorized
and directed to operate in any or all of the foregoing currencies
in accordance with the Guidelines and up to a combined total of $275
million equivalent, by means of:
(a)
purchases through forward transactions, for the
purpose of allowing greater flexibility in
covering commitments under reciprocal currency
agreements;
3/2/65
-24(b)
purchases and sales through forward as well as
spot transactions, for the purpose of utilizing
its holdings of one currency for the settlement
of commitments denominated in other currencies;
(c)
purchases through spot transactions and concurrent
sales through forward transactions, for the purpose
of restraining short-term outflows of funds induced
by arbitrage considerations; and
(d)
sales through forward transactions, for the purpose
of influencing interest arbitrate flows of funds
and of minimizing speculative disturbances.
The Federal Reserve Bank of New York is also authorized
and directed to make purchases through spot transactions, in
cluding purchases from the U.S. Stabilization Fund, and con
current sales through forward transactions to the U.S. Stabi
lization Fund, of any of the foregoing currencies in which the
U.S. Treasury has outstanding indebtedness, in accordance with
the Guidelines and up to a total of $100 million equivalent.
Purchases may be at rates above par, and both purchases and
sales are to be made at the same rates.
Chairman Martin then asked Mr. Stone to comment on proposed
revisions in the procedures for allocations of the System Open Market
Account.
Mr. Stone noted that a bill to remove the gold certificate
reserve requirement against deposits at Federal Reserve Banks had
passed both houses of Congress and presumably would be signed by the
President shortly.
Mr. Farrell and he recommended that the Committee
make certain deletions in the existing statement of procedures to
become effective when the bill was signed.
This would be a temporary
measure, pending a general review of the procedures.
First, they
would suggest deleting the word "combined" as a qualifier of the term
"reserve ratios" in the first and second paragraphs.
Secondly, since
3/2/65
-25-
the Account now would need to be reallocated only once a month, they
proposed deleting the words in the first paragraph calling for weekly
reallocations.
Finally, they would delete the words "or to such
higher level as may be necessary to eliminate the deficiency in note
or deposit reserves" at the end of the second sentence of the second
paragraph.
The resulting statement then would be applicable to a
situation in which gold certificate reserves were required only against
Federal Reserve notes.
Chairman Martin suggested that the Committee vote on the
revised procedures with the understanding that they would be employed
temporarily while the general study to which Mr. Stone had referred
was in process.
He thought it would be desirable for this study to
be undertaken immediately.
Thereupon, upon motion duly made and
seconded, and by unanimous vote, the following
procedures with respect to allocations of the
System Open Market Account were approved,
effective upon the date at which the bill
removing gold certificate requirements against
deposits at Federal Reserve Banks became law:
1. Securities in the System Open Market Account shall
be reallocated on the last business day of each month by means
of adjustments proportionate to the adjustments that would
have been required to equalize approximately the average
reserve ratios of the 12 Federal Reserve Banks based on the
most recent available five business days' reserve ratio
figures.
2. The Board's staff shall calculate, in the morning
of each business day, the reserve ratios of each Bank after
allowing for the indicated effects of the settlement of the
Interdistrict Settlement Fund for the preceding day. If
these calculations should disclose a deficiency in the reserve
NOTE:
The bill referred to was signed by the President on March 3, 1965.
3/2/65
-26-
ratio of any Bank, the Board's staff shall inform the Manager
of the System Open Market Account, who shall make a special
adjustment as of the previous day to restore the reserve ratio
of that Bank to the average of all the Banks. However, such
adjustments shall not be made beyond the point where a defi
ciency would be created at any other Bank. Such adjustments
shall be offset against the participation of the Bank or Banks
best able to absorb the additional amount or, at the discretion
of the Manager, against the participation of the Federal Reserve
Bank of New York. The Board's staff and the Bank or Banks con
cerned shall then be notified of the amounts involved and the
Interdistrict Settlement Fund shall be closed after giving
effect to the adjustments as of the preceding business day.
3. Until the next reallocation the Account shall be
apportioned on the basis of the ratios determined in para
graph 1, after allowing for any adjustments as provided for
in paragraph 2.
4. Profits and losses on the sale of securities from
the Account shall be allocated on the day of delivery of the
securities sold on the basis of each Bank's current holdings
at the opening of business on that day.
Mr. Farrell left the meeting at this point.
A proposed list for distribution of periodic reports pre
pared by the Federal Reserve Bank of New York for the Federal Open
Market Committee was presented for consideration and approval.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
authorization was given for the follow
ing distribution:
1.
2.
3.
*4.
*5.
*6.
*7.
The Members of the Board of Governors
The Presidents of the twelve Federal Reserve Banks.
Officers of the Federal Open Market Committee.
The Secretary of the Treasury.
The Under Secretary of the Treasury for Monetary Affairs
and the Deputy Under Secretary for Monetary Affairs.
The Assistant to the Secretary of the Treasury working on
debt management problems.
The Fiscal Assistant Secretary of the Treasury.
* Weekly reports of open market operations only.
3/2/65
-27
8. The Director of the Division of Bank Operations of the
Board of Governors.
9. The officer in charge of research at each of the Federal
Reserve Banks not represented by its President on the
Federal Open Market Committee.
10. The alternate
member of the Federal Open Market Committee
from the Federal Reserve Bank of New York; the Assist
ant Vice Presidents of the Federal Reserve Bank of
New York working under the Manager of the System Accout;
the Managers of the Securities Department of the New
York Bank; the Vice President of the Foreign Function
having supervisory responsibility for operations; the
Senior Foreign Exchange Officer of the Foreign Function;
the Managers of the Foreign Department; the officer in
charge, the Assistant Vice President, and the Advisor of
the Research Department of the New York Bank; and the
confidential files of the New York Bank as the Bank
selected to execute transactions for the Federal Open
Market Committee.
11. With the approval of a member of the Federal Open Market
Committee or any other President of a Federal Reserve
Bank, with notice to the Secretary, any other employee
of the Board of Governors or a Federal Reserve Bank.
The Committee reaffirmed by unanimous
vote the authorization, first given on
March 1, 1951, for the Chairman to appoint
a Federal Reserve Bank to operate the System
Open Market Account temporarily in case the
Federal Reserve Bank of New York is unable
to function.
The following resolution to provide for
the continued operation of the Federal Open
Market Committee during an emergency was
reaffirmed by unanimous vote:
In the event of war or defense emergency, if the Secretary
or Assistant Secretary of the Federal Open Market Committee (or
in the event of the unavailability of both of them, the Secretary
or Acting Secretary of the Board of Governors of the Federal
Reserve System) certifies that as a result of the emergency the
available number of regular members and regular alternates of
the Federal Open Market Committee is less than seven, all powers
and functions of the said Committee shall be performed and
exercised by, and authority to exercise such powers and functions
is hereby delegated to, an Interim Committee, subject to the
following terms and conditions:
3/2/65
-28
Such Interim Committee shall consist of seven members,
comprising each regular member and regular alternate of the
Federal Open Market Committee then available, together with
an additional number, sufficient to make a total of seven,
which shall be made up in the following order of priority
from those available:
(1) each alternate at large (as
defined below); (2) each President of a Federal Reserve Bank
not then either a regular member or an alternate; (3) each
First Vice President of a Federal Reserve Bank; provided
that (a) within each of the groups referred to in clauses
(1), (2), and (3) priority of selection shall be in numerical
order according to the numbers of Federal Reserve Districts,
(b) the President and the First Vice President of the same
Federal Reserve Bank shall not serve at the same time as
members of the Interim Committee, and (c) whenever a regular
member or regular alternate of the Federal Open Market Com
mittee or a person having a higher priority as indicated in
clauses (1), (2), and (3) becomes available he shall become
a member of the Interim Committee in the place of the person
then on the Interim Committee having the lowest priority.
The Interim Committee is hereby authorized to take action
by majority vote of those present whenever one or more
members thereof are present, provided that an affirmative
vote for the action taken is cast by at least one regular
member, regular alternate, or President of a Federal Reserve
Bank. The delegation of authority and other procedures set
forth above shall be effective only during such period or
periods as there are available less than a total of seven
regular members and regular alternates of the Federal Open
Market Committee.
As used herein the term "regular member" refers to a
member of the Federal Open Market Committee duly appointed
or elected in accordance with existing law; the term
"regular alternate" refers to an alternate of the Committee
duly elected in accordance with existing law and serving in the
absence of the regular member for whom he was elected; and the
term "alternate at large" refers to any other duly elected
alternate of the Committee at a time when the member in whose
absence he was elected to serve is available.
The following resolution authorizing
certain actions by the Federal Reserve
Banks during an emergency was reaffirmed
by unanimous vote:
The Federal Open Market Committee hereby authorizes each
Federal Reserve Bank to take any or all of the actions set
forth below during war or defense emergency when such Federal
Reserve Bark finds itself unable after reasonable efforts to
3/2/65
-29-
be in communication with the Federal Open Market Committee
(or with the Interim Committee acting in lieu of the Federal
Open Market Committee) or when the Federal Open Market Com
mittee (or such Interim Committee) is unable to function.
(1) Whenever it deems it necessary in the light of
economic conditions and the general credit situation then
prevailing (after taking into account the possibility of
providing necessary credit through advances secured by
direct obligations of the United States under the last para
graph of section 13 of the Federal Reserve Act), such Federal
Reserve Bank may purchase and sell obligations of the United
States for its own account, either outright or under repur
chase agreement, from and to banks, dealers, or other holders
of such obligations.
(2) In case any prospective seller of obligations of
the United States to a Federal Reserve Bank is unable to
tender the actual securities representing such obligations
because of conditions resulting from the emergency, such
Federal Reserve Bank may, in its discretion and subject to
such safeguards as it deems necessary, accept from such seller,
in lieu of the actual securities, a "due bill" executed by
the seller in form acceptable to such Federal Reserve Bank
stating in substantial effect that the seller is the owner
of the obligations which are the subject of the purchase,
that ownership of such obligations is thereby transferred
to the Federal Reserve Bank, and that the obligations them
selves will be delivered to the Federal Reserve Bank as
soon as possible.
(3) Such Federal Reserve Bank may in its discretion
purchase special certificates of indebtedness directly from
the United States in such amounts as may be needed to cover
overdrafts in the general account of the Treasurer of the
United States on the books of such Bank or for the temporary
accommodation of the Treasury, but such Bank shall take all
steps practicable at the time to insure as far as possible
that the amount of obligations acquired directly from the
United States and held by it, together with the amount of
such obligations so acquired and held by all other Federal
Reserve Banks, does not exceed $5 billion at any one time.
Authority to take the actions above set forth shall be
effective only until such time as the Federal Reserve Bank is
able again to establish communications with the Federal Open
Market Committee (or the Interim Committee), and such Committee
is then functioning.
-30
3/2/65
By unanimous vote the Committee re
affirmed the authorization, first given at
the meeting on December 16, 1958, providing
for System personnel assigned to the Office
of Emergency Planning, Special Facilities
Branch (formerly, Office of Civil and Defense
Mobilization--Classified Location) on a
rotating basis to have access to the resolu
tions (1) providing for continued operation
of the Committee during an emergency and
(2) authorizing certain actions by the
Federal Reserve Banks during an emergency.
There was unanimous agreement that no
action should be taken to change the existing
procedure, as called for by resolution adopted
June 21, 1939, requesting the Board of Governors
to cause its examining force to furnish the
Secretary of the Federal Open Market Committee
a report of each examination of the System Open
Market Account.
Reference was made to the procedure authorized at the meeting
of the Committee on March 2, 1955, and most recently reaffirmed on
March 3, 1964, whereby, in addition to membe:s and officers of th
Com
mittee and Reserve Bank Presidents not currently members of the Committee
minutes and other records could be made available to any other employee
of the Board of Governors or of a Federal Reserve Bank with the approval
of a member of the Committee or another Reserve Bank President, with
notice to the Secretary.
It was stated that lists of currently authorized persons at
the Board and at each Federal Reserve Bank (excluding secretaries and
records and duplicating personnel) had recently been confirmed by the
Secretary of the Committee.
The current lists were reported to be in
the custody of the Secretary, and it was noted that revisions could be
sent to the Secretary at any time.
-31
3/2/65
It was agreed unanimously that no
action should be taken at this time to
amend the procedure authorized on
March 2, 1955.
This concluded the consideration of the continuing authoriza
tions of the Open Market Committee, and the Committee turned to a
review of operations during the period since the meeting of the Com
mittee held on February 2, 1965.
Before this meeting there had been distributed to the members
of the Committee a report from the Special Manager of the System Open
Market Account on foreign exchange market operations and on Open Market
Account and Treasury operations in foreign currencies for the period
February 2 through February 24, 1965, and a supplemental report for
February 25 through March 1, 1965.
Copies of these reports have been
placed in the files of the Committee.
Supplementing the written reports, Mr. Coombs stated that the
gold stock might be reduced this week by $125 million in order to
replenish the Stabilization Fund, which ended
with a balance of $56 million.
the month of February
Scheduled sales of gold during March
already amounted to $270 million and the French would probably requesteither in March or April--an additional $150 million, which would lift
the total to $420 million.
This would increase gold losses since the
beginning of the year to nearly $900 million.
continuing on the London gold market.
Meanwhile, pressure was
The cost of intervention in
February was $86 million, and the U.S. share of Gold Pool sales came
to $43 million.
The drain on the Gold Pool had now reached the figure
3/2/65
-32
of $160 million out of the $270 million available.
Most of the pres
sure on the market was attributable to continuing French attacks on
the dollar and sterling; as far as he could tell only a minor part
originated in the Viet Nam situation.
In recent weeks, the Chinese
Communist Government had also exerted further pressure on the market
by regular purchases of gold, which now totaled more than $30 million.
He was not sure how much the Chinese had in the way of funds to continue
such purchases, but he suspected their resources were meager and soon
would run out.
Mr. Coombs reported that at Basle this coming weekend (March 6-7)
there would be discussions of the future of the Gold Pool if the $270
million should be exhausted.
He thought it would be highly advisable
in the present atmosphere to prevent the London price from going over
$35.20 even if this country's Gold Pool partners were unwilling to con
tinue to share with the U.S. the cost of intervention in the London gold
market, so that the full cost of intervention had to be absorbed by this
country.
Thus, Mr. Coombs remarked, the immediate outlook in general
was for very heavy pressure on the U.S. gold stock, further aggravated
by speculative pressure on the London gold market.
Confidence in the
dollar, which had become rather shaky in the past two or three weeks,
could be undermined still further, and in the next few weeks the U.S.
could be brought dangerously close to another crisis such as was ex
perienced in the fall of 1960.1/
1/ Three sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material related to certain
recent and prospective operations by the Bank of England.
3/2/65
-33-
In other exchange markets, the dollar had remained on or close
to the floor against the French franc, the Dutch guilder, and the Belgian
franc, and all three countries had continued to take in dollars which
from now on probably would be entirely converted into gold.
The U.S.
had about used up its credit facilities in the Netherlands and Belgium,
and, of course, the French were continuing to convert dollar accruals
into gold.
The only encouraging feature in the present situation had
been the strength of the dollar against the Swiss franc.
This reflected
seasonal factors as well as the underlying deficit in the Swiss balance
of payments which reappeared whenever short-term capital inflows tapered
off.
Here again, however, very little scope remained for financing any
renewed flow of money to Switzerland through swap arrangements or other
credits; outstanding commitments in Swiss francs now amounted to $250
million out of the $300 million available under the Swiss swap arrange
ments.
On the exchange markets generally, as in the gold market, the
3/2/65
-34
U.S. might have to pass through a fairly dangerous period before the
new balance of payments measures became fully effective.
Chairman Martin asked whether the identity of the purchasers
on the London gold market was known.
Mr. Coombs replied that it gen
erally was possible to learn of any purchases by central banks.
As
far as he knew, the only sizable central bank purchases recently were
by the Chinese.
In general, the demand appeared to be world-wide, and
there were indications that cash balances were being accumulated by
people who feared trouble and were ready to come into the market.
Any
one could buy gold through the agency of, say, a Swiss or Dutch bank.
There was no indication that any American buyers were involved.
Mr. Swan asked about the significance of the $35.20 price for
gold which Mr. Coombs had suggested should not be exceeded.
replied that that was a fairly arbitrary ceiling.
Mr. Coombs
The gold price had
risen close to $35.20 on at least two previous occasions, one of which
was at the time of the Cuban crisis, and in recent years the market and
the financial press had tended to view this figure as an informal ceiling.
The figure also had some significance in that the New York gold price of
$35.0875 plus costs of shipping gold by a routine method added up to a
London price of about $35.18.
to London by cheaper means.
It was possible, of course, to ship gold
But if the London price went much over
$35.20, expectational factors such as those seen in 1960 would be
triggered off, and events probably would move much faster than in 1960
because of that earlier experience.
-35
3/2/65
In response to a question by Mr. Mitchell, Mr. Coombs said that
the total of System drawings under the swap arrangements would come to
$535 million after a drawing planned for next week of $50 million
equivalent on the swap with the Bank of Italy.
Mr. Mitchell then
asked whether Mr. Coombs thought these drawings, other than that on
the Bank of Italy, ought to be paid off in gold.
the negative.
Mr. Coombs replied in
He was hopeful that if the new balance of payments meas
ures proved effective much of the total would prove reversible.
The
main significance he saw in the $535 million figure was that the U.S.
gold stock would have been that much lower if the System had not made
the swap drawings.
In reply to other questions by Mr. Mitchell, Mr. Coombs noted
that all earlier System drawings had been completely paid off in June
1964.
Subsequently, except for a September drawing of guilders to deal
with a special situation, there were no substantial drawings by the
System until November and December.
No drawings had been renewed more
than once, although he planned to recommend certain second renewals
today.
In general, System drawings had been repaid within the time
span the Committee had in mind although some small part of them had been
funded by issuance of Treasury bonds denominated in foreign currencies.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
February 2 through March 1, 1965, were
approved, ratified, and confirmed.
Mr. Coombs then noted that the System's $100 million standby swap
arrangement with the Netherlands Bank would reach the end of its term on
-36
3/2/65
March 15, 1965, and he requested approval of its renewal for another
three months.
Renewal of the $100 million standby
swap arrangement with the Netherlands
Bank for a further period of 3 months,
as recommended by Mr. Coombs, was approved.
During March, Mr. Coombs said, a number of drawings matured
which should be renewed if the U.S. was to avoid paying them off in
gold.
These included a $100 million drawing on the Bank for Inter
national Settlements and two drawings totaling $45 million on the
National Bank of Belgium.
Each of these would be a first renewal.
Renewal of the drawings on the BIS
and the National Bank of Belgium was
noted without objection.
Mr. Coombs then noted that three drawings upon the Netherlands
Bank, totaling $65 million, matured in March.
These already had been
renewed once, but he thought they should be renewed again.
There was
some prospect, however, that the Dutch government might make a debt re
payment to the U.S. of roughly $60 million some time in April which
would provide the funds to liquidate these drawings in advance of their
next maturity.
Thus, even though these drawings were renewed a second
time he would hope that they would not be outstanding for a full nine
months but would be paid off about seven months after they initially
were made.
Mr. Mitchell asked whether Mr. Coombs would plan to liquidate
these drawings if the Dutch debt repayment was not made, and Mr. Coombs
replied affirmatively.
It was a basic principle, he thought, not to
3/2/65
-37
let drawings run on; the integrity of the whole swap network rested on
this principle.
If it proved necessary to liquidate these drawings with
gold after this renewal, he would want to consult with the Treasury on
specific timing in the interests of orderly procedure, but the basic
decision on liquidation would be the System's.
To his mind the principle
was quite clear that the drawings should be liquidated at the earliest
possible moment, and he certainly would not anticipate coming back to
the Committee to propose a third renewal.
Mr. Shepardson remarked that in his judgment the Committee should
plan on paying off the drawings even if the potential Netherlands debt
repayment was not made.
He thought it would be undesirable to get into
a position in which swap drawings were used to finance basic positions
that should be covered by other means.
Mr. Coombs replied he agreed completely with this view, and that
it was shared by all other countries in the swap network.
Renewal of the three drawings
totaling $65 million on the Netherlands
Bank was noted without objection.
Mr. Coombs then reported that a $10 million swap of sterling
against Dutch guilders matured for the second time at the end of the
month, and he felt that in this case also he must recommend renewal for
another three months.
However, this was a type of arrangement that in
the past had been allowed to run on somewhat longer than drawings on
the regular swap lines.
A greater degree of flexibility seemed appropriate
for such third-currency swaps than for regular swap transactions because
they permitted the System to shift its holdings among currencies.
-38-
3/2/65
Renewal of the $10 million swap of
sterling against Dutch guilders was noted
without objection.
Finally, Mr. Coombs said, he expected to send a memorandum
to the Committee before the next meeting suggesting the desirability
of increases in the swap lines with the Bank of Italy and the Bank
of Japan.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account covering open market operations in U.S. Government securities
and bankers' acceptances for the period February 2 through February 24,
1965, and a supplemental report for February 25 through March 1, 1965.
Copies of these reports have been placed in the files of the Committee.
In supplementation of the writter. reports, Mr. Stone commented
as follows:
Financial markets have come to understand that monetary
policy has undergone a modest but distinct shift toward less
ease. The change has been interpreted as a step aimed at
supporting the more general program undertaken to deal with
the balance of payments. The shift in policy was widely
expected. Indeed, as I indicated at the last meeting, the
market had already, by the beginning of February, undergone
a good part of its adjustment to a somewhat less easy policy
stance.
Marginal reserve availability has now moved down to a
range surrounding zero free reserves, Federal funds have been
trading most often at or above the 4 per cent discount rate,
and member bank borrowing has increased. Bill rates have
risen about 10 basis points, putting the 3-month rate in the
neighborhood of 4 per cent, while other short-term rates have
moved up about 1/8 per cent. Yields on short-term coupon
issues, maturing within a year or two, also have moved up
about 10 basis points, but throughout the rest of the Treasury
list there have been yield increases of only a basis point or
two for the most part.
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3/2/65
While the market's adjustment to the policy shift has been
very smooth, there remains an undertone of caution, based partly
on uneasiness over the situation in the Far East and over recent
and prospective gold losses. Furthermore, there is a feeling
that unless the payments deficit is reduced substantially, and
soon, further monetary policy action may be needed. On the other
hand, the market continues to see large amounts of savings seeking
employment, and it retains the view that, barring some kind of
crisis, longer term rates are not likely to change much and might
even edge down as the year goes on.
Wnatever the longer-range view about rates, there is a feeling
in the market that the next few weeks may see some intensification
of money market pressures, and possible rate increases, for seasonal
reasons. Corporate cash needs over the dividend and tax dates this
month may be at least as great as in other recent quarterly months,
and there may be somewhat less of a cushion of liquid holdings to
fall back on, given the build-.p in other demands on corporate
liquid resources. Issuing rates on time certificates of deposit
have edged into new high ground as banks have sought to replace
actual and anticipated maturities of outstanding CDs. With major
banks paying 4-1/4 per cent or more for 3-month money, and corpora
tions in a period of net cash drain, it is possible that short
rates might press a bit higher during the period of seasonal pres
sures ahead. On the other hand, there has been a tendency during
several recent tax and dividend periods for a number of large money
market banks to move gradually to surplus basic reserve positions
to enable them to accommodate without strain the pressures that
If this advance
converge upon them on the tax and dividend dates.
preparation happens again, the upward rate pressures could well turn
out to be both mild and brief.
Recent price declines have been somewhat more pronounced in
corporate and tax-exempt bond markets than in the Treasury bond
area. Tax-exempt bonds have been in large supply and a reaction
seemed overdue after the price rise in this market which followed
the raising of Regulation Q ceilings last November. Recent price
cuts seem to have been successful in stimulating demand, but the
calendar remains substantial. Public offerings of corporate bonds
have not been heavy, but private bond placements and stock or
convertible debt offerings have competed for investible funds and
produced some rise in rates.
The Treasury financing calendar is clear of all but routine
bill roll-overs for the next three weeks, and indeed the next
significant debt operation is not likely to come until late April,
when the Treasury will announce plans for refunding its May 15
maturities.
Mr. Ellis asked whether his understanding was correct that Mr.
Stone thought the market had completed its adjustment to the recent shift
in monetary policy, and Mr. Stone replied affirmatively.
3/2/65
-40Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in Govern
ment securities and bankers' acceptances
during the period February 2 through
March 1, 1965, were approved, ratified,
and confirmed.
Chairman Martin then called for the staff economic and financial
reports, supplementing the written reports that had been distributed prior
to the meeting, copies of which have been placed in the files of the Com
mittee.
Mr. Noyes made the following statement on economic conditions:
After four years of almost incredibly stable expansion,
there is growing concern that our economy may be developing
a classic form of instability--the boom-bust inventory whipsaw
that so often frustrated our efforts to maintain stable growth.
The fact that some observers are inclined to focus their
attention on the boom side of this cycle and its inflationary
potential, while others are preoccupied with the subsequent
bust and its impact on our employment and growth objectives,
should not trap us into the comforting but erroneous conclu
sion that these concerns can be offset against one another.
It is impossible to establish with any precision the size
of the inventory build-up that has already occurred. The most
recent comprehensive data presently available are for December.
These were just revised upward by a substantial amount and there
are indications that before they are final they will be revised
still further. Taken at their face value, they would indicate
that inventories were being accumulated on a GNP basis at a
$9 billion annual rate in November and December. The staff
reply to the first question 1/ suggests that the annual rate of
accumulation in January and February may be about $10 billion,
and that over $6 billion of this is in lines other than steel
and autos. These are high rates, by any standards--about equal,
for example, to the second quarter of 1959, when inventory policy
was influenced by both widespread inflationary expectations and
the prospect of a prolonged steel strike.
1/
The staff's prepared comments on certain questions considered
by the Committee at this meeting are given at a later point
in these minutes.
3/2/65
-41
I do not wish to leave you with the impression that all of
the strength we see in our economy should be associated with
inventory accumulation, or that the absorption of the inventories
thus far accumulated would necessarily produce a recession in
economic activity. The staff answer I referred to earlier
estimates that we might see "an initial downdrag of some $8
billion annual rate," but the staff has, wisely in my judgment,
declined to specify at this stage the period over which such a
downdrag might be felt. Similarly, they omit any consideration
of the immediate or ultimate consequences of a further accelera
tion in the rate of inventory accumulation.
Obviously, I have no better basis for projecting these
magnitudes than they had. Nevercheless, it seems quite possible
that we may shortly find ourselves in a situation in which aggre
gate demand is being inflated by inventory accumulation at an
annual rate of as much as $15 billion. If this should continue
for a period of several months, it would almost certainly have
current inflationary consequences, and if it were rapidly reversed,
it would produce at best a short recession.
What can monetary policy do to forestall such a misfortune?
It is difficult to conclude that it can do much. At the heart
of one's conclusion lies a judgment as to whether a more restric
tive monetary policy now would (a) moderate somewhat the rate of
inventory accumulation, or (b) effectively defer some other demands
to be released when inventory demand disappears, or both.
There is very little evidence to suggest that changes in the
overall cost and availability of credit exert much influence on
inventory policy in the short run. While judgments differ as to
the extent of the influence, if any, I doubt that anyone would
wish to argue that inventory accumulation can be effectively
regulated by general credit policy.
Whether other types of expenditures can be deferred and later
released by a tightening and subsequent easing of credit is a
much more controversial question. It seems to me that the ques
tion cannot be answered dogmatically in the negative. To deny that
some deferral could be accomplished by alternating the posture of
policy would be to deny any anticyclical role to monetary action.
But the risks involved in attempting to push some part of the demand
pressures that are present and in immediate prospect ahead for
several months are formidable. We know very little about the so
called lags in the impact of monetary policy, but we have every
reason to believe that they vary considerably among the components
of aggregate demand. The studies that have been made suggest
that the lags may be longest in the very areas in which we might
hope to accomplish some deferral, creating a danger that the major
impact of a policy change intended to push demands ahead might
come at the very time the additional demand was needed.
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3/2/65
There is also the danger that a policy change
sufficient to accomplish any significant deferral of
demand would itself cause the expansion to lose momen
tum and thus precipitate the downturn it was intended
to prevent.
These dangers must be weighed against the strong
possibility that in the absence of restraint and subsequent
stimulation from public policy, the process of inventory
accumulation and decumulation will again upset the smooth
course of economic progress.
I have no answer to suggest to you today and any
attempt to deal with the problem now would probably be
premature. It may be that this threat to stability will
be wiped out, as others have, by some fortuitious event
that cannot be foreseen at this stage. I am afraid, however,
that the more likely possibility is that it will loom much
larger three weeks from now than it does today.
Mr. Robertson entered the meeting during the course of Mr. Noyes'
remarks.
Mr. Swan asked if Mr. Noyes would clarify the basis on which
he estimate
annual rate.
that inventory accumulation might rise to a $15 billion
Mr. Noyes replied that the latest inventory figures
available related to November and December, and the Board's staff had
estimated that the accumulation rate had risen from $9 billion in this
period to $10 billion in January and February.
However, there was some
evidence to suggest that inventory investment in the first two months
of 1965 was higher than that estimate.
The evidence did not consist
of hard figures, but rather of comparisons of current rates of produc
tion and final takings.
He personally had suggested that there might
be a gradual snowballing, with the rate rising to something on the
order of $15 billion in March.
Mr. Mitchell remarked that most analysts expected the rate of
inventory accumulation to peak out in March and April, and then to turn
3/2/65
-43
down of its own weight.
Evidently it was Mr. Noyes' view that the
current high rate would continue for a longer period.
Mr. Noyes said he thought there was some danger that it would.
The staff's answer to the first question was in accord with the expecta
tion that Mr. Mitchell had described and on that basis they had con
cluded that there might be a downdrag on GNP of about $8 billion, at
an annual rate, in late spring and early summer.
What he suggested was
that the problem would be more serious if the high rate of accumulation
continued or accelerated.
Whether it would or not depended on many
factors which he could not forecast with confidence, including the
nature of developments in the steel industry labor negotiations.
he had several reasons for fearing that a
But
snowballing might be in process.
First was the evidence to which he had referred suggesting that current
accumulation rates might be even higher than the high staff estimates.
Second was the apparent fact that inventory investment outside of steel
and autos was going forward at the high rate of $6 billion.
It was
necessary to assume that this was voluntary accumulation not directly
associated with anticipations of a steel strike, and there was no reason
to suppose that it would not continue, as it had in past inventory cycles.
Mr. Mitchell remarked that there were no suggestions of such a
development in the most recent surveys of expectations or in data on
final sales, and Mr. Noyes agreed.
Mr. Hickman remarked that if the rate of inventory investment in
February was $10 billion it was quite reasonable to expect it to be on
the order of $15 billion in March, considering both the auto-steel
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3/2/65
situations and the accumulation in other lines.
This was the sort of
situation that. had been foreshadowed by developments over the past six
months and about which the Committee had been concerned.
Mr. Koch then made the following statement concerning financial
developments:
Open market operations over the past few weeks have
achieved the slight firming in money market conditions
sought at the last meeting of the Committee. Three-month
Treasury bill rates have edged up near the 4 per cent
discount rate, and free reserves have fluctuated around
the zero level. Most other money market rates of interest
have also risen between an eighth and a quarter of a per cent.
The effect of this slight firming in money market con
ditions on interest rates on longer-term Government securities
has thus far been moderate. The average yield on U.S. Govern
ment bonds with maturities of over 10 years, for example, is
up only about 3 basis points from its late-January low. In
vestors and dealers apparently became convinced that the Govern
ment bond market had found a viable level when official purchases
of the 4-1/4 per cent bonds offered in the January advance re
funding were undertaken when they hit par.
Corporate and municipal bond yields have experienced a
somewhat larger upward yield adjustment in recent weeks, due
in large part to factors other than the recent adjustment in
policy. Sluggishness has developed in the distribution of
some recent new issues, particularly in the municipal area
where dealer inventories are at a record level.
It is still too early to tell whether the recent policy
adjustment has had the effect of ;oderating the pace of
expansion in the complex of variables that make up the other
basic financial objectives of policy, namely, the reserve base,
bank credit, and the money supply. Over the 3 months ending
with February, total reserves and total bank credit expanded
at high annual rates, 6 per cent in the case of reserves and
10-1/2 per cent in the case of bank credit. Demand for bank
loans by businesses was especially strong. The sharp contra
seasonal rise in business loans was no doubt sparked chiefly by
heavier inventory accumulation, due in part to the dock strike
and the strike threat in the steel industry, and by accelerated
foreign lending in anticipation of Governmental curbs. Some of
these temporary factors that have strengthened business loan
demand are either abating or will probably do so in the not-too
distant future, but other factors, reflecting the stepped-up
over-all economic expansion, are likely to be more long-lived.
3/2/65
-45
In contrast to the sharp growth in reserves and bank
credit, there has been no net growth in the money supply
over the past 3 months, as compared with over a 4-1/2 per cent
annual rate of increase in the preceding 3 months. Indeed,
in February the money supply actually declined.
This recent
behavior in the money stock was no doubt accompanied by some
further increase in income velocity although the bank debit
and deposit turnover figures do not show it.
The explanation for the leveling off in the money stock
despite the higher rates of growth in bank reserves and bank
credit lies mainly in the sharply higher rate of increase in
time and savings deposits at commercial banks induced by the
impact of rising rates of return. The annual rate of growth
of these deposits amounted to 20 per cent over the past 3 months.
One's judgment as to the likely inflationary effects of
recent Federal Reserve policy must rest in large part on his
interpretation of these divergent developments in the course
of bank reserves, bank credit, the money supply, and savings.
That is to say, it must rest mainly on one's judgment as to
the differential effects on the cost and availability of
credit and on spending of the leveling off in the money stock,
on the one hand, and of the rapid increase in time and savings
deposits, on the other.
In evaluating the characteristics of the recent growth
in time and savings deposits of commercial banks, it is of
relevance to note that the turnover of savings deposits of
commercial banks in the Chicago Federal Reserve District,
the only data of this kind that are available on a current
basis, has shown no rise and is still only about 1/70 as
rapid as that in demand deposits. Of course, time certif
icates of deposit, particularly negotiable certificates,
turn over more rapidly than savings deposits, but even these
deposits have fixed maturities that are much longer than the
average life of a demand deposit. Mcreover, negotiable
certificates of deposit, although now totaling almost $14
billion, still make up only a little more than 10 per cent
of total outstanding time and savings deposits.
Thus,not only are consumers and businesses saving more
in depository type assets, but commercial banks are playing
a much more important role now than earlier as savings
intermediaries. In other words, the recent increase in
the rate of bank credit expansion represents mainly the
investment of savings that would otherwise have been invested
directly by savers or by nonbank financial institutions.
The existence of a large outstanding volume of time
and savings deposits at commercial banks does pose a
potential inflationary threat if the holders of such deposits
decided to spend them in large volume. But the continuing
low turnover rate of savings deposits as well as recent
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3/2/65
reduced rates of growth in savings at other depository
type institutions suggest that most commercial bank
savings deposits probably represent funds that would
more likely flow to competitive savings institutions or
directly into purchases of securities rather than into the
spending stream if they suddenly left the banks. At least
there is no reason for assuming that most savings deposits
at commercial banks are potentially more inflationary than
shareholdings at savings and loan associations, deposits at
mutual savings banks, or savings bonds.
If one accepts this interpretation of recent develop
ments in the course of the reserve base, bank credit, money,
and savings, they do not appear to pose as much of a destabi
lizing and inflationary threat to the continuance of sustain
able over-all economic expansion as the high rates of expan
sion in bank credit and time deposits in and of themselves
might suggest.
Mr. Hickman commented that aggregate savings, ex post, equaled
aggregate investment, and any increase in bank deposits contributed to
the funds available for investment whether it was in the form of time
and savings or demand deposits.
In his judgment the recent 20 per cent
growth rate in time and savings deposits and the concurrent rapid increase
in total assets held by banks were an inflationary development.
Mr. Koch said he would agree that the time and savings deposit
growth would have expansionary implications to the extent that they
were not held idle but, as he had noted, the limited data available
suggested that their turnover had not increased recently.
It was true
that the increases in savings deposits were financing investment.
However,
they did not involve money creation but rather abstention from spending
by the savers, and thus, in his judgment, were no different from increases
in flows of funds through other financial intermediaries.
Mr. Mitchell remarked that the banks were buying these deposits
from the public; with higher ceiling rates on time and savings deposits
-47
3/2/65
banks were able to participate in intermediating the flows of funds
to a greater extent than before.
He agreed with Mr. Koch that the
basic question was whether the recent rise in deposits primarily
reflected money creation; if he thought it did he would favor a much
tighter monetary policy.
But since the turnover of these deposits
evidently was stable he concluded that they represented savings which
the depositors were not inclined to spend.
Mr. Hickman said he would agree that one could not push on a
string; the situation would be different if there was no outlet for
these funds.
But they were flowing into domestic business investment,
into mortgages, to outlets abroad, and so forth.
He added that the
ratio of aggregate liquid assets to GNP was rising in this expansion
period, for the first time in any expansion on record.
Mr. Hayes commented that even if the accelerated rise in time
and savings deposits merely represented a greater degree of intermedia
tion by banks it resulted in some increase in the liquidity of the
nonbank public.
At some point this could have inflationary consequences;
it apparently had not thus far, but one could not be sure how long this
situation would continue.
Mr. Mitchell concurred in this statement.
Mr. Reynolds then presented the following statement on the
balance of payments:
The unadjusted payments deficit on "regular" trans
actions in January-February now appears to have totaled
$600-$700 million. This is much larger than a year earlier,
during the period when the deficit was temporarily very
small, and about the same as in January-February of 1963,
when things were going rather badly.
3/2/65
-48
The deficit was swollen by a rush of long-term bank
lending to beat the Gore Amendment. New commitments were
enormous, $575 million through about February 10th, and
much of this was probably disbursed. The deficit may also
have been swollen by other anticipatory outflows, and by
the port strikes, which always delay more exports than
imports. These adverse influences may have been partly
offset by some favorable developments, including a return
flow early in January of very short-term capital that went
out over the year-end, receipt of dividends earlier post
poned to take advantage of U.S. tax cuts, and a pause, at
least, in capital outflows during the latter part of
February after the new balance of payments program was
announced.
As is usual early in the year, net "official settle
ments" were small in January-February; but within this
category there were very large transactions. The U.S.
gold stock declined by about $480 million, more than in
any other two-month period since late 1960, and U.S.
official holdings of convertible foreign currencies
(mainly sterling) were reduced by about $200 million.
This drop of nearly $700 million in reserve assets was
more than matched by a reduction in U.S. liabilities to
foreign monetary authorities.
The behavior of the gold stock will continue to
attract much attention in coming months, and it may be
helpful to review the recent and prospective reserve
behavior of those countries that are in a position to
make substantial gold purchases.
France has sought and achieved the limelight in this
area. Its announced policy is to take all reserve gains
in gold this year, and in addition to reduce its official
dollar holdings. In January-February, France bought $250
million of gold from the United States; the likely purchase
of an additional $250 million in March would bring French
dollar balances down to about the desired level of $1
billion. Thereafter, France would buy gold to the extent
of its reserve gains, which could well amount to an
additional $300 million or so.
Canada has larger official dollar holdings than any
other country--$1.6 billion that are counted as reserves
plus $200 million of additional U.S.-dollar Roosa bonds.
Canada is not expected to continue adding to its total
reserves this year, but will probably build up its gold
stock slowly out of current domestic production.
After Canada, the three countries with the largest
official dollar holdings are Italy, Germany, and Japan,
each holding about $1-1/2 billion. Total Italian reserves
3/2/65
-49-
are rising rapidly, and Italy has not repurchased either
the $200 million of gold that it sold last spring or the
$200 million of Roosa bonds that it then redeemed. Its
gold stock is lower, both absolutely and relative to total
reserves, than at any time since 1960, and its dollar
holdings are larger. With the best will in the world,
Italy may be sorely tempted to take some of its reserve
gains in gold this year, even though the renewed expansion
of Italian economic activity--when it comes--seems likely
to eliminate the payments surplus.
Unlike Italy, Germany has not been gaining reserves,
and it reduced its official dollar holdings during 1964
by more than $1 billion, while adding about $400 million
each to its gold stock, its holdings of deutschemark
Roosa bonds, and its IMF position. Germany is unlikely
to have new dollar gains to convert into gold this year,
and the internal argument will be whether to convert ex
isting holdings, as the French are urging.1/
To summarize for these five countries, which account
for about half of foreign official dollar holdings, I think
we may expect that France will buy roughly $800 million of
gold this year, that Italy may buy at least the $200 million
it sold last year, and that Canada will absorb domestic gold
production of about $150 million, while it may be hoped that
Germany and Japan will sit tight.
Among a second group of foreign countries--those that
hold large reserves almost entirely in gold--the United
Kingdom will probably not be selling gold as it did last
year, but will have to use any reserve accruals this year
to repay debts. Other countries in this gold-holding groupSwitzerland, the Netherlands, and Belgium--added some $500
million to their total reserves last year, largely during
the sterling crisis, but took less than $100 million of it
in gold. This year, their reserve gains may be smaller,
but they may still make sizable gold purchases. They pur
chased $85 million from us in January-February.
A third group of countries have more modest total reserves
but relatively large dollar holdings. Of these, Spain has the
largest holdings; it is not expected to add greatly further
to its total reserves this year, but is buying $180 million of
gold during the first half. Sweden and Denmark have taken
reserve increases largely in dollars, and each holds less than
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material related to
Japanese gold policy.
-50
3/2/65
one-fifth of its total reserves in gold, but they have given
no recent indication of being restive about their dollar
holdings. Austria took reserve gains of $90 million in
1964 mainly in gold, but is currently purchasing another
$50 million of Roosa bonds instead of gold. In Venezuela,
officials are encountering local pressures to add to the
gold stock and may do so.
Adding up these rough impressions, and making some
allowance for gains and losses by other countries, I con
cluded that foreign monetary authorities may well buy as
much as $2 billion of gold, net, this year (including gold
to be subscribed to the IMF). Free world production plus
Russian sales will probably be about $1-3/4 billion, but
industrial uses and hoarding typically take about half of
the new supply in good years and three-fourths of it in
years of market disturbance, which 1965 has certainly
started out to be, so that less than $1/2 billion may be
available for central banks. Thus, the U.S. gold stock could
well decline by more than $1-1/2 billion this year, even
allowing for the fact that our gold subscription to the IMF
will be offset by a gold deposit here by the Fund.
Most of this projected $1-1/2 billion decline in our
gold stock seems to me already in the cards, even if no one
else follows French advice, and even if the U.S. payments
situation develops favorably. The importance of making sure
that it does develop favorably lies in the imperative need
to avoid further foreign official dollar gains and gold
conversions next year.
Chairman Martin noted that at the joint meeting of the Board and
the Reserve Bank Presidents on February 18 Mr. Young had reported on the
recent meeting of Working Party 3 in Paris.
There had been a subsequent
Paris meeting, on February 17 and 18, of the Economic Policy Committee,
which Mr. Daane had attended.
He invited Mr. Daane to comment on that
meeting.
Mr. Daane said that he would summarize briefly the flavor of the
discussion at the E.P.C. meeting, which covered some of the same ground
as the meeting Mr. Young had reported on.
First, some dissatisfaction
was expressed with the short-term measures the British had taken to deal
3/2/65
-51
with their balance of payments problem.
that they had not done enough.
The feeling was quite general
The focus of attention was on the U.K.
budget; there were repeated admonitions to the effect that a tougher
budget was necessary and that it should be redesigned to release resources
for production of exports.
With respect to the U.S. situation, Mr. Daane said, the attitude
seemed to be one of welcoming the program the President had outlined and
hoping that it would prove successful.
At tne same time, there seemed to
be general skepticism regarding the effectiveness of moral suasion, partic
ularly with respect to its probable impact on U.S. direct investments
abroad.
The view was expressed that the U.S. should have included monetary
policy in the program and should definitely resort to monetary policy
measures if evidence appeared that the President's program was not having
sufficient effect.
A final highlight, Mr. Daane remarked, were the signs, particularly
with respect to the Germans, of real sensitivity to continued direct invest
ment by U.S. corporations.
Prior to this meeting the staff had prepared and distributed cer
tain questions and responses for consideration by the Committee.
These
materials were as follows:
(1) Business activity--To what extent does the present pace of
economic activity depend on production for inventories, and what
are the prospects for the economy when the rate of inventory
accumulation is reduced?
Accumulation of inventories, particularly of steel in
anticipation of a strike, has been and continues to be an
important element sustaining the advanced level of industrial
production, but it is important to note that the rise in out
put over the past six months has been widespread among major
3/2/65
-52-
industries. Steel's principal contribution to rising output
came early in 1964. Since July further increases in steel
output have been limited by capacity considerations, while
the production of consumer durable goods, apparel, and business
equipment has accelerated. It therefore is an oversimplification
to assume that the current rapid pace of expansion in industrial
activity is primarily dependent on inventory adjustments to
past (auto) and prospective (steel) strikes.
Nevertheless, the substantial accumulation of inventories
now going on is distorting the structure of production suff
ciently to pose a potential problem for coming months. Staff
estimates based on detailed study of production trends by
industry and by stage of fabrication suggest that industrial
output currently is exceeding consumption by a margin equal
to about 4 per cent of output as against a more usual margin
of about 1 per cent. The annual rate of inventory accumula
tion in January and February may well have been on the order
of $10 billion on a GNP basis, triple the rate prevailing
through most of 1964, with about a third of the total occur
ring in steel and autos, mainly the former.
If steel accumulation continues at current rates until
the official contract termination date of May 1, stocks would
then be higher than they were at the earlier peaks in 1962
and mid-1963, when strike threats also induced accumulation.
A wage settlement, or even a temporary continuation of the
present contract under conditions which suggest ultimate settle
ment without a strike, probably would result in sharp cutbacks
in steel orders and production--perhaps enough a depress the
total production index by as much as two percentage points.
If this were concomitant with a cutback in auto production
from present exceptionally high levels because, say, dealers'
stocks finally reached their usual spring peak, another one
half of a point would be subtracted from the index. To these
direct effects must be added also the effect of declines in
supplying industries. In dollar terms, the combined effect
of such a reduction in steel and auto output with accompanying
inventory decumulation might exert an initial downdrag on GNP
by some $8 billion, annual rate, in late spring and early summer.
In the event of a strike, the amount of inventory liquidation,
and the consequent impact on GNP, would obviously be much
sharper.
In light of the continuing strength being displayed in
other sectors of output and demand, the rough orders of mag
nitude cited above do not suggest the inevitability of reces
sion when steel inventory accumulation ceases and/or auto
production adjusts downward from its present phrenetic pace.
They do, however, suggest a check to the rate of economic
expansion, unless other forces, including fiscal policy,
provide a sufficiently stimulative offset.
3/2/65
-53
(2) Prices--In view of the current high rate of capacity
utilization in many industries, what are the prospects for
price stability?
Present high rates of industrial capacity utilization
have not upset the general stability of prices that has
prevailed over the past six years. The rise in the industrial
wholesale price index last fall--sparked mainly by shortages
and production bottlenecks in nonferrous metals--has not been
reversed, but neither has the price advance become cumulative
or broader in scope.
Utilization rates implied in most forecasts for further
economic expansion are not, in themselves, inconsistent with
continued overall price stability. Moreover, some of the
important cases of current high utilization rates are clearly
temporary.
One of the fortunate developments of this business expan
sion has been that spending for plant and equipment picked up,
and presumably the rise in capacity accelerated, long before
output generally reached high rates in relation to capacity.
By the end of 1962 output of business equipment was up more
than a tenth from the highs of 1957 and 1960, and since 1962,
such output has increased nearly a fifth further. Prospects
for increases in capacity commensurate with rising output are
more favorable than in earlier expansions in the postwar period.
Rates of capacity utilization, however, are only one of
many important influences on prices. In recent years business
pricing decisions have been strongly conditioned by longer
term competitive considerations, including the development of
new products and new methods, the installation of new, cost
reducing equipment, and increased substitutability of other
products and other sources of supply, foreign as well as
domestic.
Potential destabilizing forces could, however, develop
out of changes in international tensions, particularly the
Southeast Asian situation. Another important influence on
the future course of industrial commodity prices is what
happens to steel wages and prices this spring, in part because
of the potential repercussions on other wage settlements and
in part because of the cost impact of price changes in so
important a material as steel. Both last year's auto settle
ment and the current record activity in the steel industry
no doubt strengthen the union's case for increases in wages
and fringes above the 2 - 2-1/2 per cent per year increases
of the 1962 and 1963 contracts, and internal union dissension
may result in large demands. But management resistance may
be fostered by uncertainty over the extent to which any cost
increases can be passed on to buyers under present competitive
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conditions. The Administration's wage and price guideposts
may also serve to moderate the terms of the settlement and
its consequences for prices.
(3) Balance of payments--To what extent does the fourth
quarter deterioration in the U.S. balance of payments now
appear to have resulted from temporary influences?
In the fourth quarter, the seasonally adjusted deficit
on "regular" transactions was $1,450 million, $770 million
larger than in the third quarter and $700 million larger
than the quarterly average for the year. At least $500
million of the fourth-quarter deficit (i.e., two-thirds of
the deterioration from the third quarter) is attributable
to certain definable temporary influences. Even without
these influences, however, the fourth-quarter deficit still
would have been disturbingly large--about $900 million.
The main temporary development was the bulge in new
foreign security issues to $585 million, seasonally adjusted,
up $420 million from the third quarter and $320 million
above the average for the year. The bulge occurred mainly
in Canadian issues, which had been postponed earlier pending
enactment of the IET. The expectation that new foreign issues
in 1965 will be at about the same rate as in 1964 implies that
the temporary element in fourth-quarter issues may be put at
something over $300 million. In January-February 1965, new
issues were again large--$300-$350 millon--but this sum
includes $181 million of a single IBRD issue; the remainder,
seasonally adjusted, is not very different from the average
expected for 1965.
A second adverse factor in the fourth quarter was the
waiver of the scheduled U.K. year-end debt service payments
of $138 million.
Capital outflows reported by U.S. banks rose much more
than seasonally in the fourth quarter, but it is hard to say
how much of the rise could be regarded as "temporary."
Net
long-term bank lending of $330 million, seasonally adjusted,
was up about $100 million from both the third quarter and the
quarterly average for the year, but much of this increase
should probably be viewed as part of a rising trend. If there
was any acceleration of term-loan disbursements in anticipation
of Government measures to restrain capital outflows, it was
far smaller than in January 1965, when long-term bank lending
shot up to $215 million in a single month.
Short-term outflows reported by U.S. banks of $440 million,
seasonally adjusted, were up about $250 million from the third
quarter and $60 million from the quarterly average for the year.
Unadjusted, the outflow was heavily concentrated in December,
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and some of it (in addition to the portion allowed for by
seasonal adjustments) may have been temporary, flowing back
rather early in the new year. The January 1965 return flow
of $170 million (unadjusted) points in this direction. There
have been similar large January reflows in some other recent
years, but this year's net reflow occurred despite reported
efforts of some institutions to place funds abroad in anticipa
tion of Government restructions.
So far there is little evidence on which to judge whether
there were temporary movements, favorable or unfavorable, in
other "regular" transactions during the fourth quarter. The
balance of these transactions, on which little detail is yet
available, was about the same as in earlier quarters of 1964.
(4)
Bank credit and money.
A. Is the recent contraseasonal strength in bank loan
demands likely to continue, or has it been a response
to special influences likely to diminish in the near
term?
Available information suggests that a good part of the
recent unusual strength of bank loan demand is temporary. This
increased demand has been confined almost exclusively to busi
ness loans, where borrowing has been affected by a combination
of special circumstances. These temporary factors, however,
do not account for all of the loan bulge. With the economy
recently showing an accelerated rate of expansion and with
internal sources of business funds probably growing less
rapidly than financing needs, a strengthening in the under
lying trend of business loan expansion may also be in progress.
The recent acceleration in business borrowing has been
much sharper than usually has been associated with increases
in business activity at present rates. From a fairly steady
pace of $400-$500 million per month over the first 11 months
of 1964, the seasonally adjusted increase in business loans
rose to $800 million in December, $1.7 billion in January,
and $1.1 billion (preliminary estimate) in February.
Factors which probably accounted for most of this year's
bulge are the following: First, the dock strike, which tied
up a substantial volume of both incoming and outgoing mer
chandise shipments, is reported to have been mainly responsible
for the contraseasonal rise in commodity dealer loans this
year. The strike may also have contributed to the recent strong
loan demand by food processors and possibly trade concerns as
well. Second, inventory accumulation to hedge against a possible
steel strike probably accounts for most of the contraseasonal
rise in the metals group. The contribution of such borrowing
to the January-February loan bulge may have been on the order
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of $150 million a month. Third, the pace of foreign lending
rose rapidly in recent months, presumably in anticipation of
restrictive Government measures. Foreign term lending in
January amounted to more than $200 million according to pre
liminary estimates. Fourth, a loan of about $100 million
was extended to a petroleum company in mid-February to acquire
a large block of its stock.
The impact of some of these factors on loan expansion may
continue for a while, but at a diminishing rate. Liquidation
of the loan bulge connected with the dock strike may be expected
shortly. Steel inventory accumulation presumably will continue
until a strike occurs or the threat of a strike is removed.
Foreign lending will need to taper off soon if banks are to
hold outstandings within their proposed ceilings, although
some further expansion may occur in the near term because of
prior commitments.
The total impact of these temporary influences on business
loan expansion since the turn of the year may have amounted to
as much as $600 million per month. But this still leaves a
residual expansion substantially larger than the average monthly
increase in 1964. Some of this residual may reflect early bor
rowing in anticipation of large tax payments in March and April,
but some undoubtedly reflects the general strength in business
activity.
B.
To what extent has the reduced rate of expansion in
the money supply since November been a reflection of
the higher rates offered on time and savings deposits?
What are the implications of probable time and savings
deposit growth in the near term for the money supply?
Preliminary estimates indicate a substantial decline in
the money supply in February, offsetting the moderate increases
in December and January and bringing the money stock back to
the November level. This recent money supply performance in
large part probably reflects the accelerated growth in time
and savings deposits. However, a rise in U.S. Government
deposits (seasonally adjusted) also has tended to moderate
money growth over this period.
The months following previous increases in Regulation Q
ceilings also saw sharp increases in time and savings deposits
and moderation in the growth of money as the public adjusted
its liquid asset holdings to changed market alternatives.
Much of the initial adjustment takes the form of one-time shifts
out of money and other highly liquid financial assets into time
and savings deposits. The pattern of changes since November
suggests that the public's response to this change in Regulation Q
is broadly similar to that following earlier revisions.
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Rate increases, together with the extensive publicity
accorded them, presumably account for most of the surge in
savings deposit inflow since year-end. Banks generally also
have increased their outstanding negot:able CDs substantially
since year-end. Some banks have been promoting new nonnego
tiable savings and investment certificates, designed to
attract funds from small businesses and other investors
unable to acquire negotiable CDs.
Judging from the limited historical experience, it seems
likely that the recent rates of growth of savings and time
deposits will moderate soon. In periods following previous
ceiling rate increases, the influence of one-time shifts from
other assets lasted about one quarter. Moreover, as loan
demands from the temporary influences discussed above in
answer to question 4A recede, banks probably will reduce
their issuance of relatively high-cost CDs.
Correspondingly, growth in the money suppy over the near
term may accelerate. Additional economies in cash utiliza
tion stimulated by current higher yields on liquid assets
may have some moderating influence on money growth, but trans
actions needs for money, related mainly to the pace of busi
ness activity, are likely to be more directly reflected in
demands for cash balances in coming months.
(5)
Money and credit markets.
A. Has the recent shift in policy been fully reflected
in the principal money and capital markets, or are
further market adjustments likely?
Market participants generally have come to the conclusion
that a mild policy shift toward less ease has been effectuated.
Most assume the policy objectives include a lower, and at times
negative, level of free reserves, and a 3-month bill rate in
the neighborhood of the discount rate. In other words, market
participants do not now seem to expect much more firming than
already has developed during the past three weeks.
Partly because the recent policy shift has been only
moderate in scope and is being so interpreted by active in
vestors, the related adjustment in capital markets also has
been moderate. The upward movement in long-term U.S. Govern
ment rates has been relatively small, despite the unfavorable
technical position of the Treasury bond market. Adjustments
in corporate and municipal bond markets have been larger, in
part reflecting the unusual strength in these markets in
December and January, and in part the growing calendar of
new corporate and municipal issues. Upward pressures stem
ming from those forces have been tempered, however, by Treas
ury and System purchases of coupon issues during the past two
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weeks; these purchases have tended to buttress a market view,
encouraged by Administration statements, that long-term rates
are not likely to rise much.
Assuming no further change in policy, short-term rates
might still show some seasonal rise, with the most likely
time coming around the March tax and dividend dates. But
if the rise is small enough to avoid generating expectations
of a discount rate increase, the odds are against a signifi
cent furtner weakening in the long-term market. The tech
nical position of the U.S. Government securities market is
gradually improving, with dealer holdings of over-20-year
maturities reduced to under $300 million. However, further
enlargement of the calendar of corporate and municipal issues
and/or continuation of strong bank loan demand could produce
new upward rate pressures in both intermediate- and long-term
maturity areas.
B.
Assuming that the somewhat firmer policy adopted at
the last meeting has been communicated to and fully
reflected in the money market, what interest rate
structure and conditions of reserve availability
would be mutually consistent and best designed to
maintain the present policy posture?
Some moderate additional pressure upon the money market
is likely to develop between now and the mid-March tax and
dividend dates. This will result primarily from the needs
of corporations to make higher outlays for dividends and
taxes; their Federal income tax liability in March is esti
mated at some $6.9 billion, about one-tenth higher than last
year. While the existence of a $2.5 billion tax anticipation
bill will help smooth the pattern of payments, the period is
nonetheless likely to produce its usual temporary concentra
tion of pressures on Government security dealers and a tempo
rary rise in the basic reserve deficiency of major New York
City banks.
In recent years, such March tax date pressures have tended
to be reflected more in day-to-day financing rates than in
Treasury bill rates. This could be the pattern again in 1965,
particularly since major city banks have already pared their
Treasury bill holdings considerably in recent weeks in adjust
ment to tauter money market conditions and higher levels of
borrowing both by member banks and their customers.
In view of recent business loan strength, it seems reason
able to assume a larger amount of business borrowing for tax
purposes from banks in March. The likely pattern of loans
demand, however, is complicated by several temporary factors
(discussed in the answer to question 4A). Assuming these special
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demands recede as the weeks progress, large banks may accom
modate the tax-associated demands in the first half of March
more by bidding aggressively for short-term funds and bor
rowing from the System than by further adjustments in invest
ment portfolios. In these circumstances, one might expect
average borrowings from the Reserve Banks to fluctuate around
the $400-$450 million level; reserve availability to move into
the $0-$50 million net borrowed range; dealer loan rates to
advance to around 4-1/2 per cent; and the Federal funds rate
often to be at 4-1/8 per cent, even though bill rates might
not move outside a 3.95-4.05 per cent range. After the tax
date pressures are past, the money market might be expected
to return to the conditions prevailing in late February. Long
term interest rates probably would be little affected by these
money market developments.
Assuming no change in the posture of monetary policy and
continued large inflows of time and savings deposits, the
interest rate and marginal reserve developments outlined
above could be consistent with little change in reserves
behind private demand deposits, apart from seasonal movements.
Such reserves declined a little in January and substantially
in February.
Chairnan Martin then called for the go-around of comments and
views on economic conditions and monetary policy, beginning with Mr. Hayes,
who made the following statement:
1. Business activity. The domestic business situation
remains favorable--perhaps, if anything, a bit more favorable
than at the beginning of the year. The prospects for first
half growth being sustained in the second half of 1965 now
seem brighter than they did. Production gains in January were
well diffused throughout the economy. Retail sales appear to
continue at the high January level, and a record auto year is
generally forecast. There are further signs that the decline
in residential construction may be bottoming out. Unemploy
ment in January was at the lowest level since October 1957.
The chief uncertainty is of course steel, with further delays
in a wage settlement now indicated. Steel inventory accumula
tion was substantial in the fourth quarter of 1964 and is
probably continuing; but for manufacturing as a whole inventory
sales ratios in December remained at a low level.
2. Prices. Industrial wholesale prices were about un
changed in January, but readings thus far in February suggest
a renewed rise, after allowance for seasonal factors. Price
announcements continue to be predominantly on the upside.
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Clearly we must be alert to the threat of more intense cost
and price pressures.
3. Balance of payments. Our basic balance of payments
position has been obscured by the very large transfer to
foreign accounts in January and more particularly in early
February in anticipation of various measures that had been
rumored would be part of the President's balance of payments
message. It was unusual to have an overall deficit in
January despite the reversal of special year-end outflows.
For the first half of February the deficit may well have
exceeded $500 million. Our large annual deficits have con
tinued almost unchecked, and as a result our ability to
finance the deficit by any means other than gold sales has
been severely curtailed. The outlook is for further heavy
gold sales in the coming months. Sterling has strengthened,
but many uncertainties remain ano the international situation,
both financial and political, is tense and potentially explo
sive. In these circumstances we must be prepared for quick
defensive action.
Fortunately the program of voluntary restraint on foreign
bank lending is off to a good start and, together with the
related programs with respect to corporations and nonbank
financial institutions, should begin to produce significant
results in a few months; but these programs will not be easy
to administer and will call for steady resistance to pres
sures by various interests, public and private, that would
water down their effectiveness.
4. Bank credit and money. Total bank credit advanced
very strongly in January on a seasonally adjusted basis,
with total loans (adjusted) showing the largest increase on
record. For the thirteen months ending with January the net
increase in bank credit was at an annual rate of 8.3 per cent,
as compared with 7.4 per cent for the same period a year ago.
Although the growth of business loans in January reflects
several special factors--including a spurt in bank loans to
foreigners, and the effects of the steel strike threat and
the actual dock strike--basic domestic Loan demand also
appears to be strong. This impression is confirmed by the
results of our recent survey of loan projections at eight large
New York City banks.
The money supply was still on a 4 per cent per annum
growth trend in January; but time deposits scored a record
advance in the month. Undoubtedly the higher interest rates
offered on time and savings deposits have been an important
cause of this time deposit growth. Banks seem to have been
able even to attract some funds from savings and loan associa
tions.
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5. Money and credit markets. The financial markets have
concluded that a mild shift in policy has taken place and have
about completed their adjustment to it. Some further firming
of intermediate and long rates could take place, especially if
short rates should push somewhat higher in view of the tax and
dividend dates that loom ahead. On the other hand, continued
substantial flows of funds into the longer-term markets seem
to provide a good deal of insurance against any substantial
upward rate movements in this area.
Monetary policy. For the time being the System should
focus its efforts on making the restraints on capital outflows
work and might well leave monetary policy about where it is.
As the Chairman wisely and realistically stated before the
Joint Economic Committee the other day. if the program does
not work we shall probably have to move to a policy of tighter
money in order to make the attack on the problem a full success.
In try judgment the balance of payments problem is now too
critical to permit the risk of failure.
We should also be scrutinizing closely the rate of bank
credit expansion over the coming months. Some slowdown would
be desirable, apart from the expected slowdown in foreign
lending; but we may find that credit demand is so strong that
a slowdown will require a somewhat more restrictive policy.
Open market operations should be conducted in the next
three weeks in such a way as to confirm the modest change of
posture voted at the last meeting. To me this means that free
reserves should be more often below zero than above, and the
bill rate should fluctuate around 4 per cent, with swings
above that level more frequent than dips below 4 per cent.
From a psychological standpoint this sort of confirmation of
posture seems to me very important as we embark on the volun
tary restraint program. Such criticisms as are heard of the
program are usually based on the contention that Government,
including monetary policy, is not contributing enough to the
payments solution while a heavy burden is being placed on
private finance and industry. We should make clear that we
are doing our part.
I like the wording of the directive as drafted by the
staff, which takes note of the President's balance of payments
program and expresses the System's support, besides dropping
the reference to Treasury financing and indicating a need to
maintain the firmer money market conditions established in
recent weeks.
Mr. Ellis reported that steady expansion continued to prevail
in the New England economy with manufacturing employment and output
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pushing to new highs.
Further expansion was anticipated in the views
of manufacturers reporting in the Boston Reserve Bank's quarterly
survey of expectations.
Fourth-quarter 1964 sales substantially ex
ceeded earlier expectations of these manufacturers and buttressed
their outlook for the present quarter.
Their preliminary reports con
cerning capital outlays for 1965 suggested a further rise in the rate
of such investment but the returns were too incomplete to support an
estimate of how much.
Savings deposit balances in the Bank's reporting sample of 80
mutual savings banks rose by 0.7 per cent in January, Mr. Ellis con
tinued.
New deposits, interest credits, and withdrawals all increased
from December; the net result brought gains in deposit balances from
January of last. year to almost 9 per cent.
This flow of funds was
sufficient to hold unchanged at 5-1/4 per cent the interest rates Boston
savings banks charged on
conventional type mortgage loans even though
demand, as reflected in contract awards, was running impressively above
a year ago.
Mr. Ellis commented that total residential contract awards in
New England were 34 per cent higher in December than a year earlier.
Their total for 1964 was 19 per cent above that for 1963, compared with
a national increase of only 0.3 per cent.
As of February 17, this
strength in demand had been translated into an 18 per cent year-to-year
growth in real estate loans at First District weekly reporting banks;
such demand had been especially strong in the last several weeks.
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Turning to the agenda questions, Mr. Ellis noted that the
first question, relating to business activity, naturally focused on
inventories.
Granting that the special situations in steel and autos
dominated immediate prospects for the economy, the fundamental strength
underlying the whole spectrum of demand was what in his judgment would
predominate during the months further ahead.
There did not appear to
be any substantial reason to question that strength for the rest of
the year.
Incomes were high and rising, consumer spending expectations
were optimistic, and all of this was contributing to the inventory surge.
As to the second question, concerning prices, Mr. Ellis thought
the price stability rested on capacity and output high enough to out
weigh rising demand, both real and speculative.
The trend of events
in Viet Nam raised new threats that speculative demands, reinforced by
ready credit availability, would tip the scales toward price increases,
and toward the boom-bust cycle referred to by Mr. Noyes.
The staff response to the third question suggested, Mr. Ellis
said, that because the fourth-quarter surge in the balance of payments
deficit appeared largely traceable to capital outflows, including bank
lending, it seemed logical to expect the voluntary credit restraint
program to have the effect of making the fourth-quarter deterioration
temporary.
However, he failed to find in the present program any
measures that offered reassurance that the $2 billion rate of deficit
existing prior to the special events of the fourth quarter was being
resolved.
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Mr. Ellis observed that the agenda question on bank credit was
concerned with possible reasons for "the recent contraseasonal strength
in bank loan demands."
Quite obviously such temporary factors as the
dock strike, the steel labor negotiations, and foreign lending had
contributed extra strength to demand.
But the more important underlying
and longer-run consideration was the continuation of very sharp rates of
bank credit expansion.
Since July total bank credit had expanded at an
annual rate of almost 9 per cent and this was almost by definition un
sustainable.
He was concerned about the large increase in Federal Re
serve credit on the basis of which this bank credit expansion had occurred.
That, Mr. Ellis said, raised the issue of the appropriate course
for monetary policy.
Mr. Noyes had posed the controversial question of
whether or not some demands could be deferred; in his judgment one cer
tainly could hope that that was possible.
The Committee might already
have waited too long, particularly if there were lags in the effects of
policy actions.
The positive response of bankers to the voluntary
restraint program seemed to assure that there would be some reduction
in foreign lending by banks.
To the extent such reduction was achieved,
more funds would be available to domestic borrowers.
The recent degree
of credit availability, in his judgment, would continue to support un
sustainable expansion in domestic lending.
Mr. Ellis said that he had been disappointed to hear from Mr.
Stone that the market adjustment to the action taken at the previous
meeting had been completed; he would rather have heard that it was still
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in process.
He thought the slight firming trend in policy should be
continued for the next three weeks.
Differences in viewpoints as to
the appropriate degree of firmness were small but important, and the
Committee's targets should be defined carefully in the instructions
given to the Manager.
In this connection, he regretted that the staff
had not prepared a "trial" directive for this meeting, but he understood
the frustrations involved in laboring over a document that was rarely
considered.
His own preferences for policy targets, Mr. Ellis said, would
be net borrowed reserves generally in the range of zero to $50 million;
short-term bill rates in the range of 3.95-4.10 per cent, and generally
above the discount rate; Federal funds rates usually at or above the
discount rate; and member bank borrowings averaging $400 million or more.
He favored no discount rate action at this time.
Mr. Irons reported that the general economic situation in the
Southwest was one of strength.
stable levels.
Activity was at high and relatively
Industrial production was holding steady, and there were
indications that it might move up slightly further over the next month
or two.
Employment promised to show some improvement in the next few
months and perhaps to move up to record levels.
ment rate was below that of the nation.
The District's unemploy
There had been a decline in
construction contracts from the very high levels of the past few months.
Agricultural conditions were spotty, depending on the amount of rain in
particular areas, and cash farm receipts currently were running below
a year ago, but it was too early to say whether the change was significant.
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Retail sales at department stores in the District were at record levels,
and new car registrations were quite high.
Mr. Irons observed that bank loan demand was very strong in the
District, as it was in the nation.
As elsewhere, time and savings deposits
were up substantially at District banks and demand deposits were down a
bit.
Demand for Federal funds was strong, and the average volume of
discounting had risen in the past three weeks.
Apparently, as soon as
the market showed signs of firming, the larger banks found it necessary
to restore their reserve positions by buying funds at rates up to 4-1/8
per cent or by borrowing from the Reserve Bank.
However, discounting
was limited primarily to a relatively small number of banks.
The national situation, Mr. Irons said, also showed evidence of
strength and the trend certainly was expansionary.
As to monetary policy,
he noted that the Committee had made a significant move toward less ease
during the past four weeks.
The market situation was now firmer, and
participants in the market had recognized the change.
He favored con
tinuing the degree of firmness that had existed in recent weeks.
He
agreed with the figures the staff had given in response to the final
question on likely developments under the present posture of policy,
and, more generally, he agreed with their conclusions in answering all
of the questions.
He favored maintaining marginal reserve availability
fluctuating around zero, and on the negative side more often than on
the positive.
He thought dealer loan rates might rise a little, and
would expect the Federal funds rate to be at 4 per cent and occasionally
higher.
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Mr. Irons said that he had some qualms about permitting the
bill rate to move significantly above the discount rate at this time
to the 4.10 or 4.15 per cent area, except perhaps for a day or two.
Such a development might engender the feeling that a further move
toward restraint was being made and might stimulate speculation about
the possibility of another change in the discount rate.
That would
be undesirable, in his judgment, in view of the fact that the voluntary
credit restraint program had just been launched.
Were it not for that
factor, he definitely would favor a firmer policy.
He did not favor
a change in the discount rate at this time.
Mr. Swan commented that the basic economic situation in the
Twelfth District seemed to be good but it was not entirely consistent
with that in the nation.
The unemployment rate in the Pacific Coast
States, which had dropped in December, increased again in January in
contrast with a decrease at the national level.
Agricultural employment
declined in January, and while nonagricultural employment as a whole rose
slightly manufacturing employment again went down rather significantly.
There had been a much larger decline in housing starts, relative both
to December and to January 1964, in the West than in the rest of the
nation.
Lumber prices were reduced from the highs reached after the
recent floods but were still somewhat above pre-flood levels.
As spring approached, Mr. Swan said, there was a good deal of
uncertainty about both the availability and cost of agricultural labor
with the end of the bracero program.
This uncertainty seemed to be
reflected in the attitudes of processors with respect to their contracts
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with growers and in the attitudes of lending institutions with regard
to financing arrangements.
It was too early to say exactly what effect
the labor situation would have on those areas but there did seem to be
somewhat more caution than there was a year ago.
The nonferrous metals
markets remained tight and the copper situation was being aggravated
by the dock strike.
Steel production in the District remained at high
levels with some indications of shipments of structural steel to the
Midwest.
Mr. Swan remarked that weekly reporting banks in the District,
as elsewhere, had large increases in commercial and industrial loans in
the four weeks ending February 17--much larger than in the equivalent
period a year ago.
However, there was a slight decline in real estate
loans in contrast to a very substantial increase in the same period last
year.
Borrowings from the Reserve Bank in the last three weeks had not
risen at the same rate as in the rest of the country.
Mr. Swan said he was still uncertain as to how to interpret the
inventory situation.
He could not arrive at an adequate explanation
of the increase in inventories other than of steel and autos; perhaps
it simply reflected the general rise in business activity.
He had been
unable thus far to find any evidence of speculative inventory accumula
tion in anticipation of higher prices.
As a negative conclusion this
might be considered a little suspect, but at least in the Twelfth District
there was not much indication of overheating.
Mr. Swan was inclined to agree with Mr. Koch's analysis of the
significance of the recent acceleration in growth of time and savings.
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deposits.
Developments in the Twelfth District were consistent with
the staff's conclusion that the time depcsit growth rate might well
moderate somewhat after the one-time adjustment to higher interest rates,
although some further growth in savings deposits might be expected.
It seemed to Mr. Swan that, following the shift in policy at
the previous meeting in support of the national balance of payments
program, it would be desirable to hold policy unchanged until some in
dication was available of the effectiveness of that program.
He did not
think there had been enough change in the domestic situation to warrant
a further policy shift.
Like Mr. Irons, he would not quarrel with the
quantities mentioned in the staff response to the last question, and
he endorsed Mr. Irons' remarks about the undesirability at the mcment
of having a bill rate constantly above the discount rate.
He agreed
that the slightly firmer conditions recently achieved should be main
tained
but he did not think that the firming should be carried further
at this point.
In this connection he noted that the staff's expectations
with regard to levels of borrowings, free reserves, Federal funds rates,
and so forth, were related to some extent to the fact that the period
immediately ahead included the March 15 tax date.
The staff response
said that "After the tax date pressures are past, the money market might
be expected to return to the conditions prevailing in late February."
It was useful to note that the conditions referred to were those existing
subsequent to the change in policy.
satisfactory to Mr. Swan.
The staff's draft directive was
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Mr. Strothman commented that the present continuing economic
expansion in the Ninth District would seem to be explainable in part,
but by no means entirely, as stemming from construction and the steel
related industries--notably mining.
had improved markedly.
Employment in those industries
However, other industries, including retail
trade, services, and durable goods, also had shown sharp employment
increases.
in 13 years.
January unemployment in Minnesota was at the lowest rate
The Minneapolis Bank's opinion surveys continued to re
flect modest optimism but with some pessimism from predominantly
agricultural areas.
In banking, Mr. Strothman said, in recent weeks the District
had experienced a heavier-than-usual decline in demand deposits and a
more-than-seasonal increase in loans.
The extent to which inventory
buying had spurred loan demand was not clear.
Nor was it clear from
available data that demand deposit growth had slowed in the District
because of the availability of higher time-deposit rates.
Mr. Scanlon, in commenting on the first question, reported that
the trend of business in the Seventh District appeared to be vigorous
and healthy, aside from unsustainable rates of inventory accumulation
in the steel and motor vehicle industries.
Employment in most areas
continued to edge up, and unemployment rolls continued to be reduced
gradually.
Retail sales had been strong.
There had been a tendency to raise projections of activity both
for the economy as a whole and for individual firms and industries, Mr.
Scanlon observed.
There was less concern about a leveling or decline
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in general business in the second half of the year.
Forecasts of sales
of passenger cars close to the 9 million level in 1965 (down from the
rate thus far) were widely thought to be possible of achievement.
A
large Chicago steel firm expected 122 million ingot tons of steel to
be produced this year with a 17 per cent decline from the first half of
the year to the second.
Orders for business equipment had been higher
than expected, and a 10 per cent rise in total capital outlays from 1964
to 1965 seemed reasonable to informed people with whom he had talked.
Mr. Scanlon remarked that a vague uneasiness existed among
bankers and businessmen concerning the balance of payments situation
and the problems of Southeast Asia.
It was suggested that these condi
tions constituted a threat to the continuance of prosperity, but there
was little evidence that such fears had influenced business decisions.
Statements of executives of General Motors and Ford, issued
early last week, that they had reached their goals of acquiring an
additional 60-day supply of steel were greeted with surprise and out
right skepticism in trade circles, Mr. Scanlon said.
Reports persisted
that steel producers were falling further behind on promised delivery
schedules.
Allocation procedures were being enforced strictly and many
smaller users of steel had not been able to build inventories.
Except
for steel and autos there was little evidence of inventory building in
excess of operating needs.
Mr. Scanlon agreed with the staff statement on the second ques
tion, relating to prices.
3/2/65
-72On the balance of payments question, Mr. Scanlon agreed gener
ally with the staff reply although he was not thoroughly convinced that
several of the factors described as temporary in nature actually were
as temporary as the staff response implied.
Mr. Scanlon also agreed generally with the staff answer to part A
of the fourth question, relating to bank credit and money.
However, he
felt the underlying trend in bank loan demand might be stronger than
was implied in the staff statement and that corporate tax needs in mid
March might be greater than usual.
The widespread distribution of the
loan increases, both geographically and by industry group, suggested
that they were due not only to special and temporary influences but also
to a basically strong demand that was likely to persist at least for
some weeks ahead.
With respect to question 4B, Mr. Scanlon said he was unable to
provide a satisfactory answer to the first part, regarding the relation
between the higher rates on time and savings deposits and the reduced
rate of expansion in the money supply.
For the near term, he did not
foresee any unusual movements in time and savings deposit growth that
would have material implications for the money supply.
This assumed,
of course, that the level of short-term yields would remain roughly where
it was at present in relation to ceilings under Regulation Q.
The "reduced rate of expansion in the money supply since November"
appeared to Mr. Scanlon to be noticeable for the most part because it
occurred against the backdrop of the unusually large monthly gains around
the middle of the year, particularly in June and July.
The substantial
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increases that took place at that time might well have been related to
the March tax cut, then working itself out in terms of its impact upon
aggregate income.
Mr. Scanlon said he had nothing to add to the staff comment on
part A of question 5 beyond noting that the municipal market might show
some further upward rate adjustment as a result of the tighter bank
reserve positions.
He was in general agreement with staff statement
on part B, except that if the underlying loan demand was strong, as he
suspected it was, following the March tax payments banks' reserve posi
tions would not return promptly to the conditions prevailing in February.
Mr. Scanlon said he agreed with those who favored continuation
of the policy in effect over the past three weeks.
He was a little
unhappy about the reference in the directive proposed by the staff to
accommodating growth in the money supply "at a more moderate pace than
in recent months" when the most recent money supply figures showed a
decline.
However, he was inclined to accept the draft directive because
he thought the Committee's position was made clear in the second para
graph.
he did not favor a change in the discount rate at present.
Mr. Clay said it would appear appropriate to him to continue
monetary policy unchanged at this time.
A policy move had been made
at the last meeting, and that change apparently had been implemented.
It remained to be seen, however, how sensitive longer-term interest rates
might prove to be.
That policy move was only a part of a larger package
of special measures designed to deal with the international payments
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deficit.
It would appear logical, he thought, to maintain the new
monetary policy posture essentially unchanged at this juncture as the
new program of special measures was applied.
In the meantime, a close
watch could be kept on both domestic and international developments.
The performance of the domestic economy was in some ways
rather impressive, Mr. Clay said.
It was impressive to observe the
ability of the economy at this advanced stage of the upswing to absorb
the impact of recent developments in steel and autos without exhibiting
the serious strains characteristic of a boom.
It also was impressive
in terms of the widespread nature of industrial activity as discussed
by the staff's response to the questions submitted for consideration.
The latter aspect might help cushion the inevitable readjustment in
the steel, automobile, and related industries.
Nevertheless, it would
be very important to keep the expected readjustments in those industries
in perspective in formulating monetary policy in the months ahead.
The
growing capacity of the economy pointed to the need for continued expan
sion in aggregate demand, particularly when those immediate factors had
run their course.
Price developments also were on the encouraging side, Mr. Clay
said.
The staff answers rightly suggested the possibility of a continua
tion of favorable price developments so far as demand forces were con
cerned, apart from possible international tensions.
It remained true
that the more serious threat of upward price pressures rather came on
the cost side, from the outcome of the steel industry labor contract
negotiations.
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The staff analysis of the current loan expansion appeared
logical to Mr. Clay in view of the special developments that had taken
place in the economy.
The impact of the temporary factors could not
be measured, but they must be very large, as suggested by the staff
estimates.
The temporary acceleration in loan expansion resulting from
the dock strike and the threatened steel strike would appear to have
limited meaning for the formulation of monetary policy.
The bulge that
apparently took place in loan volume in anticipation of international
payments restrictions presumably should work itself out in the period
ahead as the international payments program went into effect.
In carrying out monetary policy for the period ahead, Mr. Clay
said, it should be the aim to maintain money market conditions in line
with those that had prevailed in recent weeks.
This would include a
90-day Treasury bill rate in the range of 3.95 to 4.05 per cent.
The
staff draft of the economic policy directive would be suitable for a
continuation of the current policy posture.
In his judgment no change
should be made in the discount rate.
Mr. Wayne remarked that, in view of the past month's develop
ments, it would seem that the move toward a slightly firmer policy made
at the Committee's last meeting was an appropriate one.
The balance
of payments problem remained the key element in the present situation.
If the voluntary program was reasonably successful in reducing the out
flow of funds and perhaps in producing some return flow, a considerably
slower rate of growth in total bank lending would be necessary to prevent
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an undue expansion in domestic credit.
A lower availability of reserves
would be the most appropriate way to encourage and induce such a contrac
tion.
Domestically, Mr. Wayne observed, economic and financial develop
ments of recent weeks also indicated the desirability of a firm policy,
but those conditions could change quickly.
If a continued high level of
activity could be counted on some credit restraint would be in order to
curb domestic prices.
But the present level of activity could not be taken for granted,
Mr. Wayne said.
Almost certainly, steel production would be cut back
rather sharply in the next two or three months.
It was doubtful whether
automobile sales could be maintained for long at the present feverish
pace.
Construction, even if it could hold its present level, did not
promise any significant gain.
Stagnation or declines in those three
major areas at the same time would spell trouble for the economy, in
his opinion.
While the optimism of businessmen seemed to be rising
sharply, a condition which often produced excesses in the final phase
of a period of expansion, such precarious optimism should not be encour
aged by any easing of credit.
As noted by Mr. Stone, Mr. Wayne continued, the market seemed
to have completed the adjustments, at least in the short end, needed
to reflect fully the recent shift in policy.
The current relationship
of short-term rates to the discount rate was approximately what it had
been a few weeks before the last change in the discount rate.
In the
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-77
long end, the continued heavy flow of savings approximately balanced
the strong demand and kept rates fairly stable.
But further increases
in short rates must exert considerable pressure on the longer rates.
Taking into account the need for a lower availability of reserves
to offset or induce a reduction of foreign lending, Mr. Wayne said, net
borrowed reserves of sizable amounts might be required to keep short
term rates where they were or to raise them a little.
He would not be
averse to seeing such net borrowed figures and would not like to see any
substantial amounts of free reserves.
Even so, he recognized that it
would be necessary for the Desk to provide considerable amounts of
reserves to offset the large gold losses which apparently lay ahead.
He favored a continued firm policy but no change in the discount rate
for the present.
The draft directive was acceptable to him.
Mr. Robertson made the followirg statement:
In this past month both we and the Administration
have taken major policy steps that, hopefully, will deal
adequately with the balance of payments deficit without
handicap to the achieving of our twin objective--con
tinued vigorous, noninflationary economic growth.
Nobody is sure these measures will work effectively.
The particular combination of actions is well-nigh
unique; and like any other compromise package, probably
nobody favors all parts of it. Certainly I am not partic
ularly fond of the general monetary tightening that went
along with the package. But having come forth with this
combination, I think it now behooves us to give it a
chance to show what it can do.
Insofar as the voluntary foreign loan restraint
program is concerned, our early experience reminds me
of an old saying we have out in Broken Bow country,
"You can tell how much a hog is hurt by how loud he
squeals."
Judging on that basis, the restraint program
is already doing some pinching. And, frankly, I hope
we can manage to administer our parts of it in a way
that cuts very substantially into capital outflows.
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The only reason I can see for not holding monetary
policy steady while waiting for our latest actions to
take effect is if new or exaggerated forces appear that
would push us into an inflationary spiral or a run on
the dollar if we did not act. I see no such develop
ments. We are probably already past our peak rates of
acceleration in inventory accumulation, business loans,
and bank lending abroad. Once the first quarter is
past, I suspect we could be seeing more comforting
statistics in all these areas. Now is not the time to
compound pressures by further action based on statis
tics that are still describing pre-February 12 perform
ance.
With these considerations in mind, I would vote for
a monetary policy that continued to maintain money market
and bank reserve conditions about as prevailed in the
past few weeks. While I did not favor last month's move
to tighten money market conditions further, I do not
think it would be constructive at this juncture to try
to undo that action. Looking ahead, however, I would
lay emphasis on the Manager's meeting the reserve needs
as they emerge in March without allowing any extra
measure of market pressure to develop. Modest net
borrowed reserves might result in a week or two, I
recognize, but I would not want to see a steady string
of net borrowed reserves from now until the end of
March. With this understanding, the draft of the current
directive as distributed by the staff is satisfactory to
me.
Mr. Shepardson observed that the indications of the staff reports
and other information were of a continuing strong--although possibly not
sustainable--expansionary condition in the economy.
As Mr. Ellis had
pointed out, if the program for arresting capital outflows was effective
it would result in a greater availability of funds in the domestic market.
For that reason he thought it would be desirable to continue the present
directive, calling for moving toward slightly less ease.
He favored a
range of zero to minus $50 million for free reserves, a bill rate in the
3.95-4.10 per cent range, and borrowings at the level necessary to pro
duce such conditions.
He thought the Committee's policy move at the
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previous meeting had been appropriate, but he questioned whether it
should consider the move to have been completed by the attainment of
the conditions prevailing since that meeting.
Mr. Shepardson thought that Mr. Hayes' remarks had tended in
a similar direction, although Mr. Hayes had found satisfactory the
proposed directive calling for the maintenance of current money market
conditions.
Along with Mr. Ellis, he (Mr. Shepardson) would prefer to
go a step further and move toward slightly firmer conditions, although
a drastic move certainly was not in order until there was an opportunity
to observe developments under the voluntary credit restraint program.
Mr. Mitchell said that monetary policy and expectations in the
securities market had been buffeted about on a sea of words--official
and unofficial--and as a result the market had been moving on a trend
with an ambiguous destination.
Perhaps he should defer to Mr. Stone's
judgment that the market had completed its adjustment to the recent
policy action, but he could not quite believe it; it seemed to him
that the market was highly uncertain.
Probably the best contribution
official action could make at this time would be to maintain the cur
rent degree of uneasiness.
The country's foreign friends would be happier if they believed
that the voluntary restraint program was being buttressed with some
tightening of policy, Mr. Mitchell said, and those at home who were
fearful that the domestic economy was peaking out would feel that
monetary policy was not a factor pushing the economy inexorably toward
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recession as long as bond prices, particularly in the tax-exempt field,
did not break.
But he thought a great deal of caution had to be ex
ercised in connection with any further move toward tightening, for one
reason because there still was a considerable overhang of longer-term
securities in the market.
In any case, Mr. Mitchell said, there was not too much in the
way of action on the domestic or foreign front that could be justified
in the Committee's present state of knowledge.
Domestically, the leads
and lags were such that if a recession was going to come in 1965 it was
almost here.
He did not agree with Mr. Noyes' analysis; in his judgment
a possible downturn was dangerously close.
On the foreign front the
Committee could hardly imply that the newly-conceived plan for checking
capital outflows would fail before it was off the launching pad.
Tempo
rarily, for better or worse the posture of general monetary policy had
hardened.
One could hope for an abatement of the recent rate of expansion
in business loans at banks, Mr. Mitchell continued.
He had been inclined
to agree with the staff's conclusion that much of the recent growth was
temporary.
He noted, however, that several of the Reserve Bank Presi
dents who had spoken thus far thought there was more underlying strength
than the staff had suggested, and he gave credence to their judgment.
But assuming that judgment was correct, he still did not see how one
could advocate a move to reduce the rate of bank credit growth if that
would mean a more drastic contraction in the money supply than had occurred
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in the past eight weeks.
His preference for money supply figures was
the seasonally adjusted series prepared at the St. Louis Bank; in his
judgment they gave a consisten:ly better picture of developments than
those compiled at the Board.
This series had declined at an annual
rate of about 10 per cent in the last eight weeks, after seasonal adjust
ment.
Mr. Mitchell said he felt a little nostalgic about the "trial"
directives that now had disappeared.
They had had a clear, positive
approach; there was no yielding before the hard questions.
With respect
to the draft of the regular directive, he strongly recommended deleting
the reference to accommodating growth in the money supply; in his judg
ment it would be a mistake to ignore the fact that it had declined
recently.
He suggested ending the first sentence with the phrase "to
accommodate growth in the reserve base and total bank credit."
Also,
he thought the next sentence would be a little more forthright and
stronger if it simply read "This policy seeks to support fully the national
program to strengthen the international position of the dollar," deleting
the words "and to avoid the emergence of inflationary pressures."
Mr. Daane complimented the Desk on what in his judgment had been
a highly skillful implementation of the directive the Committee had adopted
at the previous meeting; they had achieved some snugging up in reserve avail
ability and money market conditions while reinforcing the general expecta
tion that longer-term rates would prove viable.
Looking back, he had to
confess that he was a bit unhappy about the official purchases of longer-
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term securities for Treasury account since the beginning of the year,
and he was not completely convinced that the maturities chosen in
purchases for System account had been completely appropriate.
On the
whole, however, he thought the Desk had done an excellent job in attain
ing the objectives the Committee had indicated.
Mr. Daane said his policy prescription was similar to that a
number of others had expressed.
He would favor having free reserves
fluctuate close to zero but on the negative side.
With this end in
view he found the directive prepared by the staff acceptable, but he
had no strong objections to the revisions suggested by Mr. Mitchell.
Referring to the discussion after Mr. Koch's presentation of
the implications of the recent growth rate of time and savings deposits,
Mr. Daane said he found it difficult to translate the ex post equality
of saving and investment into thinking of all savings as automatically
flowing into investment and being income generating.
He preferred the
analytical approach which treated today's savings as a function of
yesterday's income and as accommodating today's investment.
In this
light he derived comfort from the high current level of savings and
viewed it as a healthy factor, necessary to accommodate a desired non
inflationary expansion in investment.
Mr. Hickman commented that it might be better to say that today's
inventory excesses were a function of yesterday's savings and yesterday's
monetary policy.
He hoped the Committee was not accentuating the unsus
tainability of present conditions.
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Mr. Hickman then complimented the staff on the excellence of
their answers to the questions posed for discussion.
He had little
to add to those answers, but thought, that an independent approach per
haps might turn up a few points that: otherwise might have been over
looked.
Business conditions in the Fourth District and in the nation
were still dominated by superheated activity in autos and steel, Mr.
Hickman said.
Since the last meeting of the Committee steel deliveries
had been lengthened, allocation systems had been reinstated, and orders
had been trimmed or rejected.
Steel production continued to run at the
annual rate of 135 to 140 million ingot tons, but most analysts believed
that output would decline sharply to aggregate about 115 to 120 million
tons for the year.
factor.
The close union election had been a highly unsettling
Extension of the bargaining beyond May 1, as some had suggested,
might aggravate the situation still further by expanding the time for
hedge buying of inventories.
Mr. Hickman noted that the auto industry also appeared to be
operating above sustainable levels, although the excess was less marked
than in steel.
Despite record sales in the past three months, inventories
by the end of February had climbed to about the year-ago level.
Both
production and sales had pretty much caught up from the strike inter
ruption, and some letdown in the auto industry was to be expected.
Nevertheless, production schedules for March continued at very high
levels.
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Accompanying the lush but ominous developments in steel and
autos, other industries, including machinery, had continued to show
moderate advances, Mr. Hickman said.
In the months and calendar
quarters ahead their continued advance would be required even to
maintain the current level of industrial production.
The question of the trend of prices was still unresolved, Mr.
Hickman continued.
There had been a number of flurries of price in
creases, followed by periods of relative calm, one of which the economy
seemed to be enjoying now.
Despite near-capacity production in autos
and steel the price line appeared to be holding at the moment.
On the
other hand, prices of aluminum products and nonelectrical machinery,
where operations were also near capacity, had been inching up.
On the balance of payments front, Mr. Hickman remarked, part
of the fourth quarter deterioration was temporary, possibly as much as
$1.5 billion of the $5.8 billion annual rate of deficit, counting factors
that contributed temporarily on both the plus and minus sides.
was surely academic at this juncture.
But that
Foreign confidence had been shaken
and massive steps were needed to restore faith in the dollar.
Insofar as bank credit was concerned, Mr. Hickman expressed the
view that part of the recent strength in business loans and in consumer
credit undoubtedly could be traced to the overheated atmosphere in autos
and steel, as well as to the dock strike and the bulge in foreign lending.
Some of the strength in business loans also could be explained by the
narrower spread in recent months between the prime rate and open-market
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rates on commercial and finance company paper.
Selective adjustments
in bank lending rates now seemed to be in process.
In Mr. Hickman's opinion, the money market had largely adjusted
to the slight shift in policy adopted at the last meeting.
But the
market for longer-term U.S. Treasury issues still had a way to go, to
judge by past experience in a free market economy.
Whether past ex
perience was a useful guide under conditions of a controlled market was
a moot question.
Both the Administration and the System had endeavored
to hold long-term interest rates below the rates that would prevail
under free competitive conditions.
The excellent chart show presented
at the last meeting raised some questions about the appropriateness of
that approach, since major adverse capital flows in the balance of pay
ments had occurred in the intermediate- and long-term areas.
Aside from his reservations about operations in the intermediate
and long-term market, Mr. Hickman thought monetary policy had been executed
appropriately and adroitly in the four weeks since the last meeting.
Over
the next three weeks, because of his concern about the domestic situation,
he would prefer to see free reserves in the range of zero to plus $50
million most of the time, but he would not be disturbed if there were
net borrowed reserves occasionally.
The bill rate should remain close
to or slightly below the discount rate, as Messrs. Irons and Swan had
suggested, and the Federal funds rate should hold at 4 per cent most of
the time.
Under the slightly firmer conditions now emerging in the money
market, Mr. Hickman thought that borrowings again would serve as a good
indicator of the degree of tightness or ease.
He would prefer to see
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borrowings at $400 million or above rather than $300 million or below.
The staff draft of the directive was acceptable to him, and he did not
regret the demise of the "trial" directive.
Mr. Bopp reported that in the Third District the strong economic
upsurges of recent months had slowed substantially.
Unemployment had
begun to increase moderately in some of the District's less-advantaged
areas, and had stopped declining in the rest.
but might have leveled off in January.
Output remained strong
Department store sales had
dropped well below the national rate of advance, and in the latest
week declined slightly from year-ago levels.
Rather than comment on each of the questions prepared by the
staff, Mr. Bopp said, he would limit his further remarks primarily to
the question of bank credit.
From a review of both national and District
trends, it appeared to him that the recent contraseasonal upturn in bank
loans and deposits was symptomatic of special circumstances superimposed
upon an otherwise moderate further expansion in business activity.
On
the national scene, the near-record expansion in business loans stemmed
largely from inventory expansion associated with strikes--the dock strike
and the threat of a steel strike--and from the apparent sizable upward
movement in foreign business loans anticipating implementation of the
Gore Amendment.
Contrary to the national picture, Mr. Bopp remarked, business
loans in the Third District had shown no more than moderate strength
this year.
One reason for this apparently was that the special factors
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stimulating loan demand in the nation were less evident in the District.
Both business loans abroad and loans to finance domestic inventories
had shown little strength.
These facts were revealed both by an examina
tion of the Reserve Bank's own figures and by a survey of District re
serve city banks.
Bankers with whom he had talked made only minor refer
ences to financing steel inventories or carrying merchandise tied up by
the dock strike.
The loan categories which had increased in the District
were those characteristic of a moderate business expansion.
As for other factors bearing upon the pace of economic activity,
Mr. Bopp said, commodity price indexes remained roughly stable, suggesting
that further increases in production could be sustained before overall
capacity pressures became pronounced.
Admittedly, however, the picture
was obscured by inventory building in anticipation of a steel strike and
by the aftermath of the auto strike.
On the international front, continued balance of payments pres
sure was evident.
In Mr. Bopp's opinion, however, any further shift in
monetary policy aimed at reducing the deficit should be deferred until
some indica:ion was available of the success or lack of success of the
package of measures introduced by the President.
Another aspect of the President's program which had to be watched,
Mr. Bopp continued, was its possible impact on the domestic economy.
It
was possible that some loan and investment funds would be diverted from
foreign to domestic uses, producing some excess in credit availability.
This development, however, remained only a possibility.
There was no
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certainty that such a redirection would occur, and if it did, that it
would in fact be excessive.
On balance, it seemed to Mr. Bopp too early to consider a change
in monetary policy based either on the international or domestic implica
tions of the President's payments measures.
Therefore, bearing in mind
both the currency pace of business activity and the evolving internaticnal
climate, Mr. Bopp recommended no change in the present posture of monetary
policy.
The figures on money market conditions mentioned by the staff in
response to the final question seemed appropriate.
He thought the ref
erence to the money supply in the draft directive implied a factual in
accuracy, and accordingly either should be deleted or replaced with a
different
statement.
Mr. Bryan said he thought the economy of the Sixth District could
be described properly as being in a state of boom.
Loan demand in the
District was particularly strong, and the figure on insured unemployment
was much better than that for the nation as a whole.
Although the data were subject to revision, Mr. Bryan said, the
national money supply narrowly defined evidently had declined in the
latest month, whereas the series including time and savings deposits had
risen substantially, and time and savings deposits themselves had gone
up like a rocket.
The question of the appropriate definition of the
money supply could be debated for a long time.
However, he would sug
gest that the Committee simply recognize that the money supply was in
determinate.
As had been pointed out in the past, "money" was anything
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that did money work, and since money had a number of functions the
appropriate definition would vary from narrow to broad depending on
the particular functions one had in view.
As to policy, Mr. Bryan thought that at the present time the
Committee ought to maintain approximately the existing degree of
firmness, with free reserves fluctuating around zero and more often
negative than positive.
However, he would like to repeat an observa
tion he had made before--at this particular juncture free reserves
were a dangerous measure, since they represented a residual after the
System had supplied all of the reserves demanded.
He also would repeat
his belief that the more fundamental measures, such as total reserves,
were growing at unsustainable rates.
Mr. Bryan thought the reference
to the money supply in the draft directive was inappropriate in light
of the recent decline in the money stock.
Mr. Shuford reported that economic activity in the Eighth
District had advanced rapidly since early last fall.
Payroll employ
ment had risen at a 6.7 per cent annual rate since September, with
significant increases shown in both the durable and nondurable goods
industries.
Manufacturing output had gone up at nearly a 10 per cent
rate, with gains in the Little Rock and Memphis areas particularly
large.
Spending, as measured by the volume of check payments, had
increased markedly in most major cities of the area.
Since September, Mr. Shuford continued, deposits at weekly
reporting banks in the District had risen at a rate a little faster
than in the nation.
Expansion centered in time deposits, which had
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risen sharply; demand deposits had grown only slightly.
Business
loans at weekly reporting banks had moved up at about a 12 per cent
annual rate, as an unusually sharp gain at banks in St. Louis was
partially offset by declines at Louisville and Memphis banks.
Nationally, Mr. Shuford said, economic activity had continued
to rise during the first two months of the year, as already had been
noted.
Production, sales, and incomes all were markedly higher now
than before the auto strike.
The expansion in activity reflected produc
tion for a precautionary buildup in steel inventories, but there was
strength in other areas as well.
Wholesale prices had increased since
last summer, and industrial prices had moved up significantly.
As had been discussed, Mr. Shuford said, the balance of payments
problem remained serious.
It was hoped and expected that voluntary credit
restraint and other aspects of the Administration's balance of payments
program might result in a reduction in the outflow of funds, but develop
ments in those areas warranted close attention.
In late November and again in early February, Mr. Shuford noted,
the Committee had made moves toward slightly firmer money market conditions
in response to the acceleration in the outflow of funds from the country
and the strength in the domestic economy.
It probably was too soon to
judge accurately the total impact of those actions.
Few figures were
available either on domestic economic conditions or on the balance of
payments since the Committee's most recent action.
Short-term interest
rates had moved higher, but most other yields had changed little.
Total
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member bank reserves, time deposits at commercial banks, and bank credit,
particularly business loans, had continued to rise markedly.
On the other
hand, growth in the money supply had slowed considerably.
Mr. Shuford said he had found Mr. Koch's observations on recent
banking and money supply developments valuable.
The February decline in
the money supply undoubtedly was due, at least in part, to the recent
rapid increase in time and savings deposits and the recent larger-than
usual rise in U.S. Government deposits.
Moreover, there frequently were
periods in which the money supply showed sharp short-run fluctuations and
perhaps the present was one of those periods.
In his opinion it was too
early to be concerned about the decline in the money supply, but if the
recent trend was prolonged unduly it would need attention.
Mr. Shuford said he appreciated Mr. Mitchell's remarks about the
usefulness of the St. Louis Bank's money supply figures.
The St. Louis
Bank probably had done more work in the area of the money supply than
most Reserve Banks because of their particular interest in the subject,
and he was grateful to the Board's staff for their encouragement and help
in this work.
He had found the discussion of the money supply this morn
ing useful and thought that further discussion of a similar nature would
be desirable.
In his judgment the money supply was an important factor
for the Committee and the Federal Reserve System to keep in view; there
was evidence in historical studies of a significant relation between its
changes and business cycle fluctuations.
However, he certainly did not
think that the money supply, however defined, should be considered as the
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exclusive guide to policy.
Other variables also were important, including
flows of funds, total bank credit, business credit, aggregate reserves,
and, in the short run, free reserves and measures of the tone and feel
of the market.
All of these were matters that the St. Louis Bank tried
to take into consideration in its analyses and which the Committee had
to consider as it reached its conclusions on monetary policy.
As Mr. Mitchell had mentioned, Mr. Shuford continued, the St. Louis
Bank's figures showed a decline in the money supply at about a 10 per cent
rate in the most recent eight weeks.
However, the staff members at the
Bank who followed the situation were not greatly concerned about this
development, for reasons similar to those Mr. Koch and others had men
tioned.
Considering a somewhat longer period, from the average for the
four weeks ending October 7, 1964, to the average for the four weeks
ending February 24, 1965, the money supply had increased at an annual
rate of 1.6 per cent.
One would, of course, find other rates of change
if the comparison was made with different starting dates.
Mr. Shuford thought it would be a mistake to delete the reference
to the money supply from the directive.
It was an important variable
over which the Committee had influence; and as he read the draft language
it did not imply either that the money supply had not declined in recent
weeks or that it would decline in coming weeks.
Mr. Shuford said he favored continuation of the policy of the
past four weeks, with money market conditions about the same as they
had been recently, including a Treasury bill rate around the discount
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rate.
He would be willing to accept the figures the staff had provided
in the answer to the last question, i.e., average borrowings around the
$400-$450 million level, dealer loan rates around 4-1/8 to 4-1/2 per cent,
and the rate on Federal funds at about 4 per cent and at time 4-1/8 per
cent.
He favored no change in the discount rate.
Mr. Balderston remarked that Chairman Martin had observed, in
his February 26 statement before the Joint Economic Committee, that since
the middle of last year the averages of both industrial material and prod
uct prices had edged up and that he could not avoid feeling that the country
had been, and still was, sailing very close to the edge in this area.
Ear
lier in his statement the Chairman had indicated his belief that "monetary
policy did what it could and should do to facilitate healthy economic growth
within the United States.
In our effort to try to do all that we could, I
only hope that we did not do a little more than we should have."
The burden of Mr. Balderston's concern today was that now, after
a business expansion entering the fifth year of its life, bank credit con
tinued to expand at an annual rate of about 8 per cent whereas real CNP
had been rising at an annual rate of only about 5 per cent.
It was to
this basic fact that he wished to call the Committee's attention; it was
portrayed in the first of the two pages of charts he had had distributed.
(Note:
A set of the charts to which Mr. Balderston referred has been
placed in the files of the Committee.)
Whether or not the cumulative
effect of those two trends had by this time created pools of liquidity
that might cause inflation, he did not know.
What was fairly clear to
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him was that, even though only 28 per cent of total credit was bank
credit, the increase in the latter that the System had permitted was
sufficiently great to add to the volume of dollars seeking investment
abroad.
It also was clear to him that the relation to GNP of the money
supply narrowly defined was a deceiving guide.
Corporations had learned
to economize in the use of cash, and so the stock of money now did not
have to be as large proportionately to GNP as once was the case.
How
to obtain an adjusted figure for money supply and its rate of growth
seemed tc him to defy solution, but he did suggest that some adjustment
was needed, at least to give some weight to corporate funds invested in
negotiable CDs.
Thus, he had had CDs included along with the narrowly
defined money supply in the middle panel on the second page of the charts,
showing recent monthly percentage changes in various monetary
series.
Some weight might also be given to savings accounts of individuals, the
recent growth in which had been stimulated to some extent by the monetary
policy of the System, in his opinion.
If future events should reveal
that the tinder had been laid for a speculative outburst it would be,
in his view, a fair criticism of the System that it permitted the rela
tionship between growth in bank credit and in GNP, as depicted in the
first chart, to exist too long.
Now that the nation faced an international liquidity crisis that
threatened to shrink further the already shrunken stock of gold, Mr.
Balderston said, it seemed to him to be high-time that the policy adopted
four weeks ago should be implemented more vigorously.
In concrete terms,
he thought that in coming weeks free reserves should be negative most of
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the time even if that resulted in some further stiffening of bill rates.
He would be willing to accept some stiffening of long-term rates also if
that were to develop.
To make clear that the Committee wished no cessa
tion in the application of the policy adopted on February 2, Mr. Balderston
suggested that the second paragraph of the draft policy directive be mod
ified to read, "To implement this policy, System open market operations
over the next three weeks should be conducted with a view to extending the
recent firming of conditions in the money market."
He would delete the
reference to the money supply in the first paragraph because, as he had
noted earlier, he considered the money supply figures to be a deceiving
guide.
Chairman Martin said he thought that Mr. Balderston's charts were
interesting and that the Committee should keep them in mind.
As to policy,
evidently the Committee felt that it should not retreat from the step
taken at the previous meeting, but the majority apparently did not favor
going as far as Mr. Balderston had suggested.
As to the directive, he
would prefer not to eliminate the reference to the money supply.
As he
had said before, words meant different things to different people, and
he did not see how the semantic problem could be resolved today.
What
was necessary, he thought, was to try to put together the best possible
language, recognizing that there inevitably would be some gray areas.
Mr. Mitchell said he had not meant to imply that money supply
references should be excluded from all of the Committee's policy directives;
he had suggested omitting the reference from this particular directive be
cause recent changes in money were difficult to interpret.
By calling for
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accommodation of growth in total bank credit the Committee would be reccg
nizing what was happening to deposits, including CDs and other time de
posits.
Mr. Koch noted that the staff had debated the question at issue
in preparing the draft directive and he might try to clarify the rationale
of the proposed language.
The thought was that the phrase "to accommodate
growth in the reserve base, bank credit, and the money supply," could be
reasonably taken to refer to the three variables as a group and not individ
ually, and with respect to a longer time period than just a few weeks.
Mr. Mitchell commented that the problem under discussion pointed
up the desirability of employing an alternative form for the directive,
such as that of the "trial"
directive, which was more specific.
Mr. Hayes remarked that the staff's memorandum on member bank
reserves indicated that the aggregate money supply had increased in every
recent month except February, and the figure for that month was labeled
"estimate."
He thought that these data did not invalidate the general
proposition that the money supply had increased in recent months.
Ac
cordingly, he did not consider the reference to be objectionable.
Chairman Martin said that that was his view also.
He then noted
that Mr. Mitchell had suggested deleting the proposed phrase "and to avoid
the emergence of inflationary pressures" from the first paragraph.
He
(Chairman Martin) would prefer to retain that phrase because he thought
there still were inflationary pressures in the economy.
In his judgment
the volume of credit, however measured, was dangerously high at present
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and this would be revealed by coming developments.
He hoped he was
wrong, but that was his conviction.
After further discussion Chairman Martin suggested that the
Committee vote on the directive as drafted by the staff.
Thereupon, upon motion duly made
and seconded, the Federal Reserve Bank
of New York was authorized and directed,
until otherwise directed by the Committee,
to execute transactions in the System
Account in accordance with the following
current economic policy directive:
In light of the economic and financial developments
reviewed at this meeting, including the generally strong
and continuing expansion of the domestic economy and the
continuing adverse position of our international balance
of payments, it remains the Federal Open Market Committee's
current policy to accommodate growth in the reserve base,
bank credit, and the money supply but at a more moderate
pace than in recent months. This policy seeks to support
fully the national program to strengthen the international
position of the dollar, and to avoid the emergence of
inflationary pressures.
To implement this policy, System open market opera
tions over the next three weeks shall be conducted with
a view to maintaining the slightly firmer conditions in
the money market that have prevailed in recent weeks.
Votes for this action: Messrs.
Martin, Hayes, Bryan, Daane, Mitchell,
Robertson, Scanlon, and Clay. Votes
against this action: Messrs. Balderston,
Ellis, and Shepardson.
Mr. Balderston said that he had voted against this action because,
as he had indicated earlier, he thought a further move to tighter condi
tions was required at present.
sented on the same grounds.
Mr. Shepardson observed that he had dis-
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Mr. Ellis said he had dissented for two reasons.
also favored a firmer policy.
First, he
Secondly, he did not believe that the
present directive form was sufficiently clear and definite to serve
adequately as an instruction to the Account Manager.
To the extent
that his dissent was on procedural grounds, he proposed to limit it
only to this occasion and not to repeat it at subsequent meetings,
even though he might continue to object to the form of the directive.
Mr. Mitchell commented that he shared Mr. Ellis' views on the
directive but had voted favorably because he thought the policy decision
was appropriate.
Mr. Bryan indicated that he had voted favorably on
the same basis as Mr. Mitchell had.
It was agreed that the next meeting of the Committee would be
held on Tuesday, March 23, 1965, at 9:30 a.m.
S
Thereupon the meeting adjourned.
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